Cabot Stock of the Week Issue: April 10, 2023

Stocks dipped a bit in this holiday-shortened week, but it felt more like a calm-before-the-storm situation. This week we get the March inflation number (Wednesday), the Producer Price Index data (Thursday), and Q1 earnings season gets underway with several of the big banks reporting on Friday, which will be more interesting/telling than usual coming off of the first-quarter banking collapse. Odds are, the market – or at least sentiment – will change drastically in the next five days.

To get ahead of any potential bad news, today we’re adding some protection in the form of another value stock from Cabot Undervalued Stocks Advisor Chief Analyst Bruce Kaser. It’s a century-old company that pays a dividend and trades at just 12 times forward earnings – and yet has been building some nice momentum of late, up 14% year to date.

Here it is, with Bruce’s latest thoughts.

Sensata Technologies (ST)

Sensata Technologies (ST) is a $4.1 billion (revenues) producer of an exceptionally broad range of highly engineered sensors and electrical protection products used by automotive, heavy vehicle off-road, industrial and aerospace manufacturers. These products are typically critical components within cars, trucks, factories and jets, yet since they represent a tiny percentage of the end-products’ total cost, they generally yield high profit margins. Also, as their reliability is vital to safety and performance, customers are reluctant to switch to another supplier that may have lower prices but also lower or unproven quality. Sensata’s franchise provides it with a durable source of revenues and profits. The company is truly global as over 60% of its revenues are generated outside of the United States, with China producing about 20%.

The company was founded in 1916, owned by Texas Instruments for decades, and returned to public ownership in 2010. Sensata’s foundation has long been as a supplier to original equipment manufacturers (OEM) and Tier One suppliers. The automotive industry still provides about 52% of total revenues, bolstered by healthy vehicle demand and higher per-vehicle content from rising secular demand for improved fuel efficiency, safety, emissions, and customer conveniences like lane-keeping and other advanced driver-assist systems.

Since gaining its independence, Sensata has pursued new opportunities in adjacent markets. The on-road truck and off-road equipment (HVOR) markets, bolstered by growing demand for more and better sensors, now generate 22% of the company’s revenues. Similarly, expansion into industrial and aerospace applications, which produce 26% of sales, is providing further opportunities for growth.

Innovation is critical to the company’s margin strength and growth potential. Sensata’s gross margin of 32.7% last year suggests that the company has reasonably strong pricing power and a healthy competitive edge. In 2022, the company’s organic growth of 4.8%, which excludes acquisitions and currency changes, outgrew its underlying markets by 8.4 percentage points, helping it produce positive growth even as its end-markets shrank.

Sensata’s “megatrends” strategy of investing into long-term secular demand trends is driving its expansion into the electrification of vehicles, the related storage and charging infrastructure and high-value energy management and energy storage products across the automotive, industrial, aerospace and other end-markets. This megatrend offers considerable growth potential, such that, while once a threat, electric vehicles are now an opportunity – the company’s expanded product offering allows it to sell more content into an EV than it can into an internal combustion engine vehicle. Both internal development and acquisitions are producing the innovations that allowed Sensata to win $700 million of new business in Electrification last year.

Sensata’s shares have slid 40% from their year-end 2021 price, as rising interest rates have compressed most tech company valuations and as investors worry about Sensata’s slowing end-markets. Also hurting the company’s shares are its recent acquisitions. While providing valuable technologies and revenue opportunities, they have also weighed on Sensata’s operating margins. The company has recognized this issue and is re-focusing on integrating its new additions and raising prices, which should help it reach its 21% operating margin target.

The company’s balance sheet carries elevated debt of about 3.4x EBITDA, creating an additional drag as interest rates are now permanently higher. Sensata plans to trim its debt burden to 1.5x-2.5x EBITDA over the next few years, which should ease investors’ worries along with Sensata’s interest costs.

Revenue growth this year will likely be positive but subdued, then return to a more typical 7-8% pace. Earnings will likely increase about 10% this year.

Risks include a possible automotive cycle slowdown, chip supply issues, geopolitical issues with China, currency and overpaying/weak integration related to its acquisitions.

ST shares are undervalued at 10.4x estimated 2023 EV/EBITDA and 12.1x estimated 2022 earnings of $3.76. We believe the shares have considerable upside potential.

Current Recommendations

Changes Since Last Week: Arcos Dorados (ARCO) Moves from HOLD to SELL

We have one sell this week, as Latin American McDonald’s franchisee Arcos Dorados (ARCO) has underperformed for too long and it’s time to sell. Otherwise, most of our stocks are in good shape; some – like Microsoft (MSFT), Novo Nordisk (NVO) and Xponential Fitness (XPOF), to name a few – are in great shape.

Let’s examine what’s happening with all of them ahead of an eventful week for the market.

Updates

Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, was down again this past week, and we’re now close to breakeven on the stock. With shares of Latin America’s largest McDonald’s franchisee falling below their 200-day moving line for the first time since November, and Bruce having sold out of the stock months ago, let’s step aside here and make room for opportunities with higher upside down the road. MOVE FROM HOLD TO SELL

Cisco Systems (CSCO), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, lost a point this week after climbing close to new 52-week highs the week before. No matter – that’s normal consolidation after a nice run-up, especially considering the market was down slightly last week. The stock still has 29% upside to Bruce’s 66 price target. BUY

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, held firm, and has been in the 37-38 range all month. In his latest update, Bruce wrote, “With $120 billion in revenues, Comcast is one of the world’s largest media and entertainment companies. Its properties include Comcast cable television, NBCUniversal (movie studios, theme parks, NBC, Telemundo and Peacock), and Sky media. The Roberts family holds a near-controlling stake in Comcast. Comcast shares have tumbled due to worries about cyclical and secular declines in advertising revenues and a secular decline in cable subscriptions as consumers shift toward streaming services, as well as rising programming costs and incremental competitive pressure as phone companies upgrade their fiber networks.

“However, Comcast is a well-run, solidly profitable and stable company that will likely continue to successfully fend off intense competition while increasing its revenues and profits, as it has for decades. The company generates immense free cash flow which is more than enough to support its reasonable debt level, generous dividend and sizeable share buybacks.

“There was no significant company-specific news in the past week.

“Comcast shares rose 5% in the past week and have 10% upside to our 42 price target. The shares offer an attractive 3.0% dividend yield. Last month, given the decline in the shares, we restored our Buy rating.” We’ll keep it at Buy as well. BUY

Eli Lilly and Company (LLY), originally recommended by Tom Hutchinson in the Dividend Growth Tier of his Cabot Dividend Investor advisory, just keeps rising, up 17% in the last month. In his latest update, Tom wrote, “LLY was upgraded to a BUY a couple of weeks ago. After a stellar 2022 where it returned 34% in a bear market, LLY has pulled back this year. LLY is notoriously bouncy and tends to pull back after every surge. Despite the recent earnings stumble, this company still grew earnings 12.7% in 2022 and is expected to grow earnings by an average of 22% per year over the next five years. It also has two drugs that could be mega-blockbusters in the pipeline that could be approved in the next year. It made sense to buy the dip and the stock is already up about 15% since being upgraded.” BUY

Gates Industrial Corp. (GTES), originally recommended by Bruce Kaser in the Buy Low Opportunities Portfolio of his Cabot Undervalued Stocks Advisor, coughed up all of its gains from the previous week. Still, shares of this specialized producer of industrial drive belts and tubing are up 14% year to date and have 21% upside to Bruce’s 16 price target. BUY

Las Vegas Sands (LVS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, gave back a point after rising sharply the week before. But the gaming company still has plenty of momentum after data showed that gaming revenue in Macau more than tripled in March (+247%), boosting all casino stocks with properties in Macau. Mike’s premise in recommending LVS was that China’s casinos were about to get a flood of activity in the wake of the country finally reopening after several years of draconian zero-Covid policies. Last month’s numbers overwhelmingly support his theory, and the stock is now up 19.5% year to date. BUY

Kimberly-Clark de México (KCDMY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, has been essentially flat since we added it two weeks ago. The Mexican stock – which is a spin-off of Kimberly Clark (KMB) – is a play on Mexico’s manufacturing costs now being 25% lower than China’s or America’s, meaning increased demand from all over the world. BUY

Microsoft (MSFT), originally recommended by Tyler Laundon in Cabot Early Opportunities, hit another new high despite last week’s market pullback. The stock is now up nearly 20% year to date as investors flee to the relative safety of big tech mega-caps, including AAPL, NVDA and others. Microsoft’s leadership position in the surging artificial intelligence market is also helping, as Microsoft just unveiled the Microsoft 365 AI Copilot, which uses ChatGPT technology to create everything from Word documents to PowerPoint presentations to Excel spreadsheets. The new product prompted a round of analyst rating upgrades, including Mizuho bumping it to 315 a share. BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in his Cabot Explorer advisory, was flat this week after a big run-up the previous two weeks. In his latest update, Carl wrote, “A JPMorgan Chase analyst estimates that in the last week of January, American doctors wrote over 300,000 prescriptions for Ozempic – a 78% increase from the same period last year. Ozempic is approved for type 2 diabetes, but people have been taking the drug to lose weight because of its effectiveness.” BUY

Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, pulled back slightly along with the market last week. In his latest update, Tom wrote, “In a highly uncertain environment like this, where the narrative can change on a dime, income is king. And this legendary income REIT is the king of income stocks. It has paid 632 consecutive monthly dividends and increased the dividend payment 119 times since its IPO in the 1990s. And the REIT has been growing stronger through acquisitions of late. Earnings grew at 9.2% for 2022, which is above the historical average, and it did it in a challenging year. Despite being a retail REIT, the portfolio is largely staple properties like drug stores and supermarkets that are resilient in a slower economy.” HOLD

SiTime (SITM), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, was down more than 4% in its first week in the portfolio. There was no company-specific news, so the drop-off was likely market-related. SiTime is a fabless semiconductor company that provides MEMS (micro-electro-mechanical systems) and silicon-based timing systems. Apple is a major customer at 20% of revenue. Year to date, the stock is still up 29%. BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, had a bad week, falling more than 7% after the company announced more price cuts last Thursday. Tesla will slash Model S and X prices by another $5,000 – the third price reduction for those models already this year. Prices for the Model Y were cut by $2,000. The cuts are viewed as a response to the company’s first-quarter deliveries coming in short of estimates despite hitting a new quarterly record. Some have speculated that the shortfall will put a dent in the company’s usually pristine profit margins. We’ll know soon: Q1 earnings are due out on April 19. HOLD

Uber (UBER), originally recommended by Mike Cintolo in Cabot Growth Investor, has been stuck in a range between 30 and 32 for the past month. This seems like a very normal holding period after shares of the ride-sharing giant had broken out in January and early February – it’s still up 27% year to date and trades comfortably above its 200-day line (28). BUY

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, had a rare sharp decline this past week following a huge rally the week before. But the net result is that shares are right around where they were in late March, in the low 520s. There was no company-specific news, and the drop-off was likely due to a combination of market weakness and sellers coming for stocks with “meat on the bone.” Shares of the beauty retailers are still up 37% in the 11 months since they were added to the Stock of the Week portfolio. Given its stair-stepping history in recent months, the latest retreat might be an opportunity to add more shares. BUY

Visa Inc. (V), originally recommended by Tom Hutchinson in Cabot Dividend Investor, was down slightly this past week along with the market. In his latest update, Tom wrote, “V is tied to the fortunes of the more cyclical stocks in the near term. But it tends to outperform that group. It held up nicely in a very tough 2022 with a -3.4% return for the year, it’s up over 30% since the September low, and it has a better than 8% return YTD. Of course, it could be under pressure if the economic situation deteriorates. But the stock is still relatively cheap, and it should fly when the market eventually senses the end of this cycle and the next recovery.” BUY

Wingstop (WING), originally recommended by Mike Cintolo in Cabot Growth Investor, has been in a range between 176 and 187 for most of the past month. In his latest update, Mike wrote, “Stop us if you’ve heard this before: WING was looking picture perfect coming into this week, but some out-of-nowhere selling on heavy volume has knocked the stock down … though it’s still holding onto support. Yes, recession fears likely had a role in Tuesday’s selling, though it’s doubtful a cheap, fast-casual place like Wingstop would be crimped much if the economy goes south. Thus, our view here is very much like most of our other names, as (a) the story is still sound and growth should remain intact, but (b) much more weakness and we’ll potentially prune our position, selling a portion of our shares. At this point, with lots of support in the 165 to 170 area, we’ll sit on our hands.” Since we got in a bit later than Mike and are sitting on a decent gain, we’ll keep WING at Buy unless it dips below that 176 support level. BUY

WisdomTree Emerging Markets High Dividend Fund (DEM), originally recommended by Carl Delfeld in his Cabot Explorer advisory, is a rock. It keeps holding in the 37 to 39 range, unaffected by all the volatility and turbulence virtually everywhere else in the market. Our lone ETF offers a high dividend yield and some of the highest-quality emerging market stocks. The fund gives broad exposure with an emphasis on income and value. BUY

Xponential Fitness (XPOF), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, was up and down this past week, but ultimately remained near all-time highs above 31. The company continues to benefit from the world’s return to gyms in the wake of Covid – Xponential Fitness is the largest global franchise group of boutique fitness studios and brands. BUY

The next Cabot Stock of the Week issue will be published on April 17, 2023.