A Boring Trade Idea
Featuring Chad Morganlander
Published on: September 9th, 2019 • Duration: 15 minutesChad Morganlander of Washington Crossing Advisors provides an update on his economic view and discuss why “boring” companies look attractive in the current environment. In this interview with Alex Rosenberg, Morganlander highlights the positive attributes of one particular company, Hormel Foods, and reviews why its shares should outperform over the next year. Filmed on September 6, 2019.
ALEX ROSENBERG: Welcome to Trade Ideas. I'm Alex Rosenberg, here with Chad Morganlander, Portfolio Manager at Washington Crossing Advisors. Chad, thanks for joining us today.
CHAD MORGANLANDER: Thanks for having me on.
ALEX ROSENBERG: Let's just, broader picture, makes sense of what's going on in this economy. We've got a jobs number this morning that people say it's a miss, 20,000 jobs here, there. I don't know if that makes a big difference, but what have we learned over the past week, two weeks, three weeks that tell you about how the overall economy is doing and the overall odds of recession at this point?
CHAD MORGANLANDER: Recession odds have increased a modest amount, potentially, to about 30% over the next 12 months. Overall, the global growth environment is one that is somewhat concerning. You have China deceleration. They're trying to rebalance their economy and that will actually be a drag on growth over the course of the next 12, 18 months or even 2 to 3 years.
Then you have the eurozone. When you look at the eurozone as a whole, they're having real issues. When you look at credit growth, their non-financial credit growth, that is really a concern. You look at the BLS numbers, you could see that credit growth has not even grown a bit over the course the last 5 years, even with negative interest rates on the private side, corporations as well as the household side. That's a major drag on global growth. Fiscal stimulus, potentially, within the eurozone could actually solve that issue, but it would have to be a massive fiscal stimulus program--
ALEX ROSENBERG: Everybody is not interested in that.
CHAD MORGANLANDER: It's just not going to happen, so what you're faced with is the United States. We're looking at a growth trajectory of around 2% to 2.25%. Worker productivity looks as if it's clicking higher, which is bodes well. Capital spending, obviously, is having a real issue. Hence, the reason why we're a little bit more balanced within one's portfolio, as well as recommending that investors move up the quality spectrum of which we've been telling investors to do, and we're doing in our portfolio over the last 36 months.
ALEX ROSENBERG: Help me with that and thank you for that backdrop. Help me understand the forth what that means in terms of the S&P 500 broader US equities overall. What are the relevant forces there? Because obviously, if the US is outperforming the rest of the world, and people feel the need to buy equities, it might not necessarily be a bad thing if you see the whole world slow down as long as the US slows down less.
CHAD MORGANLANDER: Yeah, that's the big question mark. Will aggregate demand in global trade just fall off a cliff, which would then cause massive revisions and massive lowering of expectations for the S&P earnings? Because remember, at the end of the day, earnings is what's going to actually push the S&P 500 higher. If you get just a gradual slowdown with global growth, S&P earnings that go into an earnings recession, revenue growth is 1% to 2%, and you get a monetary policy that is quite accommodative on a global scale, then this could continue to keep the market, at least stabilize the market and keep the market moving up at a 3% to 4% to 5% long-term forecasted return.
Our expectations for the S&P 500 over the next 7 to 10 years, because we do long-term forecasting return in our shop, is roughly about a 5% to 6% long-term return. That is well below-- and that's a signal-- well below the historic average. Hence, the reason why you just got to be a little bit more careful with what you're choosing and selecting.
ALEX ROSENBERG: I just want to ask one follow up question to that, which is that is this a slow lame returns year after year environment, or are we looking at maybe a huge rise followed by a huge drawdown? Based on the economic outlook, what do you think is more likely? Let's take it as a given that we'll see 5% to 6% returns per year, what will the tenor of that be?
CHAD MORGANLANDER: Well, I think it's going to have-- the frequency is going to be much more volatile and it's going to be on a backdrop of either fiscal stimulus on a global scale, regional, as well as monetary stimulus, and what they're going to do and what they're not going to do. Overall, more volatility, where you can get, for example, a trade deal. God only knows if we're going to get one, we don't know. But say, for example, that's a surprise, you can get a massive rally within the S&P 500 and also other equity markets across the globe, followed by potentially lackluster returns in the outer years.
But overall, our best guess is at a 5% long-term return in the United States, the general thematic for us is to be overweight US dollar denominated assets, massively underweight emerging markets at this point right now, and have some developed exposure but just again, thematic, be overweight US dollar denominated assets, the dollar accretion of potentially 2% to 4%.
ALEX ROSENBERG: You mentioned moving up the quality spectrum, tell us what you mean by that.
CHAD MORGANLANDER: For us, that means buy companies that have lower volatility, much more predictability within their gross margins, their operating margins. Move into companies that have a well-diversified product line and client base, and also pristine balance sheets, absolutely pristine balance sheets. We were on-- Kevin Caron, and I and the team, we run a rising dividend portfolio, and we're looking and selecting 30 to 35 names within the portfolio that have those characteristics.
The expectation and the hope is that if you do have a gap in financial stress, these type of companies, even within a recession, could actually perhaps underperform in regard to operating performance overall, but you won't get it where they earn a billion dollars and then lose 3 billion. They'll earn a billion and then perhaps in a recession, they'll earn 500 million, where each company is actually-- intrinsic value, because of cash flow use, is reinvesting back into their business and growing their intrinsic value.
ALEX ROSENBERG: Before we get into some of the specific stocks, when you look at-- you mentioned the balance sheet, are you looking for companies with a low debt to equity ratio? How does your overall column bonds play into the stocks that you're looking to buy?
CHAD MORGANLANDER: We're looking for companies that have a debt to equity ratio of around 30% or less, debt to capital ratio similar. Give for example, companies that may be able to buy back their-- or back their mortgage, pay back their debt with their free cash flow over a 3 to 5-year period even in a stressful economic environment. We're just very careful to focus our attention on that because we do know-- because we used to do analysis, Kevin Caron and I, on high yield, that when you go into a credit dislocation, companies that have a tremendous amount of debt, their equities, or the equity does poorly. It's just an obvious comment that I'm making. Why fly close to the sun when you don't need to, especially in the later half of an economic cycle?
ALEX ROSENBERG: Sure. Now, I just want to mention for folks, because when you came on in April of 2018, you mentioned Church & Dwight is a stock that was likely to have performance. Since then, Jake, how's it done?
It's up 50% since then, whereas the S&P is up, what-- 10%. It's pretty good performance, so congratulations on that, but is that the stock that you're looking at now, when you expect that delta to continue? CHAD MORGANLANDER: Well, those type of companies, we think that if you put them together and package them in a portfolio, they'll do real well. Alex, if you saw the movie Moneyball, we're looking to put players on the field that will just get on days. They don't need to hit home runs, but the average we need to get them on base. Then when Kevin Quran and myself created this strategy with the help of Matthew Battipaglia, that was the major focus when creating this idea.
CHAD MORGANLANDER: Well, those type of companies, we think that if you put them together and package them in a portfolio, they'll do real well. Alex, if you saw the movie Moneyball, we're looking to put players on the field that will just get on days. They don't need to hit home runs, but the average we need to get them on base. Then when Kevin Quran and myself created this strategy with the help of Matthew Battipaglia, that was the major focus when creating this idea. For example, right now, we have one company that's a consumer staple company that is quite boring and I know that the comments after this video come out are going to be people making fun of me. But Hormel, for example, is a perfect example of one company that investors should consider. We've owned Hormel for, I believe, over 3 years in the portfolio and it's done well. It hasn't knocked the cover off the ball, but we think that the business operation of the next 3 to 5 years going to transform itself and you can get a steady Eddie type of return, and where the intrinsic value of the company is going to be moving higher. The stock price may bounce around, but we believe that over the long run, the company could do quite well.
ALEX ROSENBERG: Hormel, I know it mostly as the maker of spam, but I feel like they do other things too.
CHAD MORGANLANDER: Well, Hormel sells lunch meat as well. They have other products and package products that they've purchased along the way from Tex Mex food and whatnot. We believe that they're going to get out of-- not get out of, but transform the business from their lower margin, more volatile business lines. By acquisition and innovation, they're going to be releasing products over the long run that it's going to increase the operating margins of the company, increase the gross margins gradually, and to in an integration gradual way.
For example, plant-based proteins. Now, I know that that's big fad now. It's really exciting for people to talk about this. They could actually, and they've announced an initiative to actually release in their product line a line of plant-based proteins, which over time, not initially, but over time of 5 years, will become a bigger portion of their revenue. They will then put it into their different channels of their business line, from retail side to actually the wholesale side to the deli meat side. They have the distribution to get this type of thing and this type of initiative done, and complete it, but the beauty of this company is that their time horizon as management, and this is the critical thing, they're not looking quarter to quarter to just beat a number. Because of their ownership structure, they're looking 5, 10, 15 years out in order to make solid decisions that will increase the intrinsic value of the company.
ALEX ROSENBERG: I just want to ask you about the global spread of sales, because given the economic backdrop, you might be looking at companies that are mostly operating perhaps in the US rather than around the world. First of all, is that the case based on your framework, and also what is when you look at Hormel with that lens, what do you see?
CHAD MORGANLANDER: I believe that the international exposure for Hormel is roughly about 9%. It's very small. There's a window of opportunity to sell into that. They're not a candidate to be acquired, because majority of the voting shares or a great deal of the voting shares are from the original family trust, similar to Hershey. This gives the management team a lot of patience in how they're going to grow their business internationally.
Some people would say this is boring, and some investors that are more momentum investors would shy away from this, but overall, we think that with smart business decisions that they're making, and acquisitions with a very, very conservative structure in how they acquire companies, and what valuation they're willing to pay, and their innovation could actually grow the intrinsic value of this company from 22 billion to potentially 24 to 25 to 26 over a longer period of time. Again, this is not for the hedge fund trader that's looking to make one or two points, but you can wake up 12, 18 or 24 months from now and see a valuation gap hire based off of just good old steady Eddie type of operations.
ALEX ROSENBERG: The stock's currently trading at 42 and change, what move would you be looking for and over what time horizon?
CHAD MORGANLANDER: Our time horizon would be 2 years, I know it's not exciting, but it would be well over 46. That's our intrinsic value. When we value companies, that's the number we come up with. If they get a surprise in operating margins, then of course, that number would go higher. We have to watch to see how great their transformation take or how rapid their transformation is via acquisitions. Keep in mind, this is a company that we can have a lot of patience with. They have more cash on their balance sheet or cash to debt so they have a lot of firepower if they want to acquire a company. They just want to acquire a company at the right price.
ALEX ROSENBERG: What would you say is the biggest risk to this trade, either for Hormel or for the broader thematic you're looking at?
CHAD MORGANLANDER: Okay, the biggest risk is commodity prices. They still are a company that's protein-based primarily so if you have commodity prices gap higher, that would be an issue. We think that would be transitory, though, and as long-term investors, we would lean into that opportunity.
ALEX ROSENBERG: Chad Morganlander of Washington Crossing Advisors, thank you so much for joining us today.
CHAD MORGANLANDER: Thanks for having me.
ALEX ROSENBERG: Since Chad sees global growth slowing, he likes buying what he calls steady Eddie stocks like Hormel. Specifically, he sees Hormel rising to $46 a share over the next 18 months.
For Real Vision, I'm Alex Rosenberg.