Large Caps Riding Wave

In the economic recovery’s sixth year, the investment adage that “a rising tide lifts all boats” no longer applies. The waters are choppy, with some public companies rising and others falling, as reflected in the market capitalizations of the Valley’s leading companies. On the directory of largest public companies in the Valley, the largest caps in the region – Walt Disney Co., Amgen Inc., Public Storage and Avery Dennison– showed strong double-digit gains. Once again, Disney is the top company on the list with a market cap of $184 billion as of June 10. James Hillman, managing director of portfolio management at Bank of New York Mellon Corp. in Century City, which compiles the Valley 50 list of publicly traded companies, said capital markets are now in the late stages of a bull run, a point in the cycle that favors large-cap stocks. However, unlike earlier in the recovery when the broad market gained value, investors are now trying to distinguish the winners from the losers. “Companies that exceed expectations will be rewarded, and those that don’t will be punished meaningfully,” he said. “This is a time when the market rewards active management of investments. Specific names, fundamentals and growing profitability will be rewarded.” Together, the 50 largest public companies headquartered in the greater San Fernando Valley region had a combined market capitalization of $388 billion as of June 10. A prominent name on the list – accounting for more than half the value – is Disney, which has benefited from a series of billion-dollar deals over the past decade by Chief Executive Robert Iger that have brought the Pixar, Marvel and LucasFilm studios into its fold. And although the Burbank entertainment company’s value has gained nearly eightfold during the recovery, there’s still more growth ahead, according to analysts. Last month Alexis Quadrani at J.P. Morgan Chase & Co. raised Disney’s target price 10 percent to $121. It closed June 10 at $110. “Disney remains our top pick in media for its consistent record of earnings outperformance versus peers, which we expect will continue from its full pipeline of content,” she wrote in a May 5 note to investors. While Disney has increased its market cap 26 percent in the last year, the second-place company on the list, Amgen, has gained even more at 33 percent. The biotech has trimmed costs through layoffs, closing facilities in Seattle and South San Francisco, and moving manufacturing to Singapore. Management plans to cut 12 to 15 percent of Amgen’s workforce as it restructures for the new biotech market, which includes “biosimilar” drugs that will compete with Amgen blockbusters losing patent protection. The company’s future looks solid with a series of new drugs ready for market, pending approval from the Food and Drug Administration. They include anti-cholesterol drug Repatha which is scheduled for FDA approval later this year; cancer treatment Kypolis, also awaiting an FDA decision; and Romosozumab, a treatment for bone loss. Eric Schmidt, an analyst at Cowen & Co. who covers the company, believes Amgen’s technology will give it a leg up. He gives the stock an “outperform” rating with a target price of $161, a 3.5 percent premium over its June 10 close of $155.55. One of the newest companies on the Valley 50 is also the most profitable. Marcus & Millichap, the apartment building brokerage in Calabasas, tops the list with a three-year return on equity of 53 percent. Essentially, ROE measures a company’s profitability against how much money shareholders invested. Brandon Dobell, partner in the Chicago investment bank William Blair & Co., said Marcus & Millichap’s high return can be attributed to its business model, which has low overhead. A real estate brokerage doesn’t require expensive manufacturing plants, inventory or an enormous workforce. Its main costs are broker commissions and office rent. “In general, service companies in real estate, technology or consumer products do not take much capital to grow and generate good cash flow,” Dobell said. Further down the list of the most profitable public companies are clusters of consumer-oriented businesses, including restaurants, apparel and residential real estate. Among the top 10, DineEquity Inc. in Glendale and Cheesecake Factory Inc. in Calabasas represent the restaurant sector with returns of 32 percent and 21 percent, respectively, while No. 2 Cherokee Inc., a Sherman Oaks apparel brand licensor, returned 41 percent to shareholders. Christopher Thornberg, founding partner at Beacon Economics in Century City, said that during the recession, companies focused on cost-cutting for survival. Now that consumer demand has returned, those companies are positioned to deliver good profits. “The consumer has come roaring back,” he said. For investors, return on equity continues to beat corporate bond rates, which averaged 4.1 percent at the end of 2014, according to the Internal Revenue Service. By comparison, the average ROE last year among the top 25 companies in the greater Valley was 18.5 percent. Most experts figure the Federal Reserve Bank will raise interest rates this year, but Thornberg doesn’t expect the 10-year Treasury rate, which averaged 2.6 percent last year, to rise more than about 3.5 percent for the next few years. At that rate, equities would continue to outperform bonds in returns to investors. – Joel Russell “We view Amgen as a better-than-average pharmaceutical company, backed by biologic franchises with good longevity, a superior geographic mix, better than average EPS growth, a superior margin structure and a solid pipeline,” he wrote in a May 15 note to investors. Big newcomer Amgen, with a market cap of $117 billion, is certainly the largest pharma name on the Valley 50. But smaller companies farther down the list have provided a bigger return for investors. For example, Kythera Biopharmaceuticals Inc. has increased its value 77 percent in the last year, giving the Westlake Village company a market cap of $1.37 billion, following FDA approval of its fat-dissolving drug Kybella. Earlier this month, the company announced it will be acquired by Irvine-based Allergan plc for $2.1 billion, giving investors an even bigger return on their money. In addition, Second Sight Medical Products Inc. in Sylmar has achieved a market cap of $496 million since going public in November with the promise to sell its artificial retina system. In contrast, MannKind Corp. has lost 30 percent after the Valencia biotech launched its inhalable insulin Afrezza, with sales figures that disappointed Wall Street. Hillman at BNY Mellon believes as credit availability improves, so will the prospects for smaller companies. He recently started telling clients to buy stock in selective small international stocks. “As we get more into a mature recovery, the ability for smaller companies to accelerate growth is better,” he said. This year also has seen significant churn on the Valley 50 list. Several large-cap companies have moved away or been acquired, including Conversant Inc. in Westlake Village, which was acquired by Plano, Texas-based Alliance Data Systems Corp. for $2.3 billion. Also, Vitesse Semiconductor Corp. in Camarillo was purchased by competitor Microsemi Corp. for $389 million and Sport Chalet Inc. was bought by private equity firm Vestis Retail Group for about $70 million. But the list gained a notable newcomer in California Resources Corp., a spin-off from oil giant Occidental Petroleum Corp., which moved from West Los Angeles to Houston last year. In conjunction with the move, Oxy spun off its California assets and formed CRC, which will be based in Chatsworth. (See interview page 10.) The company had a market cap of nearly $3 billion to rank No. 8 on the list. As part of its severance with Oxy, the company assumed $6.1 billion in debt, and for now, most of its cash flow comes from long-operating oil wells. But David Meats, an analyst at Morningstar Inc. in Chicago, thinks the company’s upside depends on whether it can use unconventional oil recovery technology, such as hydraulic fracturing, to tap into its Monterey Shale holdings in the Central Valley. Although a government report last year lowered the estimate of recoverable oil in the Monterey Shale to 600 million barrels, down from 13.7 billion barrels, CRC could take a significant portion of the total, Meats said. “There is substantial resource potential and California Resources will be at the vanguard, given its extensive experience,” Meats wrote in a report on Jan. 5. “The company has drilled over 500 unconventional wells to date, with a nearly 100 percent success rate.” While companies both large and small have increased their value in the last year, there’s more than money at stake for some local investors. Juan Ros, vice president at wealth management firm Lamia Financial Group Inc. in Thousand Oaks, has many clients who are current or former employees of Amgen or Disney. He finds they often have an emotional attachment to their holdings in those companies that goes beyond their monetary value. It becomes an issue when Ros talks to them about selling their shares to diversify their portfolio. “We don’t like to have a heavy concentration in one particular company – it’s just too risky,” he said. “That’s one of the preliminary educational mantras we teach clients: Risk is guaranteed, and returns are not. We want to get a long-term return without trying to guess the market or chase past performance.”