Transaction Summary, Second Quarter 2020
Purchases / Additions
Costco Wholesale Corp. (COST) May 2020
The Investment Committee has decided to buy a position in Costco Wholesale. Costco’s stock has underperformed the recent market rally by more than 25%, creating an opportunity to buy this high quality company. In this era of heighten economic uncertainty, Costco provides stable and high visible earnings and cash flow. We expect the company can grow regardless of the economic cycle. Costco has enormous competitive advantages due to its scale and buying power. Its low prices and no-frills operating model have created a strong value proposition for its members, driving extraordinary customer loyalty. Over the past three years, revenue has grown at almost 9% per year, driven by strong same-store-sales growth, an expanding membership base and modest increases in its membership fee. Unlike other traditional retailers, Costco generates a significant portion of its earnings from its membership fee. With a very high annual renewal rate, the membership fee represents a highly predictable recurring income stream, a coveted quality in today’s low-interest rate environment. With the bulk of its operations currently in North America, the company also has ample opportunities to expand internationally to drive further growth. The company’s first store opened in China to great fanfare, with more than 100k people signing up for membership on the first day. Finally, Costco has a strong balance sheet, with a net cash position, and a long track record of returning cash to shareholders over time.
Trims / Deletions
Lowe’s Companies (LOW) May 2020
The Investment Committee has decided to trim the portfolio’s position in Lowe’s. Since adding to the holding in mid-March, the stock has rebounded more than 75%. This strong performance created an opportunity to take some profits and reduce the position to a more prudent weighting. We continue to have high conviction in the investment case for Lowe’s. We believe household formation by millennials and the age of U.S. housing stock plus record low mortgage rates should continue to favor the housing sector. Also, approximately two-thirds of home improvement industry sales are for repair and maintenance, which continue regardless of economic cycle. We see a significant opportunity for CEO Marvin Ellison and his team to continue to drive improvements in the store as part of their ongoing turnaround program as they make improvements to merchandise, service and systems to drive sales. This team is in the early innings of this initiative and we expect more progress in coming quarters, especially in areas like Ecommerce and serving the important Pro customer. In its most recent quarterly earnings report, the company saw its online sales rise 80% as consumers spent money on their homes and gardens during lockdown.
Altria (MO) May 2020
The Investment Committee has decided to consolidate our weighting in tobacco and eliminate our holding in Altria. The U.S. tobacco market has struggled with declining volume as excise tax increases, regulations and public health concerns have taken their toll. We believe of the two tobacco holdings, Philip Morris International has the better long term prospects, with its dominant position in faster growing emerging markets.
Johnson Controls (JCI) May 2020
The Investment Committee has agreed to sell our holding in Johnson Controls. Our original investment thesis was two-fold. First, a new management team took over after the merger with Tyco with a renewed focus on profitability and cash flow conversion. This led to a large restructuring of the business, with the company eventually transforming into a more focused building controls business, with a large services segment providing recurring income. The more cyclical part of the business, the highly capital intensive car battery business, was divested in 2019. Secondly, we believed that this transition would result in significant improvements in the company’s financial position. The proceeds from the divestment of the battery division were used to reduce the company’s debt, and the remaining cash was used to repurchase 25% of the outstanding shares, and to increase the dividend. These initiatives have largely played out as expected. However, the core business is now dependent on new building construction, modernization of older buildings for energy efficiency and smart technology, and urbanization in developing countries. Given the current pull back in corporate capex, and weaker demand outlook for commercial buildings due to Covid, we have less confidence on the outlook. We believe the proceeds of this sale can be put to better use within the portfolio.