Mark Nelson, Senior Equity Analyst at Killik & Co, shares his top stock picks for the year.
1. Rio Tinto
Rio Tinto [LON:RIO] is one of the world’s largest mining companies, with a broad portfolio of top-tier assets around the globe. The company’s core products – iron ore, copper, and aluminium – play a crucial role in global economic development and stand to benefit from enduring long-term trends such as urbanisation and the growth in renewable energy. Whilst operational performance is expected to continue to improve in Rio Tinto’s important iron ore business (which accounts for over half of overall revenues and the majority of overall profits), we are particularly excited about the opportunity in the copper business.
Following several years of heavy investment, Rio expects to grow copper production by over 60% in the next five years to over one million tonnes per year (compared to 2023 levels). At the same time, we remain positive on the outlook for the price of copper, maintaining our medium-term forecasts that demand will outstrip supply in the next two or three years. However, recently-announced production shortfalls from other miners looks set to bring this supply deficit about sooner, potentially providing a boost for copper prices in the coming months.
Against this backdrop, we like Rio Tinto for its strong balance sheet, robust cash flow generation, and shareholder-friendly capital allocation policy. The company aims to pay dividends equivalent to between 40% and 60% of underlying earnings, although has averaged the top end of this range over the past seven years due in part to high commodity prices driving significant cash generation.
Following another good operational and financial performance in 2023, we believe dividends could again come in at the top end or higher of both the targeted range and consensus estimates, which currently equate to an already healthy dividend yield of around 6%.
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Zoetis [NYSE:ZTS] is a world-leading animal health company, spun off from Pfizer [NYSE:PFE] in 2013. It discovers, develops, manufactures and commercialises vaccines, medicines, diagnostics and other technologies for companion animals (i.e. pets) and livestock.
Global demand for pet health care is being driven by a range of factors, including: a growing human-animal bond; younger, wealthier pet owners; increasing pet ownership in developing countries; and improvements in nutrition, medicine and vet expertise, leading to longer pet lives.
Meanwhile, Livestock health care demand is being driven by global population growth and increased access to animal protein in developing countries. The core animal health market has shown steady and resilient operational growth over time, even during the 2009 recession, and Zoetis has consistently grown ahead of the market since becoming a public company.
Looking ahead, it is targeting mid- to high-single-digit revenue growth, driven by a broadening of the existing portfolio, emerging market expansion, share gains and innovation. More than 2,000 new products and lifecycle innovations have been introduced in the past 10 years, including nine blockbusters, and a compelling pipeline of products in renal, cardiology and oncology could be additive to revenue guidance, in our view.
Zoetis has a strong record of margin expansion, driven by portfolio mix, the ability to raise prices, and operational efficiency, with margins improving by more than 1,250bps since IPO. Further profitability gains are expected from the growth of Companion Animal in the mix, the products of which are typically at higher price points and less sensitive to generic competition than those of Livestock.
Other factors include the growth of monoclonal antibodies in the portfolio, which achieve higher gross margins, as well as further cost optimisation and simplification across the business.
Zoetis has grown the dividend by c.20% per annum and bought back more than $5bn of shares since IPO. Further systematic share buybacks, combined with margin improvement, should drive at least a low-double-digit rate of EPS growth, while the company aims to continue growing the dividend above net income. We view Zoetis as a high-quality market leader of a health care niche with strong and enduring thematic drivers, and several key products driving near-term growth.
3. Walt Disney
The Walt Disney Company (“Disney”) [NYSE:DIS] is a diversified worldwide entertainment company with operations in two business segments: Disney Media and Entertainment Distribution; and Disney Parks, Experiences and Products. In addition to its Disney brands, it produces content under Pixar, Marvel, Lucasfilm and 20th Century Studios. It also owns the Disney+, Disney+ Hotstar, ESPN+, Hulu, and Star+ video streaming services.
In September, Disney hosted an Investor Summit, where it announced that it plans to invest $60bn in capital expenditures in its parks business over the next decade. Disney’s domestic theme parks have exhibited strong results and are a crucial profit driver, with previous investments resulting in meaningful increases in park attendances. As such, we believe that investing in expanding and enhancing theme parks related to some of its most valuable IP has the potential to driver significant returns over the long-term.
Shares in Disney have been under pressure since peaking at the end of 2021 and currently trade c.20% below their 52-week high. We think this underperformance, largely due to concerns over the company’s legacy TV business is unwarranted, and the market is overlooking the growth potential of Disney’s parks and resorts as well as an upcoming inflection to profitability in the company’s streaming business, which includes Disney+. The shares currently trade on 22.2x September 2024 earnings, an attractive entry point for a company that can grow earnings in the mid-teens annually over the medium term.
McDonald’s [NYSE:MCD] operates and franchises fast food restaurants, serving a locally relevant menu of food and beverages in over 100 countries. As at 6 December 2023, there were more than 40,000 McDonald’s restaurants globally, c. 95% of which were franchised. McDonald’s shares have performed strongly over the last decade, initially as the company refranchised its restaurant network and invested to upgrade its restaurant estate and then more recently through its Accelerating the Arches strategy which was launched in 2020.
The Accelerating the Arches strategy is built on three growth pillars, including maximising the business’ marketing potential, refocusing on its core menu, and leveraging the three ‘d’s’ of drive-thru, digital, and delivery. The strategy has been a success, supporting market share gains for the company through what has been a challenging macroeconomic environment.
Not wishing to stand still, McDonald’s expanded on this strategy last year, adding the additional ‘d’ of development, aiming to accelerate the pace of restaurant openings in order to capitalise on the increased demand the company has seen in recent years.
At its Capital Markets Day in December 2023, management stated that it believes that the company can add 10,000 stores by the end of 2027, which would represent the fastest growth in its 80-year history. We believe that this, in addition to the strength of the company’s brands, its value proposition, the growth of its loyalty program, and its expansion in areas such as chicken (now as big a business as beef for McDonald’s), and coffee (now the no. 2 player in the world) feed into our expectations that McDonald’s can grow its earnings at a double-digit rate over the next five years, providing justification for its premium rating.