Cabot Stock of the Week Issue: December 5, 2022

Stocks continue to make slow-but-steady progress, even factoring in today’s drop-off. After rising 8% in October, the S&P 500 tacked on another 5.4% gain in November. That’s real, tangible momentum. And while stocks keep getting rebuffed at their 200-day moving average, and the market is always one hawkish comment from a Fed member away from another big retreat these days, we’d rather observe than prognosticate. Our observation? The evidence is improving. Accordingly, you should be buying stocks.

That said, keeping some amount of cash on the sidelines in this environment is still a wise choice. We have no sells today, so with our new addition (see below), that brings our portfolio up to 18 stocks out of a maximum of 20. In essence, that leaves us with only 10% of “cash” on the sidelines. So, in a way, we’re going against our own advice here. But all our stocks are acting well – or well enough to warrant inclusion. A couple of them are touching, or topping, all-time highs. There wasn’t one obvious laggard. So, 18 stocks it is.

What’s the 18^th stock? It’s a familiar name that has fallen on hard times in recent years, but has started to show signs of life, and has developed into quite the value play, according to Bruce Kaser, Chief Analyst of our Cabot Undervalued Stocks Advisor.

Here are Bruce’s latest thoughts on it.

Cisco Systems (CSCO)

Cisco Systems Inc. (CSCO) is a technology giant that generates over $50 billion in revenues. Its routers, switches and other gear connect and manage corporate, government, telecom and other data and communications networks. Augmenting this gear is Cisco’s broad range of applications, integration and security software and related services that allow the company to provide one-stop-shop capabilities yet also customize packages that match each customer’s needs.

Founded in 1984, Cisco emerged as a dominant provider of internet hardware and became one of the Silicon Valley tech darlings during the late 1990s dot-com bubble. However, due to its then-extreme overvaluation and stagnating revenue growth, Cisco’s share price fell sharply and still remains 40% below its March 2000 peak of about 80. Investors worry about how Cisco will generate any growth as it faces a secular headwind – its core business struggles against the rising adoption of cloud computing, which reduces the need for Cisco’s gear and its one-stop-shop capabilities.

However, Cisco’s prospects have been improving, starting with the promotion of company veteran Chuck Robbins to the CEO seat in 2015. Supporting his efforts on the financial side, Cisco replaced its CFO in December 2020 with Scott Herren. Herren previously helped Autodesk achieve a similar and successful rebuilding. From a strategic perspective, Cisco benefits from its strong reputation and entrenched position within its customers’ infrastructure. As long as it can stay close enough to competitors’ offerings, the company should retain these valuable intangible assets and buy itself plenty of time to transition to healthier growth.

Under the new leadership, Cisco is accelerating its efforts to remain relevant and increase its value. It continues to build out its offerings in the critical and faster-growth cloud services, hybrid work, security and 5G categories. To provide more recurring revenues and reduce its dependence on one-time equipment sales, Cisco is shifting its business mix to a software and subscription model. Progress is encouraging, with total revenues growing at a 3-4% annual pace, with future growth projected at a 3-5% pace. Software sales now comprise nearly 30% of total revenues, and 43% of all revenues are sold on a subscription basis. The company’s most recent quarterly results, reported on November 16, were reasonably robust and provided encouraging visibility in future revenue and profit growth. And, unlike many other tech companies, Cisco has kept a tight leash on its expense base.

Financially, Cisco is solid. It is highly profitable, with a wide 62% adjusted gross margin and an impressive 27% net profit margin. Free cash flow of nearly $13 billion last year was almost 25% of revenues – a rare feat for any company. Cisco is returning this cash to shareholders: last year about 81% of its free cash flow was distributed as share repurchases and dividends. Over the past five years, Cisco has reduced its share count by over 18%. The balance sheet is fortress-like as it holds cash that exceeds its total debt by $11 billion.

The company has its challenges. It continues to wrangle with supply chain issues, although these appear to be incrementally fading. Cisco faces constant pricing pressure, particularly on its hardware. And the company won’t be immune to the emerging slowdown in technology spending. We are also a tad wary of its generous stock-based compensation program but recognize the company’s need to retain capable talent.

Overall, Cisco is a solid and resilient company with improving growth prospects that investors continue to underestimate. The shares trade at an unchallenging 11.2x operating cash flow and 14x earnings per share based on recession-minded fiscal 2023 estimates. The 3.1% dividend yield, which is readily sustainable, adds to the shares’ appeal. With continued revenue growth and solid cash flow production, we see Cisco shares having a prosperous future.

Current Recommendations

Changes Since Last Week’s Issue:

Ulta Beauty (ULTA) Moves from Hold to Buy

Only one change today, and it’s a positive one – Ulta Beauty (ULTA) moves from Hold to Buy after the popular beauty retailer blew third-quarter earnings out of the water last week and shares subsequently ascended to new all-time highs. ULTA has been on a tear, but it’s not the only stock in our portfolio on an upward trajectory.

Here’s what’s happening with all our stocks.

Updates

Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, keeps holding steady in the 7.2 to 7.6 range. No real news here. In his latest update, Bruce wrote, “Arcos Dorados (ARCO), which is Spanish for ‘golden arches,’ is the world’s largest independent McDonald’s franchisee. Based in stable Uruguay and listed on the NYSE, the company produces about 72% of its revenues in Brazil, Mexico, Argentina and Chile. At our recommendation date, the shares were depressed as investors worried about the pandemic, political/social unrest, inflation and currency devaluations. However, the company has a solid brand, high recurring demand, impressive leadership (including founder/chairman who owns a 38% stake) and successful experience in navigating local conditions, along with a solid balance sheet and free cash flow.

“Macro issues have a sizeable impact on the shares’ trading, including local inflation and the Brazilian currency. Since early 2020, the currency has generally stabilized in the 1.00 real = $0.20 range – a remarkably favorable trait given the sharp declines in other currencies around the world. As the company reports in U.S. dollars, any strength in the local currency would help ARCO shares.

“On November 16, Arcos reported an impressive third quarter that reflects the abilities of its strong leadership and brand to navigate the post-pandemic period. Revenues rose sharply (+38% in constant currency) even with high inflation/currency erosion in Argentina that dragged reported revenues down to +17%. Revenues were about 3% above estimates. Adjusted earnings of $0.23/share nearly doubled from $0.12 a year ago and were nearly double the consensus estimate of $0.12/share. Adjusted EBITDA of $103 million rose 15% from a year ago and was 13% above estimates. In local currency, Adjusted EBITDA rose 27% but was weighed down by higher food, paper, royalty fees and overhead costs.

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

“ARCO shares rose 1% this past week and have 16% upside to our 8.50 price target.” BUY

Brookfield Infrastructure Partners (BIP), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, tumbled from 37 to 35 since we last wrote. There was no obvious reason for the fall, though BIP was perhaps due for a pullback after rising from 32 in mid-October. Keep holding. HOLD

Centrus Energy (LEU), originally recommended by Carl Delfeld in Cabot Explorer, remains in its monthlong range between 36-40, though the range is tightening, which could be a nice setup for a potential breakout soon. In his latest update, Carl wrote, “The company is well positioned to benefit from growth in next-generation nuclear technology, helping provide reliable and carbon-free electricity. … This nuclear fuel supplier for utilities in the U.S. and abroad has net income margins that are above 50% so far this year with new nuclear fuel sales contracts and commitments worth an estimated value of $270 million.

“Nuclear power provides 20% of the power for our electricity grid and more than 50% of U.S. emission-free energy, according to the Department of Energy.” HOLD

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, was essentially flat in the past week. 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, pay a generous dividend (recently raised 8%) and sizeable share buybacks.

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

“Comcast shares rose 1% for the past week and have about 19% upside to our 42 price target. The shares offer an attractive 3.0% dividend yield.” BUY

Corteva (CTVA), originally recommended by Carl Delfeld in his Cabot Explorer advisory, continues to chop around in the 64-67 range, where they’ve been since late October. Plenty of chop, but no real movement. The latest news, according to Carl, is that “the company agreed to buy biologicals firm Stoller Group for $1.2 billion, adding operations and sales in more than 60 countries and $400 million in forecast revenues from the deal.

“Corteva uses emerging technology to help farmers improve crop yields and boost output. While the market is down sharply over the past year, Corteva is up more than 40%. Although the down market does lead to quality companies that grow revenue and net profits trading at bargain prices, a strong case can be made for stocks like Corteva that are recession-resistant and outperforming the market on a relative basis. Recently, Corteva reported a 12% increase in net sales and beat earnings expectations by about 50%.” BUY

Enphase Energy (ENPH), originally recommended by Mike Cintolo in Cabot Top Ten Trader, broke out to new all-time highs above 330. This is a very bullish sign after the stock had repeatedly hit a wall in the 320-325 area on previous breakout attempts. In his latest update, Mike wrote, “Fundamentally, we’re encouraged that ENPH and solar names, in general, have held their own despite weak oil prices; historically the groups would move somewhat in tandem, but it’s good to see solars dance to their own drummer given the demand trends in the U.S. and overseas. All in all, we think this stock can help lead the market’s next uptrend—we’ll hold onto our half-sized stake (if you’re not yet in, we’re OK starting a position around here), and will look to average up on any decisive upside action along with a more solid market environment going forward.” Barring a huge dip in the next few weeks, ENPH has been our single best performer in 2022. And it might not be done yet. BUY

Green Thumb Industries (GTBIF), originally recommended by Tim Lutts and then Michael Brush in the Sector Xpress Cannabis Advisor, had a huge breakout this past week, leaping from 12 to 16 – its highest point since April! Some of those gains have come today after President Biden signed legislation to expand cannabis research, which boosted all marijuana stocks. But GTBIF was already on an upswing prior to this morning. In his latest issue, Michael drilled deeper into the reasons behind Green Thumb’s recent strength: “Green Thumb manufactures and distributes a portfolio of branded cannabis products including &Shine, Beboe, Dogwalkers, Doctor Solomon’s, Good Green, incredibles and RYTHM. The company operates a national retail cannabis store called RISE. It has 77 retail stores.

“Green Thumb is expanding its medical footprint in Florida through a lease agreement with the convenience store chain Circle K. Through this exclusive agreement, Green Thumb can lease space adjacent to Circle K stores. Green Thumb is starting with a ‘test and learn phase’ that will see about a dozen medical dispensaries at Circle K convenience stores and gas stations in 2023. This could be a big deal since the Circle K chain has 600 locations in Florida.

“Green Thumb reported 3% sequential Q3 sales growth and 12% year-over-year growth to $261 million, on November 2. Year-to-date revenue increased 17% to $758 million compared to the first nine months of 2021.

“Revenue growth was primarily driven by increased retail sales in New Jersey and Illinois, the addition of 12 retail locations, and increased store traffic. Same-store sales (at stores open at least 12 months) declined 1.6% as price compression offset continued traffic and volume growth. Gross margins slipped to 50.2% from 55.4% in the comparable period last year. Green Thumb posted its ninth consecutive quarter of positive net income, delivering $10 million, or four cents a share in profits. The company reported $48 million in cash flow, and cash of $147.3 million against $255.5 million in debt.

“Key performance drivers for the retail business for the quarter were: Legalization of adult use sales in New Jersey; new store openings and store purchases, particularly in Illinois, Maryland, Massachusetts, Minnesota, Rhode Island, and Virginia; and increased store traffic particularly in Illinois.

“Green Thumb trades at a price-to-sales ratio of (3.65), which seems reasonable given its 12% year-over-year sales growth. Ongoing market developments in Illinois and New Jersey could be strong catalysts for Green Thumb Industries, says Stifel, which has a buy rating on the stock. Illinois will increase its store footprint by more than 2.5 times. Considerable upside exists in New Jersey as product offerings expand.

“A positive here is that Green Thumb is founder-run. Founder Ben Kovler is chairman and CEO. Research shows that founder-run companies often outperform. Kovler has a 26% stake in the business and holds nearly 59% of voting power. Cantor Fitzgerald has a 12-month price target of 36.” BUY

Kinross Gold (KGC), originally recommended by Clif Droke in his Sector Xpress Gold & Metals Advisor, was up about 8% this week and is trading right around the top of its six-month range. There was no real catalyst behind the move, other than the improving stock market. Any break above the 4.3-4.4 range would be very bullish for this stock. If you haven’t bought already, this looks like a good time to do so. BUY

NerdWallet (NRDS), originally recommended by Tyler Laundon in Cabot Early Opportunities, had a rough first week in the portfolio – or, more specifically, a rough morning today, down 6%. There was no apparent reason for the sharp pullback, aside from some Monday market weakness. Not to fret. We still like the story and the stock.

Here’s some of what Tyler wrote about NRDS last week, in case you missed it: “NerdWallet is an online financial services company on a mission to ‘provide clarity for all of life’s financial decisions.’ The company pursues this mission by operating a website and app for personal and small-business finance.

“NerdWallet’s digital platform aims to give consumers and small businesses trustworthy and knowledgeable financial information so they can make smart money moves. Go to www.nerdwallet.com and you’ll find information on credit cards, banking, travel, personal loans, mortgages, insurance, investing and more.

“…The company makes money through fees paid by financial service partners. It has over 19 million average monthly unique users (MUU), defined as a user with at least one session in a given month, as of the end of September 2022.

“That’s an increase of 11% over the previous year, which might not sound like much. But in a time where consumers have drifted away from online platforms, even modest growth is impressive. Registrations are up 60% over a year ago as a better user experience appears to be drawing in eyeballs.

“…In NerdWallet’s Q3, reported on November 2, the company surpassed expectations to deliver revenue of $143 million (+45%), well ahead of consensus of $135 million. EBITDA, a measure of earnings, was $14.5 million. That was way ahead of expectations of just $8.9 million.”

After this past week’s drop, now you can get the stock for cheaper. BUY

Ormat Technologies Inc. (ORA), originally recommended by Brendan Coffey in his Sector Xpress Greentech Advisor, was basically flat for a second straight week on the heels of a big dip, from 100 to 90, in late November. There was no real reason for the drop-off, and the stock may be forming a nice-looking launching pad in preparation for another big upmove. The renewable energy stock is up more than 14% in 2022. BUY

Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, held mostly firm this week after dipping from 65 to 63 the previous week. In his latest update, Tom wrote, “After an impressive rally from the October low, O has given some of it back over the last week. There isn’t any negative company-specific news behind the recent weakness. It’s somewhat typical of how this stock trades. O still has the right stuff for this market. It’s recession-resistant and a great source of income. But it may have gotten a little ahead of itself in the near term. It will still likely continue to trend higher, but perhaps in a choppier fashion than we’ve seen recently.” BUY

Rivian (RIVN), originally recommended by Tyler Laundon in Cabot Early Opportunities, nudged up from 29 to 30 this past week on no news. The stock has been in the same 28-35 range for the past two months. The electric vehicle maker is ramping up production and is on track to make about 25,000 new cars this year. BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was down slightly this past week, with all of the losses coming during this morning’s mini market sell-off. In November, the company topped 100,000 monthly deliveries from its Giga Shanghai factory in China for the first time – a 40% rise from October, and a 90% improvement from last November. However, Tesla plans to cut production in the Shanghai factory going forward, a sign that demand in China may be waning. Or at least the market is interpreting that way, which likely has something to do with this morning’s drop. Keeping at Hold until the stock can regain momentum for more than a few days. HOLD

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, just keeps hitting new all-time highs, and last week’s earnings seemed to accelerate the gains. The beauty retailer’s third-quarter earnings, reported last Thursday, December 1, exceeded analyst expectations and boosted its outlook. Comparable-store sales improved 14.6%, well ahead of the 8.8% jump analysts anticipated. Net income increased 27.5% year over year, to $274.6 million. And full-year earnings guidance was raised to a range of $22.60 to $22.90, ahead of the $20.70 to $21.20 expected. We are now sitting on about a 23% gain in ULTA since it was added to the portfolio in May. If you got in shortly after our recommendation, you can sell a few shares here to book some profits. Otherwise, I’m upgrading to buy, which is probably long overdue. MOVE FROM HOLD TO BUY

Wingstop (WING), originally recommended by Mike Cintolo in Cabot Growth Investor, was up 3% this past week in lockstep with the gains in the market. In his latest update, Mike wrote, “WING continues to act constructively—yes, its move to new multi-month highs two weeks ago didn’t hold (again, that’s par for the course these days), but instead of coming under distribution, shares have retreated grudgingly on low volume. Contrast that to the big buying sprees seen in July, late August and especially after earnings in October (biggest one-day volume total since September 2020) and it certainly seems like the buyers are in control, or at least that the sellers have left the building. Combine that with the great underlying growth story and we think this is a decent area to fill out our position. … We’re obviously optimistic here, thinking WING can hold up should the market have some further wobbles and eventually get moving should the market kick into gear.” BUY

WisdomTree Emerging Markets High Dividend Fund (DEM), originally recommended by Carl Delfeld in his Cabot Explorer advisory, was up another point this week to reach 36. The fund offers a high dividend yield and some of the highest-quality emerging market stocks in the world with an average price-to-earnings ratio of around 5. DEM gives broad exposure to large caps, mid-caps and small caps with an emphasis on income and value. BUY

Xponential Fitness (XPOF), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, is hitting multi-month highs in the mid-22s. The stock hasn’t been this high since April. The only real news is that the company – the largest global franchisor of boutique fitness brands – signed a master franchise agreement in Japan for its Rumble and AKT brands. The deal gives Xponential the option to license a minimum of 100 new studios in Japan over the next eight years. BUY

The next Cabot Stock of the Week issue will be published on December 12, 2022.