Q1 2025 Newsletter
The new Administration’s suite of across-the board-tariff hikes signaled a major change to the global trading order. The overall weighted average tariff will increase to 23%, which is higher than the Smoot-Halley tariffs of early 1930s. The theme for 2025 is that investors should prepare for volatility around policy changes and budget and tax negotiations given the different approaches between the current and preceding Administrations.
The theme for 2025 is that investors should prepare for some volatility around policy changes and budget and tax negotiations given the different approaches between the current and preceding administrations.
The current Administration views tariffs as a tool to lessen trade deficits and strengthen negotiations by encouraging more open trade agreements while generating income for the Treasury. While some countries have retaliated others have taken a more accommodative approach, but the ultimate resolution will involve negotiations over an indeterminate period.
The previous Administration also employed tariffs albeit on a targeted group of imports, including steel and aluminum, semi-conductors, electric vehicles, critical minerals and batteries. In either case tariffs can increase the cost of imports, adding to inflation and weakening retail demand. A haphazard roll-out can also disrupt supply chains and often invite retaliatory actions.
At the end of the first quarter key economic indicators suggested that the US economy remained reasonably resilient with stable consumer spending and low unemployment. The Federal Reserve’s most recent quarterly projections (issued mid-March) expect one or two rate cuts this year. Fed officials modulated the inflation projection from 2.5% to 2.8% in 2025 and left projections in 2026 and 2027 unchanged at 2.2% and 2.0% respectively. In March, U.S. employers added jobs at a much stronger pace than expected at 228,000, well above the gain of 140,000 jobs economists had expected to see.
Consumer sentiment has fallen, possibly over concerns of the consequences of tariffs, with one such recent survey from the Deutsche Bank indicating the probability of the US entering a downturn within the next 12 months has climbed to 43%. The change in sentiment along with swings in various economic policies has created a climate of uncertainty and volatility in the equity markets.
Despite the volatility of the markets and heightened perception of a contraction phase of the business cycle, it is important to keep a longer-term perspective. Previous market instability occurred with the financial crisis of 2008 and the pandemic of 2020/21. In both instances monetary and fiscal policy alleviated the lack of liquidity and ensured the free flow and access to capital. In addition, the scientific community speedily produced a vaccine.
Periodic market disruptions, such as tariffs, tend to distract attention from longer-term trends which could be transformative. There are several investment themes on the horizon that have the capability to shape the markets over the next decade. We will highlight just two of these transformative innovations.
The next generation of artificial intelligence (AI) “bots” will have greater reasoning, intuition, complexity and be capable of mimicking human thought and actions. AI is expected to be transformative and integrated into everyday life and businesses. This will lead to increased automation and efficiencies and allow businesses to streamline operations and drive economic growth in a range of industries and services. AI will also have an increasing impact in drug discovery and clinical trials, reducing timelines to market and improving treatment and longevity.
Quantum computing is also advancing rapidly and may be one of the most influential technological advancements. These are computers that operate with “quantum bits” that can solve very complex problems, particularly optimization problems that existing computers are unable to solve. These computers will be able to analyze and develop solutions and create value for businesses in finance, materials, life sciences, and mobility. McKinsey has estimated that 5,000 quantum computers will be operational by 2030 with more advanced models available after 2035.
Volatility and uncertainty are constant characteristics of equity markets. What varies are the reasons for these attributes. Volatility has been correlated with the superior historical returns that equity markets generate over time. Investors with a longer-term perspective and discipline have been rewarded as new waves of technology and innovation create growth and shareholder value.
April 2, 2025
Company Comments
Comments follow regarding common stocks of interest to clients with stock portfolios managed by Delta Asset Management. This commentary is not a recommendation to purchase or sell but a summary of Delta’s review during the quarter.
Caterpillar Inc. { CAT }
Founded in 1925, Caterpillar (CAT) is the world’s largest manufacturer of construction and mining equipment, with 2024 sales of $64.8 billion. The company also manufactures and sells diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. The company’s products are used in road building, mining, logging, agriculture, petroleum and general construction. Specific products include tractors, scrapers, graders, compactors, loaders, off highway truck engines and pipe layers. The company’s global reach is evidenced by its nearly 52% of revenue generated outside of North America.
Targeted organic growth areas include a major push to increase its service and parts along with expanded and upgraded equipment offerings. CAT expects to double its higher margin parts and service business over the next several years.
CAT is a global leader in the new construction equipment market. The company has built its product portfolio and significant scale through a combination of organic initiatives and acquisitions. It is the largest or second-largest manufacturer of virtually every product category it manufactures, and it generates a high return on capital. We believe the CAT brand, manufacturing scale and vast dealer network will help lead to market share growth, healthy global expansion and high profitability.
Caterpillar has made the transition to a more outsourced business model to create a less cyclical business and to reduce its break-even production levels. CAT began this transition in 2014 by closing and consolidating numerous facilities, reducing its manufacturing floor space considerably. The company now outsources 75% of the parts that go into its equipment. During this period, operating margins improved from mid-single digits to over 14%.
Caterpillar’s equipment is distributed through a worldwide network of 156 independent dealers located in more than 190 countries with over 2,000 dealer branches. The strong dealer support network is a key component to Caterpillar’s success and is a competitive advantage. Many equipment customers state that responsive after-market product support is a key differentiator in the purchasing decision. Equipment downtime on a scheduled project can cost millions of dollars.
Caterpillar has shifted its operational planning to focus more on return on investment versus incremental margin when evaluating its efficiency of capital in making investments. The company will allocate higher capital investment to higher return businesses and restrict capital investment in businesses generating subpar returns. Targeted organic growth areas include a major push to increase its service and parts along with expanded and upgraded equipment offerings. CAT expects to double its higher margin parts and service business over the next several years. New equipment is expected to drive growth through increasing market share, including digital applications aimed at machine connectivity, data collection and predictive analytics as well as electric-powered machines and automated trucks. Caterpillar has more than 1.5 million connected pieces of equipment that are digitally joined, providing data that help customers manage their fleets more productively and profitably.
At the same time, the company faces a range of operational and financial risks. Performance can be impacted by rising interest rates, unfavorable exchange rate movements, declining commodity prices and economic weakness. Longer-term challenges include regulatory emissions standards requiring CAT to make significant investments in research and development to meet stricter requirements. In addition, CAT faces more competition in its faster-growing international markets.
China’s appetite for commodities is a key driver of global commodity prices. China’s government boosted infrastructure work following the global financial crisis in 2008. The construction industry’s share of the country’s gross domestic product rose from 5.9% in 2008 to 6.8% in 2023. China has experienced an economic contraction recently due to oversupply in its real estate sector.
With construction and resource segments making up over 50% of Caterpillar’s sales, its share price has tended to move with commodity prices. Continued urbanization and infrastructure improvements globally should bode well for Caterpillar over the long term. The company continues to expand its manufacturing facilities in emerging markets and is increasing its exposure to the mid-tier markets through simpler, non-Caterpillar branded equipment to appeal to the cost-conscious buyer.
We believe the company has sustainable long-term competitive advantages and can grow revenue in the low single digits over the next decade. Efficiencies gained through leaner manufacturing processes and competitive returns from research and development spending should enable the company to experience free cash flow margins of over 10%. Based on these assumptions, our financial model indicates that at the current stock price, Caterpillar’s stock offers a potential long-term annual return of approximately 7.0%.
Walmart Inc. { WMT }
Founded in 1962, Walmart began with a single store in Rodgers, AR. Today, it has grown to more than 10,616 retail stores in 26 countries serving more than 255 million customers a week. The company is the world’s largest retailer operating in a variety of formats, including discount stores, neighborhood markets, super centers, grocery stores as well as e-commerce websites. Walmart, with $648 billion in annual sales, possesses tremendous scale and leverage to extract the most favorable terms possible from suppliers and vendors. The company is especially adept at using its cost advantage to maintain low price leadership and keep constant pressure on competitors.
With its purchasing power providing cost leverage to keep prices low, Walmart is a formidable omnichannel retailer and remains the most valuable outlet for top manufacturers in terms of dollar sales.
With unrivaled purchasing power, scale, brand equity and a growing e-commerce platform, Walmart is currently the only American retailer that can compete on a comprehensive basis with Amazon’s retail offering. The company offers a wide variety of fulfillment options for transactions made through either physical or digital channels with its large store footprint, deep vendor relationships and trusted brands. With its purchasing power providing cost leverage to keep prices low, Walmart is a formidable retailer and remains the most valuable outlet for top manufacturers in terms of dollar sales.
Walmart has redirected capital expenditures toward development of its global omnichannel capabilities. The company is now the No. 2 online retailer behind Amazon. Walmart is better positioned than other traditional retailers with its already efficient operations, bulk procurement and a dense network of stores which serve as convenient distribution outlets. Company stores are located within 10 miles of 90% of the U.S. population and Walmart has roughly 2.5 times the store count of Target. The company’s “Click and Collect” offering (ordering online and pick-up at store) is sometimes more convenient than ship to home, particularly in groceries where there can be spoilage concerns if a customer is unable to receive a package shortly after it arrives.
With the acceleration of e-commerce during the pandemic, Walmart’s digital investment has begun to pay off as reflected in e-commerce sales contributing 18% of comparable sales in 2024 versus 2.1% in 2020. Walmart’s “omnichannel” efforts combine e-commerce with its retail stores creating a competitive advantage. The company launched Walmart+, a membership offering multichannel benefits such as free shipping with no order minimums, as well as pick-up and other benefits which help customers save more time and money.
International will continue to be an opportunity for growth. The company’s strategy is centered on increasing penetration in its existing markets and by entering new, emerging markets. Walmart executes this strategy by acquiring local retail chains and then improving operating efficiency to reduce pricing and drive sales volumes. The company is narrowing its focus internationally to ensure proper investment in businesses and strategies that are core to the company. Operating internationally can be more challenging than domestically since the company must adjust to different cultures, laws and varying degrees of economic development. However, we believe strategic international expansion remains a viable growth alternative for Walmart.
Overall, we expect Walmart will be able to grow sales in the low single-digits driven by strong e-commerce growth and international expansion. We expect Walmart’s improved U.S. distribution and better inventory management to generate average cash flow margins of 6.0%.
Enbridge Inc. { ENB }
With the successful merger with Spectra Energy Corporation in 2017, Enbridge, a Canadian company, is now North America’s largest energy infrastructure company with strategic pipelines transporting crude oil, natural gas and liquids. Enbridge’s Mainline system moves two thirds of all crude oil exports from Canada and approximately 25% of North American crude oil. Canada’s oil sands supply is landlocked and separated by long distances from most of its refining markets and relies on pipelines for transport. Western Canada production is projected to exceed pipeline capacity, making the company’s Mainline system and its access to various North American refining markets more valuable. In gas transmission, ENB owns more than 30,000 miles of natural gas transmission pipelines and transports approximately 20% of all-natural gas consumed in the U.S.
Enbridge’s Mainline system moves two thirds of all crude oil exports from Canada and approximately 25% of North American crude oil. Canada’s oil sands supply is landlocked and separated from most of its refining markets by long distances and relies on pipelines for transport.
ENB assets are well positioned in the North American pipeline industry that possesses burdensome regulatory requirements, elusive right of way easements, lengthy development cycles and significant funding requirement – all of which raise high barriers for anyone outside incumbent operators to construct additional pipeline capacity. Moreover, ENB has a number of high-quality investment opportunities and has the capacity to invest $6 billion a year to further growth.
Generally, Enbridge will not pursue expansion opportunities without securing contracted capacity. The company is insulated from direct commodity price exposure as approximately 95% of cash flow is underpinned by long-term (10-20 years), fee-based contracts. However, the cyclical supply and demand nature of commodities and related pricing can have an indirect impact on the business as shippers may continue to accelerate or delay certain projects.
In addition to pipelines, the company operates a diverse energy portfolio as a distributor and operator of alternative energy. Enbridge owns and operates Canada’s largest natural gas retail distribution company and provides distribution services in New Brunswick, New York state, Ontario and Quebec. Enbridge is also Canada’s second largest wind and solar power generator. Beginning with its first investment in a wind farm in 2002, Enbridge committed $5.4 billion toward wind, solar, geothermal, power transmission and a host of other emerging technology projects. This segment accounts for a small but growing contribution to the company’s consolidated earnings. In 2022, the company acquired Tri Global Energy which had a strong track record of success in developing and integrating renewable energy projects in North America.
Due to its size and profile, Enbridge faces many challenges on its capital projects from environmental concerns. Permitting and regulatory delays could hinder the timeline of some projects. Enbridge’s Line 3 extension went through several elements of regulatory approval, and delays created cost overruns and reduced return on invested capital.
Regulated assets are subject to economic and political regulation risk by which regulators and other government entities may change or reject proposed or existing projects, including permits and regulatory approvals for new projects. Enbridge’s long-term thesis hinges on the ability to secure additional growth projects that drive earnings and dividend growth.
The Trump Administration’s threat of across-the-board tariffs have caused some concern for export-oriented Canadian companies. Enbridge has indicated that potential U.S. tariffs on Canadian crude imports have not yet had a major impact on cross-border flows. Although Enbridge would not pay the tariffs, as it does not own the crude shipments, its shippers could be subject to higher costs. Enbridge executives have discounted the long-term retention of tariffs because of the cross-dependency and interconnectedness of the energy system in North America.
With Enbridge positioned to benefit from growing oil sands supply with its Mainline system and increasing demand for natural gas, the company is positioned to generate significant free cash flow, allowing the company to grow its dividends and fund pipeline expansions and investments toward renewable energy. Based on these assumptions, our valuation model indicates a long-term average annual return of approximately 9.7%.
Eaton { ENT }
Established in 1911 as a manufacturer of truck axles, Eaton has transformed its portfolio through a stream of acquisitions in the past two decades. Today, it is a diversified global industrial company that manufactures components, systems and services that manage electrical and mechanical power. Eaton is a virtual pure play on the industrial economy, primarily selling to and providing services to original equipment manufacturers (OEMs). The company offers energy-efficient products and services in a wide variety of markets, including agriculture, data centers, military contracting, manufacturing, aviation, commercial and residential construction and healthcare. Eaton continues to position its systems and services toward less cyclical, faster growing, higher margin end markets.
Going forward, we believe the electrical equipment and systems market has good growth opportunities due to the need for electrical power capacity, regulatory changes driving energy efficiency, demand for power-hungry data centers, industrial digitization such as Artificial Intelligence (AI) driving data demand and power quality and safety.
Eaton is one of the leading global providers of electrical components and systems for power quality, generation, distribution and control. The company’s Electrical Group now accounts for over 70% of total revenues. Its electrical systems have had a slower growth profile versus its industrial businesses. Going forward, we believe the electrical equipment and systems market promises good growth opportunities due to the need for electrical power capacity, regulatory changes driving energy efficiency, demand for power-hungry data centers, industrial digitization such as Artificial Intelligence (AI) driving data demand and power quality and safety. In addition, Eaton should benefit from the growing demand to control power and mechanical systems remotely for electrical grids, factories and data centers. Management is also driving stronger through-the-cycle profitability and free cash flow through product line optimization, multi-year productivity plans and raising the overall level of operational excellence.
Through the years, Eaton has either innovated or acquired many forms of power management and distribution, focusing on highly engineered motors, drives and hydraulic systems used in various industrial end markets. The company’s industrial businesses (aerospace and vehicle) – which make up 30% of total company revenue – are market leaders with competitive advantages, including its manufacturing scale, cost advantages and high customer switching costs. These businesses have vast installed bases that grow primarily through innovation. Eaton’s installed bases require significant customer capital investment, which leads to good recurring aftermarket revenue streams. Eaton’s after-market services also serve to protect long-term customer relationships.
Eaton, along with its industrial peers, faces some operating challenges. Some of its domestic and international end-markets are tied to aerospace, vehicle and various commodities. A downturn in these markets will negatively impact Eaton’s earnings and return on invested capital. We believe these potential challenges to be cyclical in nature with good long-term prospects, particularly in aerospace and electric vehicles. Management’s current strategy, focused on structural cost reduction throughout the organization, should continue to lead to higher long-term operating profitability as these end-markets recover and grow.
In January 2025, news of DeepSeek, a Chinese artificial intelligence model demonstrated that its latest model chip, DeepSeek-R1, was more energy efficient than chips currently on the market. This news caused Eaton’s stock to pull back as it implied that the demand for electricity-to-power data centers might not be as strong as initially expected. Despite this report, many tech companies have reaffirmed their investment plans that will render electricity more widely used and in demand, which will benefit Eaton.
We believe the company’s leadership position, extensive installed base, recurring after-market service revenues and long-term customer relationships should provide support for long-term growth and higher profitability. We expect Eaton will grow revenues in mid-single digits on average with cash flow margins of 24% over our 10-year modeling period. Based on these assumptions, our stock valuation model indicates Eaton’s current stock price offers an average annual long-term rate of return of approximately 6.0%.
April 2, 2025
Specific securities were included for illustrative purposes based upon a summary of our review during the most recent quarter. Individual portfolios will vary in their holdings over time in relation to others. Information on other individual holdings is available upon request. The information contained herein has been obtained from sources believed to be reliable but cannot be guaranteed for accuracy. The opinions expressed are subject to change from time to time and do not constitute a recommendation to purchase or sell any security nor to engage in any particular investment strategy. Any projections are hypothetical in nature, do not reflect actual investment results and are not a guarantee of future results and are based upon certain assumptions subject to change as well as market conditions. Actual results may also vary to a material degree due to external factors beyond the scope and control of the projections and assumptions.