Sector by Sector: Mizuho's Key Themes for Investors in 2017

February 15, 2017

With the first quarter of the year well in motion, it is no surprise that policy, market conditions and technology disruption are affecting a variety of industries, as well as overall investor sentiment.

Where should investors looks for the best bang for their buck? What’s to come? Here are a few key perspectives from Mizuho’s US equity research team.

Trump Promises to Make Infrastructure Great Again

When it comes to “making America great again,” the one initiative that may not have been top-of-mind is infrastructure improvements. However, campaign rhetoric came to a fore on January 24, when the Trump Administration released its top 50 priority infrastructure projects. These initial projects span electricity & transmission, water/waterways, highways & bridges and airport infrastructure initiatives, with a total $137.5 billion estimated expenditure.

The efforts by both Republicans and Democrats to further infrastructure projects is a positive sign for the industry, says Mizuho power, utilities & alternative energy analyst Jim von Riesemann. Another positive signal is the inclusion of electricity and transmission projects and "clean" infrastructure within Trump’s plan, indicating that the administration will not be a death-knell to renewable energy progress. 

Within his coverage, Dominion, Duke Energy and Southern Company all stand to gain from the Atlantic Coast Pipeline being named as priority by Trump, potentially paving a smoother path toward full approvals.

In addition, the water utility sector could have the opportunity to flourish under Trump’s legislation. “With proposed spending of $110 billion for water & sewer system rehabilitation, utilities could contribute their resources and regulatory standing to further support these projects in the longer term construction phases,” von Riesemann says. 

Oil and Gas Picture Depends on Currency Recovery, M&A and Policy 

For oil and gas, a combination of policy, currency recovery and M&A are likely to drive the market. 

According to energy analysts Tim Rezvan and Brian Zarahn, commodity price recovery will be essential to the industry landscape throughout the year (Mizuho’s 2017 price deck assumes oil, natural gas and natural gas liquids rise 27%, 34%, 32% YoY). At the same time, rising interest rates will result in potential headwind for MLPs.

“We expect additional general partner/incentive distribution rights restructurings will take place to lower MLP cost of capital and improve long-term growth outlook,” writes Zarahn, while Rezvan “remains cautiously optimistic on the E&P sector in '17.”

While 2016 saw an oil price rally, “recent macro factors, specifically OPEC news and nervousness on the medium-term gas price outlook, have driven E&P equities since late November and we expect bottoms-up stock-picking to become more important throughout '17.”

Permian production growth will be a key driver of higher US oil production, the analysts write. Gassy E&Ps are particularly promising, with Rezvan naming Rice Energy (RICE) a notable performer.  

M&A is another prominent theme for oil & gas. “We think improving commodity prices and a more benign regulatory backdrop will improve capital market aces in 2017,” write the analysts as they advise investors to “expect further consolidation of private E&Ps in core basins, funded largely with equity” and note that investment grade MLPs with no IDRs are well positioned to be consolidators this year.   

Most notably, Noble Energy’s $3.2 billion acquisition of Clayton Williams sets the pace for large acquisitions and industry consolidation for the rest of the year. 

ACA, Drug Pricing Dictate Healthcare’s Vitality

Perhaps more bluntly than any other industry, Trump’s election sounded immediate warning signs for the healthcare sector given the potential impact on the Affordable Care Act (ACA). 

Immediately upon Trump’s victory, Mizuho’s Director of Research Sheryl Skolnick downgraded all her ACA vulnerable buy-rated stocks to neutral in the face of expected industry upheaval. Over the past few months, she has laid out a more hopeful path forward, praising UNH’s growth, liquidity and dividend, as well as heightened interest in US healthcare companies from international investors.

In a continued time of ACA purgatory, health insurers “need a stable market, stable rules and a broader pool — none of which has been fixed yet, nor does it seem likely it will be in time,” said Skolnick to MarketWatch. She cites the current April deadline as “barely enough time to do the bids for 2018,” adding that “timing is tight.”

For 2017, key issues in specialty pharmaceuticals surround drug pricing and M&A. In her 2017 outlook, analyst Irina Koffler notes that muted drug pricing in 2017 is one dynamic that renders the sector a promising prospect for the year. “We think the investment case for specialty pharma stocks is growing more attractive.”

“As we see it, the biggest risks are still company-specific rather than government-driven, and we don't expect investors to miss entry points by waiting for additional clarity on both. M&A is hoped to provide a boost, but may only benefit select names in our group…the biggest near-term tailwind to the sector is a change in the tax code allowing domestic companies to repatriate foreign cash, which could spur a wave of healthcare M&A,” Koffler wrote.

When it comes to drug distributors, “drug pricing uncertainty weighs on earnings visibility,” says analyst Ann Hynes. “Although the brand price inflation and generic deflationary pressure could be transitory issues related to political rhetoric, we think guidance reductions indicate that companies are still struggling to get a good hold on the pricing environment.” Given low earnings visibility, Hynes recommends remaining on the sideline for her covered companies.

The usually sunny biotech sector has seen recent drawdowns, but retains solid potential for 2017 growth. Biotech analyst Salim Syed identifies three major factors that can turn around the market: positive clinical data, M&A and clarity on the political landscape.

M&A is also a factor to watch, as is potential tax reform driven by the Trump administration and a repatriation holiday for the largely overseas large-cap biotech industry. 

In fact, an investor survey taken at November’s Mizuho Global Investor Conference in New York found that most expectations strongly favored biotech as the best-performing subsector in 2017. 85% of investors in the survey also voiced the opinion that biotech/pharma will outperform the S&P in 2017. 

REIT Subsectors Show Promise

While Mizuho’s global REIT report broke down key opportunities and potential bubbles internationally in 2016, a more current picture shows that there are a few areas for optimism in American real estate at the moment.

While market volatility is likely “here to stay in the near term,” as REIT analyst Haendel St. Juste said to, he maintains that they remain a good long-term investment.

The US healthcare REIT sector has performed relatively well so far during 2017, despite the uncertain landscape of the underlying business under a Trump administration, says analyst Richard Anderson. 

“There has been talk of the skilled nursing business catching a break if dismantling the ACA also means suspending (for now) the drive for new value-based payment models. Meanwhile, the threat of rising interest rates has not materialized yet to the degree feared, which has provided a support mechanism for the sector,” he said. However, Anderson still urges caution and recommends an underweight investment for now.

Multifamily is another big opportunity for REITs.  Mizuho’s Anderson “continues to favor the multifamily sector from this point forward, following the reset of same store expectations from management. Our thesis is not predicated on same store ramping up during 2017, as we don't expect much, but rather anticipation of a fundamental improvement commencing in 2018.”

Most recently, St. Juste initiated coverage on another promising sub-sector: single-family rental REITs. “We think the single-family rental REIT sector is one of the more compelling investment ideas in REITs today,” he writes. “We are initiating coverage with a positive view given the favorable demand, growth and value attributes…and we see a multi-year runway for growth, internally and externally, as well as a built-in hedge against inflation and rising interest rates.”

AI, ADAS and Apple Drive Tech Expectations

When it comes to the technology sector, there are a few clear-cut areas of promise such as artificial intelligence, ADAS and Apple. On the other end of the spectrum, gaming and internet stocks provide more of a mixed bag.

A much-anticipated theme is artificial intelligence, which is finally beginning to meet and exceed its business expectations, notes Mizuho analyst Vijay Rakesh.  

“While the idea of artificial intelligence has been around for quite some time, we are beginning to make another push into the world of machine learning. As we enter a new spring for AI after a number of winters in its 50+ years of existence, Deep Learning and AI are driving the next revolution, with one trillion devices expected to be connected by 2020.” 

Some of the major players in AI include not only Google, Facebook and Amazon, but also Huawei as a key supplier of hardware architecture, and Baidu, which has the founder of Deep Learning leading its AI effort. 

Self-driving cars, which reply upon Advanced Driver Assistance Systems (ADAS), are also sure to pick up speed in 2017. Some key developments have already surfaced this year at CES, where at least three original equipment manufacturers announced solid state LiDAR chip solutions, bringing the industry one step closer to autonomous driving. 

According to Rakesh, LiDAR will be a key factor in driving the next wave of disruption by lowering costs, with NVDA and NXPI key players in automotive ADAS.

Of course, Apple is another prominent topic for technology investors and consumers with recent F1Q17 earnings inspiring optimism in analyst Abhey Lamba, who “remain(s) positive about the upcoming upgrade cycle opportunity given strong installed base growth,” maintaining his Buy rating and delivering a modest raise to his price target.

On the flip side, expectations for internet and gaming companies are mixed, with Twitter and GrubHub showing signs of distress while EA, Facebook and Square are a few of the stocks driving optimism going forward. 

Wrapping It Up

While danger lurks for certain segments of the market, 2017 appears to be more promising for investors than initially anticipated. As Q2 approaches, keep in mind key industry considerations from the Mizuho equity research team for optimal results. 

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Simon Hylson-Smith

CEO, Paragon

Simon Hylson-Smith is a former financial industry editor and currently CEO of Paragon.

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