Thank you for subscribing to the Cabot Undervalued Stocks Advisor. We hope you enjoy reading the November 2020 issue.
We briefly discuss the soon-to-evaporate election cloud, the merits of holding value stocks when growth/momentum stocks tumble, and highlight one of our portfolio stocks that had some earnings issues along with several others that reported strong earnings that lifted their share prices meaningfully.
Earnings season is in full swing. Six portfolio companies report later this week. We encourage subscribers to visit the reporting companies’ websites to review their earnings-related slide presentations and listen to the post-earnings conference call. These are all available to the public under the “Investor Relations” tab. Sometimes what portfolio companies actually do can seem murky – a quick visit to their website can help clarify, and (at least to me, a certified investment geek) provide some fascinating reading.
Please feel free to send me your questions and comments. This newsletter is written for you and the best way to get more out of the letter is to let me know what you are looking for.
I’m best reachable at Bruce@CabotWealth.com. I’ll do my best to respond as quickly as possible.
Cabot Undervalued Stocks Advisor 1120
At Least One Uncertainty Cloud Should be Evaporating
There remains a lot going on. The pandemic, domestic and international economies struggling, zero/negative interest rates, and an unusually high number of other clouds still obscure the investing horizon. But, with election season rapidly approaching its end, one major source of uncertainty will likely evaporate. Investors can then sort out with more clarity the path of federal and state policies, including the chances and possible size of a new round of fiscal stimulus.
This past week at least modestly illustrated the merits of a value strategy. Two of our three “Strong Buy” stocks, Molson Coors Beverage Company and Equitable Holdings, surged on company-specific news that highlighted their underlying value. Other “non-value” stocks not on our recommended list, like Apple, Amazon, Microsoft and Facebook, provided company-specific news that should have been flattering but instead sent their stocks down between 5% and 9%.
For investors that focus on high-growth and momentum-driven stocks, having at least a few value stocks can provide portfolio stability. This added stability can help boost investor resolve to stay the course when markets get sloppy and the macro news looks grim, as it did late last week.
Last week, we moved Columbia Sportswear to a Hold from Buy, as it had only a handful of percentage points of remaining upside. This was a good call directionally, but we should have moved it to a Sell, as it subsequently reported disappointing earnings, sending its stock down to about where we had initially recommended it. Being price-sensitive investors, and following our analysis of the company’s updated situation, we are returning the shares to a Buy. Perhaps partly offsetting this, Hold-rated Marathon Petroleum reported surprisingly strong earnings, sending its shares up 14% for the week.
After you receive this letter, six portfolio companies will report earnings. If you have the time and inclination, listen to the management call that accompanies each report. You can find these under the company’s “Investor Relations” tab on their website, and the calls are webcast and open to the public. Most are available for a few weeks or longer for those not able to listen to the live webcast. The management and brokerage analysts often use a lot of jargon, which can make it difficult to follow sometimes.
Fortunately, the companies also provide a slide deck that highlights the results in a fairly straightforward manner (although they usually de-emphasize the “low-lights”). Often, clicking through a slide deck can quickly help you become more familiar with a company and its operations, which not only can help you keep your resolve when things slip but also provide a fascinating window into what the company is doing and its priorities.
Share prices in the table reflect Tuesday (November 3) closing prices. Please note that prices in the discussion below are based on mid-day November 3 prices.
Send questions and comments to Bruce@CabotWealth.com.
Upcoming Earnings Releases
- November 4: Equitable Holdings (EQH)
- November 5: Voya Financial (VOYA)
- November 5: General Motors (GM)
- November 5: Universal Electronics (UEIC)
- November 5: Terminix Global Holdings (TMX)
- November 6: ViacomCBS (VIAC)
- November 9: Tyson Foods (TSN)
Today’s Portfolio Changes
Columbia Sportswear (COLM) – from Hold to Buy
Marathon Petroleum (MPC) – from Hold to Buy
Portfolio Changes During the Past Month
Columbia Sportswear (COLM) – from Buy to Hold
Quanta Services (PWR) – from Hold to Sell (Special Bulletin – October 30)
Quanta Services (PWR) – from Buy to Hold (raising price target to 64 from 61)
Terminix Global Holdings (TMX) – new Buy
Bristol-Myers Squibb (BMY) – from Hold to Buy
Chart Industries (GTLS) – from Buy to Sell (Special Bulletin – October 15)
Bristol-Myers Squibb (BMY) – from Strong Buy to Hold
Growth Portfolio stocks have bullish charts, strong projected earnings growth, little or no dividends, low-to-moderate P/Es (price/earnings ratios) and low-to-moderate debt levels.
|Stock (Symbol)||Date Added||Price Added||11/3/20||Capital Gain/Loss||Current Dividend Yield||Price Target||Rating|
|Chart Industries (GTLS)||07-15-20||—||—||62.2%||—||—||Sold 10/15/20|
|MKS Instruments (MKSI)||02-19-20||117||115||-1.3%||0.7%||130||Hold|
|Quanta Services (PWR)||12-03-19||41||67||65.9%||0.3%||—||Sold 10/30/20|
|Tyson Foods (TSN)||12-10-19||89||56||-36.6%||3.0%||75||Buy|
|Universal Electronics (UEIC)||11-04-16||57||39||-32.6%||—||47||Buy|
|Voya Financial (VOYA)||05-31-18||52||50||-4.0%||1.2%||62||Buy|
MKS Instruments (MKSI) generates about 49% of its revenues from producing critical components that become part of equipment used to make semiconductors. MKS’ products are generally in the stronger segments of this currently healthy market. While MKSI shares closely track the broad semiconductor indices, the expansion of its Advanced Markets segment, including its 2016 acquisition of Newport Corporation, as well as its 2019 acquisition of semiconductor-related Electro Scientific Industries, may allow its shares to break out. MKS recently promoted 13-year company veteran Dr. John T.C. Lee to CEO.
The company reported third-quarter results that were fairly impressive. Revenues increased 28% from a year ago and were slightly ahead of estimates. Per share earnings of $1.99, which includes some adjustments, were 72% higher than a year ago and about 8% ahead of consensus estimates. Results showed decent sequential improvement from the mildly pandemic-weakened second quarter.
The year-over-year revenue growth was driven by a robust 61% increase in its semiconductor segment, while advanced materials revenues fell 4%. MKS gave encouraging guidance for the fourth quarter.
In the quarter, higher earnings were due to better cost of goods sold and operating leverage that boosted operating margins by over 5 percentage points. Free cash flow was a sturdy $123 million compared to $44 million a year ago. MKS is strengthening its balance sheet, as debt net of cash is now only $113 million, compared to $360 million at year-end.
One risk that we have heard elsewhere is that Chinese tech companies are stockpiling key components and supplies. MKS is likely benefitting from this in the near-term, yet it raises our concerns for the entire semiconductor industry’s mid-term outlook.
Most of MKS’s growth is coming from its core semiconductor operations, suggesting that its recent acquisitions of ESI and Newport aren’t performing as well as hoped.
The company is holding its Virtual Investor Day on December 10, available to anyone through the MKS website.
Overall, the MKSI story remains positive but we don’t believe there is enough upside to warrant a Buy at this point. The shares are a true “hold” – fine to keep but not yet worthy of incremental new funds.
MKSI shares rose 5% this past week and have about 13% upside to our 130 price target.
Valuation remains reasonable at 14.1x estimated 2021 earnings of $8.12. The estimate increased about 4% from last week. HOLD.
Quanta Services (PWR) reported strong third-quarter results last week, with adjusted per-share earnings of $1.40, up 23% from a year ago and well ahead of the $1.09 consensus estimate. Also, the company raised its full-year adjusted earnings per share guidance to a midpoint of $3.58, which includes likely losses of about $0.39 from its Latin America operations that it is exiting, implying that remaining earnings would be close to $4.00/share. The company is clearly executing on its growth strategy.
The stock briefly traded above our 64 price target on the report date, before closing at 62.66, up about 3% in a choppy but positive overall market. We moved the shares to a Sell last Friday, October 30. We viewed the risk/reward trade-off as unfavorable at that point. The PWR holding produced a 54% profit since the stock was recommended last December. SELL.
Tyson Foods (TSN) is one of the world’s largest food companies, with over $42 billion in revenues last year. Beef products generate about 36% of total revenues, while chicken (31%), pork (10%), and prepared/other contribute the remaining revenues. It has the #1 domestic position in beef and chicken with roughly 21% market share in each. Its well-known brands include Tyson, Jimmy Dean, Hillshire Farms, Ball Park, Wright and Aidells. As only 13% of its sales come from outside the United States, Tyson’s long-term growth strategy is to participate in the growing global demand for protein. The company has more work to do to convince investors that the future is brighter, particularly as it is more of a commodity company (and hence has lower margins) compared to its food processor peers.
New CEO Dean Banks officially took the new role on October 3. Given his lack of industry experience but strengths in technology, we will be watching what changes he makes.
This past week, competitor Sanderson Farms (SAFM) received and rejected an unsolicited $142/share takeover offer from private equity firm Durational Capital. Tyson was rumored to be a co-bidder with Durational but apparently it was not. The 15% premium offer seems like a low-ball bid, but does highlight the undervaluation of all chicken processors including Tyson.
TSN shares were flat for the past week and remain at the bottom of their 58-65 trading range. The stock has 31% upside to our 75 price target.
Tyson currently trades at 11.4x estimated 2020 earnings of $5.03/share and 9.8x estimated 2021 earnings of $5.86. The estimates were unchanged in the past week. Currently the stock offers a 2.9% dividend yield. While the shares may take some time to recover, we are staying with the name. BUY.
Universal Electronics (UEIC) is a major producer of universal remote controls that subscription broadcasters (cable and satellite), TV/set top box/audio manufacturers and others provide to their customers. The company pioneered the universal remote, named the ‘One for All’, which was quickly adopted by consumers after its launch in 1986. Since then, the company has expanded into a range of remote control devices for smart homes, safety and security and other residential and commercial applications, driven by its proprietary technology. The company has a global roster of customers, with about 40% of sales produced outside the United States. Comcast is a 10%+ customer and they hold warrants for up to 5% of Universal’s shares.
For UEIC shares to start a sustained move upward, their revenues need to stop declining and turn (even if slightly) positive. While expanding profit margins help, the shares aren’t cheap enough for this to make much of a difference yet.
Stable/rising revenues could come from a recovery in net cable subscriptions, particularly upon the return of live sports (a major driver of new subscriptions) or when in-home installations resume. Another source of revenue growth may come from upgraded products that allow better control of set top boxes that manage a wide range of media including cable, Netflix/etc., and other digital technologies. Also, the company is expanding into Alexa-like home devices, which could boost revenue growth.
There was no meaningful news this week for UEIC. The company reports earnings on November 5, with a consensus earnings estimate of $0.91.
UEIC shares fell about 5% in the past week, and have 23% upside to our 47 price target.
UEIC shares trade at 10.7x estimated 2020 earnings of $3.56 and 8.9x estimated 2021 earnings of 4.31. Both estimates were unchanged compared to last week.
We are patient for now with UEIC shares because of the larger opportunity on the horizon, potential for better results in the next quarter or two, and the increasingly low valuation. BUY.
Voya Financial (VOYA) is a U.S. retirement, investment and insurance company serving 13.8 million individual and institutional customers, with $606 billion in assets under management and administration. The company previously was the U.S. arm of Dutch financial conglomerate ING Group, from which it was spun off in 2013. Voya has several appealing traits. Even though it is well capitalized, it is migrating toward a capital-light model, which should allow it to use some of its excess capital to repurchase shares. Strong earnings and cash flows, lower capital intensity and share repurchases should help boost its share price to our 62 target (32% implied upside).
There was essentially no news on the stock this past week. Voya reports on November 5, with a consensus estimate of $1.38.
Voya shares rose 2% in the past week and has about 24% upside to our 62 price target.
VOYA trades at 13.4x estimated 2020 per-share earnings of $3.74 and 8.4x estimated per-share earnings of $5.96. The 2020 estimate rose a cent this past week. BUY.
Growth & Income Portfolio
Growth & Income Portfolio stocks have bullish charts, good projected earnings growth, dividends of 1.5% and higher, low-to-moderate P/Es (price/earnings ratios), and low-to-moderate debt levels.
|Stock (Symbol)||Date Added||Price Added||11/3/20||Capital Gain/Loss||Current Dividend Yield||Price Target||Rating|
|Bristol-Myers Squibb (BMY)||04-01-20||55||61||12.1%||2.9%||78||Buy|
|Dow Inc (DOW)||06-05-18||68||49||-28.7%||5.7%||60||Hold|
|Total S.A. (TOT)||09-04-18||62||32||-47.9%||9.5%||43||Hold|
Like most biopharma companies, Bristol frequently issues news releases regarding its various treatments. Unless they meaningfully either strengthen or weaken our view on the company, we likely won’t comment on them here. It was generally a quiet news week for Bristol.Bristol-Myers Squibb Company (BMY) is a New York-based global biopharmaceutical company. In November 2019, the company acquired Celgene for a total value of $80.3 billion, including $35.7 billion in cash and $40.4 billion in stock. We are looking for Bristol-Myers to return to overall revenue growth, both from resilience in their key franchises (Opdivo, Revlimid and Eliquis) and from new products currently in their pipeline. We also want to see the company execute on its $2.5 billion cost-cutting program. We see most of these initiatives remaining intact after it completes the MyoKardia acquisition.
On Tuesday, Bristol released stock-moving news that its experimental psoriasis treatment Deucravacitinib met its testing goals in a late-stage study. This boosts the chances of FDA approval and thus Bristol’s earning power.
BMY shares rose 4% in the past week. The shares have about 26% upside to our 78 price target.
The stock trades at a low 8.3x estimated 2021 earnings of $7.41 (estimate unchanged from last week). The 2.9% dividend yield is well covered by the company’s enormous $13.5 billion in free cash flow likely this year. BUY.
Broadcom, Inc. (AVGO) designs, develops and markets semiconductors (about 72% of revenues) that facilitate wireless communications. The company’s foundation is its #1 industry position in high performance RFIC (radio frequency integrated circuits), whose use in high-end smartphones has driven Broadcom’s growth and profits. About 25% of total revenues come from chips that go into high-end smartphones, with Apple providing about 20% of Broadcom’s total revenues. The company also provides software that runs technology infrastructure including telecom and corporate networks (about 28% of total revenue).
Despite Apple’s weak share price following its earnings report last week, iPhone sales were ahead of most expectations, providing encouragement about future volumes of Broadcom chips (Apple is a 20% customer of Broadcom). We don’t expect a 5G “supercycle” but healthy new phone purchases, helped by strong wireless telecom carrier support, will be supportive for Broadcom.
AVGO shares were unchanged in the past week. The stock has about 15% upside to our 410 price target.
The shares trade at 16.2x estimated FY2020 earnings of $22.05 and 14.2x estimated FY2021 earnings of $25.21. Both estimates were unchanged in the past week. The shares pay a 3.6% dividend yield. HOLD.
Dow Inc. (DOW) is a commodity chemicals company with manufacturing facilities in 31 countries. In 2017, Dow merged with DuPont to temporarily create DowDuPont, then split into three parts in 2019 based on the newly combined product lines. Today, Dow is the world’s largest producer of ethylene/polyethylene, which are the world’s most widely-used plastics. Dow is primarily a cash-flow story driven by two forces: 1) petrochemical prices, which are often correlated with oil prices and global growth, along with competitors’ production volumes; and 2) ongoing efficiency improvements (a never-ending quest for all commodity companies to maintain their margins).
Dow’s third-quarter earnings report (October 22) was encouraging. Per-share earnings of $0.50 were down 45% from a year ago but well-ahead of the $0.31 consensus estimate. Operating EBITDA, a scrubbed measure of cash operating profits excluding the various charges and gains, fell 20% from a year ago, to $1.5 billion, largely due to the weaker sales but partly offset by cost-cutting. Compared to the pandemic-damaged second quarter, Dow saw healthy sequential gains in revenues (+16%) and a near-doubling (+96%) of its Operating EBITDA. Their cost-cutting appears to be making progress and the CEO said they remain on-track for $300 million in cuts this year. Management commented that demand in China is basically back to pre-Covid levels, and provided an encouraging overall outlook.
Overall, Dow is making progress with its strategic goals. Free cash flow was a healthy $1.5 billion and $156 million higher than a year ago. This source of cash, along with proceeds from asset sales, has allowed Dow to reduce its debt net of cash by 12%, or about $1.8 billion. This is fairly impressive given everything that has happened this year.
Dow shares rose about 4% this past week and have about 24% upside to our 60 price target.
The shares trade at a reasonable 15.4x estimated 2022 earnings of $3.14, although this is two years away. This estimate is unchanged for the week.
Valuation on estimated 2020 earnings of $1.42 is less meaningful as this assumes no recovery.
The high 5.8% dividend yield is particularly appealing for income-oriented investors. Dow currently is more than covering its dividend and management makes a convincing cast that it will be sustained. However, there is a small risk of a cut if the economic and commodity recoveries unravel. HOLD.
Total S.A. (TOT), based in France, is among the world’s largest integrated energy companies, with a global oil and natural gas production business, one of Europe’s largest oil refining/ petrochemical operations, and a sizeable gasoline retail presence. The company is also expanding somewhat aggressively into renewable power generation, aiming for a strong position in a low-carbon world that they project could arrive by 2050. For perspective, Total plans to invest $13 billion across all capital projects in 2020, with $2 billion of that going into renewables projects. Overall, the alternative energy initiatives may either be highly profitable or value-destructive.
While low energy prices have hurt Total like all integrated producers, the company’s low production costs (management claims its costs are below $25/barrel), efficient operations and sturdy balance sheet position it well relative to its peers. Also, the company’s production growth profile may still be among the best in the industry despite sharp capital spending reductions.
Total reported good third-quarter results last week. Net income of $0.29/share fell 74% from a year ago but appears to be about 50-70% better than a range of consensus estimates. Adjusted net operating income from its business segments fell 60% but still was a reasonable $1.5 billion. As expected, profits from its exploration/production, natural gas/renewables, and refining segments deteriorated sharply from a year ago but marketing/services profits rose 12%.
Cash flow from operations was a very respectable $4.3 billion, although it was 41% below the year-ago results. Total reduced its capital spending while also trimming its debt (net of cash) by $2.5 billion. The company’s gearing (leverage) was 22%, approaching its target of “below 20%”. Currently, Total has an investment grade, Single A credit rating. The company remains on track for $1 billion in operating cost cuts this year.
Critically and encouragingly, the company reiterated their commitment to the high €0.66/share quarterly dividend. Management stated that the dividend remains supported by oil prices, which have remained at $40/barrel or better (averaging $42.90/barrel in the quarter), particularly given the company’s good results this past quarter.
The dividend currently produces a 9.5% yield. Brent crude prices (the London-based benchmark) fell sharply last week but have rebounded to about $40 currently. One might best consider about half of the dividend safe, and the other half more speculative based on oil prices.
TOT shares rose 6% this past week, partly on its strong earnings report and partly due to some recovery in oil prices in the past few days. Risks clearly remain, including rising Covid cases in Europe and the U.S., which increases the risk of new demand-weakening stay-at-home orders. Total’s shares have about 32% upside to our 43 price target.
TOT shares trade at 10.8x estimated 2021 earnings of $2.82 and 7.9x estimated 2022 earnings of $4.11. The 2021 estimate ticked slightly down while the 2021 estimate ticked up by a cent this past week. We would consider the 2022 estimate to reflect “normalized” earnings.
The shares remain a tad below 33 support, and investor sentiment is awful but modestly improved from last week. Given the increasingly volatile (weak) commodity prices, we are less likely to want to add to our position on weakness. The company’s ADS trade on the NYSE with one TOT ADS equal to one ordinary share. HOLD.
Buy Low Opportunities Portfolio
Buy Low Opportunities Portfolio stocks appear capable of a big rebound from recent lows. They have strong projected earnings growth; low-to-moderate price/earnings ratios (P/Es); no dividend requirement and low-to-moderate debt levels. Investors should expect volatility as the stock market alternately embraces the companies’ current successes and remains wary of the stocks’ recent downturns.
|Stock (Symbol)||Date Added||Price Added||11/3/20||Capital Gain/Loss||Current Dividend Yield||Price Target||Rating|
|Columbia Sportswear (COLM)||06-30-20||80||79||-1.1%||—||100||Buy|
|Equitable Holdings (EQH)||11-15-19||24||22||-5.4%||3.0%||28||Strong Buy|
|General Motors (GM)||12-31-19||37||35||-3.2%||—||45||Strong Buy|
|Marathon Petroleum (MPC)||09-04-18||84||32||-62.0%||7.3%||41||Buy|
|Molson Coors (TAP)||08-04-20||37||39||5.3%||—||59||Strong Buy|
|Terminix Global Holdings (TMX)||10-13-20||45||48||8.0%||—||57||Buy|
Columbia Sportswear (COLM) produces the highly recognizable Columbia brand outdoor and active lifestyle apparel and accessories, as well as SOREL, Mountain Hardware, and prAna products. For decades, the company was successfully led by the one-of-a-kind Gert Boyle, who passed away late last year. The Boyle family retains a 36% ownership stake and Gert’s son Timothy Boyle remains at the helm.
Columbia reported disappointing third-quarter results, with adjusted earnings per share of $0.94, down about 46% from a year ago and about 25% below the consensus estimate of $1.26. Revenues fell 23% and were about 9% below estimates. Adding to investor frustration, the company’s fourth quarter outlook was discouraging: sales were guided to about 2% below consensus estimates and earnings were guided to about 20% below consensus estimates. With the news, the shares fell 23% on Friday.
Management said the shortfalls were due to a deferment of orders until the fourth quarter, but this didn’t explain weak 4Q guidance. Overall, it appears that the company is struggling with weak brick-n-mortar store sales as customers have remained generally leery of in-person shopping at Columbia stores and the wide range of third-party retailers that carry Columbia merchandise. Also, there have been some supply constraints that have limited shipments to retailers, as well as volatility in retailer orders due to their uncertainty surrounding the pandemic. Sales in Latin America and Asia Pacific (China, Korea, Japan) were unexpectedly weak, as well.
Encouragingly, e-commerce sales jumped 55% (to a still-small 12% of total sales). This channel promises to be a source of strength for the foreseeable future. Helping with its online sales efforts, Columbia completed the deployment of their new X1 platform.
The company said that orders continued to strengthen, that it has a freshened line of merchandise, and that the channel inventory (inventory held at third-party retailers) is lean. Also, it raised its cost-cutting goal to $100 million this year. Along with the earnings release, Columbia announced the retirement/replacement of its chief operating officer and some additional internal promotions and changes to its supply chain, ecommerce and digital operations. Columbia’s balance sheet remains solid, holding $315 million in cash and no debt, providing it with considerable financial flexibility.
As price-sensitive investors, we are moving Columbia shares back to a BUY. The shares are now modestly below our initial recommendation price, driving their renewed appeal. Columbia’s long-term earning power appears unimpeded but is being pushed out into the future compared to what we had initially anticipated. Also, we think the company is being exceptionally conservative with its forward guidance, given the wide range of uncertainties and the danger that another significant “miss” would more severely damage their credibility. From a technical perspective, the shares are likely washed out, yet would benefit from any post-election stimulus.
Columbia’s shares fell 19% this past week. The shares have about 29% more upside to our 100 price target.
The shares trade at 20.6x estimated 2021 earnings of $3.77. The earnings estimate fell by 11 cents from a week ago due to the weak results and guidance. For comparison, the company earned $4.83/share in 2019. BUY.
Equitable Holdings (EQH) owns two principal businesses: Equitable Financial Life Insurance Co. and a majority (65%) stake in AllianceBernstein Holdings L.P. (AB), a highly respected investment management and research firm. Acquired by French insurer AXA in 1992, Equitable began its return to independence with its 2018 initial public offering as part of a spinoff. AXA currently owns less than 10% of Equitable. With its newfound independence, Equitable is free to pursue new opportunities.
The company is well-capitalized and has significant liquidity. Its diverse, high-quality investment portfolio is hedged against adverse changes in interest rates and equity markets. Equitable has continued its share repurchase program through the pandemic.
AllianceBernstein shares are modestly attractive in their own right. While the price spike on the Morgan Stanley/Eaton Vance merger news took away a lot of the appeal, the stock has fallen back recently to almost pre-deal levels. Our October 14 note has more color on AllianceBernstein.
Equitable announced an agreement to transfer the financial risk on $12 billion of its retirement-income annuities to a reinsurer, Venerable Holdings, LLC. The deal frees up $1.2 billion of capital that Equitable was required to hold to protect the value of the annuities. With some of that newly-excess capital, Equitable said they will repurchase an incremental $500 million in shares in 2021, on top of their previous repurchase commitments. The deal releases about 13% of its annuities book, helpful as many of these older annuities have expensive and higher-risk market exposure features.
Interestingly, Equitable said they are negotiating to buy a 9.9% stake in Venerable and receive a board seat. Venerable (actually the parent VA Capital), is backed by a high-quality consortium of private equity and insurance companies. We see this as a back-door way to recapture some of the foregone value in the now-transferred annuities as well as participate in Venerable’s growth as an emerging specialist in this type of business.
Supported by the Venerable transfer news, EQH shares rose about 22% in the past week and have about 22% upside to our 28 price target.
Equitable reports on November 4. The consensus earnings estimate is $1.18.
Like many insurance companies, investors often value Equitable on a book value basis. On this basis, EQH shares trade at 78% of its $28.68 tangible book value, a considerable discount. We note that the book value will likely move around some in the third and fourth quarters, depending on the timing of the mark-to-market of its private equity investments and other factors.
EQH shares are also undervalued on earnings, trading at 5.0x estimated 2020 earnings of $4.46 (unchanged from a week ago). The shares offer a 3.0% dividend yield. STRONG BUY.
General Motors (GM) under CEO Mary Barra (since 2014) has transformed from a lumbering giant to a well-run and (almost) respected auto maker. The company has smartly exited many chronically unprofitable geographies (notably Europe) and trimmed its passenger car roster while boosting its North American market share with increasingly competitive vehicles, particularly light trucks. We consider its electric and autonomous vehicle efforts to be near industry-leading. Its GM Financial operations are well-capitalized but will be tested as the pandemic unfolds. Near-term, the shares will trade based on progress with a federal stimulus plan, the general U.S. economic outlook, trends in light vehicle sales, its progress with alternative vehicles and of course its earnings, which will be reported pre-market on November 5. The consensus estimate is $1.43.
We expect the company to provide more color on its Nikola negotiations as well as its progress on electric and autonomous vehicles. Some investors are expecting news about a possible spin-off of its alternative vehicle operations, but we believe these are core to GM’s future and will not be spun off.
This past week, GM shares rose about 2%, but have gained about 41% since the end of June. The stock has about 26% upside to our 45 price target. The target price implies 8.2x multiple on 2022 estimated earnings of $5.50.
GM shares trade at 12.8x estimated 2020 earnings of $2.80 and 7.5x estimated 2021 earnings of $4.79. Both estimates moved up from a week ago. GM remains an attractive cyclical stock. STRONG BUY.
Marathon Petroleum (MPC) is a leading integrated downstream energy company and the nation’s largest energy refiner, with 16 refineries, a majority interest in midstream company MPLX LP, 10,000 miles of oil pipelines, and product sales in 11,700 retail stores.
Following its agreement to sell its Speedway retail gas station chain to the Japanese company Seven & i Holdings, the parent of the 7-Eleven chain, for $21 billion in cash, Marathon will be losing a huge source of annual cash flow but also will be shedding as much as 30% of its $32 billion in debt (including debt of its MPLX pipeline subsidiary). The deal will likely close in early 2021. Some of the proceeds will likely be returned to shareholders through share repurchases.
Marathon reported encouraging third-quarter results, with an adjusted net loss per share of $(1.00), much worse than the profit of $1.63 a year ago but much better than expectations for a $(1.74) loss. The quarter had several charges and adjustments that made a direct comparison to a year ago and to estimates somewhat murky, but the company clearly had a better quarter than the market expected. Better refining margins and volumes, as well as strong cost-cutting, drove the results.
The company gave encouraging fourth-quarter guidance although it may have to reach to achieve it. Helping its outlook, Marathon is on track to reach and possibly exceed its $1.4 billion cost-cutting target. Its MPLX pipeline partnership is showing good performance, as well.
With its $16 -$17 billion in Speedway proceeds, plus about $1 billion in unrelated tax refunds, Marathon would have about $7 - $8 billion in proceeds available to repurchase its shares after it pays down its debt to a target of $3-$4 billion, net of cash on hand. This would translate into repurchasing as much as 200 million shares, or 30% of its shares, over the next year or two.
Marathon is making progress toward its goal of reducing its carbon emissions and is ramping up its renewable fuels program.
All in, a very encouraging report. As we noted in our letter last week, we have done further research into the industry and are finding that, given the sharp stock price sell-offs, the refinery stocks may have considerable appeal for highly-risk-tolerant investors who can wait perhaps a year or two. Near-term, the margin and volume outlook is humbling to say the least, as the rising number of Covid cases threatens a return to stay-at-home orders. However, we believe that eventually a combination of vaccine/prevention/saturation will boost the demand for oil products. Interestingly, the surge in home deliveries has kept the demand for diesel fuel used by trucks relatively sturdy.
So, while the shares carry considerable risk and may be suitable only for risk-tolerant investors, we are moving Marathon shares to a BUY.
MPC shares rose about 14% in the past week. The shares have 28% upside to our 41 price target.
The shares will continue to trade near-term around progress on a federal stimulus plan, the pace of the economic recovery and gasoline/jet fuel consumption, on oil prices and on refiner margins. An emerging issue is the possibility of a Democratic sweep in the upcoming election – oil refiners would be particularly exposed to higher corporate income tax rates and bans on fracking (which could increase the input cost of their domestic oil supplies). We should know the election outcome very soon.
The shares trade at 11.3x estimated 2022 earnings of $2.83. This estimate is about 19% higher from a week ago, largely due to the strong earnings report. The 2022 estimate is a reasonable proxy for “normalized” even though it is two years away. Estimates are for a loss of $(3.34) this year and a loss of $(0.81) in 2021. The 2020 estimate improved sharply but the 2021 estimate is unchanged.
The 7.3% dividend yield looks reasonably sustainable unless economic conditions remain subdued for an extended period. BUY.
Molson Coors Beverage Company (TAP) – The thesis for this company is straightforward – a reasonably stable company whose shares sell at a highly discounted price.
One of the world’s largest beverage companies, Molson Coors produces the highly recognized Coors, Molson, Miller and Blue Moon brands as well as numerous local, craft and specialty beers. About two-thirds of its $10 billion in net revenues are produced in the United States, where it holds a 24% share of the beer market.
Investors’ primary worry about Molson Coors is its lack of meaningful (or any) revenue growth as it has relatively few of the fast-growing hard seltzers and other trendier beverages in its product portfolio. So, the key is for revenues to be stable or slightly positive – rapid growth is not necessary for the stock to work as this is a revenue and cash-flow stability story.
Any indication that it is building its “alternative” beverage capabilities would be positive, as would resilience/recovery in its core beer volumes. Other concerns, like its modestly elevated (but investment grade) debt and the size/stability of its free cash flow, generally stem from the revenue debate. Recent financial results have been encouraging. A new CEO is overseeing efforts to improve execution.
We anticipate that the company will resume paying a dividend mid-next year. A $0.35/share quarterly dividend is possible, which would provide a generous 3.6% yield on the current price.
Molson Coors results showed that the company is making progress with its turnaround and that investors underestimate this progress. Net revenues of $2.75 billion fell 3.1% from a year ago, but about 4% better than consensus estimates. Adjusted per share earnings of $1.62 were nearly 60% better than estimates. Underlying EBITDA of $713 million was 1% higher than a year ago and 26% higher than estimates.
Pandemic-related closures/limitations at restaurants, sports arenas and other venues continues to weigh on net sales, particularly in Europe where revenues fell 12%. Overall pricing remains positive but mix was a slight headwind. Currency changes provided a modest tailwind as foreign-currency-denominated revenues translated into more dollars.
Operating efficiency efforts provided a modest lift as overhead costs fell 8%, some of which was due to avoiding marketing spending at now-closed sporting and live entertainment events.
The company produced $433 million in cash from operations and reduced its net debt by $266 million. In many ways, these are the most two important statistics for the Molson Coors story – if cash flows and debt repayment remain healthy, eventually the company’s underlying value will become obvious to the market, as will its ability to pay a respectable dividend.
TAP shares rose 14% in the past week. The shares have about 53% upside to our 59 price target.
The shares trade at 9.3x estimated 2020 earnings of $4.15 and (the same) 9.3x estimated 2021 earnings of $4.15. Both estimates rose from last week. These valuations are remarkably low.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 7.3x estimates, among the lowest valuations in the consumer staples group and well below other brewing companies.
For investors looking for a stable company trading at an unreasonably low valuation in a momentum-driven market, TAP shares have considerable contrarian appeal. Patience is the key with Molson Coors shares. We think the value is solid although it might take a year or two to be recognized by the market. STRONG BUY.
Terminix Global Holdings (TMX) is both a new company and an old company. While the name “Terminix” is one of the largest and most widely recognized names in pest control, the company previously was obscured inside of the ServiceMaster conglomerate. With the sale of its ServiceMaster Brands operations recently completed, the company changed its name to Terminix and started trading under the TMX ticker symbol on October 5.
Terminix shares fell sharply last year due to new disclosures about its legal liability from deficient termite treatments. These liabilities will likely cost the company upwards of $100 million or more.
In early 2020, the company fully addressed its problems by removing the CEO, announcing plans to divest its non-pest control operations, and ring-fencing the termite treatment liabilities. These steps should allow the company to put its difficult past behind it. In August, Brett Ponton, former head of Monro (MNRO) joined as the new CEO. His leadership at Monro led to sales growth and a strong recovery in its share price. Our expectation is that he will bring sales growth, operational efficiency and integrity to Terminix, ultimately leading to a higher share price.
Terminix reports earnings on November 5. The consensus estimate is not clear, given that the recent changes to the company’s structure may not be incorporated into all of the analyst estimates.
Terminix shares were unchanged in the past week and have 20% remaining upside to our 57 price target.
Terminix reports on November 5. Reliable consensus earnings estimates are not yet available, but we anticipate that 2022 estimates will settle at around $1.60/share. This would put the TMX multiple at a high 29.7x, but we recognize that these types of companies generally are valued on EV/EBITDA. On this basis, the shares trade at about 16.5x EBITDA.
Major risks include the possibility of new disclosures that would significantly increase the company’s litigation expenses, difficult industry competition that may exert pricing pressure, and possible execution risks by the new leadership. TMX shares carry more risk than typical CUSA stocks, but if its litigation and sub-par margins are behind them, we see a clear path to a higher stock price.
With a reasonable valuation, solid balance sheet, renewed focus and better revenue and margin outlook, there is a lot to like about Terminix. BUY.
ViacomCBS (VIAC) is a major media and entertainment company, owning highly recognized properties including Nickelodeon, Comedy Central, MTV and BET, the Paramount movie studios, Showtime and all of the CBS-related media assets. The company’s brands are powerful and enduring, typically holding the #1 market shares in the highest-valued demographic groups in the country. ViacomCBS’ reach extends into 180 countries around the world. Viacom and CBS re-merged in late 2019 and are now under the capable leadership of former Viacom CEO Robert Bakish.
Viacom is being overhauled to stabilize its revenues, boost its relevancy for current/future viewing habits and improve its free cash flow. Its challenges include the steady secular shift away from cable TV subscriptions, which is pressuring advertising and subscription revenues. The pandemic-related reductions in major sports are also weighing on VIAC shares. However, ViacomCBS’ extensive reach, strong market position and strategic value to other, much larger media companies, and its low share valuation, make the stock appealing.
There was very little meaningful news on Viacom this past week. We’re intrigued by Viacom’s streaming push. With Disney’s major change in strategy to emphasize streaming, Viacom’s increasingly unified streaming service becomes more attractive as an acquisition target, particularly with the company’s relatively small $18.5 billion market cap.
ViacomCBS reports earnings this coming Friday. The consensus estimate is $0.81.
VIAC shares ticked up about 5% this past week and have about 45% upside to our 43 price target.
ViacomCBS shares trade at about 7.7x estimated 2021 EBITDA, which we believe undervalues the company’s impressive leadership and assets. On a price/earnings basis, VIAC shares trade at 6.4x estimated 2021 earnings of $4.63 (estimate ticked up from a week ago). ViacomCBS shares offer a sustainable 3.2% dividend yield and look attractive here. BUY.
Strong Buy and Buy – This stock is worth buying.
Hold – The shares are worth keeping but the risk/return trade-off is not favorable enough for more buying nor unfavorable enough to warrant selling.
Retired – This stock has been removed from the portfolio, primarily for being fully valued. We generally view the company as fundamentally solid with few problems. Investors may choose to hold these shares to minimize portfolio turnover, seek to capture continued upward share price momentum, or other reasons.
Sell – This stock is approaching or has reached our price target, its value has become permanently impaired or changes in its risk or other traits warrant a sale.
The next Cabot Undervalued Stocks Advisor issue will be published on December 2, 2020.
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