From the Desk of Irwin Michael – July 10, 2015

Global equity markets have remained very volatile as the U.S. dollar and commodity prices have continued to fluctuate due to worries about the ongoing negotiations with Greece, China’s deflating stock market, and the U.S. Federal Reserve’s interest rate intentions. Nonetheless, we believe that share price variability, economic and political uncertainty, and summertime inactivity due to vacation seasonality present excellent buying opportunities for alert investors. Two undervalued common stocks, which we recently added to the ABC Funds’ portfolios include: PepsiCo and Valero Energy.

PepsiCo operates worldwide beverage, snack and food businesses, such as the Pepsi and Frito-Lay brands. On July 9th, the company reported organic revenue growth of 5.1% (excluding currency) and core EPS of $1.32 versus analyst expectations of $1.24. Moreover, PepsiCo raised the outlook for its core earnings per share growth rate (excluding acquisitions and earnings fluctuations) from 7% to 8%. Higher sales were aided by increased prices for their products, which insulated the negative effect of the rising U.S. dollar. Strong gross margin expansion and the continued success of its snack businesses helped the company’s EPS climb higher. We believe that PepsiCo represents an excellent lower risk, liquid investment in a capricious market and carries a 3% dividend yield. In addition, we are attracted to the company’s excellent brands, great cash flow potential and positive outlook. However, the company could also be broken up by splitting into two portions; Pepsi and Frito-Lay (Tostitos, Doritos, Lays, etc.). A split could provide further appreciation potential.

Valero Energy is the world’s largest independent petroleum refiner, producing conventional gasoline, distillates, jet fuel, petrochemicals and other refined products.  The company is inexpensive as it trades under a 10.0x price to earnings multiple, has a strong balance sheet and an attractive 7.5% free cash flow yield. The company has been using its excess cash generated from its operations to fund its dividend and to buy back a significant amount of its outstanding shares. We believe that investor sentiment for the refining industry has recently become more positive. Consequently, in our view, Valero combines an attractive valuation with a specialized energy industry exposure and a 2.5% dividend yield.

 

Irwin A. Michael Signature

Irwin A. Michael, President
I.A. Michael Investment Counsel Ltd.

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