Note: To accommodate our Thanksgiving week schedule, there will be no issue of Cabot Stock of the Week published next week. The next issue will be published November 28.
As for today, the broad market’s long-term trend remains up, and today my recommendation is an undervalued stock recommended by Azmath Rahiman, chief analyst of Cabot Benjamin Graham Value Investor.
Cabot Stock of the Week 173
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The broad market’s long-term trend remains up, but as I mentioned last week, there are growing signs of divergence—which is normal after such a long bull run. Not only are fewer of our stocks marching ahead persistently, but the number of stocks hitting new lows on a daily basis has been growing. To me, this is typical long-term topping action. The trouble is, every top evolves differently; there’s no predicting when and where the ultimate top will be. So the best thing you can do is to keep on following the various successful systems. Buy and hold strong growth stocks with constructive patterns, and sell them when they falter. And buy undervalued stocks, and sell them when they are fully valued.
Today’s featured stock is an undervalued recommendation from Azmath Rahiman, chief analyst of Cabot Benjamin Graham Value Investor. Here are Azmath’s latest thoughts.
Signet Jewelers (SIG)
Signet Jewelers is the world’s largest retailer of diamond jewelry, with retail stores in the U.S., U.K. and Canada. As of January 2017, the company had 3,682 stores located in malls and off-malls principally as Kay Jewelers, Jared, Zales Jewelry, Piercing Pagoda, H. Samuel and Ernest Jones. Signet Jewelers is focused on the middle market with product price points from $50 to $10,000. This market accounts for around half of the $41 billion U.S. market. Signet acquired Zales Corporation for $1.4 billion in 2014, which increased the company’s market share from 9.7% in 2013 to 15.2% in 2017.
Diamond specialty retailers like Signet have experienced increasing competition from supercenters like Walmart and online stores. However, according to a survey by WeddingWire in 2013, around 47.7% of engagement rings were purchased from jewelry chain stores and only 6.5% from online retailers, indicating that diamond retailing is one of those retail business which is not significantly threatened by e-commerce websites like Amazon. Customer experience and expert advice in specialty retail stores is a major factor in consumers’ preference for brick and mortar specialty retailers.
The retail jewelry industry is highly fragmented, with the top three players accounting for only 21% of market share. Currently, Signet, Tiffany and Berkshire Hathaway’s subsidiaries, Ben Bridge Jeweler, Borsheims Fine Jewelry and Helzberg Diamonds, are the leading competitors in the space. As consolidation in the industry increases, competition will increase among the large players. And as disposable income continues to rise with the growing economy, diamond retail sales will see reasonable growth in the future. The sheer size of the company helps Signet to increase its bargaining power with suppliers, establish direct diamond contracts with mining companies and maintain strong visibility through its nationwide retail chains and TV advertisements.
Credit quality of receivables is a risk not to be ignored. However, due to the lower credit exposure of Zales, credit sales as a percentage of total sales is only 37% for the whole company, whereas for the Sterling division (which includes Kay and Jared Jewelers), it’s 62%. The company is planning to outsource its capital-intensive in-house credit program for a premium to private-label credit card provider ADS, which will help Signet retain more cash. I consider this a better risk management strategy in the long run—at the cost of interest income.
Since the acquisition of Zale Jewelry in 2014, the company has been working to increase the synergies between its Sterling and Zale divisions. Around 25% of Signet’s revenue comes from Zales. However, the operating profit margin of Zales is only 4% relative to 18% at Sterling Jewelers. Due to the fundamentally similar business models of both Sterling and Zales, I expect Signet to efficiently boost the operating profit margin of Zales with the help of better synergies and supply chain management. If Signet manages to boost the profitability of Zales to 10%, we can expect to see 12% growth in Signet’s operating profit, leading to a higher free cash flow in the future.
I believe management’s recent strategic initiatives to outsource the in-house credit business and close Zales’ underperforming in-mall stores will yield better margins in the coming years. Signet’s current revenue of $6.26 billion and net-profit of $325 million is expected to grow conservatively at around 5% annually over the long term. Signet plans to distribute 70% to 80% of free cash flows in the form of dividends and buybacks. With a current valuation of nine times earnings and an expected free cash flow yield of 10%, the company is a bargain for long-term investment. BUY.
Signet Jewelers Limited (SIG 72)
Clarendon House
2 Church Street
Hamilton HM11, Bermuda
www.signetjewelers.com
CURRENT RECOMMENDATIONS
The addition of Signet Jewelers brings the portfolio to 21 stocks and that’s one too many, so once again I worked through the portfolio, looking for at least one stock to sell—and in the end, it wasn’t difficult to decide which one would go. Details below in SUPV. As to the other stocks, there are a few weak spots (and BEAT remains oversold), but none deserve to be sold at this point.
Baidu (BIDU), originally recommended by Paul Goodwin in Cabot Emerging Markets Investor and featured here last week, continues to build a base in the mid-230s, with the lowest end of the range on top of 230, the level that acted as resistance back in August. It’s an attractive setup. BUY.
BB&T Corp. (BBT), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her Dividend Growth Tier, is a bank with good growth prospects and decent valuation. The stock recently dropped for six consecutive days, but has found support at the 46 level, which looks like a good entry point. In her latest update, Chloe wrote, “Interest rates have slid slightly over the past two weeks, but a December rate hike remains a near-certainty. More likely, financial stocks were spooked by lousy bank earnings from Europe, where Credit Agricole SA led international bank stocks lower. Assuming the slump doesn’t get significantly worse today, BBT remains on Buy.” BUY.
BioTelemetry (BEAT), originally recommended by Tyler Laundon of Cabot Small Cap Confidential, corrected 38% top-to-bottom before finally rallying yesterday. To me, this looks like a great entry point, provided the company continues to execute, but I don’t believe in averaging down in growth stocks. In Tyler’s latest update, he wrote, “BioTelemetry reported earlier in the week and the results were perfectly acceptable, but nothing to write home about. This is one of those trying times as an investor because a big acquisition was recently closed, and you want to see all the anticipated benefits overnight. But it’s not like you can just mash the two companies together and be off and running, especially in the healthcare industry. I think BioTelemetry will pay off for us; we just need to be patient. I moved the stock to Hold after the report due to the stock’s weakness, but I anticipate moving back to Buy, provided shares firm up. At that point, investors that purchased at significantly higher prices should be able to average down, and claw back to breakeven (and then to positive gains!) more rapidly. As an aside, shares of the most notable competitor, iRhythm (IRTC), have also recently begun to weaken. I find this telling given that iRhythm reported a good quarter and several analysts raised price targets (Morgan Stanley went from $50 to $65). However, shares of IRTC have fallen over 10% since and just broke below their 50-day line. I also had a chance to look over Medtronic’s (MDT) preliminary Q2 results. That company also has heart monitoring services, and is a decent bellwether stock for the medical device field. Medtronic reported slightly better-than-expected results, and its initial estimate for Hurricane Maria impact (a massive $250 million) came in much lower (roughly $60 million). There’s potential that this news could provide some relief to the broader medical device group. We’ll just have to wait and see. For now, continue to Hold BioTelemetry.” HOLD.
Broadridge Financial Solutions (BR), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her Dividend Growth Tier, surged nearly 5% on big volume after reporting earnings last Wednesday, and has pulled back normally since. In her update that day, Chloe wrote, “Broadridge is a tech company that provides information and services to financial companies. The company reported earnings that beat estimates this morning, including year-over-year growth of 3% in revenues and 50% in adjusted EPS. The stock is hitting 52-week highs and looks very healthy. Dividend growth investors who don’t own it can buy a little here, or try to wait for a pullback to the stock’s 50-day moving average, currently around 82.” Since then the 50-day moving average has climbed to nearly 83. I had the stock on hold before the earnings announcement, simply because the stock had got so extended, and I’ll keep it on hold at least a bit longer, looking for the chart to settle down. HOLD.
China Lodging Group (HTHT), originally recommended by Paul Goodwin of Cabot Emerging Markets Investor, has been tracking its 50-day moving average since selling off two weeks ago, and that average has now flattened out, giving a clear sign that the uptrend has stalled. In Paul’s update last week, he wrote, “The announcement of a special cash dividend of 64 cents per American Depositary Share to all holders as of December 4 is likely providing some support, but you should keep any new investments small until earnings are safely in the can.” The expected earnings date is November 28. HOLD.
Exact Sciences (EXAS), originally recommended by Mike Cintolo in Cabot Growth Investor, has been hot! In his latest update, Mike wrote, “EXAS has surged in the wake of another outstanding quarterly report. I wrote about some of the firm’s numbers in last week’s update (sales up 156% and Cologuard tests up 136%, while revenue per test and cost per test both headed in the right direction), but what impresses me just as much are the underlying reasons for that growth. Cologuard’s compliance rate remains much higher than other colon cancer screening methods (66% in the quarter), which has allowed it to attract untapped, younger parts of the market (half of Cologuard users have never been screened before!). Because of that, management has actually upped its long-term forecast, believing it can eventually capture 40% of the market—that would be 32 million tests per year, up from 570,000 this year! Obviously, you can’t hang your hat on such a distant forecast, but it’s clear the potential remains enormous as more and more physicians order the test (10,000 new doctors in Q3 alone). The stock is very extended here after a big run, and a plunge into the high 40s (back toward our average buy price of 46.5) would be a red flag. In fact, we could consider booking partial profits if EXAS continues to go vertical. But we’re not going there yet—the buyers are in control here, so hold on if you’re already in, and if not, you can start a position on a dip into the mid-50s.” Since then, the stock has pulled back normally over a four-day period, and if all is well, it may build a base in the mid-50s. Buy on pullbacks. BUY.
Facebook (FB), originally recommended by Mike Cintolo in Cabot Growth Investor, has pulled back normally since releasing a great earnings report. In his latest update, Mike wrote, “ Facebook reported another solid quarter last week, with sales up an incredible 47% (advertising revenues rose 49%) and earnings leaping 77%, both of which were was well north of expectations. Daily active users totaled 1.37 billion, up 16% from a year ago, and, of course, that doesn’t include user totals on Instagram, Messenger or WhatsApp. That said, management again set forth a big spending target for 2018 (up 45% to 60%!). Historically, the company’s initial spending guidance has proven to be too high, but that’s a big reason why analysts see Facebook’s earnings up just 14% next year. The stock isn’t in bad shape, but the RP line is still basically flat since late July, telling us it’s not a great leader right now. We’ll stay on Hold.” In my book, FB has the potential to be one of the last participants in this long bull market. HOLD.
Grupo Supervielle (SUPV), originally recommended by Paul Goodwin of Cabot Emerging Markets Investor, Supervielle reported third quarter results last Wednesday, and the numbers looked good; not only did the company beat analysts’ estimates, but management raised guidance for the full year. But as we always say, the action of the stock in reaction to earnings is what counts, and SUPV’s reaction was not pretty. The stock plunged through its 25-day moving average last Friday and then through its 50-day moving average today. If we hadn’t bought so high, our loss wouldn’t be so big, but we can’t change that. SUPV has the potential to fall further, so I’m getting out here. SELL.
HubSpot (HUBS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, has fallen over the past two weeks on post-earnings profit taking, but the sellers seem to have run out of ammunition, and with the stock sitting just below its 50-day moving average, and just on top of resistance at 78 set in June and September, buying here looks like a low-risk proposition. BUY.
Nucor (NUE), originally recommended by Crista Huff of Cabot Undervalued Stocks Advisor for her Buy Low Opportunities Portfolio, has now been falling for three weeks, but that just makes it more attractive to Crista. In her latest update, she wrote, “Nucor is a low-cost producer of a diversified portfolio of iron and steel products, and an undervalued mid-cap growth stock. I had downgraded NUE from Buy to Hold on October 24 when there was less than 10% upside to my 65 price target. Now that the share price has come down (within its normal trading range), I’m moving NUE back to a Strong Buy recommendation. There’s about 17% upside as NUE retraces its December 2016 high of 65.” Now the upside is 19%. BUY.
PayPal (PYPL), originally recommended by Mike Cintolo of Cabot Growth Investor, has been climbing steadily higher for months, but in the past few days it’s paused to take a rest between 74 and 75—which is good. In Mike’s latest update, he wrote, “PayPal PYPL remains in a firm uptrend, though there’s no question the stock is extended to the upside, so pullbacks or shakeouts are possible. Still, given that shares broke out of a post-IPO base “just” six months ago, I think there’s more upside down the road. One thing I’m watching will be news on Venmo, the firm’s increasingly popular peer-to-peer money transfer service ($9.4 billion of volume in Q3, up 93% from a year ago). PayPal is just starting to monetize the platform, allowing users to pay with Venmo at over two million merchants, and while management will go slow, this could end up being an extra avenue of growth in the years ahead. Sit tight if you own some, and if not, try to buy on dips toward the 25-day line [now near 71 and rising].” BUY.
Pembina Pipeline (PBA), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her High Yield Tier, remains the highest-yielding stock in the portfolio, and is thus particularly attractive for investors seeking current income. The stock has been trending higher for nearly two years, roughly doubling in the process, and buying dips has been the best strategy over that period. Most recently, the company surged higher over two weeks to hit a new high, and now is pulling back to cool off. If you’re not on board yet, try to buy after the bottom of this pullback. BUY.
Planet Fitness (PLNT) originally recommended by Mike Cintolo in Cabot Top Ten Trader, released an excellent earnings report last Tuesday after the market close and the stock gapped up to new highs on Wednesday morning on huge volume—a very positive sign—and has continued higher since. If you don’t own yet, wait for a pullback. BUY.
Pulte Group (PHM), originally recommended by Crista Huff of Cabot Undervalued Stocks Advisor for her Growth portfolio, has climbed steadily higher since releasing an excellent third quarter earnings report three weeks ago. In her recent updates, Crista wrote, “PHM has risen roughly 72% this year, and is still climbing. I’m moving PHM from Buy to Hold. Experience shows me that when a stock rises a tremendous amount, it then spends quite a few months resting (with pullbacks!). Look no further than the two-year price chart on Goldman Sachs (GS) to see a good visual of that scenario. I’m going to sell PHM very soon. Long-term investors still own a very undervalued aggressive growth stock, so hold PHM if you’re so inclined. But I’m going to make room for a new investment idea that carries less obvious downside risk.” Interestingly, Mike Cintolo likes the stock for growth-oriented accounts, but I’m inclined to sell when Crista sells and pick up the next low-risk opportunity. HOLD.
Quanta Services (PWR), originally recommended by Crista Huff of Cabot Undervalued Stocks Advisor for her Growth Portfolio, released third quarter earnings on November 2 and the stock immediately plunged from 38 to 36. But it’s been stabilizing in that area since, and Crista is still bullish. In her latest update, Crista wrote, “Quanta provides specialized infrastructure and network services to the electric power, oil and natural gas industries. PWR is a very undervalued aggressive growth stock. The share price ratchets up and down, and seems to be bouncing at 35.5 during the current pullback. I expect the stock to resume climbing soon. There’s 20% upside to my fair-value price target of 44. Buy PWR now.” BUY.
Sociedad Quimica y Minera de Chile (SQM), originally recommended by Paul Goodwin of Cabot Emerging Markets Investor, is a diversified South American miner with a major presence in the lithium market, which is expected to thrive as electric cars grow in popularity. In Paul’s latest update, he wrote, “SQM has been biding its time, trading sideways under resistance at 62 as it waits for its quarterly report on November 22, after the close. That means the reaction will come just as U.S. markets close for the Thanksgiving holiday. Analysts estimate revenue at $519 million and EPS at 41 cents.” Paul’s keeping the stock rated hold until after the earnings report, but I like the setup a lot, so I’m sticking with Buy. BUY.
Square (SQ), originally recommended by Mike Cintolo in Cabot Growth Investor, keeps on climbing! It’s now 25% above its 50-day moving average, which is down at 32. I’ll keep it rated Hold, waiting for a better entry point, but if you’re into trading, you might happily take some profit here. HOLD.
Tesla (TSLA), a recommendation of Cabot Top Ten Trader, has been base-building in the 300 area, setting up for a renewed assault on its old high of 390—which could come next week, or next year. Fundamentally, the future for the company remains very bright, as Tesla leads revolutions in both electric cars and self-driving cars, but the stock is temporarily out of action, as reality catches up (a bit) to expectations. HOLD.
VMware (VMW), originally recommended by Cabot Benjamin Graham Value Investor, was officially “fully valued” when it hit 118.75, so it can be sold anytime. But given that the stock’s main trend remains up, I’m sticking with it. The stock hit another new high today. HOLD.
Wynn Resorts (WYNN), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her Dividend Growth Tier, advanced for seven consecutive days, hitting new highs on many of them, before pulling back today. In Chloe’s latest update, she wrote, “WYNN broke out past resistance at 150 after October gaming numbers from Macau beat estimates last Wednesday, and the stock is now hitting new 52-week highs. After a six-month rally, WYNN spent September and October consolidating, but now looks ready to get going again. Dividend growth investors can buy here.” BUY.
THE NEXT CABOT STOCK OF THE WEEK WILL BE PUBLISHED NOVEMBER 28, 2017
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