Cabot Stock of the Week Issue: March 20, 2023

For now, it seems like we might avoid a 2008-style, full-on banking collapse, thanks in part to some swift backstopping by the Federal Deposit Insurance Corp. (FDIC) and UBS’ buyout of Credit Suisse. All of those rescue missions, including Flagstar Bank, a subsidiary of New York Community Bank, agreeing to buy a majority of Signature Bank’s deposits, have calmed the market waters. In fact, the S&P 500 is up 2% since we last wrote, with the Nasdaq up more than 3.5% thanks to a recent flight to mega-cap tech stocks such as Nvidia (NVDA), Apple (AAPL), and our newest addition to the portfolio, Microsoft (MSFT).

So, for the time being, things don’t look as potentially disastrous as they did a week ago. As a result, we have no new sells today, with most of our stocks either holding steady or gaining – one of them just hit new all-time highs! Still, market waters remain quite choppy, so today we’re adding another reliable large-cap dividend stock that outperformed the market by a wide margin last year – and has the fundamentals to do so again this year.

It’s a favorite of Cabot Dividend Investor Chief Analyst Tom Hutchinson, who recently upgraded it to Buy. Here are Tom’s latest thoughts.

Eli Lilly (LLY)

Indiana-based Eli Lilly is a global pharmaceutical giant with over $28 billion in annual revenue, 38,000 employees, and sales in 120 countries. Founded in 1876, it’s one of the oldest companies on the exchange. But the company is more noteworthy for its unusually higher focus on R&D, where it allocates more than 25% of sales compared to an average in the high teens for the industry.

The R&D focus pays off as Lilly has arguably the very best pipeline and lineup of recently launched drugs in the industry. Back in 2014, the company faced the steepest patent cliffs among its peers. But Lilly very successfully overcame the issue and about 70% of revenue now comes from drugs lost since then. The stock has returned 655% over the last 10 years, more than three times the 202% return of the overall market over the same period.

Lilly has been about the best of the large pharmaceutical companies at delivering needed drugs and therapies. It’s important to understand the demographic backdrop in which Lilly is accomplishing this.

The U.S. population is aging at warp speed. More than a third of the population is over age 50. The fastest-growing segment of the population is 65 and older, as an average of 10,000 baby boomers turn 65 every single day and will continue to do so for many years to come. It’s also a similar situation in many major countries around the world.

Demand for healthcare should escalate along with the population in the years ahead, and that will give Lilly a huge tailwind.

Lilly has a novel approach to new drugs. It focuses on drugs and treatments for unmet medical indications where there is: 1) a higher chance of FDA approval, 2) higher market share, and 3) higher profit margins. These highly desirable drugs and treatments are harder to pull off. But Lilly has been consistently successful at doing so.

The company has a strong presence in diabetes (Trulicity, Jardiance, Humalog, Basaglar), oncology (Alimata, Cyramza, Verenio), and newer drugs in immunology (Taltz and Olumiant). Many of these drugs are difficult to duplicate and provide Lilly with more patent protection than most of its peers.

As we continue to be in a bear market and the economy is likely to turn south at some point this year, a defensive sector like healthcare is a great place to be as revenues are consistent regardless of the state of the economy. In the 2022 bear market, when the S&P 500 returned -19.4% and the Nasdaq was down 33% for the year, LLY provided a stellar 36.5% return for the calendar year.

LLY has blown away the return of both its peers and the overall market in every measurable period over the last 15 years and has provided a whopping 34% average annual return over the last five years. And now, prospects look better for the company than they did at any time over that five-year period.

Lilly is in a position where many of the newer drugs are in a high growth trajectory and profit margins are increasing. The company grew earnings 12.7% in 2022 and has guided towards 14.4% to 17.2% earnings growth this year while average S&P 500 earnings have been shrinking. But things are expected to get even better. Analysts on average are expecting Lilly to grow earnings by over 22% per year for the next five years.

Drugs that await a likely FDA decision sometime this year include two potentially game-changing mega-blockbuster drugs. One is an Alzheimer’s drug (Domanemab). There is a massive unmet need for this common disease with few drugs or treatments available. Another is a current diabetes drug that has had very successful late-stage trials for weight loss. Obesity is a massive problem, and this drug has thus far proven to be superior to anything else on the market.

Current Recommendations

Changes Since Last Week: None

We have no changes this week, which is a nice reprieve after a couple weeks of selling. Very few of our stocks fell much this past week, and several of them are performing quite well, including new addition Microsoft (MSFT). We’ll see how this week’s Fed rate hike affects them, and the market as a whole. Another 25 basis-point hike is expected; anything less than that (or more) could really send stocks for a loop in either direction.

In the meantime, here’s the latest with our recommendations.

Updates

Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, didn’t budge this week despite reporting earnings last Wednesday. EPS (26 cents per share) surpassed estimates (23 cents) and was up from 22 cents per share a year ago. Revenues improved 30% in the quarter and were up 36% for full-year 2022. Despite the strong numbers, shares of Latin America’s largest McDonald’s franchisee barely reacted. We’ll see if another week to digest the numbers brings in more buyers. BUY

Centrus Energy (LEU), originally recommended by Carl Delfeld in Cabot Explorer, kept falling, and is now down to 33 after touching as high as 50 less than a month ago. Last week we downgraded the stock to Hold, and we’ll keep it right there, as the nuclear energy stock is getting caught up in the selling that’s hammering most growth titles outside of certain mega-cap tech stocks. Nothing has fundamentally changed with the company or its story (i.e., the world, and the U.S. in particular, becoming more open to using nuclear energy again), and we still have a nice gain on it. So we’ll keep hanging on to it. HOLD

Chewy (CHWY), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, has been mostly flat ahead of earnings this Wednesday (March 22). Analysts are anticipating 10.5% revenue growth and narrowing profit losses. We’ll see how Wednesday’s earnings report impacts shares. BUY

Cisco Systems (CSCO), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, had a good week, breaking out of its monthlong 47-48 range to break above 50 for the first time in more than a month. There was no company-specific news. Shares still have 32% 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, was up a point, to 36 from 35, on no news. The stock still has 20% upside to Bruce’s 42 price target. BUY

Gates Industrial Corp. (GTES), originally recommended by Bruce Kaser in the Buy Low Opportunities Portfolio of his Cabot Undervalued Stocks Advisor, was flat this week. Shares of this specialized producer of industrial drive belts and tubing still have 20% upside to Bruce’s 16 price target. BUY

Las Vegas Sands (LVS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was up and down but ultimately unchanged at 55. The dip to 53 last Wednesday prompted Mike to sell it in Cabot Growth Investor. But Mike still likes the company: “To be clear, all that we’ve written about in recent weeks holds true—the firm’s cash flow should soar in the quarters to come as Macau comes back online, and this dive doesn’t break the stock’s big-picture upmove that got moving late last year. Translation: If the market can hang in there, LVS could easily shape up again, and if it does, we could get back in down the road.” With a 9% return in less than three months, we’ll keep it at Buy. BUY

Microsoft (MSFT), originally recommended by Tyler Laundon in Cabot Early Opportunities, had a great week, as mega-cap tech stocks have become a popular safe haven amid the recent bank-induced selling. Shares rose to 270 from 253 and are now up 12.6% for the year. The company’s leadership in the burgeoning artificial intelligence movement is also fueling it, 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. Great start for this stock since we added it two weeks ago and may continue to be as long as mega caps remain in favor. BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in his Cabot Explorer advisory, was up to 142 from 140 this past week. There are many reasons to like the stock, and Carl relayed some of them in his recent update: “The company, which develops therapies for diabetes and obesity, is set to cut the U.S. list prices for several insulin drugs by up to 75%. Novo plans to also increase production of the weight loss drug Wegovy to meet high demand, which should translate into higher revenue growth and profits.” BUY

Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, was down slightly this past week and has fallen from 68 to 62 in the past two months. REITs have drawn the ire of the sellers of late, and O has gotten caught up in that, though not in a disastrous way. In his latest update, Tom wrote, “In a rudderless and directionless market, income is king. And this legendary income REIT is the king of income stocks. It has paid 63 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. O has been trending slowly higher since the middle of October and should continue to be an investor favorite in this tough market.” BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, regained some of its recent losses, rising to 184 from 174 since we last wrote. There was no real news – a rarity for Tesla. More likely, investors are probably getting over their disappointment stemming from Tesla’s February 28 Investor Day, when the company didn’t provide many specifics after promising big things going into it. We’ll see if the recovery can continue in the coming week. HOLD

Uber (UBER), originally recommended by Mike Cintolo in Cabot Growth Investor, appears to have bottomed around 30 a week ago and is back up to 32. As Mike, who sold the stock two weeks ago, wrote last week, “shares did bounce back nicely (and are holding up well today) after a favorable court ruling in California that basically says the firm’s drivers can remain (cheaper) contractors instead of (more expensive) employees. If UBER can hold up in this selling storm and pop higher when the bulls reappear, we could always get back in as the underlying cash flow story is for real.” Last week we downgraded the stock to Hold, and we’ll keep it right there. HOLD

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, pulled back again despite being a little over a week removed from another strong earnings report. Earnings per share of $6.68 improved 23% from a year ago and handily beat $5.69 estimates. Revenues increased 18% year over year, as demand for beauty products remains resilient even as inflation continues to take a toll on other segments of the economy. And yet, the stock is down about 2.5% since the report. Most likely, the positive quarter was already built into shares, as the stock is still up 8% year to date. Keeping at Buy, as this could be a nice entry point. BUY

Visa Inc. (V), originally recommended by Tom Hutchinson in Cabot Dividend Investor, was up about 2% this past week after falling the previous week. In his latest update, Tom wrote, “I like V over the longer term. It’s a great business that will continue to grow in the years ahead. And the stock is still relatively cheap. After an impressive -3.4% return in last year’s bear market, V delivered strong returns in the earlier part of this year. Even if the market continues to stumble and cyclical stocks go out of favor again, V should continue to hold up relatively well and showed a preview of how well it will react when the market finally turns for good. It’s well worth holding through the uncertainty into the next recovery.” BUY

Wingstop (WING), originally recommended by Mike Cintolo in Cabot Growth Investor, had an excellent first week in the portfolio. The stock rose from 167 to 187 – a new all-time high! There was no obvious news; however, commercials for the wings-and-fries restaurant chain have been all over every March Madness broadcast, so our timing for adding this was fortuitous, if unintended. Plus, the company just released three new wing sauce flavors in conjunction with March Madness, so that’s likely helping matters. Regardless, it seems this restaurant’s profile is rising, and so is the share price. 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, held steady at 27 after a dip the previous week. The stock is up 18% year to date, spurred on by an excellent fourth-quarter 2022 earnings report in which revenues improved 44% year over year and EPS tripled estimates. People are returning to gyms in a post-Covid world, and Xponential Fitness is taking full advantage. BUY

The next Cabot Stock of the Week issue will be published on March 27, 2023.