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Cash flow is king for CI fund manager

Priest expects U.S. profits to surprise on the upside


This year hasn't been a particularly good one for the U.S. market but fund manager William Priest is hopeful 2006 will be a little better.

Mr. Priest has been managing the CI American Value Fund since July, 2003. The fund, which has assets of $196-million, has gained 2.64 per cent in 2005. The fund had risen 7.73 per cent in the 12 months ended Nov. 30, and 8.57 per cent a year in the three years ending November. The five-year return was a loss of 4.62 per cent annualized.

Mr. Priest expects that U.S. corporate profits will continue to surprise on the upside in 2006 and he considers the price/earnings multiples on the market are "reasonable." Accordingly, "our view would be that you would have another year where the market would be in the area of 6 to 8 per cent positive," said the chief investment officer of New York-based Epoch Investment Partners Inc.

The portfolio is currently modestly overweight energy, but had earlier this year been substantially overweight in that sector. And it carries a significantly lower-than-market weighting in financial issues.

"The complex financial companies . . . we think are unanalyzable," he said. So the fund doesn't own the big banks or mortgage finance giants Freddie Mac and Fannie Mae. "You can own some single-line companies like a reinsurance company but even there, if they have been in business for a long time, their investments are black box; you don't know what you are buying into," he added. In addition, he thinks there are "bad debts buried in a lot of finance companies that haven't surfaced yet."

His three picks for Best Bets are all in different fields but there is a common theme tying them together: free cash flow. "All of our companies generate free cash flow," Mr. Priest said.

He likes Harrah's Entertainment Inc. (HET-NYSE), a Las Vegas-based casino operator. Mr. Priest, whose forecasts have a three-year horizon, is impressed by Harrah's management and notes that it is committed to creating shareholder value through dividend increases and reducing debt. Also, in his view, Harrah's is "the best run by far of any casino operator."

It has the highest customer loyalty and a return on invested capital that is double the industry average, he said. He expects that Harrah's will transform Caesar's Entertainment Inc., which it acquired in June, into a more profitable business and boost its free cash flow substantially. He thinks the shares, which closed yesterday at $67.36 on the New York Stock Exchange, could rise to $90.

Bunge Ltd. (BG-NYSE) of White Plains, N.Y., is the least known of the three integrated global agribusiness giants and is "only starting to be recognized by Wall Street," Mr. Priest said. The other two in the "oligopoly" are Archer Daniels Midland Co. and Cargill Inc. The three are benefiting from the rising demand for higher-value foods such as processed foods from developing countries, including China and India, and so should do well regardless of what the global economies do, he said.

Bunge's margins are improving as its product mix shifts from commodities to processed foods, he added. Bunge generates "an enormous amount of free cash flow," he said, adding that free cash flow is expected to almost double between 2005 and 2007. He sees the shares rising to $85, up from yesterday's close of $53.80.

Mr. Priest's third choice was Microsoft Corp. (MSFT-Nasdaq), the software giant. "Microsoft is increasingly focused on profitability," rather than growth, which is leading to increasing free cash flow generation, he said. Now, Microsoft requires that any new projects turn a profit within a specified period.

He expects profit will grow around 10 to 15 per cent in the next fiscal year, which begins in July. And Microsoft has "lots of cash on the balance sheet" which makes him think that it could declare another significant cash dividend or buy back more shares. His price target for Microsoft, which ended yesterday's session at $27.09, is $40.

American Tale

CI American Value Fund manager William Priest expects that U.S. corporate profits will surprise on the upside in 2006. His portfolio is currently overweight in energy but light on financial services stocks.


Asset Class: U.S. Equity

5-star rating: 3

RRSP eligibility: Yes

Min. invest (initial): $500

Subsequent: $30

Fund Type: Open-ended

Total assets: $195.65-million

Sales fee type: optional

Management expense ratio: 2.49%

TOP 10 HOLDINGS, AS OF NOV. 30, 2005

Microsoft: 4.15%

Exxon Mobil: 3.56

Davita: 3.00

Bunge Ltd.: 2.98

Laboratory Corp. of America: 2.81

Endo Pharmaceuticals Holdings: 2.78

Ventas Inc.: 2.74

Wellpoint Inc.: 2.69

Harrah's entertainment: 2.68

Apple Computer: 2.56

RETURNS, AS OF NOV. 30, 2005

1-year: 7.73%

3-year: 8.57

5-year: -4.62

10-year: 5.86

© 2007 The Globe and Mail. All rights reserved.

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