Morningstar

Saxo Morningstar High Dividend EUR Q2 2020 commentary

SaxoSelect Commentaries

Saxo Bank

Instruments traded
Stocks
Asset classesGlobal equities (excluding emerging markets)
Investment styleHigh quality stocks offering attractive dividends
Quarterly return+10% (net of fees)
Annualised volatility (since inception)21.3%

Market overview

For many, 2020 is certainly living up to its reputation as a year we’d rather forget – both in health and wealth – despite significant signs of financial improvement in the second quarter. Indeed, we have seen two of the more extraordinary periods an investor can face:

  • The first quarter saw record falls, with share markets purportedly having their worst first quarter since the Great Depression in 1933.

  • The second quarter saw one of the fastest market recoveries since at least 1983, notwithstanding that this mellowed in June as fears of a second wave of infection grew.  

For most investors, the net result was a modestly negative year-to-date performance. But, peculiarly, this is no different than what one might expect in a typical six-monthly period. 

Technology and ‘new economy’ stocks continued to outperform as they thrived in the work-from-home environment. This contrasts with some long-established businesses, whose stocks are struggling despite decades of delivering positive cash flows for investors. The performance gap –embodied by growth and value stocks – has stretched to the bounds of extremity, which we believe offers a contrarian opportunity. 

Bond markets have moved strikingly too, with liquidity now moving freely and conditions largely settling. For example, we saw strong performance from riskier bond markets – as might be expected with such a speedy market recovery – with most of the earlier losses overturned. In fact, corporate bond yields are now back towards the record lows of late 2019, especially among higher-rated issuance, which seemed unfathomable to some just months ago.

Portfolio performance

Second quarter 2020
10%
Year to date 2020
-20%
201927.50%
2018*-8.80%
2017N/A
2016 N/A
2015 N/A
Since Inception*
-7.00%

*Inception:12.01.2017
Performance is net of all fees

Best-performing positions

  • MPLX is a partnership that owns both pipelines and gathering and processing assets, with extensive holdings in the Appalachian region. The stock rebounded well in Q2 following a tough Q1. After Morningstar Investment Management (MIM) updated its model for first-quarter results and the negative impact of lower refinery runs and well curtailments in the short term, its fair value estimate remains USD 20 per share. This estimate implies a 2020 EBITDA multiple of 8.6 times and a 2020 distribution yield of 14%. The position is held in the portfolio into Q3.

  • Broadcom is the combined entity of Broadcom and Avago. It boasts a highly diverse product portfolio across an array of end markets, including radio frequency filters and amplifiers used in high-end smartphones, such as the Apple iPhone and Samsung Galaxy devices, through to wired infrastructure and enterprise storage. Broadcom reported second-quarter results consistent with management’s guidance, with healthy networking demand offset by typical seasonal weakness in wireless. MIM think the firm has weathered the recent coronavirus-related headwinds relatively well thanks to its significant cloud and enterprise infrastructure exposure. The position remains in the portfolio for Q3.

  • ING Group is a global banking institution with market-leading banking operations in the Netherlands and Belgium, and a range of digital banks across Europe and Australia. MIM estimate that ING's fair value is EUR 13 per share, which is equal to ING's 2019 tangible book value and 19 times what we estimate ING will earn in 2020. Having suffered in Q1, the stock price rebounded to close Q2 at EUR 6.20 per share, well below MIMs fair value estimate. The position remains in the portfolio for Q3.

Worst-performing positions 

  • BT Group is the incumbent fixed-line phone company in the UK, providing phone, internet access and television services to residential and business customers. Earnings results were broadly in line with expectations, but the news that it is suspending its dividend payments – and intends to cut the dividend in half once it resumes – weighed on the stock price. Despite this, with MIM’s fair value estimate at GBP 250, the stock remains heavily discounted in the market.

  • BAE Systems is a British global defence company with a dominant position in the UK. It is a top-six supplier to the US Department of Defense and has a strong presence in key defence markets (eg Saudi Arabia and Australia). The stock price declined over Q2 despite an upbeat trading update from the company, where it sees strong underlying demand and order intake in line with pre-corona expectations. This supported the stock price, with still considerable room for growth to reach MIM’s fair value price of GBP 570 per share.

  • Established in 1865 in Hong Kong, London-based HSBC is one of the largest banks in the world with 40 million customers worldwide. The stock priced suffered with HSBC reporting a weak first-quarter result, attributable to a material increase in expected credit loss. Yet the bank remains well planted with its strong market position, cost advantages and switch costs for customers. Furthermore the price remains heavily discounted in the market compared to MIM’s fair value price of GBP 620 per share.
     

Outlook

As the risk of a second wave of coronavirus infection increases, the validity of the overall market rebound is being questioned. There is arguably higher uncertainty than any period since World War II. For example, we have clear demand shocks to contend with, including everything from suppressed household spending to a lack of corporate investment. We have supply chain issues too, which would all be exacerbated if we saw another spike in coronavirus cases.

Looking forward, it is perhaps best to acknowledge three things: herd behaviour, policy response influence, and the opportunity to buy at low prices. The second quarter rebound highlighted the ever-important balance between return generation and risk management, reiterating why an investor can do well by staying emotionally grounded and smartly diversifying into attractively priced assets. 

Morningstar Investment Management encourages investors to focus on what they can control: saving more, reviewing financial goals and keeping sight of the long term.

Disclaimer

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