May 4, 2022

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

We’re back in the States after an unplanned but superb extended stay in London. It seems that most of the pandemic-driven adrenaline rush in speculative stocks has burned off, leaving a tremendous amount of losses in the wake, while stocks of companies with more enduring business models that trade at prosaic valuations continue to hold their ground or advance.

In the letter, we review earnings reports of several Recommended companies as well as provide updates on all of the others.

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.

Market Overview

Back From London
After my unplanned but superb extended stay in London, courtesy of some absurd rules promulgated by the CDC, I returned to the States very early this morning (London time). It’s great to be home and not only greeted by my family but also by a now-rare two-day bull market in stocks.

It seems that most of the pandemic-driven adrenaline rush in speculative stocks has burned off, with literally hundreds of names down 60% or more from their peak prices. And, more than a few highly notable stocks, including Netflix (NFLX) and DocuSign (DOCU), have given up all of their pandemic gains and then some. Stocks of companies with more enduring business models that trade at prosaic valuations continue to hold their ground or advance.

Share prices in the table reflect Tuesday (May 3) closing prices. Please note that prices in the discussion below are based on mid-day May 3 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
None

Portfolio changes during the past month
New Buy: Big Lots (BIG)
The Coca-Cola Company (KO): Raising price target from 64 to 69.

Upcoming Earnings Reports
Wednesday, May 4: Barrick Gold (GOLD)
Thursday, May 5: Organon (OGN)
Wednesday, May 18: Cisco Systems (CSCO)

Growth & Income Portfolio

A

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.

*Note: 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.

On April 29, Bristol-Myers reported first-quarter adjusted earnings of $1.96/share, up 13% from a year ago and about 4% above the consensus estimate. Sales rose 5% from a year ago (up 7% on a local market basis which excludes currency changes) and was about 3% above estimates. The company continues to put up respectable and positive numbers even as sales of patent-expired Revlimid fell 5% and sales of new products was a bit lower than we’d like to see.

The company trimmed its revenue guidance from +2% to flat due to modestly faster-than-expected decay of Revlimid and Abraxane sales. Profit guidance was reduced by 3% due entirely to re-including some costs in the adjusted earnings – but lower earnings are, still, lower earnings. We note that other than these “new” costs, the lower sales are not expected to hurt earnings, as Bristol is stepping up its cost-savings initiative. All-in, a reasonable quarter that continues to support our thesis.

The company’s gross profit margin expanded on the higher sales, but this was partly offset by higher overhead costs. Cash net of debt slipped about 9% in the quarter as the company repurchased over $4 billion (about 2.5% of the share count) and refinanced some of its debt. An additional $750 million in repurchases will be completed over the next two quarters.

BMY shares were flat in the past week and trade just below our 78 price target. Valuation remains reasonable compared to its peers and the company seems to be executing on its strategy while also maintaining a solid financial posture, so we are inclined to let the stock at least reach 78 before deciding on what changes to make to the rating and/or price target. BUY

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 slipped 2% in the past week and have 32% upside to our 66 price target. The dividend yield is an attractive 3.0%. BUY

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.

On April 25, Coca-Cola reported earnings of $0.64/share, up 16% from a year ago and about 10% above the consensus estimate. Despite suspending its Russia operations, the company reiterated its full-year volume, revenue, profit and free cash flow guidance. Overall, the outlook for Coke remains strong, with no changes to our price target or rating.

Revenues adjusted for acquisitions, divestitures and currency changes rose 18%. Revenues were 7% higher than the consensus estimate. Prices increased by 7%, surprisingly strong and reflective of the value of its brands. Volumes grew 11%, partly from an easy comparison to weaker business a year ago and partly from incremental demand growth as the company improves its marketing and distribution. Coke’s non-carbonated beverages sales growth was over 10%.

“Volumes sold” is formally called “concentrate sales” and primarily measures the company’s sales to its bottlers and distributors. “Unit case volume” is a measure of end-demand by people that consume the products, and this past quarter unit case volume rose by 8%. Often these two metrics don’t match in any given period due to differences in shipment timing.

Coke’s margins expanded modestly to 31.4% even as marketing spending increased and currencies moved unfavorably. The company’s incremental profit margin (what it makes from selling one more serving) is high, so it benefitted from sharply higher revenues. It is reinvesting some of this into better marketing – a practice that we believe is important to its future profits.

KO shares slipped 3% in the past week and have 10% upside to our recently and tepidly raised 69 price target. Coca-Cola’s fundamentals remain sturdy with respectable revenue, profit and free cash flow growth. Management continues to focus on execution in its core business while generally avoiding any major non-core commitments.

We are tepid on the price target raise, as KO shares now trade noticeably above their record high and have healthy upward momentum even as valuation is no longer “cheap” – traits that are a tad unfamiliar and uncomfortable for a value/contrarian investor. However, we also rarely have the chance to own a high-quality and enduring franchise like Coca-Cola, so we will be a bit more patient with the shares. BUY

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 news flow related to economic growth, energy prices and any industry capacity changes. In the meantime, Dow shareholders can collect a highly sustainable 4.1% dividend yield while waiting for more share buybacks, more balance sheet improvement, more profits and a higher valuation.

On April 21, Dow reported first-quarter adjusted operating earnings of $2.34/share, up 72% from a year ago and about 14% higher than the consensus estimate. Overall, the report indicates that fundamentals at Dow remain strong and that earnings estimates will likely continue to increase. Reflecting this, Dow shares jumped about 3% on the day. No change to our price target or rating.

Revenues rose 28% from a year ago (about 5% above the consensus estimate), with all operating segments and geographic regions showing good growth. Nearly all of the growth in revenues came from higher local prices (+28%) as tighter supplies of its array of petrochemical and other products provide Dow and other producers with strong pricing power. While volume growth of 3% may seem sluggish compared to more highly cyclical companies or high-growth tech companies, we would consider this pace to be healthy and slightly faster than the growth of the overall global economy. The strong dollar weighed modestly on revenues when local revenues were converted into U.S. dollars.

The strong pricing power more than offset higher input costs, driving the operating profit higher compared to a year ago. The operating profit margin of 15.9% rose from 13.1% a year ago. Earnings from Dow’s various joint ventures slipped $50 million, to $174 million, due to planned maintenance projects and higher input costs. Compared to years of losses as several of these projects ramped up, we are satisfied with the profit contribution this quarter.

Free cash flow was $1.3 billion, of which Dow used $600 million to repurchase shares as part of its new $3 billion share repurchase program. The balance sheet remains sturdy.

As previously announced, Dow is taking a minority stake in a joint venture that will build a massive liquified natural gas (LNG) import facility in Germany, which will meet as much as 15% of that country’s natural gas needs. Also, Dow continues to advance its decarbonization through high-return, low-risk initiatives – our favored approach. The company also released its annual benchmark update, showing that Dow (not surprisingly) compares favorably to its competitors. While the study’s results are highly polished for investor consumption, we believe that the company takes this study very seriously internally and could provide deeper color if requested. Also, the study provides incremental transparency and a degree of accountability that many other companies would be hard-pressed to match.

Overall, a good report for Dow that was encouraging regarding its near-term prospects. Dow has several headwinds, including potential pricing pressure from new supply in a year or so, rapidly rising natural gas input prices, a complicated demand situation in China, and to some degree reliance on high oil prices for its pricing power. The shares have been strong this year, in a difficult market, and continue to have strong dividend support, but the upside from our perspective is probably capped around our price target.

Dow’s earnings estimates continued to increase this past week, reflecting the strong results and potential for an enduring upcycle. Dow shares rose 1% in the past week and have 14% upside to our 78 price target. BUY

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 last June and we think it will divest its animal health segment sometime in the next five years.

On April 28, Merck reported first-quarter adjusted earnings of $2.14/share, up 84% from a year ago and about 17% above the $1.84/share consensus estimate. Sales rose 50% from a year ago and was about 9% above estimates. Sales excluding Covid treatment mulnupiravir (branded as Lagevrio) rose 19%. Keytruda (+23%) and Gardasil (+59%) generated impressive growth, quieting skeptics. The company raised and narrowed its full-year revenue and earnings guidance by about 1%, to a pace of about 18% year-over-year growth. As Merck doesn’t release a balance sheet or cash flow statement until it files its 10Q, we will have to wait on reviewing the company’s financial condition, but we anticipate few issues. All-in, an encouraging quarter.

Merck shares rose 3% in the past week and have about 14% upside to our 99 price target. The company has a strong commitment to its dividend (3.2% yield) which it backs up with generous free cash flow, although its shift to a more acquisition-driven strategy will slow the pace of dividend increases. BUY

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.

Allison Transmission Holdings, Inc. (ALSN) – Allison Transmission is a midcap ($6.4 billion market cap) manufacturer of vehicle transmissions. Many investors view this company as a low-margin producer of car and light truck transmissions that is destined for obscurity in an electric vehicle world. However, Allison produces no car and light truck transmissions, instead it focuses on the school bus and Class 6-8 heavy-duty truck categories, where it holds an 80% market share. Its 35% EBITDA margin is sharply higher than its competitors and on-par with many specialty manufacturers. And, it is a leading producer and innovator in electric axles which all electric trucks will require. Another indicator of its advanced capabilities: Allison was selected to help design the U.S. Army’s next-generation electric-powered vehicle. The company generates considerable free cash flow and has a low-debt balance sheet. Its capable leadership team keeps its shareholders in mind, as the company has reduced its share count by 38% in the past five years.

On April 27, Allison reported first-quarter earnings of $1.30/share, up 21% from a year ago and about 2% above the consensus estimate. The company maintained its full-year revenue, profit and cash flow outlook, which calls for 12% sales growth, 9% EBITDA growth and flat free cash flow. These results were encouraging, and good enough to push up the shares in the following several trading days.

In the quarter, revenue rose 15% and was about 5% above estimates. On-Highway segment sales represents most of the company’s sales, and its revenues rose 14% as demand for last mile, regional and vocational trucks continues to be sturdy. Service Parts segment sales rose 14%. Defense industry sales slipped 22%, but this segment represents only 5% of total revenues. Allison’s sales outlook remains healthy.

Adjusted EBITDA rose 10% and was about 11% above estimates. Profit growth lagged revenue growth due to sharp increases in input prices as well as tight labor, transportation and procurement conditions. These supply issues will likely continue, and Allison’s price increases are clearly helping offset the effects. Overhead expenses increased modestly, helping dampen the drag on earnings.

The company’s shareholder-friendly reputation was bolstered as it raised its dividend by 11%, repurchased 2% of its shares and raised its buyback authorization by $1 billion to a total of $4 billion. Allison’s balance sheet was essentially unchanged during the quarter, so the debt burden remains reasonable.

Allison shares rose 7% in the past week on the encouraging earnings report (the higher consensus estimate reflects this) and have 24% upside to our 48 price target.

The stock pays an attractive and sustainable 2.2% dividend yield to help compensate for the wait. BUY

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 related to its economic conditions (in particular, inflation, running at a 10.5% rate), currency and the chances that a socialist might win this 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.

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

ARCO shares rose 1% in the past week and have 14% upside to our recently increased 8.50 price target. BUY

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 2% in the past week and have about 27% upside to our 14 price target. The projected dividend, which would produce a generous 7.6% yield, looks fully sustainable. BUY

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.

Over the past week, commodity gold dipped 2% to $1,868/ounce. The 10-year Treasury yield rose to 2.97% and ticked above 3% earlier this week. The spread between this yield and inflation of 8.5% remains exceptionally wide compared to a long-term average spread of perhaps one to two percentage points, strongly suggesting many more interest rate hikes ahead. Chatter about the “real” yield turning positive is based on other yields and inflation rates and we consider them to be less useful. The U.S. Dollar Index, another driver of gold prices (the dollar and gold usually move in opposite directions), rose to 103.53, reaching a level not seen for nearly 20 years. The prior peak was set in 2001 at 119.43.

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

Barrick shares rose 1% in the past week and have about 20% 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. BUY

Big Lots (BIG) – Big Lots is a discount general merchandise retailer based in Columbus, Ohio, with 1,431 stores across 47 states. Its stores offer an assortment of furniture, hard and soft home goods, apparel, electronics, food and consumables as well as seasonal merchandise. The company has a large and loyal customer base of 22 million Rewards program members, which has growth steadily over the past decade. Big Lots should benefit if consumers trade down due to a slowing and inflationary economy. While low, the 5.5% cash operating profit margin appears stable. Management guided for weak first-quarter results and investor expect the full-year guidance may be too high, as well.

We are intrigued enough by the shares’ remarkably low valuation to make this stock a Buy. On conservative fiscal 2022 (ending in January 2023) estimates, the shares currently trade at 3.1x EV/EBITDA and 7.3x per-share earnings. These multiples imply a dour recessionary future for the company. The EV/EBITDA multiple is sharply below an average of perhaps 5x-9x for its peers. Even adjusting for scale and quality, a discount of this size for BIG is unwarranted.

From a historical perspective, Big Lots’ shares trade unchanged from their 2007 price level and are down 50% from their stimulus-boosted peak at over 70 last year.

Big Lots’ balance sheet carries only $4 million of debt compared to $54 million in cash. While the balance sheet ebbs and flows with its inventory needs, the company is operated primarily as a debt-free business. This provides Big Lots with considerable endurance and flexibility. We would rate the management and board quality as “good enough.” Big Lots generates positive free cash flow that is strong enough to provide a reasonably sustainable $0.30/share quarterly dividend and repurchase its own shares.

The presence of investor Mill Road Capital (5.1% stake) is interesting. We doubt whether Mill Road has the financial firepower to execute a buyout on its own and are also skeptical of its proposal for Big Lots to lever up to do a share buyback. Nevertheless, Mill Road has publicly highlighted the company’s deeply discounted shares – a positive without a doubt.

All-in, while BIG shares carry higher risk, the risk/return trade-off appears compelling.

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

Big Lots shares fell 3% in the past week and have 39% upside to our 45 price target. Investor fears of a recession drove the shares lower. The dividend produces an attractive 3.7% yield. BUY

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.

On Thursday, April 14, Citigroup reported earnings of $2.02/share that fell 44% from a year ago but were 45% above the consensus estimate. The report was positive in the sense that it largely contained no new negatives.

Net interest income rose 3% from a year ago but the bank hasn’t benefitted much from rising interest rates. Fee income fell 9%. Expenses rose 15% as Citi is finding that business transformation is expensive. Credit costs remained low, but the bank added reserves to help cover losses in Russia and other possible effects of the war in Ukraine. At 2.35% of loans, Citi has plenty of loan loss reserves. Citi’s capital ratio slipped to 11.4% but remains more than adequate. Share buybacks reduced Citi’s share count by 6% over the past year. Citi said it would work to return capital to a 12% ratio by year end.

The bank trades at only 64% of its tangible book value of $79.03/share. Citi’s peers trade at between 130% and 200% of tangible book value. As the bank makes more progress with its strategic overhaul – a grinding process for sure – the share valuation should converge with its peers, providing exceptional upside with what appears to be limited downside.

Citi shares rose 1% over the past week and have about 68% upside to our 85 price target.

As long as the bank can execute its turnaround, the shares remain highly discounted. Investors have largely lost patience with Citibank. We are holding tight to the shares as our confidence remains sturdy and the shares remain overly discounted on a price/book basis as well as on an earnings basis.

Citigroup investors enjoy a 4.0% dividend yield and perhaps another 3% or more in annual accretion from the bank’s share repurchase program. BUY

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 straightforward – 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.

On May 3, Molson Coors reported first-quarter adjusted earnings of $0.29/share, which compared to $0.01/share a year ago and the consensus estimate of $0.19. Sales grew 17% and were about 3% higher than estimates. The company reaffirmed its full-year revenue and earnings guidance. Driving the strong results were healthy volumes (+5%) and pricing (+10%). Molson Coors continues to whittle down its debt balance and also initiated a $200 million share repurchase program in the quarter. The company reported just ahead of our publishing deadline, so we haven’t had a chance to fully process the results, but our initial view is that the quarter provided encouragement for our thesis.

TAP shares fell 2% in the past week and have about 30% 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 8.7x estimated 2022 results, still among the lowest valuations in the consumer staples group and below other brewing companies. The 2.6% dividend only adds to the appeal. BUY

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.

OGN shares rose 3% in the past week and have about 42% 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 3.5% dividend yield. BUY

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.

On April 26, Sensata reported adjusted earnings of $0.78/share, down 9% from a year ago but about 3% above the consensus estimate. Revenues were flat but a tad above estimates. The company initiated a dividend, at $0.11/share per quarter, which produces an attractive 3.8% yield. Despite the respectable results and new dividend, the shares fell through midday trading due mostly to the weak stock market.

Revenues rose 4% from a year ago and was about 2% above the consensus estimate. On an organic basis (adjusted for acquisitions, divestitures and currency changes) was unchanged, perhaps a bit disappointing as Sensata should be producing at least some growth, even though the results were above the company’s previous guidance. Sensata’s organic revenues grew noticeably faster than its end markets, which fell more than 6%, but this is a bit uninspiring as a target. Pricing strength helped boost revenues.

Margins slipped due to lower volumes, higher input costs and higher research spending. The company continues to invest in new products, which is helping its market share but weighing on earnings. Similarly, the company announced a $580 million acquisition, similarly helping its strategic positioning but is a drain on free cash flow.

Sensata’s heavy investments are starting to weigh on our view of its shares, but we will remain patient as the valuation remains attractive and the company is making both strategic and earnings progress. The new dividend provides an attractive yield while we wait.

ST shares rose 4% in the past week and have about 59% upside to our 75 price target. BUY

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.

The next Cabot Undervalued Stocks Advisor issue will be published on June 1, 2022.