Spring has finally sprung after a long winter and the Day Hagan Logix Tactical Dividend strategy generated strong April performance, as significant value began to be recognized in some previously out-of-favor industries. For the month of April, the strategy was +2.41 percent*, ahead of its benchmark Russell 1000 Value (+0.33 percent) and the broad-based S&P 500 Total Return (+0.38 percent). For the year to date through the end of April, Day Hagan Logix is now -1.10 percent, with the Russell 1000 Index down -2.52 percent. All numbers are total return and gross of fees. Although we are somewhat differentiated from other dividend-based benchmarks since we use adjusted yield for valuation purposes (with income as a byproduct), it is worth noting that the S&P 500 Low Volatility High Dividend Index is at -5.14 percent year to date, meaningfully lower than Day Hagan Logix returns.
During the month of April, the portfolio’s Medical Distributors holdings had particularly strong performance, second only to Energy among the seven industry groupings we own. This represented a welcome turnaround. Over the last several months, Amazon’s potential entry into the distribution of pharmaceuticals led to a negative overhang in the industry, particularly for the “Big 3” distributors: AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson (MCK), all of which are currently held in our portfolio. As we have discussed in past letters, we felt the scope, impact and general likelihood of Amazon’s involvement in this complex industry was vastly overstated. In any case, in mid-April it was reported that Amazon Business had abandoned its plan to distribute drugs and our holdings quickly moved higher as a direct result. While Amazon may still look to sell more commodity-like medical supplies moving forward, the idea of effectively tapping into and being a major player in the pharmaceutical distribution space apparently became less realistic as they explored it further. This was the outcome we’ve been discussing in recent updates.
Amazon reportedly had not been successful in convincing big health systems to change their entrenched supply chain relationships, which are typically long-term contracts. Amazon also found it challenging to envision creating a supply chain platform that would meet the needs of pharmaceutical storage and delivery, which includes factors like refrigeration, not to mention significant regulation. Suffice it to say, any health system, large or small, would be reticent to use a novice like Amazon in this regard. Concerns around drug pricing have also weighed on Medical Distributors in the recent past, but as we wrote in March, somewhat pessimistic pricing scenarios are already baked into current stock prices, and this continues to be true even after strong April performance. In any case, regardless of the noise around the Medical Distributors industry and the underlying stocks we own, we believe, based on our objective and comprehensive methodology, that there is still meaningful strategic upside (an average of 54 percent across our four holdings) just to reach fair market value as we measure it.
We sold two names that hit their price targets: C.H. Robinson (CHRW) and FLIR Systems (FLIR) in the latter part of April. We continue to hold their respective underlying industries—Airfreight & Logistics and Communications & Networking—in our portfolio as the industries remain attractively valued. CHRW was purchased in June 2015 and held for just under three years for a total return of about +52 percent*. FLIR, on the other hand, realized +35 percent* total return in just seven months. We generally do not expect to hit our measure of fair market value in such a short period of time, but we are pleased that the market so quickly recognized how undervalued FLIR was when we first entered the position in September of last year. The sales of CHRW and FLIR, alongside an increase in three existing positions, led to a modest overall increase in portfolio cash, the defensive cash position dictated by the Day Hagan Logix methodology. Note that we strive to be fully invested. There are currently industries and stocks we are watching closely for potential inclusion in the portfolio, but as always, we will follow our process and the weight of the evidence. Across the portfolio, our seven industries hold twenty-seven total equities, on the low end of a range that has typically been between 25 and 45 names historically.
As we are in the thick of earnings season, it is worth noting that Ventas (VTR), our specialized REIT focused on the healthcare space, reported earnings at the end of April and, based on that report, was up nearly 9 percent on that day. The reaction to VTR appeared to take another one of our healthcare REIT holdings, Welltower (WELL), up nearly 6 percent as well. While we view quarterly earnings reports as important to monitor, at times we find the broader market perception to be myopic, often moving the stock meaningfully in either direction, but losing the strategic big picture along the way (especially in the context of the way we measure value). In the case of VTR, however, it was interesting that while the quarter was solid based on traditional metrics, it was not a “blowout.” Our interpretation is that the move up was more of a recognition, after a reasonable quarter and slightly positive guidance, that VTR (and WELL in turn) was sitting at or near trough prices. In other words, the rest of the market now realizes how undervalued the companies are. We continue to feel our early March Specialized REIT industry purchases offered highly attractive entry points, with potentially negative macro and industry-specific headwinds already priced in.
We discussed the Energy space quite a bit in recent letters, but as Energy led our industry groupings performance-wise over the past month, we are starting to reap the benefits of our patience and validate our perspective on value. From a macro perspective, demand growth and tighter supply are likely to be a tailwind for (or at the very least, help maintain) current oil prices. However, WTI Oil is already up over 150 percent since early 2016 while energy stocks have not fared nearly as well during that same timeframe, lagging by over 100 percentage points. As respected research shop Cornerstone Analytics mentioned, “The behavior of the energy stocks looks like an episode of what we saw late in the tech bubble (but in reverse).” We continue to see meaningful upside potential in our Energy holdings based on our measures of fair market value, with the added benefit of energy exposure serving as an inflation hedge.
Our focus remains on energy names that meet our valuation criteria, with, as is the case for all of our portfolio holdings, a fundamental overlay that includes healthy balance sheets and solid free cash flow generation over time. We note as an example that one of our more recent portfolio additions, Cabot Oil & Gas (COG), purchased in February of this year, already generated 50 percent of the company’s free cash flow target during Q1 with meaningful exploration capital expenditures (CapEx) already incurred for the year. The company has a 30 million share repurchase plan in place, but management indicated it may go beyond that, as it balances repurchases with sustainable dividend growth and organic growth investment. Based on our valuation work, we view fair market value for COG as about double the current price.
As we head into the month of May, please do not hesitate to contact us at any time with questions or comments. We appreciate your faith in us and in the Day Hagan Logix strategy.
- Robert Herman
- Donald L. Hagan, CFA
- Jeffrey Palmer
- Arthur S. Day
Note: Day Hagan Logix Tactical Dividend YTD net return through 4/30/2018 = -1.27. S&P 500 Total Return YTD through 4/31/2018 = -0.38 percent.
Print Copy of Article: Day Hagan Logix Tactical Dividend Strategy Update May 2018 (pdf)
The S&P 500 Index is based on the market capitalizations of 500 large U.S. companies having common stock listed on the NYSE or NASDAQ. The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. Indexes are unmanaged, fully invested, and cannot be invested in directly.
Disclosure: *Note that individuals’ percentage gains relative to those mentioned in this report may differ slightly due to portfolio size and other factors. The data and analysis contained herein are provided "as is" and without warranty of any kind, either expressed or implied. Day Hagan Logix (DH Logix), any of its affiliates or employees, or any third-party data provider, shall not have any liability for any loss sustained by anyone who has relied on the information contained in any DH Logix literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. DH Logix, accounts that DH Logix or its affiliated companies manage, or their respective shareholders, directors, officers and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. DH Logix uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. When evaluating the results of prior DH Logix recommendations or DH Logix performance rankings, one should also consider that DH Logix may modify the methods it uses to evaluate investment opportunities from time to time, that model results do not impute or show the compounded adverse effect of transactions costs or management fees or reflect actual investment results, that some model results do not reflect actual historical recommendations, and that investment models are necessarily constructed with the benefit of hindsight. For this and for many other reasons, the performance of DH Logix’s past recommendations and model results are not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries, nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.
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