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July 21, 2019

Valuation Dividend – Quarterly Report Q1 2019

The Valuation Dividend returned 12.06% in 19Q1, vs. 11.93% for its benchmark Russell 1000 Value, on a total return basis.

The memories are still fresh that the US large cap equity market lost more than 10% of its value in Q4 of 2018, with ~9% alone in December. Barely did investors have a chance to regroup, and the Russell 1000 index rose 8.4% in January and closed 19Q1 14% higher. The Fed that turned dovish was the prime catalyst behind the US equity market rally. On January 4, Fed Chairman Powell indicated inflation was muted and the central bank would be in no hurry to raise rates, leading the R1000 to rise 3.4% on the day. In late March, the Fed formally trimmed the number of rate increases they foresee in 2019 from two to zero while holding its benchmark funds rate unchanged in a range of 2.25% to 2.5%. The central bank will also complete its balance sheet roll-off program at the end of the September, which will likely leave the Fed balance sheet with at least $3.5 trillion in bonds, down from roughly $4.25 trillion when the program started. In the 1st quarter, the 10 Yr US treasury yield has dropped from 2.7% at the end of 2018 to 2.5%, touching a low of 2.4% in late March. Despite the yield drop, the R1000 Value index underperformed the R1000 in Q1 by nearly 200 bps, as growth oriented sectors such as Technology, Industrials, and Energy were among the best performing sectors. From the factor’s perspective, dividend yield didn’t work, with the bottom two quartile dividend yielding stocks outperforming the top two quartiles.

Cisco (CSCO) and Accenture (ACN) rode the technology sector rally in Q1 to deliver impressive returns, as investors bet on better growth and a subsiding trade war threat between the US and China. Cisco also beat its FY19Q2 revenue and earnings estimates. The trade friction with China didn’t have any material impact on its net gear business in the quarter, and Cisco was able to post strong growth in its security and software-defined networking areas, indicative of Cisco’s progress in aggressively transitioning to a software model and accelerating its pace of innovation. Also in the quarter, Cisco hiked its dividend by 6%, while increasing its share buyback plan by $15 billion to $24 billion. Separately, Accenture beat estimates for its FY19Q3 earnings and raised its full-year profit forecast as it continues to benefit from investments in digital and cloud services, driven by large digital transformation programs as well as by catch-up spending on legacy and rationalization projects at certain enterprises.

For Ameriprise (AMP), strong equity market returns, low volatility, and renewed confidence in US economic growth are the perfect recipe for the company to perform well, as it generates nearly 75% of its operating profits from the wealth advisory and asset management businesses.

Target (TGT) reassured investors with its strong 18Q4 results and healthy 2019 outlook that its investment in stores have paid off and the company is on a strong footing to capitalize on its scale and innovation to drive sustainable top line growth and profitability gains. Target has transformed itself to boast the most comprehensive suite of fulfillment choices and the most extensive coast to coast retail network in the US retail industry, and a competitive suite of exclusive brand offerings to offer consumers the best omnichannel retail experience.

Darden (DRI) in the quarter reported better than expected 19Q3 results and raised FY19 guidance for the 3rd consecutive time this year. Strength in its comparable store sales growth was again broad based across its major brands and Cheddar’s Scratch Kitchen has finally caught up with legacy brands’ HR in terms of personnel turnover and training pipeline, a critical component of restaurant operations. Darden has proven itself the uncontested leader in the casual dining industry, and it continues to gain market share with superior top line strength.

On the detracting side, Walgreens was the worst performer. The company, which competes with CVS on the retail pharmacy side, fell in sympathy with CVS Health (CVS), which in late February provided disappointing 2019 EPS guidance that was well below the consensus estimate. CVS Management cited ongoing pharmacy reimbursement and pricing pressures as its biggest headwind. In early March, Walgreens’ CFO at an investor’s conference commented that so far in 2019, the company had underperformed its ability to mitigate pressure from low reimbursement and low generic deflation through contract winning, volume gains and better negotiation. Unfortunately, Walgreens’ underperformance continued in April as in early April the company announced FY19Q2 earnings which missed consensus estimates and lowered its FY19 EPS outlook from $6.60-6.70 to $5.98. Walgreens, however, believes operation will stabilize in 2020 and EPS can return to mid to high single digit growth afterwards as the company is to realize annual savings in excess of $1.5 billion by 2022 and capitalize on material contributions from partnerships it has established with Microsoft, Lab Corp, Fedex, Kroger, etc.

The healthcare sector was a bottom performing sector in 19Q1 in the US large cap. equity space, reversing its strong relative performance in 18Q4. Pfizer (PFE)’s stock return was exacerbated by its soft FY2019 guidance, due to unfavorable US dollar and strong generic and biosimilar competition, especially its 2 nd best-selling drug Lyrica will lose exclusivity in June this year. That said, the mid-long term outlook for Pfizer remains unchanged that 2021 will be a real inflection year when its growth outlook dramatically improves with multiple pipeline drugs hopefully reaching the market with scale.

The Valuation Dividend currently enjoys an average dividend yield of 3.2%. We aim for the strategy to maintain strong income generation ability, attractive valuation, robust balance sheet strength, and broad sector exposure.

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