Cabot Stock of the Week Issue: January 17, 2023

Is it real? Is the latest mini-rally – with the S&P 500 up 4% to start the year and 11.5% since the mid-October bottom – the real deal, or yet another bear market rally? We’ve been duped several times in the last year, with big yet short-lived rallies last March, last May, last July and August, and from mid-October through the end of November all leading to lower lows (or close to them) than before within a matter of weeks. Those four bear market rallies lasted anywhere from two to six weeks. This latest push has lasted roughly three weeks. So, it’s very possible Lucy is about to pull the football away from our collective swinging foot any minute … again.

Here’s a reason to think this rally might be different, from the market timer I trust most, our own Mike Cintolo: “(T)he action over the past two weeks has been superb: Under the surface, breadth has been great, with measures like the advance-decline line soaring and our own Two-Second Indicator turning green, as the number of stocks hitting new lows drying up to very bullish levels. And, believe it or not, the move has been so impressive during the past two weeks that one of the two granddaddy blastoff indicators we follow (the 2-to-1) appears to have flashed green today, something that’s both rare and almost always portends higher prices in the months ahead.”

That’s what Mike wrote to his Cabot Growth Investor subscribers late last week. When Mike’s “blastoff indicators” flash green, I usually take it as a Buy signal. Do with it what you will.

But, just in case we’re being set up for yet another Charlie Brown-and-the-football moment – and because we’ve had our foot on the growth pedal of late, with recent additions including decidedly growthy titles Chewy (CHWY), Las Vegas Sands (LVS) and Novo Nordisk (NVO) – today I’m adding a deep value, large-cap financial stock to cover our bases. It’s a longtime recommendation of Cabot Undervalued Stocks Advisor Chief Analyst Bruce Kaser, and here are Bruce’s latest thoughts on it.

Citigroup (C)

Citigroup (C) is one of the four largest banks in the United States, with total assets of $2.4 trillion. The bank was founded in 1812 as the City Bank of New York and began an international expansion in the early 20^th century to become a truly global bank. However, Citibank seemed to get caught in nearly every major credit crisis, starting with the 1987 “Third World Debt Crisis.” These issues and weak leadership led to a merger with Sandy Weill’s Travelers Group in 1998. However, the deal left the bank an unwieldy conglomerate with too many disparate operations in a world that had radically changed. The bank’s continued ineffective leadership and loose compliance and risk-management culture led to Citi’s disastrous and humiliating experience in the 2009 global financial crisis, which required an enormous government bailout. The successor CEO, Michael Corbat, navigated the bank through the post-crisis period to a position of reasonable stability. Unfinished, though, is the project to restore Citi to a highly profitable banking company, which is the task of new CEO Jane Fraser (promoted in March 2021).

Fraser, an impressive 17-year company veteran, brings leadership and turnaround experience in nearly every segment of the bank. Her efforts are focused on accelerating the growth of the successful Treasury and Trade Solutions and Global Wealth Management operations. The personal banking and capital markets operations remain laggards, so these segments are in turnaround mode. Her task also includes cleaning up regulatory and compliance issues, upgrading the tech infrastructure, tightening and focusing its culture, and cutting expenses.

To an extent perhaps unmatched in the industry, Citi has operations across the globe. Global reach works best in capital markets-type of activities like commercial and investment banking (Citi is performing well in these) but tends not to work in local market activities like consumer banking (where Citi is struggling). So, Fraser is in the process of offloading 13 consumer units in markets ranging from Mexico to Australia and South Korea. These divestitures should boost capital levels while reducing expenses. Wealth management, which has both global and local features, is a good business for Citi, where it is well-positioned in several attractive regions including Asia.

As it sits today, Citi is in reasonably strong financial condition. Capital (at a 13.0% CET1 ratio) is sturdy and comparable to its major peers. Credit quality is healthy as are credit reserves. The primary problem is profits. In the most recent quarter, return on tangible common equity was a dismal 5.5%, far behind the 15+% returns of peers like Bank of America and JPMorgan. Citi’s leadership is targeting returns of 11-12% by 2024 or 2025 through its turnaround efforts.

The outlook for Citi’s earnings in 2023 is uninspiring, but we are encouraged by the bank’s turnaround progress. We see stronger results starting in 2024, as the benefits of the turnaround become clearer. Its divestitures should largely be completed this year, removing an operational overhang. Revenues should increase modestly with steady net interest income and incremental fee revenue growth. Expenses will continue to tick upward this year, which is disappointing in the near term but common with most turnarounds – expenses increase as the company spends on new staffing, software and other upgrades before it removes older costs, creating expensive but temporary redundancy. For 2024, expenses could be flat or potentially incrementally lower.

Trading at 61% of tangible book value (compared to Bank of America at 160%, JPMorgan at 200% and Wells Fargo at 130%) and 8.0x estimated 2023 earnings, Citi shares are among the cheapest in the banking sector – a major attraction as expectations are low. As the bank grinds along with its turnaround, the valuation should improve significantly. Investors are paid an attractive and sustainable 4.1% dividend yield while waiting. Additional accretion will result from the bank’s share repurchase program once it is restarted.

All-in, Citi shares offer considerable upside potential for patient investors.

Current Recommendations

Changes Since Last Week: None

That’s right – no changes for the first time in more than a month! It’s because all our stocks are either flourishing or steadily recovering. A couple of them are at new all-time highs; several others are at 52-week or multi-year highs; and a few have bounced back encouragingly (see: TSLA) after huge December sell-offs.

With the addition of Citigroup (C), we are now up to 18 stocks – two shy of our 20 cap. The total is a reflection of an improving market. We’ll see if it keeps improving this week.

In the meantime, here’s what’s happening with all of our stocks – most of it good!

Updates

Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, is at new two-year highs. The stock broke above 8.3 resistance last week and is now hovering around 8.7, giving us a nice four-month return. There was no news, other than the company announcing it will host its annual Investor Event on February 2. Instead, it appears ARCO is getting a boost from the resurgent market. We’ll see if it can hold – or even extend – these highs this week. BUY

BioMarin Pharmaceutical Inc. (BMRN), originally recommended by Mike Cintolo in Cabot Top Ten Trader, broke through resistance at 108 and is now at 18-month highs in the 112-113 range. There was no news. Mike views it as a potential new leader in the biotech space in large part due to Roctavian, its new one-time infusion drug for severe hemophilia that recently gained approval for conditional use in the European Union and is reportedly nearing FDA approval here in the U.S., perhaps as early as the first quarter. Right now, Wall Street appears to be betting on that approval. BUY

Centrus Energy (LEU), originally recommended by Carl Delfeld in Cabot Explorer, is continuing its recovery, up to 36 after dipping as low as 30 in late December. In his latest update, Carl wrote, “Centrus Energy (LEU) shares increased 13% this past week as interest in nuclear stocks continues to be firm and its stock trades at low multiples to future earnings.” HOLD

Chewy (CHWY), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, jumped from 38 to 44 in the last week and has recovered nearly all its late-December losses. The company is a pure-play U.S. retailer for pet supplies, which rarely see much of a downturn in sales since, like grocery stores, they’re considered essential. Analysts expect revenues to improve 13% this year, even as a potential recession looms. BUY

Cisco Systems (CSCO), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, held firm in the past week and remains in the 47-49 range it’s been in for the past two months. In his latest update, Bruce wrote, “Cisco Systems (CSCO) is facing revenue pressure as customers migrate to the cloud and thus need less of Cisco’s equipment and one-stop-shop services. Cisco’s prospects are starting to improve under a relatively new CEO, who is shifting Cisco toward a software and subscription model and is rolling out new products, helped by its strong reputation and entrenched position within its customers’ infrastructure. The company is highly profitable, generates vast cash flow (which it returns to shareholders through dividends and buybacks) and has a very strong balance sheet.

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

“CSCO shares … have 35% upside to our 66 price target. The valuation is attractive at 9.2x EV/EBITDA and 13.8x earnings per share. The 3.1% dividend yield adds to the appeal of this stock.” BUY

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, maintained its steady rise after finally breaking above 36 the previous week. Now at 38, this is the highest shares have been since August. Earnings are due out next week, January 26. In his latest update, Bruce wrote, “The company promoted the Deputy CFO and nine-year Comcast finance executive to the CFO role, following the promotion of CFO Mike Cavanaugh to president. We see this transition as generally uneventful but wonder if the shuffling was to keep senior executives on board, as there is no path to the chief executive seat given the Roberts family’s lock on the position. One likely motivation is that incoming CFO Jason Armstrong brings a fresh perspective, particularly with his sell-side experience as the former head of Goldman Sachs’ cable and telecom research group.

“Comcast shares rose 8% for the past week and have 11% upside to our 42 price target. The shares offer an attractive 2.8% dividend yield.” BUY

Corteva (CTVA), originally recommended by Carl Delfeld in his Cabot Explorer advisory, has had a nice bounce-back after a big dip in December, advancing from 58 to 62. That’s still well shy of its early-December highs above 67, but it’s a nice sign nonetheless. In his latest update, Carl wrote, “Corteva (CTVA) shares gained two points as the company will report earnings on Wednesday, February 1. This conservative stock is a bit expensive but still a buy and is a favorite among institutional investors, who hold 82% of outstanding shares.” HOLD

Green Thumb Industries (GTBIF), originally recommended by Tim Lutts and then Michael Brush in the Sector Xpress Cannabis Advisor, keep holding firm at 8, as there’s been no news to coax cannabis stocks off their knees just yet. It may take an act of Congress (like, say, the SAFE Banking Act finally passing) to get the group going. Regardless, there’s enormous upside in this sector, and Green Thumb is one of the industry leaders. We have a 20%-plus loss on the stock, but we’ll hang on to GTBIF as long as it doesn’t dip below 8. HOLD

Kinross Gold (KGC), originally recommended by Clif Droke in his Sector Xpress Gold & Metals Advisor, has finally broken free of its 3.95 to 4.38 range, rising as high as 4.74 last week. We’ve been saying a break higher could be coming if the market makes a push, and that’s what’s happened since the calendar flipped to 2023. This gold stock, which also boasts a 2.6% dividend yield, is a strong buy right now if you don’t already own it. BUY

Las Vegas Sands (LVS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, rose from 53 to 54 in its first week in the portfolio. LVS is a play on China’s reopening, as Sands owns and operates a series of entertainment and gaming properties in Macau, where the vast majority of its business is done these days. Mike wrote last week, “As you’d expect, business has been sour—EBITDA from its China operations came in at negative $152 million in Q3, but that was actually better than Q3 2020 (-$233 million) and, given the obliteration of travel, doesn’t seem all bad.

“By comparison, these hotel resorts saw cash flow of $755 million in Q3 2019, and while it probably won’t get back up there in the near future, it shows you the potential should things return toward normal.

“But Sands is actually about much more than China—even before the virus, one-third of its profits came from Singapore, where it operates one of the country’s two casino resorts. The story is the same there, though far less extreme, with travel to the nearest airport now at 56% of comparable 2019 levels, up significantly from earlier this year. Interestingly, despite the decline in air travel, business there is very good, with the area’s gaming revenue about even with pre-pandemic levels, and for Sands’ operation, EBITDA was a solid $343 million, down ‘only’ 21% from 2019 data.

“Interestingly, the company is still in expansion mode despite the recent hiccups: Next year capital expenditures are anticipated to be nearly $1.5 billion, focused mostly on a big expansion and renovation of its Singapore operations.

“All told, the story here is about a firm that’s surviving (actually EBITDA positive) even under very tough circumstances—and if China’s reopening momentum holds, there’s little doubt business will boom back toward prior levels, which should keep buyers interested in the months ahead.

“The stock was around 74 before the virus clobbered the world—by May of last year, it was down to 28, pulled down by business and, of course, the bear market itself. Really, though, that was the start of a messy bottoming process, with a rally into the 40 area and some wild volatility after that, with reopening hopes rising and falling in quick order. But since late October, shares have changed character, rallying nicely and, last week, popping above the 50 area on decent volume.

“Buy on dips, as long as the stock doesn’t fall below recent support at 46.” BUY

NextEra Energy (NEE), originally recommended by Tom Hutchinson in Cabot Dividend Investor, finally broke above 84, rising to 86 this morning. Perhaps the market is looking ahead to a strong quarter from the company when it reports earnings next Wednesday, January 25. In his latest update, Tom wrote, “This traditional and clean energy utility rolled into one is a good stock to own in just about any market. But the current circumstances make the stock a must-own. We are likely heading into recession, an environment where the relative performance of utilities thrives. Defense is in. There’s something about a looming recession that turns investors toward the safest stocks. NEE also has a higher level of growth than its peers and should benefit along with the alternative energy sector when the market recovers.” BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in his Cabot Explorer advisory, inched up another point this week, to 139. One catalyst was the FDA’s decision to expand the label for Novo Nordisk’s oral diabetes medication, Rybelsus, allowing patients with type 2 diabetes to now take the drug without having to first try another treatment. Rybelsus brought in $437 million in sales in the most recent quarter, accounting for 13% of Novo Nordisk’s GLP-1 treatments. GLP-1 is a hormone that slows digestion, stops the liver from making too much sugar and helps the pancreas produce more insulin. The hormone is often found in low levels in patients with type 2 diabetes. Novo Nordisk specializes in treatments for diabetes and supplies half of the world’s insulin. Analysts from Morgan Stanley project the potential market for obesity drugs to reach $50 billion by 2030 – more than 20 times greater than it is today. BUY

Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, is at four-month highs above 66. In his latest update, Tom wrote, “The legendary income REIT has been going sideways since the middle of November. It’s holding up but can’t seem to get above that 65 per share level (Editor’s Note: Now it has!). The stock is almost always bouncy. And there is no telling what the next few weeks might bring. But this is a popular and defensive income stock that should hold its own in the event of a recession this year. Investors should find their way to O and the stock should be buoyant over the course of the year. Although it’s a REIT, O tends to move more in sync with the safe defensive stocks.” BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, appears to have righted the ship, at least for now, rising to 129 after dipping as low as 108 just two weeks ago. Last week the company reduced the price on its Models 3 and Y cars by as much as 20%, hoping to boost sales. In the U.S., the price cuts mean certain Model 3 sedans and Model Y SUVs now qualify for electric vehicle tax credits under the new Inflation Reduction Act. The real test of whether the worst is truly behind TSLA shares will be next week’s (January 25) earnings report, where analysts are anticipating 38.4% revenue growth and 35% EPS growth. If Tesla exceeds those expectations, even by a little, it could extend the recent mini-rebound to a full-blown recovery. Stay tuned. HOLD

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, just keeps hitting new all-time highs! It’s now up to 494, up 5% year to date and 25% in the last three months. It’s arguably our best performer, with a 29% gain since being added to the portfolio last May. If you bought back then, you could book profits on a few shares now, perhaps selling a quarter position. If you still haven’t bought shares of this thriving beauty retailer, you could buy on dips – which lately have been few and far between. BUY

WisdomTree Emerging Markets High Dividend Fund (DEM), originally recommended by Carl Delfeld in his Cabot Explorer advisory, is up to 38 for the first time since last June after spending months in the 34-37 range. That’s a bullish move and makes DEM an even stronger Buy than it was before. 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, came back to Earth slightly after gapping up from 22 to 26 last week. The minor pullback, to the high 24s/low 25s, looks perfectly normal thus far and presents a nice little entry point. Xpontential Fitness is a leading franchisor of boutique fitness studios. Shares are up roughly 40% since we added the stock to the portfolio in late September. BUY

The next Cabot Stock of the Week issue will be published on January 23, 2023.