Cabot Stock of the Week Issue: January 23, 2023

Stocks are showing more resilience this month than they did through most of 2022.

To wit: After three straight down days following the Martin Luther King holiday last week, it looked like we were headed for another low and that the latest upmove was yet another false start. Instead, stocks have rallied for two straight days, and the S&P 500 is at new 2023 highs. Granted, it’s early still, and the indexes are still well below the temporary highs they hit as recently as late November. But the S&P at least is doing something it’s rarely done in the past year: risen above its 200-day moving average. For the most part, the 200-day line has acted as overhead resistance since last spring. It’s possible we’re on the precipice of an actual breakthrough!

Of course, with fourth-quarter earnings season underway and the Fed likely to hike rates again next week (February 1), there are a lot of possibilities right now, both good and bad. These next few weeks feel like an important crossroad for the market, right up until Valentine’s Day, when the latest CPI data gets unveiled. In the meantime, the market looks healthy, so today we take another big swing and add a mid-cap technology stock just recommended by Cabot Early Opportunities Chief Analyst Tyler Laundon.

Here are Tyler’s latest thoughts on it.

TELUS International (TIXT)

We took a crack at TELUS International (TIXT) in mid-2021 and captured a modest 12% return within a few months. With the stock down nearly 40% since then, looking like it’s coming off an all-time low, and having a solid story offering steady growth and profitability, TIXT has risen to the top of my buy list.

The backstory is that TELUS is a digital customer experience company that serves over 600 major 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.

The company is particularly strong in high-growth markets, including tech and games (47% of Q3 revenue), media and communications (24%), eCommerce and fintech (11%) markets.

TELUS was spun out of parent company Telus Corporation (TU), one of Canada’s leading telecom providers, in February 2021. This relationship continues today as TELUS still derives over 16% of revenue from its parent company, which remains a controlling shareholder (owns about 75% of voting shares).

Revenue was up 11% to $615 million in Q3 2022. Full-year 2022 revenue should be up around 13% to $2.49 billion when Q4 is in the books. EPS should be about $1.21 (+21%).

Looking into 2023, revenue should continue to grow by around 12%, to $2.8 billion, while EPS should be up around 13%, to $1.37.

There could be some modest upside potential due to the January acquisition of WillowTree, a high-growth digital customer experience company focused on mobile applications, web interface and marketing, WillowTree grew revenue by 48% to $94 million in the first half of 2022.

Foreign exchange headwinds in mid-2022 may also be abating which could help boost investor sentiment.

Telus should deliver Q4 earnings in mid-February and host an Investor Day on February 16.

As for the stock, TIXT came public at 25 in February 2021 and, after a rough start (pandemic), rallied to an all-time high of 40 in October 2021. A painful drawdown pulled TIXT to 20.7 by last May. Shares then rallied to 31.5 last summer before giving it all back, and then some, last fall. From mid-November through the end of 2022, TIXT mostly traded in the 18.5 to 21 range. Shares jumped 4.5% earlier this month, crossed the 50-day line, and have traded higher almost every day since. The 200-day line is about 8% higher. With the trend improving and a conservative growth story, we’ll jump in with a trader’s attitude, looking to make a modest double-digit return in the next couple of months. But you can certainly hold on for longer than that should the stock keep rising.

Current Recommendations

Changes Since Last Week: None

For a second straight week, we have no changes, and our portfolio is almost at capacity with 19 stocks. With several of our companies reporting earnings in the next two weeks, that could soon change. But for now, there are no red flags, and several of our stocks are hitting either multi-month, multi-year or even all-time highs!

Here’s what’s happening with all of them as glimmers of hope have emerged in the new year.

Updates

Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, held firm after rising to new two-year highs. There was no news, though the company is nearing its annual Investor Event on February 2. Arcos is the largest McDonald’s franchisee in Latin America, and sales are on track to rise 34% in 2022 while earnings per share are expected to more than double. BUY

BioMarin Pharmaceutical Inc. (BMRN), originally recommended by Mike Cintolo in Cabot Top Ten Trader, dipped slightly this week, though it’s still up 37% since November 9. 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, held firm at 36. It has recovered well after dipping below 31 in late December, as renewable energy stocks as a group appear to be getting healthy again. HOLD

Chewy (CHWY), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, dipped from 44 to 43 after getting downgraded by Morgan Stanley last week. No matter – the downgrade was by a mere dollar (from 32 to 31), and the stock remains well above its 200-day moving average. Let’s stick with the evidence in front of us, which is a solid chart and a company with double-digit sales growth. 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. 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 slipped 1% for the week and have 37% upside to our 66 price target. The valuation is attractive at 9.2x EV/EBITDA and 13.6x earnings per share. The 3.2% dividend yield adds to the appeal of this stock.” BUY

Citigroup (C), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, had a solid first week in the portfolio, rising from 50 to 51. In his latest update, Bruce wrote, “Citi is one of the world’s largest banks, with over $2.4 trillion in assets. The bank’s weak 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.

“Citigroup reported bland fourth-quarter results. Earnings (excluding the effect of divestitures) were $1.10/share, which fell 45% from a year ago and was 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.

“With the shares trading at only 61% of the $81.65/share tangible book value, we have plenty of patience to wait.

“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, widened incrementally to negative 109 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 61% of tangible book value and 8.0x estimated 2023 earnings. The remarkably low valuations assume an unrealistically dim future for Citi.

“Citi shares rose 4% in the past week and have 69% upside to our 85 price target. Citigroup investors enjoy a 4% dividend yield. We anticipate that the bank is done with share buybacks until there is more clarity on the economic and capital market outlook, which could readily be a year or more away.” BUY

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, is at its highest point since August. We’ll see how fourth-quarter earnings, due out this Thursday (January 26), affect the stock’s recent momentum. Analysts are expecting both EPS and revenues to be flat.

In his latest update, Bruce wrote, “Chatter is increasing about the possibility that Comcast will divest its Sky unit. The Britain-based satellite operation provides TV, mobile phone and internet service to 23 million customers in six countries (U.K., Italy, Germany, Austria, Ireland and Switzerland). Sky is Europe’s leading sports broadcaster and is home to Premier League Football and Formula 1 auto racing.

“Comcast paid a sharply overpriced $40 billion for this asset (about 15x EBITDA) during a complex takeover battle in 2018 when Disney was bidding for 21^st Century Fox. Today, the business is probably worth about $15 billion, based on EBITDA of about $2.1 billion and a multiple of about 7x. Profits have slid from $3 billion in 2019 due to aggressive competition and cord-cutting. Reflecting the mistake, Comcast took an $8.6 billion charge last October. A divestiture doesn’t appear to be imminent, however, as change happens slowly at Comcast and as Sky is an integral component of its European operations.

“Part of the value of Sky is that it provides Comcast with a global streaming platform. Sky is rolling out its Peacock streaming service gradually, launching it in Europe first on a country-by-country basis to consumers who may have no idea what Peacock is or offers. This roll-out differs from, say, what Netflix can do. The Netflix brand is widely known around the world, allowing the company to almost instantly gain a sizeable market share upon entering a new country.

“Comcast shares rose 2% in the past week and have 8% upside to our 42 price target. The shares offer an attractive 2.7% dividend yield.” BUY

Corteva (CTVA), originally recommended by Carl Delfeld in his Cabot Explorer advisory, dipped from 63 to 62 last week, but has still recovered nicely since dipping to 58 in December. Earnings are due out next Wednesday, February 1. Let’s keep holding and see how it responds. HOLD

Green Thumb Industries (GTBIF), originally recommended by Tim Lutts and then Michael Brush in the Sector Xpress Cannabis Advisor, is flirting with dipping below support at 8. If this closes below 8, we may have to reassess. As for cannabis stocks as a group, 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. So, we’ll keep holding for now. HOLD

Kinross Gold (KGC), originally recommended by Clif Droke in his Sector Xpress Gold & Metals Advisor, held firm after finally breaking above 4.38 the previous 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 2.5% 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, was up another point this week, to 55. In his latest update, Mike wrote, “LVS remains in a firm uptrend, and we think it can do very well going ahead. Near term, the China/reopening story is a bit obvious, so some sort of pullback or rest period is likely—but if it’s well controlled, it should be buyable.” BUY

NextEra Energy (NEE), originally recommended by Tom Hutchinson in Cabot Dividend Investor, had a rough week, falling from 86 to 82 ahead of earnings this Wednesday, January 25. Analysts are expecting 35.8% revenue growth and 24% EPS growth, so perhaps any bad news is already baked into the share price. In his latest update, Tom wrote, “NEE has leveled off over the past six weeks or so after roaring back from the low in October. It is up over 27% since the low and is forming a solid base at this higher level. NEE is also well positioned for a weaker economy and possibly recession in the months ahead. The earnings are defensive but also growing because of the company’s huge presence in alternative energy, where costs continue to fall. It’s a great stock to own anytime. But heading towards a likely recession, it’s one of the very best.” BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in his Cabot Explorer advisory, jumped to 141 – new all-time highs! A new share repurchase program likely helped. Also, Morgan Stanley projects the potential market for obesity drugs to reach $50 billion by 2030 – 20 times greater than it is today (Novo Nordisk specializes in treatments for diabetes and supplies half the world’s insulin). There’s a lot to like here. BUY

Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, was flat this week. In his latest update, Tom wrote, “After surging in late October through early November, O had been bouncing around and could never get above the 65 per share level. But last week it finally broke above 65 for the first time since the summer. Hopefully, it can run for a while longer. Investors appear to be appreciating a defensive and legendary income stock amid the current uncertainties. I expect more of the same in the early part of this year as we move toward a recession.” BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, is starting to regain its mojo. After dipping as low as 108 to start the year, Tesla shares are now back above 140 ahead of the pivotal fourth-quarter earnings report this Wednesday, January 25. Analysts are looking for 36% revenue growth and EPS growth of 33%. Recent price cuts on its Models 3 and Y cars, by as much as 20%, have helped revive shares. But better-than-expected Q4 results might accelerate the recovery. We’ll know a lot more in about 48 hours. Keeping at Hold for now. 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 497, up 6% year to date and 30% in the last three months. It’s arguably our best performer, with a 30% 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 39 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, is enduring a normal pullback after rising as high as 26 earlier this month. Now back down to 24, shares of this boutique fitness studio franchisor are still up from where they started the year (22). You could buy here if you haven’t already done so, as the stock is still comfortably above its 200-day moving average. BUY

The next Cabot Stock of the Week issue will be published on January 30, 2023.