Cabot Stock of the Month Issue: May 11, 2023

Market Review

The markets traded sideways through most of April. But since then, the choppiness has returned—along with worries about the uncertainty regarding the debt ceiling, the expiration of the immigration-limiting legislation, and ongoing debate about the possibility of a recession.

Yet, economically speaking, the trends are still healthy. Manufacturing has held up, employment continues to rise, and job openings are still underutilized (as you can tell if you’ve been in a restaurant lately!).

Still a positive—despite doom and gloom forecasts, as well as rising mortgage rates—the housing market continues to thrive. That is, the market for new housing. Sales of new single-family houses in the U.S. soared 9.3% in the last reported month—a new high for the year. The seasonally adjusted annualized rate was 683K in March, handily beating forecasts of 630K. The biggest sales gains were in the Northeast and the West, followed by a small increase in the Midwest, and a bit of a decline in the South.

Prices are still up—with an average sales price of $562,400, compared to $511,800 a year ago.

The earnings season is winding down. So far, 85% of the S&P 500 companies have reported quarterly earnings; 79% of them have reported a positive EPS surprise and 75% of S&P 500 companies have reported a positive revenue surprise.

FactSet continues to forecast an overall blended earnings decline of 2.2%, which is better than the -6.7% predicted at the end of March.

Style wise, growth stocks are still outperforming value, especially large caps, which are up 15.35% year-to-date.

As for sectors, the two best are Communication Services stocks, up 21.55%, followed by Technology (up 21.54%). On the losing end are Financial Services (down 5.47%) and Energy (down 8.28%).

Here at Cabot, we’re still seeing promising signs of a market rebound, but investors continue to sell into the strong days, so we’re remaining cautious for now.

Feature Recommendation- Brookfield Infrastructure Partners L.P. (BIP): An Undervalued Infrastructure Play

My recommendation today comes from Tom Hutchinson, Chief Analyst, Cabot Dividend Investor and Cabot Income Advisor.

In our interview, Tom told me that one of his favorite companies in his portfolio is Brookfield Infrastructure Partners L.P. (BIP), noting that “This company is one of the oldest hands at investing in infrastructure assets all over the world. The company focuses on high quality, long-life properties that generate stable cash flows, have low maintenance expenses and are virtual monopolies with high barriers to entry.

“Its assets are among the most reliable and defensive revenue generators anywhere with properties like toll roads in South America, natural gas pipelines in North America, and cell towers all over the world. There are also automatic inflation adjustments built into its long term contracts. The is a great stock anytime, but the relative performance should be superior amid recession and inflation.”

In his original recommendation, Tom had this to say about Brookfield: “The company particularly focuses on high quality, long-life properties that generate stable cash flows, have low maintenance expenses and are virtual monopolies with high barriers to entry.

“BIP was established by world renowned, Toronto-based asset manager Brookfield Asset Management (BAM) in 2008 to take advantage of the infrastructure build-out. BAM still acts as manager and General Partner and owns a 30% stake in BIP.

“While infrastructure investing has recently started to boom, Brookfield was early to the party. BIP has had the foresight to scour the globe and pluck the very best assets before much of the potential competition got wise to the phenomenon. It now has valuable partners and contacts all over the world that enable the company to find profitable projects as they become available.

“Brookfield has a current portfolio with 2,000 assets in 30 countries on five continents. The assets are diverse and well-chosen for reliable cash flow and profitability. They are vital properties that continue to generate cash in any economy and are tailor made to generate dividend income.

“As a Master Limited Partnership (MLP) BIP pays no income tax at the corporate level provided the bulk of earnings are paid out to shareholders in the form of distributions. As a result, it has a higher payout than most regular dividend stocks.

“MLPs are not a perfect structure because most pay out all the earnings in distributions and have to either issue new stock shares or borrow money to get funds for expansion. The strategy can dilute shareholder value and raise too much debt over time. In order to maintain the strong balance sheet with investment grade rated debt and maintain shareholder value, Brookfield shifted gears on its strategy.

“To raise capital, it is now relying on asset rotation in addition to retained earnings. The idea is to sell mature assets when returns have maximized and use the proceeds for high return projects.”

Tom shared further insights into Brookfield in a recent update to his subscribers, saying, “The infrastructure juggernaut has been bouncing around to nowhere since the end of 2020. The stock had been held back more recently by a strong dollar and higher lending rates, but those things have been receding and BIP has been acting better.

“It recently hit the highest price level since last fall until pulling back again but it’s still up 10% YTD. The stock is now right around the midpoint of its 52-week price range and should be a solid holding amid inflation and/or recession. Brookfield reports first-quarter earnings this week and the stock could get a lift. (This security generates a K-1 form at tax time.) BUY”

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About the Analyst: Tom Hutchinson, Chief Analyst, Cabot Dividend Investor and Cabot Income Advisor

Tom Hutchinson is a Wall Street veteran with extensive experience in multiple investing and finance disciplines. Tom’s expertise includes specialized areas of mortgage banking, commodity trading, and in a financial advisory capacity for several of the nation’s largest investment banks.

For more than a decade, Tom created and actively managed investment portfolios for private investors, corporate clients, pension plans and 401ks. He has a long track record of successfully building wealth and providing a high income while maintaining and growing principal. As a financial writer, Tom’s byline has appeared in The Motley Fool, StreetAuthority, Newsmax and more.

He has written newsletters and articles for several of the nation’s largest online publications, conducted seminars and appeared on several national financial TV programs. For the past 10 years, Tom has authored a highly successful dividend and income portfolio with a stellar track record of success.

With the stock market seemingly stuck in a sideways environment lately -- a situation that usually finds investors looking for some conservative, income-generating ideas – I decided to ask Tom, Cabot’s dividend expert, for his thoughts on markets, sectors, and the current turmoil in regional banks. Here’s our interview:

Nancy: Please share your thoughts and concerns re: the banking industry, specifically the recent collapse of Silicon Valley Bank, the closure of Signature Bank and the buyout of Credit Suisse by UBS and First Republic by JPMorgan. Is this the beginning of a larger crisis in the banking industry? What is your opinion of the deposit guarantees for Silicon Valley’s uninsured account holders?

Tom: The banking situation has already escalated to a wider crisis than commonly believed just a week or two ago. Silicon Valley Bank failed in early March. The failure of First Republic last week proves the crisis isn’t over. Now, PacWest and other regional banks are under pressure. And there is a possibility many more banks could fail.

I still don’t believe it will be a market-shattering event, at least at this point. But this probably isn’t over yet. More bank failures will cause more ugly days in the market.

Perhaps more impactful is the fact that the crisis increases the likelihood of a recession later this year or early next, as the hugely important smaller banks will no doubt be less willing to lend.

The deposit guarantees calm the waters in the near term. But they will likely cause more problems over the longer term. If bad behavior is rewarded, you tend to get more of it. Taking responsibility for sound financial decisions away from banks and large depositors and placing it on the taxpayers will only weaken the banking system longer term.

Nancy: Morgan Stanley recently reported that they believe commercial real estate values could tumble 40% in the near future, due to the repricing to higher rate debt, as well as the expected glut of office buildings following COVID. Do you agree, and if so, what are your expectations for the commercial REIT business?

Tom: The commercial real estate situation is very concerning. I don’t really have a good feel for the situation myself. But there is the potential that falling commercial real estate will cause a bigger banking crisis.

Nancy: And speaking of REITs, I noticed that you put a hold on Realty Income (O) and sold Medical Properties Trust (MPW). Please comment on your thinking.

Tom: O was lowered to a hold for mostly technical reasons. MPW has problems that the market simply will not forgive or look past until the REIT proves otherwise. And that will take some time. Those two downgrades were more about the individual REITs than concern with the sector as a whole.

Nancy: I note that the investment banking industry is beginning to change their minds on the REIT outlook for this year, saying that strong balance sheets, as well as increasing IPO activity suggest an improving industry. Do you agree?

Tom: REITs have two problems right now, high interest rates and low stock prices. As tax advantaged securities, they pay out the bulk of earnings in the form of dividends. Without retained cash, they have to borrow or issue new stock to raise money for expansions and acquisitions. The high rates and low prices raise costs and reduce the feasibility of most potential expansions and therefore stunt the growth of most REITs.

Of course, the sector is cheap and individual opportunities are emerging. But the interest rate/stock price dynamic needs to improve before I will get bullish on the overall sector.

Nancy: Your portfolio includes several energy companies. Do you think they will benefit from the recent OPEC supply cuts? How do you see 2023 shaping up for that sector?

Tom: That’s a tricky one. It’s important to note that the energy stocks in the portfolio are all midstream companies. Profits for these companies are not levered to the price of oil and gas. They generate revenue from fees charged for the transport, processing, and storage of oil and gas.

The overall energy sector is mostly about prices, and prices are in sort of a tug-of-war right now. The increased possibility of recession is a drag on prices, as demand for oil and gas will fall. Prices always fall on those days when recession fears take center stage. But that drag is offset by China’s ending of COVID restrictions and return to activity, OPEC’s production cuts, and continued global supply constraints.

I do believe prices are cheap relative to where they are likely to average over the next year or two. Oil prices fell below $70 per barrel this week, from a high of over $120 last June. That’s better than the 40% plunge largely caused by a restricted Chinese economy, which is coming back. Goldman Sachs is saying that oil prices will rebound as high as $95 per barrel by the end of the year.

In short, I think energy is cheap and will reward longer-term investors, and perhaps even short-term investors. But there is a risk that they decline further if a recession does unfold in the quarters ahead. Investors will be rewarded over time but need to have the belly for some potential volatility along the way.

Nancy: Are there any sectors or sub-sectors that you currently see as oversold?

Tom: I like the defensive sectors, particularly utilities. Defensive stocks struggled early in the year during the cyclical rally. But the sector is one of the best performing over the last month as recession fears have grown. But the most oversold sector is energy. The S&P 500 energy companies have an average P/E ratio of 6.7, by far the lowest of any of the 11 sectors and well below the S&P 500 average of about 20.

Nancy: What are the 3-5 most critical challenges to growth of the stocks in your portfolio right now?

Tom: I would say recession, inflation, and stagflation. The risk of recession and uncertainty about the stickiness of inflation and the Fed’s reaction to it is holding back the market and will likely continue to do so until there is more clarity.

Stagflation is also a possibility. Stocks have risen this year and have been buoyant under the circumstances. It’s possible that the market remains solid without another major selloff. At the same time, the recovery might be lame as the Fed will have to keep rates high, or at least much higher than in past recoveries. The big downs and ups of the past may give way to a lasting choppiness with slow growth and continued inflation.

Portfolio Updates

Bruce Kaser, chief analyst Cabot Value Investor and Cabot Turnaround Letter, recently updated his view on M/I Homes (MHO), saying, “On Friday, April 28, shares of M/I Homes (MHO) reached our 67 price target. The company reported strong first-quarter results, its balance sheet is robust, and the outlook is encouraging, yet the shares continue to trade at only 88% of tangible book value. We incrementally raised our price target to 71.”

As I noted in my Market View section, the new homes market has been on fire recently. Finished new homes are double the 2021-2022 lows, but 84% of the current inventory is not yet completed. And with improving building supply availability, declining cycle times, and continuing higher demand than supply, the near future looks bright for the home builders.

Some of the largest builders, including Beazer Homes, D.R. Horton, and PulteGroup have all beaten earnings estimates, by 34.5%, 21.6%, and 32.0%, respectively.

And MHO didn’t disappoint, reporting an earnings rise of 54.2% and revenue increase of 9%. The company posted EPS of $3.64 per share, compared to $3.16 a year ago. Over the last four quarters, the company has surpassed consensus EPS estimates four times.

Earnings estimates for the company continue to rise, up 11.5% in the last 60 days.

I’m going to go a little cautious here, as expectations of a recession are still strong, and if that happens, housing will definitely suffer. Consequently, let’s take some of our profits from MHO off the table. The shares are up almost 54% from my original recommendation, so let’s Sell one-half, and let the other half ride.

Tom Hutchinson recently posted an update on Qualcomm (QCOM), saying, “This is a great longer-term stock of a company with a huge share of mobile 5G chips and strong exposure to some of the fastest growing areas in technology. Meanwhile, it sells at a very cheap valuation by historical standards. QCOM has been pushed around by the sector since it’s been under pressure but there has been new life lately. Inflation is coming down, interest rates are falling, and technology is the best performing sector YTD with the group up more than 20%. At some point this year, the market should start sniffing out the recovery, if one hasn’t already begun. And QCOM can make up for lost time fast when it moves. HOLD”

Shares fell when the company reported earnings, as the report was mixed. The $2.15 per share EPS met analysts’ expectations, and sales beat, coming in at $9.28 billion, both down for the year.

That was expected, but the impetus for the stock’s decline was the company’s forecast for the current quarter, adjusted earnings of $1.80 a share on sales of $8.5 billion, which was lower than analysts were predicting (earnings of $2.17 a share on sales of $9.13 billion).

But it looks like better days for the company are ahead. As I have previously noted, the company is expanding its auto business. And that segment was boosted by Qualcomm’s announcement that it is acquiring Israel’s Autotalks Ltd, a maker of chips used in crash-prevention technology in vehicles. Sales from the auto business rose 20% to $447 million in the second quarter, ended March 26.

Bottom line, Qualcomm remains profitable, has excellent free cash flow and a nice dividend yield of 2.94%, while we wait for price appreciation.

Let’s continue to Hold.

Devon Energy (DVN) reported that oil production reached an all-time high of 320,000 barrels per day in its first quarter. The company posted net earnings of $995 million, or $1.53 per share, in its first quarter. That was a nickel more than analysts had predicted for earnings.

Devon also increased its share-repurchase authorization by 50%, to $3.0 billion. The company has repurchased $692 million of shares year-to-date.

Like Tom Hutchinson, I think this sector is oversold, so let’s continue to Hold for now.

In a recent posting, Bruce Kaser, Chief Analyst of Cabot Turnaround Letter and Cabot Value Investor, commented on his Citigroup (C) recommendation, saying, “On April 14, Citigroup reported a good first quarter, with adjusted earnings of $1.86/share falling 1% from a year ago but 11% above the $1.67 consensus estimate. Revenues rose 12% due to higher interest rates, as fee income slipped 3%. The net interest margin of 2.41% improved from 2.05% a year ago and 2.39% in the prior quarter.

“The sale of First Republic Bank to JPMorgan is an incremental positive for all banks, as it averts a highly likely collapse of the struggling bank. However, it seems unlikely that there will be no other fallout from the Fed’s aggressive rate hike campaign.

“Citi shares remain attractive as they trade at 57% of tangible book value of $84.21 and offer a sustainable 4.3% dividend yield. BUY”

These shares remain very undervalued. I agree with Bruce. Buy.

Our speculative holding, Curaleaf (CURLF), recommended by Michael Brush, Chief Analyst of Cabot Cannabis Investor, is still underwater, but Michael believes that it’s just a matter of an industry that hasn’t yet met its potential. In his recent update, he noted, “Shares of Curaleaf (CURLF), arguably one of the better companies in the space, are down 72% from where they traded right after its 2018 initial public offering. It has fallen to 2.29 from 8. Yet during the same time, it grew revenue to around $1.4 billion from $75 million, says Curaleaf founder and CEO Boris Jordan. “We have not had a down retail quarter,” says Jordan. “Every single quarter we have had more retail customers than in the prior quarter.”

“Cannabis stocks overall are down 90% from their February 2021 peak, even though several states have legalized since then and more people join the ranks of users, driving up annual legal cannabis sales to a current annual run rate of around $30 billion, from $25 billion in 2021.

“Curaleaf is opening two dispensaries in Florida in Boca Raton and West Palm Beach, bringing its total in the state to 60 stores. It is also launching its premium cannabis flower and pre-roll brand Grassroots in the Sunshine State. Curaleaf executive chair Boris Jordan says the company is emphasizing growth in Florida, Arizona, New Jersey, Illinois, Pennsylvania, and Massachusetts. It is rolling out automation in Florida to reduce costs. It also just bought a medical dispensary chain called Deseret Wellness in Utah, a high-growth and high-margin state.

“Curaleaf has a price/sales ratio of 1.41. BUY”

The company will report earnings on May 17. Analysts are forecasting a loss of $0.05 per share on revenues of $332.98 million.

These shares are for the long-term; buy for the speculative section of your portfolio.

Tyler Laundon updated his view on Huron Consulting (HURN), saying, “Huron Consulting (HURN) will be out with Q1 results next Tuesday, May 2. Recall that in Q1 revenue in the Digital capability (44% of total revenue) rose 37% to $130.1 million. Management said healthcare (+18%) and education (+44%) were very strong markets as well. In Q1 we’re looking for revenue to grow 13% to $299.6 million and EPS to grow 35% to $0.66. For the full-year revenue is seen up 8% to $1.25 billion while EPS should grow 18% to $4.05. HOLD”

Huron’s earnings report was excellent. The company posted quarterly earnings of $0.87 per share, beating the analysts’ estimates of $0.67 per share, and walloping last year’s earnings of $0.49 per share.

Revenues came in at $317.9 million, beating the estimate by 4.96%, and considerably higher than year-ago revenues of $260.05 million.

Over the last four quarters, the company has surpassed consensus EPS and revenue estimates four times.

The shares of Huron Consulting (HURN) were recently upgraded to a Zacks Rank #2 (Buy). This upgrade is essentially a reflection of an upward trend in earnings estimates

The company also maintained its 2023 revenue forecast of $1.22 billion to $1.28 billion, EBITDA as a percentage of revenues of 12.0% to 12.5% and non-GAAP adjusted diluted earnings per share of $3.75 to $4.25.

Continue to hold.

Carl Delfeld, Chief Analyst of Cabot Explorer, advised subscribers to Sell shares of Kraken Robotics (KRKNF), saying, “Kraken announced a $4 million follow-on order from a NATO Navy client, but this stock is just not moving despite the company expecting to post a profit in the coming year. Part of the problem is that management puts a low priority on investor relations and communications. Let’s step aside. Move from Buy a Half to Sell.”

I agree. No matter how well a company’s fundamentals look, if no one is paying attention to the shares, we could be waiting a long time for appreciation. Sell.

After some unexplained selling in Shift4 (FOUR), Mike Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader, had this to report: “Shift4 was walloped today after earnings, though there was no obvious reason why: Q1 was a great one for the company, with revenue less network fees up 34% on a 66% gain in transaction volume, once again thanks to both its core restaurant and hospitality clients and many newer industries, too. (In that new category, the top brass said Shift4 went live at a mega-resort in Arizona, two “large Las Vegas properties,” the Chicago White Sox and the Washington Commanders while inking a deal with Six Flags to run their food and beverage payment system.)

“Meanwhile, EBITDA doubled, earnings topped estimates and management actually nudged 2023 guidance higher, including the fact that it now expects free cash flow of at least $225 million (well over $2.50 per share). Of course, the fear is that the Fed is going to crush the economy, which will crush consumer spending, which would in turn crimp Shift4’s growth.

“That’s always possible, but given our small position (4% of the portfolio) and the fact that FOUR is down in an area of support, we’ll stick with our position a bit longer and see if we see any snap back action in the days ahead. HOLD”

I agree; let’s change our recommendation to Hold for now.

Tyler Laundon commented on our newest recommendation, TransMedics Group (TMDX), noting, “TransMedics reports on Monday, May 1. Revenue is expected to rise 127% to $36.1 million while EPS loss is seen improving by 34% to -$0.25. For the full-year revenue is expected to be up 71% to $160 million while EPS loss is seen improving by 33% to -$0.82. HOLD THREE QUARTERS”

The company did indeed report earnings, with a revenue increase of 162%, to $41.6 million, beating estimates by $38.1 million. EPS loss was -$0.08. The company’s Heart segment grew 15% to $16.9 million, Liver grew 43% to $23.1 million, and Lung slowed to $1.6 million (a segment that the company is targeting for expansion in the next couple of quarters).

Looking forward, management increased their revenue growth outlook from a range of $138 - $145 million to $160 - $170 million (+71% - 82%).

I think these shares have a long trajectory ahead. For now, let’s continue to buy on any retracement.

Portfolio

*Aggressive (A), Moderate (M), Conservative (C)

ETF Strategies

Currently, First Trust Water ETF (FIW), iShares US Energy (IYE), AGF U.S. Market Neutral Anti-Beta Fund (BTAL), ALPS Medical Breakthroughs ETF (SBIO), Vanguard Dividend Appreciation Index Fund (VIG), US Healthcare Ishares ETF (IYH), and Communication Services Select Sector SPDR Fund (XLC) are showing positive returns.

I haven’t yet seen an entry signal for adding new funds, but I have started a Watch List, as follows:

US Medical Devices Ishares ETF (IHI)

Dynamic Semiconductors Invesco ETF (PSI)

Innovator Ibd Breakout Opportunities ETF (BOUT)

O’s Russell Smallcap Qlty Divd ETF (OUSM)

Adaptive Growth Opportunities ETF (AGOX)

I’ll keep an eye on these and send you some ideas for building out your portfolio with a few of them once I see buy signals.

Portfolio

*Aggressive (A), Moderate (M), Conservative (C)

Infrastructure: Waiting for Funding and Ready to Take Off

Zion Market Research estimates that the global Infrastructure market—valued at around $3.1 Trillion in 2021—is forecast to reach $5.9 Trillion by 2028.

Guggenheim Investments adds, “There is a US $4.5 trillion annual global infrastructure investment need and US $2.5 trillion annual shortfall in infrastructure investment. $4.5 trillion is needed annually to fulfill the 17 United Nations Sustainable Development Goals (SDGs) from now until 2030, with a current annual shortfall of US $2.5 trillion.”

And that’s great news for Brookfield Infrastructure. As Tom mentioned, the company’s strategy of asset rotation is working well. Last year, Brookfield saw 10% Organic growth and 10% from asset rotation. Four asset sales were secured, and three more are in progress, with five new investments coming online.

The company says its main drivers are:

Organic growth:

• Capture inflation and margin expansion in our business
• Execute and replenish capital backlog

Capital Deployment :

• Invest capital targeting 12–15%+ returns

And its three global themes—Digitalization, Decarbonization, Deglobalization—are motivating many of its investments

It sees exceptional market opportunities in:

• Fiber Networks: Once-in-a-100-year investment cycle to upgrade copper networks
• Wireless Infrastructure: Incremental towers required to support 5G, IoT and AI
• Data Centers: 10,000 MW of incremental capacity required

Right now, Brookfield Infrastructure Partners L.P. (BIP) has built up a huge infrastructure portfolio, accounting for some $45 billion in physical assets today.

Recently, the company entered a partnership with Intel, for a new semiconductor fabrication facility in Arizona. Intel will retain 51% and operating control of the facility while BIP retains 49% of this $30 billion facility. BIP’s $15 billion contribution will include very little debt. Instead, it will mostly be funded by retained cash flows and capital recycling of current investments, along with a portion funded by non-recourse debt. The company’s expected rate of return is 4% - 8.5%.

Brookfield also recently said it would buy “a premier European data center platform for $2.4 billion,” which will provide incremental recurring cash flow from 100 megawatts (MW) of in-place capacity. Additionally, the company and its partners have disclosed plans to extend capacity by 400 MW over the next few years.

Lastly, Brookfield has announced that it is also acquiring Triton International (transportation logistics) in a $13.3 billion cash-and-stock deal.

Analysts are expecting BIP to see its earnings grow by more than 70% next year and an average of 33% over the following five years.

Brookfield has increased its payout for 14 straight years, and is currently paying a dividend yield of 4.33%.

Growth, valuation, and a great dividend yield—Brookfield looks like a good “Buy.”

The next Cabot Money Club Stock of the Month issue will be published on June 8, 2023.