Financially fit. Financials in the broad market were up as banks benefited from a rise in yields. The portfolio’s holdings in the sector kept pace on a relative basis with much of the strength driven by businesses beyond traditional banks including Charles Schwab Corp. (SCHW), a top contributor from the capital markets industry.
Shares of Schwab have shot higher over the past six months as the company closed on its acquisition of former rival T.D. Ameritrade and has begun showing progress on boosting profitability through greater efficiency gained from the merger. Rising yields have widened the gap between the rate received on low-risk bonds owned by Schwab and the interest it pays on customer deposits. As a result, investors bid up shares in anticipation of strong earnings growth going forward.
We’ve trimmed our stake in Schwab as the discount to intrinsic value narrowed; however, we continue to maintain a position in the company based on our view that over the intermediate term, earnings power will climb as a result of growth in the firm’s retail brokerage and registered investment advisor platform businesses as well as further efficiencies achieved from its acquisition of T.D. Ameritrade.
A full tank. The Energy sector continued to move higher in response to the ongoing economic resurgence. We’ve been selective in the space, looking for differentiated businesses where results aren’t solely driven by the price of oil. Holly Frontier Corp. (HFC), a top contributor that we featured last period is one such example.
The small independent petroleum refiner has reaped the benefits of expectations of greater demand for petroleum products. The optimism has resulted in a 50-plus percent rise in the price of oil, gas and associated products. The return to normal should continue to boost sales for Holly Frontier, which has begun diversifying its business into renewable diesel fuels.
With shares priced below book value, we believe Holly Frontier’s stock price continues to offer upside opportunity as the economy returns to trend growth. Additionally, the company’s relatively strong balance sheet should allow it to weather potential delays in the reopening of the economy.
Utility player. The uptick in investor optimism caused some defensive areas of the market, such as Utilities, to fall out of favor. Our holdings in the sector were up during the period and outperformed the benchmark on a relative basis, and we continue to find opportunities in the sector such as Exelon Corp. (EXC), a modest contributor during the period.
The company is a large multi-state utility with regulated as well as unregulated operations. Following a strategic review, Exelon recently announced a plan to separate the two businesses. The decision, in our view, sets the stage for a re-rating of the company.
Based on our analysis, investors appear to be undervaluing Exelon’s two business lines under the current operating structure. We believe the regulated line has desirable transmission/distribution assets and strong opportunities for rate base growth. Meanwhile, the unregulated merchant power segment trades at less than 5x enterprise value/earnings before interest, taxes, depreciation and amortization, which represents a steep discount to the average multiple for publicly traded power companies.
In our view, Exelon remains a compelling opportunity relative to fully regulated utilities.