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Value Investor
Wealth Building Opportunites for the Active Value Investor

February 2, 2022

Thank you for subscribing to the Cabot Undervalued Stocks Advisor. We hope you enjoy reading the February 2022 issue.

Word puzzle Wordle is the latest craze, but it isn’t the most popular parlor game. This title is held by “What Is Russian President Vladimir Putin Going to Do With Ukraine?”

We provide our theory which is not found anywhere else yet could readily explain his motivation. Related to this crisis, we move shares of ConocoPhillips (COP) from Buy to Hold, as they have surged above our recently raised 89 price target.

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.

Market Overview

The World’s Most Popular Parlor Game
Released less than four months ago, Wordle is a “stimulating and wildly popular daily word game that has become a cultural phenomenon,” according to The New York Times, which just paid a “low-seven figures” price to buy the game from its founder.

Illuminating just how untrendy I am, I had never heard of the game until this weekend. Perhaps sensing some reputational risk if news of this shortcoming became public, my family brought me up to speed. After being provided the first word, I took an unconventional approach (not surprising for a contrarian investor) to solving the puzzle. Rather than trying to guess the daily word outright, I focused on the yet-unused but high-probability letters, then creating a word that contained as many of these as possible. This way, I was likely to find all five of the correct letters – it would then be easy to put them in the right order to solve the puzzle.

Despite a barrage of comments like, “you clearly don’t understand how to do this,” and “Dad, seriously… you’re not even trying,” my method found the right solution by the fourth line.

But this note isn’t about Wordle. Without a doubt, the most popular guessing game today is “What Is Russian President Vladimir Putin Going to Do With Ukraine?”

Putin is savvy and highly motived to keep his title, so there must be some rational reason why he is assembling a massive military force on three sides of Ukraine. Below we list commonly stated guesses for his build-up. We also provide our guess – which we have not seen stated anywhere yet.

  • Re-integrate Ukraine into Russia.
  • Boost his perhaps-weakened standing within Russia by showing strength against an outside enemy.
  • Prove that he remains highly relevant on the global stage.
  • Punish the West for delaying/halting the Nord Stream 2 pipeline.
  • Bluff to extort concessions from the West.
  • Bolster his standing among allies like China, Iran, North Korea and others by openly challenging the West’s military capabilities.
  • Provide something for his soldiers to do, lest they become bored and/or demoralized.
  • Demonstrate his power by showing he has a massive army at his personal disposal.

While all of these make sense on some level, we wonder why Putin is being so deliberate. It would seem that he has missed his best opportunity – invading weeks/months ago when the West was unprepared. Today, the West is increasingly aligned in its potential military and economic responses, making an outright invasion much less likely to succeed. The delay violates a lesson that Putin learned long ago, “when a fight is inevitable, you have to hit first.”

We see a more prosaic rationale – paying off his wealthy Russian oligarch allies, whose political support is critical to Putin’s reign. Russia is a major exporter of oil, natural gas, wheat, aluminum and other commodities, and the producers of these commodities are controlled by the oligarchs. What better way to buy their allegiance than by enriching them with high commodity prices? Putin creates a military crisis, which drives up commodity prices, and the bribe is complete. And, perhaps best of all, the bribe is paid for with other people’s money.

There are, of course, many side-benefits, which include all of the eight listed above. And, being opportunistic, Putin might press further on any of these if the situation allows. But the key is the bribe.

Putin would want to keep the crisis going as long as possible, but once the futility of an invasion becomes obvious, and other pressures on commodity prices like warmer weather fade, the crisis will lose power and it will end.

How is this relevant to investors? We currently have a Buy rating on ConocoPhillips (COP). The shares have been driven by sharply rising oil prices, and now appear fairly valued assuming about $95/barrel. We saw real value when we initiated our Buy rating, but not so much today.

The direction of oil prices is unpredictable, but at close to $90/barrel they would seem to have more downside risk than upside risk.

As Ukraine tensions ease (meaning, no invasion) and springtime approaches, oil could easily slip to the mid-$60 range. Also, currently high energy prices provide incentives for U.S. drillers, OPEC+ and other oil-producing nations to produce more oil. We note that OPEC+ meets on February 2. Worries about a possible U.S. recession may also pressure oil prices.

As ConocoPhillips shares have reached and exceeded our 89 price target, and we see the upside and downside risks balanced, we are moving the shares to a HOLD. There is nothing wrong with Conoco as a company and we would be ready to buy again if the share price falls sharply.

Why not move directly to a Sell? In situations like this, where a stock continues to surge above what we believe is a generous price target, we are happy to ride the upward momentum. But, we won’t buy any more shares, and we would likely trim out of some of our position (a third, perhaps). Then, on weakness we would pull the plug.

We recognize that we could be terribly wrong. Oil prices might continue to rise to $100/barrel, or higher. This would push Conoco shares to well over $100 or more, as well. Investing is a game of balance.

Share prices in the table reflect Tuesday (February 1) closing prices. Please note that prices in the discussion below are based on mid-day February 1 prices.

Note to new subscribers: You can find additional color on past earnings reports and other news on recommended companies in prior editions and weekly updates of the Cabot Undervalued Stocks Advisor on the Cabot website.

Send questions and comments to Bruce@CabotWealth.com.

Today’s Portfolio Changes
ConocoPhillips (COP) – Move from Buy to Hold.

Portfolio changes during the past month
None.

Growth & Income Portfolio

Growth & Income
Portfolio

Growth & Income Portfolio stocks are generally higher-quality, larger-cap companies that have fallen out of favor. They usually have some combination of attractive earnings growth and an above-average dividend yield. Risk levels tend to be relatively moderate, with reasonable debt levels and modest share valuations.

Growth/Income Portfolio
Stock (Symbol)Date AddedPrice Added2/1/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Bristol-Myers Squibb (BMY)04-01-2054.8264.2517.2%3.4%78.00Buy
Cisco Systems (CSCO)11-18-2041.3255.4334.1%2.6%66.00Buy
Coca-Cola (KO)11-11-2053.5860.8613.6%2.7%64.00Buy
Dow Inc (DOW) *04-01-1953.5061.3914.7%4.6%78.00Buy
Merck (MRK)12-9-2083.4781.91-1.9%3.4%99.00Buy

CUSA Valuation and Earnings
Growth/Income Portfolio
Current
price
Current 2022
EPS Estimate
Current 2023
EPS Estimate
Change in
2022 Estimate
Change in
2023 Estimate
P/E 2022P/E 2023
BMY61.867.838.140.0%0.5%7.97.6
CSCO61.803.423.680.0%0.0%18.116.8
KO60.232.442.600.4%0.0%24.723.2
DOW58.496.256.36-1.0%0.3%9.49.2
MRK76.877.257.230.6%1.0%10.610.6

Current price is yesterday’s mid-day price.
CSCO: Estimates are for fiscal years ending in July.

Bristol Myers Squibb Company (BMY) shares sell at a low valuation due to worries over patent expirations for Revlimid (starting in 2022) and Opdivo and Eliquis (starting in 2026). However, the company is working to replace the eventual revenue losses by developing its robust product pipeline while also acquiring new treatments (notably with its acquisitions of Celgene and MyoKardia), and by signing agreements with generics competitors to forestall their competitive entry. The likely worst-case scenario is flat revenues over the next 3-5 years. Bristol should continue to generate vast free cash flow, has a solid, investment-grade balance sheet, and trades at a sizeable discount to its peers.

If Bristol can demonstrate at least the reasonable potential for merely stable revenues during its patent expiration period, which we believe will happen, the shares are remarkably undervalued. On a free cash flow yield basis, assuming an average of $15 billion/year, the shares trade at a 11% free cash flow yield.

Bristol-Myers is expected to report earnings of $1.80/share when it reports on February 4.

BMY shares rose 4% in the past week and have about 20% upside to our 78 price target. Valuation remains low at 8.3x estimated 2022 earnings, compared to 11x or better for its major peer companies. The stock’s 8.0x EV/EBITDA multiple is similarly cheap, compared to 9-10x or better for peers.

Either we are completely wrong about the company’s fundamental strength, or the market must eventually recognize Bristol’s earnings stability and power. We believe the earning power, low valuation and 3.3% dividend yield that is well-covered by enormous free cash flow make a compelling story. BUY

BMY_CUSA_20220202

Cisco Systems (CSCO) is facing revenue pressure as customers migrate to the cloud and thus need less of Cisco’s equipment and one-stop-shop services. Cisco’s prospects are starting to improve under a relatively new CEO, who is shifting Cisco toward a software and subscription model and is rolling out new products, helped by its strong reputation and entrenched position within its customers’ infrastructure. The company is highly profitable, generates vast cash flow (which it returns to shareholders through dividends and buybacks) and has a very strong balance sheet.

There was no significant company-specific news in the past week.

CSCO shares fell 2% in the past week and have 20% upside to our 66 price target. The dividend yield is an attractive 2.7%. BUY

csco_cusa_20220202

The Coca-Cola Company (KO) is best-known for its iconic soft drinks yet nearly 40% of its revenues come from non-soda beverages across the non-alcoholic spectrum. Its global distribution system reaches nearly every human on the planet. Coca-Cola’s longer-term picture looks bright but the shares remain undervalued due to concerns over the pandemic, the secular trend away from sugary sodas, and a tax dispute which could cost as much as $12 billion (likely worst-case scenario). The relatively new CEO James Quincey (2017) is reinvigorating the company by narrowing its oversized brand portfolio, boosting its innovation and improving its efficiency, as well as improving its health and environmental image. Coca-Cola’s balance sheet is sturdy, and its growth investing, debt service and dividend are well-covered by free cash flow.

There was no significant company-specific news in the past week.

KO shares rose 1% in the past week and have about 6% upside to our 64 price target.

While the valuation is not statistically cheap, the shares remain undervalued given the company’s future earning power and valuable franchise. Also, the value of Coke’s partial ownership of a number of publicly traded companies (including Monster Beverage) is somewhat hidden on the balance sheet, yet is worth about $23 billion, or 9% of Coke’s market value. This $5/share value provides additional cushion supporting our 64 price target. KO shares offer an attractive 2.8% dividend yield. BUY

KO_CUSA_20220202

Dow Inc. (DOW) merged with DuPont to create DowDuPont, then split into three companies in 2019 based on product type. The new Dow is the world’s largest producer of ethylene/polyethylene, the most widely used plastics. Investors undervalue Dow’s hefty cash flows and sturdy balance sheet largely due to its uninspiring secular growth traits, its cyclicality and concern that management will squander its resources. The shares are driven by: 1) commodity plastics prices, which are often correlated with oil prices and global growth, along with competitors’ production volumes; 2) volume sold, largely driven by global economic conditions, and 3) ongoing efficiency improvements (a never-ending quest of all commodity companies). We see Dow as having more years of strong profits before capacity increases signal a cyclical peak, and expect the company to continue its strong dividend, reduce its pension and debt obligations, repurchase shares slowly and restrain its capital spending.

Industry conditions will likely be strong for a while. Dow remains well-positioned to generate immense free cash flows over the next few years, even as the stock market cares little about cash but rather is focused on the incremental newsflow related to economic growth, energy prices and any industry capacity changes. In the meantime, Dow shareholders can collect a highly sustainable 5.0% dividend yield while waiting for more share buybacks, more balance sheet improvement, more profits and a higher valuation.

On Thursday, January 27, Dow reported a strong quarter. Revenues of $14.4 billion grew 34% compared to a year ago and were about 1% above consensus estimates. Earnings of $2.15/share compared to $0.81 a year ago and were a cent above consensus estimates. Also, the company guided for a strong first quarter, with adjusted EBITDA up about 20% from a year ago and about 16% above prior analyst estimates.

Higher prices drove the strong results. Fourth-quarter pricing rose 39%, faster than the 34% revenue increase, as volumes fell. Operating expenses including research and development, sales, and overhead, rose only moderately. Helping Dow’s results are its joint ventures. In 2021, these generated $250 million in dividends to Dow, much higher than in 2020.

Dow’s free cash flow – a key part of our thesis – was impressively strong at $2.1 billion, bringing the full-year free cash flow to $5.7 billion.

For perspective, this full-year total is equivalent to 14% of its market cap of $42 billion. And, this total understates the run-rate pace, as it includes a $(228) million negative free cash flow in the first quarter partly due to one-off problems in Texas and elsewhere, and includes a $1.2 billion pension contribution. If annualized, the fourth-quarter pace of $8.4 billion is the equivalent of 20% of the company’s market value.

Dow is not neglecting its core business to generate this cash flow: it continues to invest heavily in a wide range of new growth, efficiency, decarbonization and other initiatives. The company is also returning much of the cash flow to investors either directly through dividends and buybacks (totaling $3.1 billion in 2021) or indirectly by reducing the company’s pension and debt liabilities (totaling $8.9 billion for 2021).

Is this pace of cash flow production sustainable? Dow is driven by volumes and pricing. We see pricing and volumes remaining relatively stable for 2022, which would allow the company to replicate its 2021 cash flow production, as higher capital spending will be at least offset by lower pension contributions. Dow’s first-quarter guidance points to about $2.7 billion of EBITDA, down about $200 million from the fourth quarter but about 20% higher than the year-ago quarter and supportive of our “stronger for longer” view.

Overall, Dow shares remain inexpensive. The stock price is rising but so are earnings and cash flow estimates, such that the already-low valuation multiples aren’t increasing. Holding back Dow shares are concerns about the sustainability of the current price and volume trends later in 2022 and into 2023 and beyond. We continue to hold to our “stronger for longer” thesis and our 78 price target and watch the dividends and internal cash flow build up while we wait.

Dow shares rose 7% in the past week and have 28% upside to our 78 price target. BUY

dow_cusa_20220202

Merck (MRK) shares are undervalued as investors worry about Keytruda, a blockbuster oncology treatment (about 30% of revenues) which faces generic competition in late 2028. Also, its Januvia diabetes treatment may see generic competition next year, and like all pharmaceuticals it is at risk from possible government price controls. Yet, Keytruda is an impressive franchise that is growing at a 20% rate and will produce solid cash flow for nearly seven more years, providing the company with considerable time to replace the potential revenue loss. Merck’s new CEO, previously the CFO, is accelerating Merck’s acquisition program, which adds return potential and risks to the story. The company is highly profitable and has a solid balance sheet. It spun off its Organon business in June and we think it will divest its animal health segment sometime in the next five years.

The consensus estimate for Merck’s upcoming fourth-quarter report is $1.52/share.

Merck shares rose 3% in the past week and have about 21% upside to our 99 price target.

Merck produces generous free cash flow to fund its current dividend (now yielding 3.4%) as well as likely future dividend increases (the company recently raised its dividend by 6%), although its shift to a more acquisition-driven strategy will slow the pace of increases. BUY

mrk_cusa_20220202

Buy Low Opportunities Portfolio

Buy Low Opportunities
Portfolio

Buy Low Opportunities Portfolio stocks include a wide range of value opportunities, often with considerable upside. This group may include stocks across the quality and market cap spectrum, including those with relatively high levels of debt and a less-clear earnings outlook. The stocks may not pay a dividend. In all cases, the shares will trade at meaningful discounts to our estimate of fair value.

Buy Low Opportunities Portfolio
Stock (Symbol)Date AddedPrice Added2/1/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Arcos Dorados (ARCO)04-28-215.416.7725.1%7.50Buy
Aviva (AVVIY)03-03-2110.7511.9010.7%5.1%14.00Buy
Barrick Gold (GOLD)03-17-2121.1319.17-9.3%1.9%27.00Buy
Citigroup (C)11-23-2168.1065.83-3.3%3.1%85.00Buy
ConocoPhillips (COP)9-24-2165.0290.4939.2%2.0%89.00Hold
Molson Coors (TAP)08-05-2036.5348.1331.8%2.8%69.00Buy
Organon (OGN)06-07-2131.4233.255.8%3.4%46.00Buy
Sensata Technologies (ST)02-17-2158.5757.02-2.6%75.00Buy

Buy Low Opportunities Portfolio
SymbolCurrent
price
Current 2022
EPS Estimate
Current 2023
EPS Estimate
Change in
2022 Estimate
Change in
2023 Estimate
P/E 2022P/E 2023
ARCO6.120.300.370.0%0.0%20.416.5
AVVIY11.601.221.351.5%1.5%9.58.6
GOLD18.781.141.16-2.1%-1.4%16.416.2
C63.997.988.60-0.2%-0.3%8.07.4
COP77.077.986.740.0%0.0%9.711.4
TAP48.764.104.360.0%0.0%11.911.2
OGN31.505.936.020.0%0.0%5.35.2
ST64.954.074.690.0%0.0%16.013.8

Current price is yesterday’s mid-day price.
CSCO: Estimates are for fiscal years ending in July.

Arcos Dorados (ARCO), which is Spanish for “golden arches,” is the world’s largest independent McDonald’s franchisee. Based in stable Uruguay and listed on the NYSE, the company produces about 72% of its revenues in Brazil, Mexico, Argentina and Chile. The shares are depressed as investors worry about the pandemic, as well as political/social unrest, inflation and currency devaluations. However, the company has a solid brand and high recurring demand and is well-positioned to benefit as local economies reopen. The leadership looks highly capable, led by the founder/chairman who owns a 38% stake, and has the experience to successfully navigate the complex local conditions. Debt is reasonable relative to post-recovery earnings, and the company is currently producing positive free cash flow.

Macro issues, including issues in Brazil including its economic conditions (in particular, inflation, running at a 10.1% rate), currency and the chances that a socialist might win next year’s Brazilian presidential elections will continue to move ARCO shares. Brazil is one of the most Covid-vaccinated countries in the world, which reduces pandemic-related demand risks.

In advance of its Investor Day on January 26, the company provided strong preliminary fourth-quarter results. Same-store sales compared to two years ago (pre-pandemic) rose 24% and Adjusted EBITDA rose above the prior quarterly record which was set in the fourth quarter of 2019. The company also said it plans to open at least 250 new locations over the next three years – an encouraging indicator of its confidence in its future. Most of the new stores will be in freestanding buildings, as the secular trend for mall-based traffic remains negative. Arcos’ innovative ideas are generating new ways to reach potential customers.

Arcos is presenting at the Credit Suisse 2022 Latin America Investment Conference this week.

ARCO shares rose 13% in the past week to a new 52-week high and have about 13% upside to our 7.50 price target. We remain steady in our conviction in the company’s recovery. BUY

ARCO_CUSA_20220202

Aviva, plc (AVVIY), based in London, is a major European company specializing in life insurance, savings and investment management products. Amanda Blanc was hired as the new CEO in July 2020 to revitalize Aviva’s laggard prospects. She divested operations around the world to re-focus the company on its core geographic markets (U.K., Ireland, Canada), and is improving Aviva’s product competitiveness, rebuilding its financial strength and trimming its bloated costs. Aviva’s dividend has been reduced to a more predictable and sustainable level with a modest upward trajectory. Excess cash balances are being directed toward debt reduction and potentially sizeable special dividends and share repurchases.

Much of our interest in Aviva is based on its plans for returning its excess capital to shareholders, including share repurchases and dividends. These distributions could be substantial. We also look for incremental shareholder-friendly pressure from highly regarded European activist investor Cevian Capital, which holds a 5.2% stake.

There was no significant company-specific news in the past week.

Aviva shares rose 1% in the past week. Insurance company stocks are sensitive to financial market gyrations (in both directions) they have leveraged balance sheets with their principal tangible assets being investments and securities. Aviva shares have about 19% upside to our 14 price target. BUY

AVVIY_CUSA_20220202

Barrick Gold (GOLD), based in Toronto, is one of the world’s largest and highest-quality gold mining companies. About 50% of its production comes from North America, with the balance from Africa/Middle East (32%) and Latin America/Asia Pacific (18%). Barrick will continue to improve its operating performance (led by its new and highly capable CEO), generate strong free cash flow at current gold prices, and return much of that free cash flow to investors while making minor but sensible acquisitions. Also, Barrick shares offer optionality – if the unusual economic and fiscal conditions drive up the price of gold, Barrick’s shares will rise with it. Given their attractive valuation, the shares don’t need this second (optionality) point to work – it offers extra upside. Barrick’s balance sheet has nearly zero debt net of cash. Major risks include the possibility of a decline in gold prices, production problems at its mines, a major acquisition and/or an expropriation of one or more of its mines.

Barrick announced encouraging preliminary production results, saying that it will meet its annual guidance for the third consecutive year. Meeting/exceeding production guidance suggests that the company is functioning well – that the leadership understands its mining operations well enough to gauge their production capabilities and then deliver on its targets. Barrick continues to build credibility with investors by meeting its guidance. That said, Barrick will produce 4.44 million ounces this year, at the very low end of its 4.4 - 4.7-million-ounce guidance range.

The company said its fourth-quarter production costs would be about 4-6% lower than third quarter costs. With stronger production yet lower costs, Barrick’s earnings will likely be strong. The company reports on February 16.

Over the past week, commodity gold slipped 3% to $1,802/ounce. Per-ounce gold prices remain range-bound between $1,700 and $1,900. The 10-year Treasury yield rose to 1.80%. While this yield is just below a post-pandemic high, it is roughly equal to interest rates in late 2019, suggesting that yields could rise a lot more given the 7% inflation rate (compared to maybe 2% in late 2019). The next CPI data release is on February 10. Rarely have we so eagerly awaited this previously mundane statistic.

The U.S. Dollar Index, another driver of gold prices (the dollar and gold usually move in opposite directions), ticked up to 96.38. The index remains about 3% below its pre-Covid late-2019 level of about 99.

Barrick shares fell 2% this past week and have about 41% upside to our 27 price target. The price target is based on 7.5x estimated steady-state EBITDA and a modest premium to our estimate of $25/share of net asset value.

On its recurring $.09/quarter dividend, GOLD shares offer a reasonable 1.9% dividend yield. Barrick paid an additional $0.42/share in special distributions last year (no clarity on 2022 special dividends), lifting the effective dividend yield to 4.1%. BUY

gold_cusa_20220202

Citigroup (C) – Citi is one of the world’s largest banks, with over $2.4 trillion in assets. The bank’s weak compliance and risk-management culture led to Citi’s disastrous and humiliating experience in the 2009 global financial crisis, which required an enormous government bailout. The successor CEO, Michael Corbat, navigated the bank through the post-crisis period to a position of reasonable stability. Unfinished, though, is the project to restore Citi to a highly profitable banking company, which is the task of new CEO Jane Fraser.

There was no significant company-specific news in the past week.

Citi shares rose 3% over the past week and have about 28% upside to our 85 price target. The valuation remains attractive at 84% of tangible book value and 8.6x estimated 2022 earnings. Our set of peer banks currently trade at an average of 2.0x tangible book value and 12.7x estimated 2022 earnings. Citi shares are among the cheapest in the banking sector – a major attraction as expectations are low. As the bank grinds along with its turnaround, the valuation should continue to lift.

Citigroup investors enjoy a 3.1% dividend yield and perhaps another 3% or more in annual accretion from the bank’s share repurchase program. BUY

C_CUSA_20220202

ConocoPhillips (COP), based in Houston, Texas, is the world’s largest independent E&P company, with about two-thirds of its production in the United States. Conoco’s shares are depressed, as investors avoid climate-unfriendly companies, have low interest in exposure to volatile and unpredictable oil and gas prices, worry that company management will lose its new-found capital spending discipline, and are concerned that OPEC+ will reopen their spigots, sending oil prices tumbling.

We see resilient oil prices, as demand remains strong, alternatives aren’t yet plentiful enough, supply growth is restrained as shareholders prioritize cash flow rather than capital spending, and as majors seek to reduce their carbon footprint. We like Conoco’s low valuation, investment-grade balance sheet, strong free cash flow, and public commitment to limiting its capital spending to 50% of its annual cash flow. The shares offer a respectable base-level dividend to shareholders that appears rock solid.

Conoco is expected to report $2.18/share in earnings when it reports on February 3.

West Texas Intermediate crude rose 4% from a week ago to $88.19/barrel, while natural gas in the United States is priced at $4.80, up 25% from a week ago. Cold weather across the heavily populated northeastern U.S. and in Europe, and rising military tensions in the Ukraine, continue to pressure natural gas prices.

ConocoPhillips shares rose 5% in the past week and are now above our recently raised 89 price target. As noted in our opening comments, we are moving ConocoPhillips to a Hold rating. HOLD

COP_CUSA_20220202

Molson Coors Beverage Company (TAP) is one of the world’s largest beverage companies, producing the highly recognized Coors, Molson, Miller and Blue Moon brands as well as numerous local, craft and specialty beers. About two-thirds of its revenues come from the United States, where it holds a 24% market share. Investors worry about Molson Coors’ lack of revenue growth due to its relatively limited offerings of fast-growing hard seltzers and other trendier beverages. Our thesis for this company is straight-forward – a reasonably stable company whose shares sell at an overly discounted price. Its revenues are resilient, it produces generous cash flow and is reducing its debt. A new CEO is helping improve its operating efficiency and expand carefully into more growthier products. The company recently reinstated its dividend.

There was no significant company-specific news in the past week.

TAP shares fell 4% in the past week and have about 43% upside to our 69 price target. The stock remains cheap, particularly on an EV/EBITDA basis, or enterprise value/cash operating profits, where it trades at 8.2x estimated 2022 results, still among the lowest valuations in the consumer staples group and below other brewing companies. The 2.8% dividend only adds to the appeal. BUY

TAP_CUSA_20220202

Organon & Company (OGN) was recently spun off from Merck. It specializes in patented women’s healthcare products and biosimilars, and also has a portfolio of mostly off-patent treatments. Organon will produce better internal growth with some boost through smart yet modest-sized acquisitions. It may eventually divest its Established Brands segment. The management and board appear capable, the company produces robust free cash flow, has modestly elevated debt and will pay a reasonable dividend. Investors have ignored the company, but we believe that Organon will produce at least stable and large free cash flows with a reasonable potential for growth. At our initial recommendation, the stock traded at a highly attractive 4x earnings.

There was no significant company-specific news in the past week. Organon was selected as Cabot’s Stock of the Week this week.

OGN shares rose 7% in the past week and have about 40% upside to our 46 price target (using the same target as the Cabot Turnaround Letter). The shares continue to trade at a remarkably low valuation while offering an attractive 3.4% dividend yield. BUY

ogn_CUSA_20220202

Sensata Technologies (ST) is a $3.8 billion (revenues) producer of nearly 47,000 highly engineered sensors used by automotive (60% of revenues), heavy vehicle, industrial and aerospace customers. About two-thirds of its revenues are generated outside of the United States, with China producing about 21%. Investors undervalue Sensata’s durable franchise. Its sensors are typically critical components that generally produce high profit margins. As the sensors’ reliability is vital to safely and performance, customers are reluctant to switch to another supplier that may have lower prices but also lower or unproven quality. Sensata has an arguably under-leveraged balance sheet and generates healthy free cash flow. The relatively new CEO will likely continue to expand the company’s growth potential through acquisitions. Electric vehicles are an opportunity as they expand Sensata’s reachable market.

Sensata reported reasonable fourth-quarter results but forward guidance was below the consensus estimates so the stock was moderately weak on the news.

In the quarter, adjusted earnings of $0.87/share rose 2% from a year ago and were about 7% above the consensus estimate. Revenues of $935 million rose 3% from a year ago, but fell 1% after adjusting out revenues from acquisitions and from currency effects. The revenues were about 2% above the consensus.

Revenues were held back by production weakness at automakers but helped by outgrowth (more content per vehicle, including electrification components, such that Sensata revenues grew more than the car industry), growth in industrial demand and acquisitions. The company’s profit margin contracted modestly due to higher labor and input costs along with higher “mega-trend” investments in electrification and other technologies that will help Sensata participate in faster-growing secular trends.

Despite full-year 2022 guidance being weaker than analyst estimates, Sensata anticipates reasonably good growth: revenues would increase by about 8% excluding acquisitions and earning per share would increase by 8% ex-currency. Analysts had previously expected 15% earnings per share growth.

Guidance was subdued partly due to an anticipated sluggish recovery of 7% growth in global auto production weighed down by China. The company also expects growth to stall in industrial demand and heavy/off-road vehicles.

The company continues to generate sizeable amounts of free cash flow while investing in new technologies that are producing meaningful revenues. Sensata’s balance sheet remains healthy and arguably underleveraged, even though the net debt balance increased modestly from a year ago due to its acquisitions and some inventory building. Sensata announced a new $500 million share repurchase program – a good move in our view as the shares are undervalued.

ST shares fell 3% in the past week and have about 33% upside to our 75 price target. BUY

st_cusa_20220202

Disclosure: The chief analyst of the Cabot Undervalued Stocks Advisor personally holds shares of every recommended security, except for “New Buy” recommendations. The chief analyst may purchase or sell recommended securities but not before the fourth day after any changes in recommendation ratings has been emailed to subscribers. “New Buy” recommendations will be purchased by the chief analyst as soon as practical following the fourth day after the newsletter issue has been emailed to subscribers.

Strong Buy – This stock offers an unusually favorable risk/reward trade-off, often one that has been rated as a Buy yet the market has sold aggressively for temporary reasons. We recommend adding to existing positions.
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.
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.

Note for stock table: For stocks rated Sell, the current price is the sell date price.


The next Cabot Undervalued Stocks Advisor issue will be published on March 9, 2022.