Cabot Stock of the Week Issue: February 6, 2023

Hey, we made it through an interest rate-hike week without the Fed tanking stocks! It may be the best indicator of real progress in the market yet. Toss in the fact that so many big tech names flopped on earnings (Apple, Amazon and Google in particular), and it feels like a miracle that stocks are higher today than when I last wrote. With all three major indexes comfortably above their 200-day moving averages for the first time since 2021, has the current rally graduated from another bear market rally to the start of the next bull market?

For the first time in more than a year, it’s a legitimate question. But the answer is still uncertain. It’s possible Federal Reserve officials will sound a more hawkish tone this week and trigger some delayed post-rate-hike selling. Plus, earnings season is still in full swing, and the response to big-name earnings flops this week might not be as forgiving as last week if the Fed sets a more sour tone. We’ll see. For now, the good vibes are palpable. So, it’s a good time to take another big swing.

This week, that means adding an electric vehicle stock that just came public last summer and is starting to show signs of life after a rough start. It’s a stock recently recommended by Carl Delfeld in his Cabot Explorer advisory. Here are Carl’s latest thoughts.

Polestar Automotive (PSNY)

Bloomberg reported global EV sales for 2022 last week, and while overall global auto sales declined to 81 million, EV sales jumped 68% and for the first time account for 10% of all auto sales.

China accounts for an amazing 66% of total world EV sales as 25% of China’s auto sales last year were EVs. About 11% of Europe’s auto sales were EVs and in Germany, the proportion reached 25%. America’s EV sales last year surged 40% but they represented only 6% of total new U.S. auto sales in 2022.

While all eyes are on Tesla, I’m recommending this week an EV maker you never hear about in the media. Polestar Automotive (PSNY) is a Swedish premium electric vehicle manufacturer. Founded by Volvo and Zhejiang Geely Holding Group in 2017, Polestar enjoys technological and engineering synergies with Volvo.

Polestar is headquartered in Gothenburg, Sweden, and its vehicles are on the road in markets across Europe, North America, China, and the Asia-Pacific region. By the end of this year, the company plans to have its cars available in 30 markets. Polestar cars are currently manufactured in China, with 2024 manufacturing planned in America.

Polestar has an edge on much of the competition for two reasons. It has an “asset light” strategy through access to world-class owner/partner Volvo’s factories. It has a firm foothold in China – the fastest-growing EV market in the world. And it has a growing reputation for elegant and arresting design.

Polestar has so far produced two electric performance cars. The Polestar 1 was built between 2019 and 2021 as a low-volume electric performance hybrid GT with a carbon fiber body. The Polestar 2 electric performance fastback is the company’s first fully electric, high-volume car.

Polestar plans to launch one new electric vehicle per year, starting with Polestar 3 – the company’s first electric performance SUV, which launched in late 2022. Polestar 4 is expected to follow in 2023, a smaller electric performance SUV coupe. Then, in 2024, the Polestar 5 electric performance 4-door GT is planned for launch. This will showcase the brand’s future vision in terms of design, technology, and sustainability. Polestar aims to produce a truly climate-neutral car by 2030.

In March 2022, Polestar revealed its second concept car, an electric performance roadster. The hard-top convertible presents an evolution of the unique design.

Polestar 3 is a powerful electric SUV that will be the first model to be manufactured for North America and other markets starting in mid-2024 out of Volvo’s plant in Ridgeville, South Carolina.

Polestar delivered approximately 21,000 vehicles in the fourth quarter of 2022, bringing the preliminary estimate for full-year global volumes to 51,500 cars, up 80% year-on-year. For 2023, Polestar anticipates global volumes to increase by nearly 60% to approximately 80,000 cars.

Polestar expects to post its unaudited preliminary financial results for 2022 on Thursday, March 2, 2023. The company has adequate resources to execute its plan, with about $2 billion in cash, and to support Polestar’s increasing production volumes, Volvo Cars is providing $800 million in financing with an equity conversion option for Volvo Cars.

As for the stock, it came public last June via SPAC and finished its first day above 13 per share. It was all downhill for the ensuing four months, with PSNY shares dipping as low as 4 in October. Since then, they’ve mostly been up, rising as high as 8 in November, dipping back below 5 in December, but now in steady climb mode, topping 6 per share in late January and staying there, just above its 50-day moving average (though below the 200-day line). You can buy it right now.

One thing to note, however: The recent price discounts by Tesla on several of its models could put pressure on its smaller competitors, including Polestar. Something to keep an eye on, especially in future earnings results, but so far it hasn’t slowed PSNY’s share price.

Current Recommendations

Changes Since Last Week: None

No changes this week, with only Corteva (CTVA) encountering any meaningful turbulence following an earnings miss. Another of our companies, TELUS International (TIXT), reports earnings this week (February 9). And Tesla (TSLA), Ulta Beauty (ULTA) and Xponential Fitness (XPOF) remain red-hot.

So, let’s get into it. Here’s a more detailed look at what’s happening with all our stocks.

Updates

Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, was flat this past week on the heels of its annual Investor Event on Thursday. The company also reported fourth-quarter and full-year 2022 same-store sales results, though the full earnings report isn’t due out until mid-March. The results for Latin America’s largest McDonald’s franchisee were impressive: 35.7% comparative-store sales growth in Q4, 39.4% for the full year. While those results didn’t move the needle much on ARCO’s share price, it’s possible gains were already baked in considering the stock is up 13% in the last three months. But it does bode well for next month’s full earnings results. Until then … BUY

BioMarin Pharmaceutical Inc. (BMRN), originally recommended by Mike Cintolo in Cabot Top Ten Trader, pulled back slightly this past week – no surprise given that it had risen to two-year highs. There was no news. The trend remains very much up for this potentially emerging biotech leader, with shares up more than 35% in the last three months. BUY

Centrus Energy (LEU), originally recommended by Carl Delfeld in Cabot Explorer, pulled back a couple points after touching as high as 42 early last week. But the momentum for nuclear energy is there, as Carl wrote in his latest update: “Nuclear energy expansion is getting more politically acceptable to talk about, as evidenced by a new movie by Oliver Stone called ‘Nuclear Now’ that screened recently at Davos (and received a warm reception, reportedly). Centrus stock trades at relatively low multiples to future earnings. Buy a Half.” Last week, we bumped LEU back up to buy on momentum; we’ll keep it there despite the predictable mini-pullback. BUY

Chewy (CHWY), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, gapped up to 49, shattering 45 resistance and nearly matching its highs from last August. Why the strength? An upgrade from Wedbush Analysts (from “Neutral” to “Outperform”) helped, as did the steadily improving market. Because pet food and supplies never go out of business, Chewy remains a strong all-weather play in case we do get a recession this year. BUY

Cisco Systems (CSCO), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, remains in the 47-49 range it’s been in for the past three months. It’s not likely to budge much with Q4 earnings coming up on February 15. Shares have 37% upside to Bruce’s 66 price target, and the valuation is attractive at 9.7x EV/EBITDA and 13.6x earnings per share. Having been stuck in such a tight trading range for so long, it’s worth starting a small position now (if you haven’t already) ahead of earnings, which have the potential to trigger a breakout. BUY

Citigroup (C), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, pulled back a couple points this morning after holding mostly firm of late. There was no apparent news triggering the decline. In his latest update, Bruce wrote, “On January 13, Citigroup reported bland fourth-quarter results. Earnings (excluding the effect of divestitures) were $1.10/share, which fell 45% from a year ago and were about 8% below the $1.19 consensus estimate. Revenues (excluding the effect of divestitures) rose 5% from a year ago and were about 1% above estimates.

“Rising interest rates helped boost net interest income, but this was more than offset by higher credit costs and elevated transformation and other expenses. Citi’s already-healthy capital strength increased further. Overall, nearly two years into CEO Jane Fraser’s term, the bank is making progress with its turnaround. But, given the paltry 5.5% return on tangible equity compared to its medium-term goal of 11-12%, the bank has a long way to go.

“In the quarter, net interest income rose 23% from a year ago, as the net interest margin expanded to 2.39% from 1.98% a year ago. Partly offsetting the higher margin, loans balances fell 2%. However, excluding to-be-divested Legacy businesses, loans grew 2%. Fee income fell 27% (ex-divestitures): better trading profits were more than offset by weaker asset management and investment banking fees.

“Operating expenses rose 5% (ex-divestitures), which we find disappointing as we would like these to remain flat given all of the efficiency improvements underway. However, we recognize that with most turnarounds, expenses increase as the company spends on new staffing, software and other upgrades before it removes older costs, creating an expensive but temporary redundancy. This appears to be where Citi is today.

“Credit costs surged to $1.8 billion compared to a negative ($465 million) a year ago. We view this sharp reversal as a return to more normal credit costs. Loan losses increased 36% but impressively were still below 0.2% of average loans. Non-accruing loans also remain low. The bank increased its reserves by a reasonable $593 million, compared to the unusual post-pandemic $1.2 billion reduction a year ago. Total reserves are now 2.6% of total loans, a size we consider healthy. In the credit card segment, reserves are 7.6% of these loans, also robust even as the economy slows. For perspective, the credit card portfolio is about 23% of total loans – indicating that this bucket is a sizeable driver of Citi’s growth and profits.

“Citi’s capital of 13.0% (using the CET1 ratio) is sturdy, particularly when combined with its 2.6% credit reserves. However, despite this strength, the bank has no immediate plans to repurchase shares given the macro and market exit uncertainties.

“For 2023, the bank expects revenues to increase 5%, coming almost entirely from higher fee income as it anticipates minimal improvement in net interest income. Expenses will increase 7%, with credit costs continuing to normalize (increase). Overall, 2023 will likely be an uninspiring year for profit improvement at Citigroup. We see stronger results in 2024, as the benefits of the turnaround become clearer. Exits of the legacy businesses in Mexico, Asia, Russia and Poland are underway and likely to be mostly done by year’s end or so.

“The president of Mexico is to meet with Citigroup CEO Jane Fraser regarding the planned sale of Citi’s Mexico retail operations, although neither a date nor a location has been set yet. Insights into the purpose (support or dissuade a deal) or outcome of the meeting aren’t generally available.

“This past week, the yield spread between the 90-day T-bill and the 10-year Treasury bond, which approximates the drivers behind Citi’s net interest margin, was essentially unchanged at negative 112 basis points (100 basis points in one percentage point). This spread is the widest since at least the early 1980s. Our interpretation is that investors are assuming that the Fed rate hikes and other macro drivers will drag inflation down to sub-5% or less this year. Given that the inflation metrics are flattening out or declining (inflation over the past four or five months has been tame at sub-3%), this assumption seems reasonable.

“Citi shares trade at 63% of tangible book value and 8.4x estimated 2023 earnings. The remarkably low valuations assume an unrealistically dim future for Citi.

“Citi shares fell 1% in the past week and have 65% upside to our 85 price target. Citigroup investors enjoy a 4.0% dividend yield.

“When comparing Citi shares with a U.S. 10-year Treasury bond, Citi offers a higher yield (4.00% vs. 3.55%) and considerably more upside potential (65% according to our work vs. 0% for the Treasury bond). Clearly, the Citi share price and dividend payout carry considerably more risk than the Treasury bond, but at the current valuation, Citi shares would seem to have a remarkably better risk/return trade-off.” BUY

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, remains at 39 in the wake of decent enough fourth-quarter earnings. In his latest update, Bruce wrote, “Comcast reported a reasonable quarter, with relatively stable revenue and profits, despite sharply larger losses at its Peacock streaming unit. The company raised its dividend by 7.4% and continued to repurchase shares ($3.5 billion in the quarter). Free cash flow fell 65% due to lower profits, higher capital spending, higher interest expenses and higher cash taxes. The balance sheet maintained a steady leverage ratio. We expect that 2023 will look about like 2022, but with more losses at Peacock as the company continues its rollout. We anticipate improvement in 2024 as ad spending recovers and as capital spending steps down. All in, the Comcast story remains on track as an undervalued grind-it-out producer of free cash flow.

“Revenues rose less than 1% and were fractionally above estimates. Adjusted earnings of $0.82/share rose 7% from a year ago and were 5% above the consensus estimate of $0.78/share. Adjusted EBITDA fell 5% and was about 4% below estimates. Excluding severance costs, EBITDA was higher than a year ago.

“The core cable business remains flat-to-positive. Revenue growth was 1% while adjusted EBITDA rose about 2%. Revenues and profits are being maintained by incrementally higher pricing as the customer count is flat. The service mix is shifting away from traditional services (video, voice) to broadband and wireless – the effect on profits appears to be positive, although incrementally higher capital spending is incrementally eroding the economics. Free cash flow was down 2%.

“NBC Universal revenues rose 6% but profits slid by 36% due to higher Peacock losses along with higher FIFA World Cup programming costs, weaker revenues from its linear TV operations and higher severance costs. Capital spending for the segment doubled in 2022 vs 2021 due to the construction of the Epic Universe theme park in Orlando set to open in 2025. The Peacock subscriber count increased to over 20 million (more than double a year ago and up over 33% from last quarter). However, losses in Peacock were higher ($978 million loss vs $559 million loss a year ago). The full-year Peacock loss was $(2.5 billion) and a $(3 billion) loss was guided for 2023. In our view, Comcast needs to rein in these losses significantly starting no later than year-end 2023 – if this business isn’t improving by then it may be a chronic money-loser.

“Sky revenues fell 1% due to weaker advertising and other pressures. EBITDA fell 15% on higher severance and other costs. The overall profit trend in this segment is positive but lumpy from quarter to quarter. Full-year profits were up 7%.

“Comcast shares … have 6% upside to our 42 price target. The shares have limited upside, but the earnings report was reasonable enough to keep the stock a bit longer.” Since we’re not strictly value investors, we’ll keep CMCSA shares at Buy. BUY

Corteva (CTVA), originally recommended by Carl Delfeld in his Cabot Explorer advisory, has dropped sharply since reporting earnings last Wednesday. Revenues and earnings topped estimates. In fact, earnings were double what they were a year ago, while revenue grew 10%. But shares have pulled back anyway, from 64 to 61. That’s still above the 200-day moving average (59), and the quarterly numbers looked good on the surface even if Wall Street didn’t embrace them. So, we’ll keep this agriculture and seed company at hold for now. HOLD

Kinross Gold (KGC), originally recommended by Clif Droke in his Sector Xpress Gold & Metals Advisor, pulled back for the first time in weeks as gold prices fell sharply. That’s something to keep an eye on, but the overall trend in both gold prices and KGC shares is up, with the latter rising 6% year to date. Earnings are due out on February 15. BUY

Las Vegas Sands (LVS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was flat after inching up the week before on the heels of mixed earnings. In his latest update, Mike wrote, “Las Vegas Sands (LVS) is our favorite way to play China’s economic reopening, which itself is something of a follow-on move to the U.S.’s own reopening back in late 2020/early 2021. In Q4, the firm’s results were just so-so, but our biggest takeaway was that Sands was solidly EBITDA positive ($329 million if you adjust for bad luck at the tables) despite the fact that air traffic to Singapore’s closest airport was likely down 30% or so from Q4 2019, while Macau visitation was off more than 80%! Given the travel boom going on in the U.S., we think it’s likely Sands’ bottom line could mushroom in the quarters ahead as China (and other countries) break free from (oftentimes forced) cabin fever. As for the stock, LVS isn’t at a pristine entry point, but we like the firm uptrend, the minor dip of late and, of course, the market’s power.” BUY

Medical Properties Trust (MPW), originally recommended by Tom Hutchinson in Cabot Dividend Investor, was off slightly in its first week in the portfolio. In his latest update, Tom wrote, “This high-paying and recession-resistant hospital REIT has pulled back a little the past couple of weeks after rallying strongly in the first half of January. But the stock remains in a technical uptrend that began in October. The dividend is safe, and the operational performance of the company is solid, with better than 30% earnings growth last quarter. MPW is dirt cheap with a high yield and a recession-resistant business. This should be a good year.” BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in his Cabot Explorer advisory, had an up-and-down week after reporting earnings last Wednesday. While earnings topped expectations, revenues and 2023 guidance fell slightly short, prompting a brief but deep sell-off that caused NVO to fall from 139 to 132 in a day. Now it’s back up to 137 as investors have had time to digest the Q4 and full-year 2022 results, which weren’t all bad—revenues improved 26% in 2022, earnings per share improved 13.7%, and revenues are expected to improve 13-19% this year. So, a lot of the selling may be a result of an overcooked share price – NVO is still up 22% in the last three months. The quick bounce-back is a good sign going forward, so let’s keep NVO at Buy. BUY

Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, pulled back minimally this week. In his latest update, Tom wrote, “The legendary income REIT isn’t exciting, but it tends to deliver as advertised over time. O has delivered a positive return over the last year in a down market. It also returned 10% over the last three months and has finally overtaken the elusive 65 per share level. Hopefully, O can keep running. It’s a popular and defensive income stock that should hold its own in the event of a recession.” BUY

TELUS International (TIXT), originally recommended by Tyler Laundon in Cabot Early Opportunities, held steady in its second week in the portfolio. It’s a digital customer service company that serves more than 600 brands around the world. It designs, builds and manages next-gen engagement, HR, AI and content moderation tools that clients use to better serve their customers. Earnings are due out this Thursday, February 9 so we’ll see how those move the needle. BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, just keeps rising like it’s 2020 all over again suddenly. After losing more than 60% of their value in 2022, shares are up 58% year to date and are motoring toward 200 again. Strong fourth-quarter earnings appear to be the biggest catalyst behind the rebound, as the electric vehicle maker reported record revenue of $21.3 billion, up 33% from Q4 a year ago. Meanwhile, adjusted EPS of $1.19 topped analyst estimates of $1.13. Last month’s price cuts to certain models also seem to be helping from a perception standpoint. Shares are still well shy of the 200-day moving average, so we’ll keep them at Hold for now despite the massive recovery. Eventually, the stock will settle down, at which point it may become more buyable. But the rally is encouraging. HOLD

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, hit new all-time highs yet again last week! The lack of a recession – with unemployment falling to 53-year lows and GDP up 2.9% in the fourth quarter – has been good news for this beauty retailer. The stock is up 10% year to date and 24% in the last three months, and our gains are now north of 35%. As I’ve written the last couple weeks, you can book profits and sell a few shares if you got in early after we added ULTA to the portfolio last May. Otherwise, it remains a Buy – preferably on rare dips – until it shows any sign of weakness for the first time in six weeks. BUY

WisdomTree Emerging Markets High Dividend Fund (DEM), originally recommended by Carl Delfeld in his Cabot Explorer advisory, fell another point, from 38 to 37. Still, it’s been a solid winner for us and is still up 5% for the year. 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. This ETF 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, held firm after hitting all-time highs above 27 the week before. A cooling-off period makes sense after shares of this boutique fitness studio and brand company have advanced 19% year to date and 56% (!) in the last three months. That it hasn’t even pulled back much only enhances the investment case for this stock. BUY

The next Cabot Stock of the Week issue will be published on February 13, 2023.