Cabot Stock of the Week Issue: November 21, 2022

It was a quiet week for the market, at least by 2022 standards, and you should expect more relative calm in this Thanksgiving-shortened week, as much of Wall Street is likely already in vacation mode. Stocks have recovered nicely from their mid-October bottom, with the S&P 500 up more than 10% since that nadir. But the bear market remains, as both the S&P and the Nasdaq are well shy of their 200-day moving averages, though the outperforming Dow has traded above its 200-day line since the start of the month.

So, proceeding with caution is a good approach, which is why we’re adding another reliable dividend-paying stock to the Stock of the Week portfolio this week. It’s a real estate investment trust (REIT) that pays a monthly dividend – in fact, it calls itself “The Monthly Dividend Company.” It was originally recommended by Tom Hutchinson in his Cabot Dividend Investor advisory, and here are Tom’s latest thoughts on it.

Realty Income (O)

Realty Income (O) is one of the highest-quality and best-run REITs on the market. Cash flow from a conservative portfolio of over 11,000 properties has enabled the company to amass a phenomenal track record of paying monthly dividends—to such an extent that Realty Income has the audacity to refer to itself as “The Monthly Dividend Company.” It is a Dividend Aristocrat with more than 25 consecutive years of dividend growth.

Realty is the world’s fourth-largest REIT, has operated for over 51 years, and currently has 11,427 properties rented to 1,125 tenants in all 50 states, Puerto Rico and the United Kingdom. Since its 1994 IPO, Realty Income has amassed a record as one of the most successful income investments on the market.

Here are a few things to like about it:

• 14.25% average annual total return since 1995
• 628 consecutive monthly dividends
• 100 consecutive quarterly dividend increases
• 119 monthly dividend hikes
• 4.4% annual dividend growth since 1994
• Sky-high credit ratings.

How do they do it?

The company buys established properties with a proven record of profitability and rents them to high-quality tenants. The business model is to generally use a “sale-leaseback” arrangement whereby Realty Income purchases the property from the tenant and then the company remains there and pays rent under long-term leases of 10 to 20 years.

Most of these leases are also “net leases,” meaning the lessees pay all the costs associated with the property including maintenance, insurance, and taxes. This arrangement frees Realty Income from unpredictable expenses and the REIT just receives regular rent payments with built-in increases over time.

Although Realty Income is a retail REIT, it is far less volatile than most because of the diversification and remarkably stable clients that offer essential services that are recession resistant. Its largest clients include Walgreens, 7-Eleven, Dollar General, FedEx, Walmart and CVS. Tenants have a historic median 98.2% occupancy rate.

Defensive dividend-paying stocks got clobbered in the market selloff from mid-August to mid-October as interest rates spiked higher and fixed-rate investments became more attractive. O was no exception. The stock plunged 26% to a two-year low. But the selling was overdone as we are likely headed toward a recession that should pressure interest rates lower. Plus, some of the very best recession stocks took the brunt of the selloff. In fact, O has recovered about half of the decline in the past month and now has upward momentum.

For long-term investors, there is probably no bad time to buy the stock. But there are better times. And this is one of them. O currently sells well below the pre-pandemic high despite the fact that the company continued to grow earnings through the pandemic.

It’s a stock that has averaged a better than 14% return since its IPO in 1994. But the returns are much higher if the stock was scooped up during the low periods. It also provides a monthly income as you wait for the stock to regain traction as a high-yielding defensive play in an uncertain market.

It’s true that high interest rates can negatively affect REITs as competing fixed-rate investments become more attractive and the cost of funding for acquisitions increases. But O pays a nearly 4.6% yield that should remain attractive, especially considering the monthly payout. Realty also made a large acquisition recently that should ensure solid earnings growth over the next year.

Because most tenants are staples that remain strong during a recession, earnings should remain solid, as they did through the pandemic. There are also inflation adjustments built into the contracts.

O is a great way to pick up one of the very best income stocks on the market at a cheap price ahead of a period of historic relative outperformance.

Current Recommendations

Changes Since Last Week’s Update

Tesla (TSLA) moves from BUY to HOLD

Most of our stocks are acting well, with one exception: Tesla (TSLA). Shares of the world’s most dominant electric vehicle maker have been in free fall, hitting a two-year low in large part due to the bizarre recent behavior of its founder, Elon Musk (though the bizarre behavior has little to do with Tesla itself). We’re not going to get rid of TSLA anytime soon – not with a return of more than 9,000% since being added to the portfolio 11 years ago (keep taking a bow, Tim Lutts!) – but the stock is going the wrong direction fast, so today we’ll downgrade it to Hold.

We have no other changes, bringing our portfolio up to 16 stocks as we head into the holiday season. Here’s what’s happening with all of them. Happy Thanksgiving!

Updates

Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, was up slightly after the company beat third-quarter earnings estimates last Wednesday. Revenues at the world’s largest independent McDonald’s franchisee grew 27% from Q3 in 2021, while earnings per share swelled by 83%. The top-line number narrowly (3%) beat analyst estimates, while the bottom line surpassed estimates by 82%. Shares got a modest boost after the report but have since coughed up much of those gains.

At around 7.20 as of this writing, ARCO shares have about 18% upside to Bruce’s 8.50 price target. BUY

Brookfield Infrastructure Partners (BIP), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, was down slightly this past week on no news. In his latest update, Tom wrote, “This bankable infrastructure partnership got ridiculously oversold when the market had a conniption over rising interest rates. But interest rates likely topped out ahead of a likely recession, and BIP has come roaring back. It’s up 18% from the October low already and I believe it has a lot further to go. This stock is made to be a gem during recession, inflation and a crummy market. Earnings are recession-proof. Inflation adjustments are built into the contracts. And it pays a great dividend. (This security generates a K-1 form at tax time).” HOLD

Centrus Energy (LEU), originally recommended by Carl Delfeld in Cabot Explorer, pulled back from 39 to 37 after a big run-up the week before. In his latest update, Carl wrote, “Centrus Energy surprised investors as it came out with a quarterly loss of $0.42 per share versus the Zacks consensus estimate of $0.78. This compares to earnings of $2.95 per share a year ago. “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 mostly flat on the heels of a strong push from 30 to 34 in the first two weeks of November. 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 worry 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 … have about 21% upside to our 42 price target. The shares offer an attractive 3.1% dividend yield.” BUY

Corteva (CTVA), originally recommended by Carl Delfeld in his Cabot Explorer advisory, had an inauspicious first week in the Cabot Stock of the Week portfolio, falling from 66 to 64. There was no apparent reason for the pullback other than normal consolidation after the stock had been hovering at all-time highs since late October. In his latest update, Carl wrote, “Corteva shares were off two points … in their first week as an Explorer stock. Corteva has delivered $175 million in productivity savings so far in 2022 as it seeks significant profit margin expansion by 2025.

“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 has caused many quality companies that are growing revenue and net profits to trade 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%. Earnings per share are projected to grow from $2.50 this year to perhaps $3.25 in 2023.” BUY

Enphase Energy (ENPH), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was up another 3% after we upgraded it to Buy last week. In his latest update, Mike wrote, “ENPH is the leader in microinverters for solar arrays, and business is booming both in the U.S. and especially in Europe, where individuals and businesses are racing for energy security as everything in that part of the world remains a mess—and, really, there’s not likely to be too much of a slowdown given the green energy bill this year and the vulnerability to energy supplies in Europe. (Management obviously agrees and has a couple of big capacity expansions coming online next year.) Plus, the firm’s battery systems and EV chargers should ramp nicely in 2023, which is likely to make next year’s earnings estimates (up 24%) appear conservative. The stock had a tough correction (28% from high to low) that knocked us out a few weeks ago, which we don’t regret; if the Q3 report (sales up 81%, earnings up 108% and well above expectations) wasn’t up to snuff, the stock could have bit the dust like so many others. But it didn’t. Instead, the stock gapped up toward its old highs and, while it hasn’t been able to break through yet (again, par for the course with growth stocks), it certainly looks like it wants to if the growth stock environment can shape up.” BUY

Green Thumb Industries (GTBIF), originally recommended by Tim Lutts and then Michael Brush in the Sector Xpress Cannabis Advisor, pulled back from 14 to 12 this week after advancing 19% the previous week. The marijuana retailer is coming off a strong third quarter in which it reported 12% year-over-year sales growth, driven by much-improved retail sales in Illinois and New Jersey, plus the addition of 12 new retail stores. The stock is now up 55% since the start of July. BUY

Kinross Gold (KGC), originally recommended by Clif Droke in his Sector Xpress Gold & Metals Advisor, was down about 5% this past week. This looks like a normal pullback following a 27% jump in the first two weeks of November. The company reported decent earnings earlier this month, as EPS improved 41% year over year, though revenues were flat. The gold miner is also in the midst of a $300 million share repurchase program, which seems to be helping. BUY

Ormat Technologies Inc. (ORA), originally recommended by Brendan Coffey in his Sector Xpress Greentech Advisor, declined sharply on Friday, plummeting from 100 to 90 for no apparent reason. In the grand scheme, the drop-off isn’t that concerning, as the stock is still about where it was at the start of November and up about 10% in the last six weeks. Considering shares of the geothermal energy company were at all-time highs a week ago, we’ll keep it at Buy. Worth keeping a close eye on what it does from here though. BUY

Rivian (RIVN), originally recommended by Tyler Laundon in Cabot Early Opportunities, has been on quite the rollercoaster the last two weeks, with only a 5% net improvement in the share price. In his latest update, Tyler wrote, “Rivian (RIVN) sold off hard going into its earnings report, but the next day coincided with the CPI release and a decent report sent the stock soaring 17% (it has gone up more since then). The highlights from the quarter are that Rivian is benefiting from lower shipping costs, is tightening its belt to reduce CapEx and, seemingly, doing a great job ramping up production as efficiently as is reasonably possible. Deliveries in the quarter totaled 6,584, a little lighter than hoped but up nicely from 4,401 in Q2. The company produced 7,363 vehicles, up 67% from Q2. This all translated to $536 million in revenue, which is a hair on the light side. But management reaffirmed its guidance to produce 25,000 units by the time 2022 is done and said pre-orders for R1T and R1S are now around 114,000, an increase from 98,000 in August. There are an additional 100,000 vehicles on order from Amazon (AMZN). By pushing some spending out into 2023, Rivian’s current cash balance of $13.8 billion should now stretch well into 2024. It has been encouraging to see some of these vehicles on the road lately, and I think that will become more common and help the stock, assuming the company continues to execute.” BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, is in free fall, and it’s time to downgrade it to Hold. The EV maker just recalled 312,000 vehicles due to a taillight issue – its 19^th (!) recall this year. Meanwhile, its founder, Elon Musk, is making a mockery of his new toy, Twitter, which is almost certainly prompting some TSLA shareholders to sell – image matters on Wall Street. So, the stock is now at a two-year low, trading in the low 170s. In the long run, it’s probably a great buying opportunity, as the stock has lost nearly half its value in the last two months; but it’s shown no signs of slowing, so we’ll adhere to the don’t-try-and-catch-a-falling-knife rule of thumb and downgrade to Hold until the stock establishes a clear bottom. MOVE FROM BUY TO HOLD

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, just keeps rising, tacking on another five points since we last wrote and now within striking distance of its September highs (446). There was no news, though the beauty retailer may be getting a Black Friday/holiday shopping season bump. It reports earnings on December 1. We’ll keep it at Hold until after those have passed since even a narrow miss could prompt a retreat after such a big advance. HOLD

Wingstop (WING), originally recommended by Mike Cintolo in Cabot Growth Investor, cooled off after rising exactly 12 points in its first week in our portfolio. But the stock didn’t give back many of those gains and instead looks like it’s establishing a new base. In his latest update, Mike wrote, “WING remains one of a handful or two of potential leaders that has had a good run (including a positive reaction to earnings) and has held up well since—probably partly because the stock already went through the wringer earlier this year, which almost surely wiped out the major weak hands. Moreover, while we’re not big into looking at the macro picture (overall economy), any sort of slowing inflation should continue to help costs, even as consumer spending remains in fifth gear. We’d still like to average up on our purchase (buying another half-sized stake, which equates to 5% of the portfolio), but with the 50-day line down near 140, we’ll hold off a bit longer, aiming to enter on some sort of dip or further rest. If you don’t own any, we’re not opposed to nibbling on minor weakness.” BUY

WisdomTree Emerging Markets High Dividend Fund (DEM), originally recommended by Carl Delfeld in his Cabot Explorer advisory, gave back a point after adding two the previous week. The fund offers both 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 to large caps, mid-caps and small caps in these countries with an emphasis on income and value. The stocks in its basket tend to be conservative, defensive companies with low valuations and high dividends. BUY

Xponential Fitness (XPOF), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, was essentially flat in the past week following a big earnings breakout the week before. In his latest update, Tyler wrote, “Xponential Fitness (XPOF) delivered a Q3 revenue beat with sales rising 56% to $64 million. EPS of $0.10 missed by $0.05. Management raised full-year guidance to $236 million (at the midpoint), implying 53% growth, well above previous guidance of just 39% growth. North America led the charge with 17% same-store sales growth. Franchisees continue to invest, with 36 studios opening just in the last week of September. XPOF has nearly 3,000 more studios contractually obligated to open. With so many fitness studios having closed during the pandemic and a lot of momentum, XPOF continues to look good.” BUY

The next Cabot Stock of the Week issue will be published on November 28, 2022.