Please ensure Javascript is enabled for purposes of website accessibility
Undervalued Stocks Advisor
Wealth Building Opportunites for the Active Value Investor

November 9, 2022

Well over two decades ago, I oversaw the investment strategy for a large branch office of a major investment management firm. Our clients were flush with gains from a decade of tech mania – and highly reluctant to shift from their winning strategy. A major challenge was convincing clients to stay invested in stocks but step aside from high-flying dot-com stocks.

Long the Dow, Short the Nasdaq

Well over two decades ago, I oversaw the investment strategy for a large branch office of a major investment management firm. Our clients were flush with gains from a decade of tech mania – and highly reluctant to shift from their winning strategy. A major challenge was convincing clients to stay invested in stocks but step aside from high-flying dot-com stocks.

To best accomplish this, we boiled all of the macro issues, valuation problems and everything else into a single phrase, “Long the Dow, Short the Nasdaq.” While we didn’t advocate short-selling of tech stocks, this phrase conveyed the point: Focus on dull, cheap and enduring stocks that could be found in the Dow Jones Industrial Average and avoid trendy yet shaky tech stocks that drove the Nasdaq index. The approach resonated exceptionally well, perhaps helped by its sheer simplicity, so our clients felt more comfortable and confident in making the shift.

This strategy is probably good advice in the current market. Even with the sharp declines in many tech stocks, there probably is more downside to the former high-flyers. Many business models have no hope of becoming profitable, while many companies with more enduring businesses still seem overvalued. Tech companies are highly vulnerable to competition – one day they are dominating their industries, the next day they are Meta Platforms with a broken business model as new technologies shove them aside. The hundreds of billions of dollars of private equity money that today sits patiently on the sidelines will eventually be invested in new private tech companies whose sole goal is to displace the current public tech leaders.

However, industrial companies have much more enduring franchises. It seems highly unlikely that much new funding will seek to aggressively displace the lead held by Gates Industrial’s drive belts or hydraulic power products, or Allison’s transmissions. And these kinds of industrial companies generate free cash flow well in excess of their needs, allowing them to send that cash to shareholders.

Today’s market and economic era seems ripe for a return to the “Long the Dow, Short the Nasdaq” type of approach.

Share prices in the table reflect Tuesday (November 8) closing prices. Please note that prices in the discussion below are based on mid-day November 8 prices.

Note to new subscribers: You can find additional color on our thesis, recent earnings reports and other news on recommended companies in prior editions of the Cabot Undervalued Stocks Advisor, particularly the monthly edition, on the Cabot website.

Send questions and comments to Bruce@CabotWealth.com.

Today’s Portfolio Changes
None

Last Week’s Portfolio Changes
None

Upcoming Earnings Reports
Aviva plc (AVVIY) – Wednesday, November 9
Arcos Dorados (ARCO) – Thursday, November 10
Cisco Systems (CSCO) – Wednesday, November 16
Big Lots (BIG) – Thursday, December 1

Growth/Income Portfolio
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.

The shares were flat in the past week and have 46% upside to our 66 price target. The valuation is attractive at 9.1x EV/EBITDA and 12.9x earnings. The 3.4% dividend yield adds to the appeal of this stock. BUY

Comcast Corporation (CMCSA) – With $120 billion in revenues, Comcast is one of the world’s largest media and entertainment companies. Its properties include Comcast cable television, NBCUniversal (movie studios, theme parks, NBC, Telemundo and Peacock), and Sky media. The Roberts family holds a near-controlling stake in Comcast. Comcast shares have tumbled as worry about cyclical and secular declines in advertising revenues and a secular decline in cable subscriptions as consumers shift toward streaming services, as well as rising programming costs and incremental competitive pressure as phone companies upgrade their fiber networks.

However, Comcast is a well-run, solidly profitable and stable company that will likely continue to successfully fend off intense competition while increasing its revenues and profits, as it has for decades. The company generates immense free cash flow which is more than enough to support its reasonable debt level, pay a generous dividend (recently raised 8%) and sizeable share buybacks.

On October 27, Comcast reported a decent third quarter that was consistent with our thesis. Excluding the one-time boost from the year-ago Tokyo Olympics, revenues would have grown by 5%. Even with the one-time boost a year ago, third quarter profits rose by 6%. Small losses in the number of cable subscribers were nearly offset by an increase in wireless subscribers. Comcast repurchased $3.5 billion of shares in the quarter. Overall, the company is making incremental progress with its incremental initiatives to defend its franchises and is returning sizeable amounts of cash to shareholders. Comcast’s revenues were in-line with estimates while adjusted earnings and adjusted EBITDA were above estimates.

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

Comcast shares rose 2% for the past week and have about 31% upside to our 42 price target. The shares offer an attractive 3.4% dividend yield. 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 and 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). Recent concerns about a recession have send Dow shares to well-below our estimate of their fair value, even as the company’s long-term prospects and ability to maintain its dividend are attractive. Dow shares are a recommended Buy in our sister publication The Cabot Turnaround Letter.

On October 20, Dow reported third quarter operating earnings that were 60% lower than a year ago but about 3% ahead of the consensus estimate. Sales fell 5% but were 8% above the consensus estimate. Excluding the effect of the strong dollar, sales would have declined by only 1%. Overall, it was a reasonable quarter that showed the effects of modestly weaker demand combined with higher raw material and energy costs compared to a year ago and to the prior sequential quarter (Q2). Free cash flow was a robust $1.5 billion, although this declined by 35% from a year ago. This metric remains 3x the quarterly dividend payout. Dow repurchased $800 million of its shares in the quarter – a smart buy given the discounted price. The balance sheet remains solid.

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

Dow shares rose 7% in the past week and have 20% upside to our 60 price target (same as in Cabot Turnaround Letter). The quarterly dividend appears readily sustainable and provides an appealing 5.6% yield. The shares trade at a modest 6.5x EV/EBITDA multiple and 11.6x EPS on recession-minded 2023 estimates.

Earnings estimates continued to tick downward. The shares are in the part of the cycle where, barring a confidence-eroding economic climate, long-term investors will look through the earnings trough to an eventual recovery. This may lead to the counter-intuitive situation where the valuation multiples increase as earnings estimates decline. BUY

State Street Corporation (STT) – State Street is the world’s largest custodian bank, with $38 trillion in assets under custody/administration. About 56% of its revenues are produced from custody, client reporting, electronic trading and full enterprise solutions services for investment managers. The balance is produced from investment management fees on ETFs, foreign exchange fees, securities financing fees and net interest income. The industry has combined into four dominant firms due to economies of scale. State Street’s shares are out of favor and unchanged since 2007 due to concerns over its anemic growth and steady pricing pressure from competitors. However, we see State Street as a solid, well-capitalized franchise that provides critical services, with a slow-growth but steady revenue and earnings stream. Our interest in STT shares is that we can buy them at an attractive valuation. We also find the dividend yield appealing.

On October 18, State Street reported a good quarter, with adjusted earnings of $1.82/share falling 9% from a year ago but beating the consensus estimate by about 3%. Revenues fell 1% but were essentially in-line with estimates. Weakness in revenues related to the value of stocks and bonds were nearly offset by higher net interest income and foreign currency services revenues. Expenses were flat, so the pre-tax margin slipped to 29.1% from 29.9% a year ago. State Street remains committed to returning to a 30% pre-tax margin. The bank said it would repurchase about $1 billion of its shares in the fourth quarter – nearly 5% of shares outstanding and a savvy purchase as the stock is considerably undervalued.

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

State Street shares rose 3% in the past week and have about 22% upside to our 94 price target. The company’s dividend (3.3% yield) is well-supported and backed by management’s strong commitment. BUY

BUY LOW OPPORTUNITIES PORTFOLIO
Allison Transmission Holdings, Inc. (ALSN) – Allison Transmission is a midcap manufacturer of vehicle transmissions. While 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, Allison actually produces no car or light truck transmissions. Rather, it focuses on the school bus and Class 6-8 heavy-duty truck categories, where it holds an 80% market share. Its 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. 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 October 26, Allison reported a strong quarter on an absolute basis with earnings rising 63% although profits were only about 4% above estimates. Revenues rose 25%. The company used its profits to repurchase about 3% of its total share base in the quarter – an impressive nod to shareholders. Allison incrementally raised its full-year guidance across the board. The balance sheet remains solid and free flow increased 20% from a year ago. Allison is an understated and undervalued company that continues to make progress with its operational and strategic initiatives while also generating attractive financial performance.

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

The shares have surged 33% since troughing in mid-September – a huge rebound reflective of the company’s enduring quality, strong balance sheet and improving sentiment around economic strength.

The shares rose 1% in the past week and have 11% upside to our 48 price target. The stock pays a respectable and sustainable 1.9% dividend yield. 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, political/social unrest, inflation and currency devaluations. However, the company has a solid brand, high recurring demand, impressive leadership (including founder/chairman who owns a 38% stake) and successful experience in navigating local conditions, along with a solid balance sheet and free cash flow.

Macro issues have a sizeable impact on the shares’ trading, including local inflation and the Brazilian currency. Since early 2020, the currency has generally stabilized in the 1.00 real = $0.20 range – a remarkably favorable trait given the sharp declines in other currencies around the world. As the company reports in U.S. dollars, any strength in the local currency would help ARCO shares.

Current Brazilian president Bolsonaro lost the October 30 presidential election and said he will cooperate in the transition of power, although he did not concede defeat. It appears that the related protests will fade, which is a positive for McDonald’s business.

ARCO shares slipped 3% this past week and have 14% upside to our 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, hired as CEO in July 2020, is revitalizing Aviva’s core U.K., Ireland and Canada operations following her divestiture of other global businesses. The company now has excess capital which it is returning to shareholders as likely hefty dividends following a sizeable share repurchase program. We expect that activist investor Cevian Capital, which holds a 5.2% stake, will keep pressuring the company to maintain shareholder-friendly actions.

Aviva is expected to report interim results on November 9. We hope to hear an update on Aviva’s capital position and outlook.

Based on management’s estimated dividend for 2023 (which remains credible but is subject to a smaller increase than the current guidance for a 48% boost), the shares offer a generous 8.3% yield. Based on this year’s actual dividend, the shares offer an attractive 5.6% dividend yield.

Aviva shares rose 4% in the past week. The shares have about 39% upside to our 14 price target. 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 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 reported a reasonable quarter but the company’s profits and cash flows are being incrementally squeezed by modestly lower gold prices, modestly weaker production volumes and higher costs. The company’s financial and operating condition remains strong but its underlying profitability is not as healthy as we had anticipated, even excluding the weaker gold price. We are staying with the Barrick position as it remains a well-managed company, is well positioned to benefit from an eventual rebound in gold prices, has a solid balance sheet and pays a respectable base dividend that appears sustainable.

Adjusted earnings of $0.13/share fell 46% from a year ago but were 18% above the consensus estimate. Revenues fell 11% from a year ago but were modestly higher than estimates. Adjusted EBITDA of $1.2 billion fell 31% from a year ago but was 4% above estimates.

Barrick felt the impact of lower gold prices, but most of the weaker profits were due to lower production and higher costs. Gold prices were only 3% lower than a year ago, but production was 7% lower and costs per ounce rose 21%. Production is lower due to various issues at its mines – nothing major but a lot of small issues that add up. Higher energy costs throughout their production chain, as well as higher labor and consumables costs, weighed on results. Also, the company is spending more to maintain its production, as seen in the 48% increase in “minesite sustaining capital expenditures.”

Third quarter and year-to-date gold costs were above the range provided in the full-year guidance and the company acknowledged that its full year costs will exceed this guidance.

The head of the giant Nevada Gold Mines operation is retiring. While difficult to discern whether this is a normal retirement or a performance-driven change, we see the change as a positive.

The balance sheet remains solid with $145 million of cash in excess of debt. Barrick will pay a regular $0.10 base dividend and a $0.05 performance dividend this quarter. The company is also repurchasing shares but at a slow pace, in our view.

Over the past week, commodity gold jumped 4% to $1,714/ounce. The 10-year Treasury yield ticked up to 4.14%. Investors are anticipating the “end-game” in which Treasuries peak at a roughly 5.0% yield to roughly match or slightly exceed the anticipated inflation rate in a year or so. If this scenario pans out, gold and equity prices in general should rise.

The US Dollar Index, another driver of gold prices (the dollar and gold usually move in opposite directions), fell 2% to 109.47.

Any wavering by the Fed in its now-strident rate hike campaign would also likely result in gold rebounding sharply. Until this happens, gold will probably remain out of favor. Investing in gold-related equities is a long-term decision – investors shouldn’t allow near-term weakness to deter their resolve.

Barrick shares rose 4% in the past week and have about 72% upside to our 27 price target. Our resolve with Barrick shares remains undaunted through the recent sell-off. 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. Our initial case for Big Lots rested with its loyal and growing base of 22 million rewards members, its appeal to bargain-seeking customers, the relatively stable (albeit low) cash operating profit margin, its positive free cash flow, debt-free balance sheet and low share valuation.

Our thesis was deeply rattled by the company’s dismal first-quarter results although second quarter result, while dismal, were better than the market’s dour consensus. The company needs to offload its still-bloated inventory at sharp discounts while also now loading the company with what is probably permanent debt.

We are retaining our HOLD rating for now: Investor expectations are sufficiently depressed to provide some downside cushion, while management should be able to extract itself from the worst of the inventory problem over the next few quarters. Nevertheless, the Big Lots investment is now high-risk due to the new debt balance, the lost value from the inventory glut and the likelihood of a suspension of the dividend.

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

Big Lots shares slipped 3% this past week. The stock has 89% upside to our $35 price target. The shares offer a 6.5% dividend yield, although, as noted, investors should not rely on this dividend being sustained.

We reiterate our view that Big Lots shareholders who are not willing or able to sustain further losses in the shares should sell now. There is no reasonably definable floor to a stock like Big Lots when fundamentals and valuation are ignored while investors reduce their risk exposure. HOLD

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 October 14, Citi reported adjusted earnings that fell 39% from a year ago yet were about 3% above the consensus estimate. Revenue excluding divestitures fell 1% and were fractionally below the consensus estimate. Overall, a reasonable quarter for Citigroup with a moderately encouraging outlook as the bank maintained its full-year revenue and expense guidance. Its major divestitures (Mexico consumer and Asia consumer) are on track. The Citigroup turnaround remains a slog, measured in years rather than quarters, but appears likely to be successful. Citi shares offer an attractive dividend yield and considerable upside potential for patient investors. The valuation is very low on an absolute basis and substantially below its peers.

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

This past week, the yield spread between the 90-day T-bill and the 10-year Treasury bond, which approximates the drivers behind Citi’s net interest margin, fractionally narrowed to negative 3 basis points (100 basis points in one percentage point).

Citi shares trade at 57% of tangible book value and 6.8x estimated 2023 earnings. The remarkably low valuations assume an unrealistically dim future for Citi.

Citi shares were flat in the past week and have about 83% upside to our 85 price target. Citigroup investors enjoy a 4.4% dividend yield. We anticipate that the bank is done with share buybacks until there is more clarity on the economic and capital market outlook, which could readily be a year or more away. BUY

Gates Industrial Corp, plc (GTES) – Gates is a specialized producer of industrial drive belts and tubing. While this niche might sound unimpressive, Gates has become a leading global manufacturer by producing premium and innovative products. Its customers depend on heavy-duty vehicles, robots, production and warehouse machines and other equipment to operate without fail, so the belts and hydraulic tubing that power these must be exceptionally reliable. Few buyers would balk at a reasonable price premium on a small-priced part from Gates if it means their million-dollar equipment keeps running. Even in automobiles, which comprise roughly 43% of its revenues, Gates’ belts are nearly industry-standard for their reliability and value. Helping provide revenue stability, over 60% of its sales are for replacements. Gates is well positioned to prosper in an electric vehicle world, as its average content per EV, which require water pumps and other thermal management components for the battery and inverters, is likely to be considerably higher than its average content per gas-powered vehicle.

The company produces wide EBITDA margins, has a reasonable debt balance and generates considerable free cash flow. The management is high-quality. In 2014, private equity firm Blackstone acquired Gates and significantly improved its product line-up and quality, operating efficiency, culture and financial performance. Gates completed its IPO in 2018, with Blackstone retaining a 63% stake today.

Gates reported a reasonable quarter but reduced its full-year guidance as currency and supply chain headwinds aren’t relenting as fast as the company had hoped. The company continues to improve its execution and its future looks bright once Gates passes through the currently choppy macro environment.

Full-year guidance was reduced due to on-going currency headwinds as well as slower than anticipated easing of supply chain issues, inflation and costs associated with its production capacity increases. Sales were guided to increase by 5.5-8.0%. The midpoints of both the Adjusted EBITDA and adjusted EPS guidance fell by 7.5%.

In the quarter, revenues were essentially flat compared to a year ago but were about 4% below estimates. Adjusted income of $0.31/share was flat compared to a year ago and in-line with the consensus estimate. Adjusted EBITDA of $178 million fell 3% from a year ago and was about 7% below estimates.

Excluding the drag from the strong dollar, sales were healthy. In local currencies, sales rose nearly 8% and this included the negative effect of suspending their operations in Russia. The EBITDA margin slipped from 21.3% to 20.6% due to the strong dollar, rising costs and production inefficiencies from supply chain disruptions that more heavily affected its Power Transmission segment. In the Fluid Management segment, revenues and profits were meaningfully better than a year ago.

The company reduced its overhead expenses by an impressive 8% and passed through to its customers much of its higher costs. These helped margins improve from the second quarter.

Debt remains modestly elevated but this is not an issue given Gates’ management quality, business franchise and healthy-enough free cash flow. Third quarter free cash flow was $73 million and is implied to be about $200 million in the fourth quarter. The share count fell 5% from a year ago as the company balanced the merits of an improved debt level vs. lower share count. We would like to see lower debt but appreciate management’s recognition of the discounted share price.

At the current price and based on estimated 2022 results, the shares offer a 12% free cash flow yield (free cash flow divided by market cap). This is a sizeable discount to what the company is worth. GTES shares were flat in the past week and have about 23% upside to our 14 price target. 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 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 re-instated its dividend.

On November 1, Coors reported a reasonable quarter as revenues rose 4% but underlying earnings fell 25% due mostly to higher costs and currency effects outside of the Americas region. Product pricing was robust. Earnings were below the consensus estimate. Forward guidance was generally maintained although full-year underlying profits will likely increase around 7% compared to the prior guidance of around 9%, due to weaker demand in Central and Eastern Europe (impact of Ukraine war?) and higher cost inflation. The earnings “miss” plus the guidance trim drove the decline in the shares.

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

TAP shares rebounded 6% in the past week and have about 34% 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 8.6x estimated 2022 results, still among the lowest valuations in the consumer staples group and below other brewing companies. The 2.9% dividend yield only adds to the appeal. BUY

Organon & Company (OGN), a spin-off from Merck, specializes in patented women’s healthcare products and biosimilars, and also has a portfolio of mostly off-patent treatments. It may eventually divest its Established Brands segment. The management and board appear capable as they work to boost internal growth augmented by modest-sized acquisitions. The company produces robust free cash flow, has modestly elevated debt and pays a reasonable dividend.

The company reported a weak third quarter with flattish revenues but a narrower profit margin. While the results were ahead of estimates, this essentially reflects a company that is seeing a slower erosion relative to expectations, but a company that is eroding nonetheless. Organon raised its EBITDA margin guidance for the full year but its other guidance remained largely unchanged.

Revenues fell 4% (+3% ex-currency changes) and were about 1% above estimates. Adjusted earnings of $1.32/share fell 16% from a year ago but was about 20% above estimates. Adjusted EBITDA of $546 million fell 11% from a year ago and was about 17% above estimates. The company excludes stock-based compensation from its adjusted earnings numbers. We frown upon this, especially in an era when options are likely to be underwater and may need to be reissued at lower strike prices.

Volumes rose nearly 5% but local pricing eroded 2%, producing the +3% revenue growth ex-currency. Gross profit margins are improving to a respectable 64.2% (not adjusted) but the EBITDA margin continues to slide as Organon is spend more on selling and product promotions while also investing more heavily in research and development. Another disappointment not reflected in adjusted EBITDA is the $70 million of costs associated with the spin-off. The spin-off occurred over a year ago and Organon should be completely finished with this transition.

Organon’s balance sheet currently carries $600 million less debt than on its spin-off date but also less cash, such that net debt is essentially unchanged from the spin-off date. Working capital has absorbed close to $600 million of cash year-to-date, nearly all of which is spin-off related. Another $263 million in cash has been lost to one-time spin-off payments. Again, the spin-off was over a year ago and these flows and costs should have been sorted out by the last year-end. We are wondering what is going on with Organon’s financial function that they can’t manage to convert more profits into cash.

OGN shares fell 9% in the past week. Investors have basically given up on the company. The shares have about 92% upside to our 46 price target (using the same target as the Cabot Turnaround Letter). The shares offer an attractive 4.7% 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 October 25, Sensata reported adjusted earnings that fell 2% from a year ago but were in-line with the consensus estimate. On a currency-adjusted basis earnings would have increased by 7%. Revenues rose 7% and were slightly higher than the consensus estimate. The company continues to grow faster than its end markets and is winning new business awards at a reasonable pace but tracking below its goals. Expenses rose faster than sales, squeezing its margins. For Sensata, this margin pressure is an on-going challenge. Sensata said it expects to restore its 21% operating margin next year, but this effort likely remains a slog. Free cash flow was weak due to a build-up of excess inventory and from acquisition-related compensation. Sensata took advantage of its weak share price by repurchasing 2.3 million shares, about 1.5% of total shares, in the quarter.

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

ST shares rose 3% in the past week and have about 79% upside to our 75 price target. Our price target looks optimistic in light of the broad market sell-off, but we will keep it for now, even as it may take longer for the shares to reach it. 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 subscribe

Growth/Income Portfolio
Stock (Symbol)Date AddedPrice Added11/8/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Cisco Systems (CSCO)11/18/2041.3244.618.00%6.30%66Buy
Comcast Corp (CMCSA)10/26/2231.531.91.30%3.40%42Buy
Dow Inc (DOW) *4/1/1953.549.65-7.20%5.60%60Buy
State Street Corp (STT)8/17/2273.9676.153.00%3.30%94Buy
Buy Low Opportunities Portfolio
Stock (Symbol)Date AddedPrice Added11/8/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Allison Transmission Hldgs (ALSN)2/22/2239.9942.516.30%2.00%48Buy
Arcos Dorados (ARCO)4/28/215.417.4137.00%2.20%8.5Buy
Aviva (AVVIY)3/3/2110.759.99-7.10%5.60%14Buy
Barrick Gold (GOLD)3/17/2121.1315.61-26.10%2.60%27Buy
BigLots (BIG)4/12/2235.2417.88-49.30%6.70%35Hold
Citigroup (C)11/23/2168.146.12-32.30%4.40%85Buy
Gates Industrial Corp (GTES)8/31/2210.7111.224.80%0.00%14Buy
Molson Coors (TAP)8/5/2036.5351.2940.40%3.00%69Buy
Organon (OGN)6/7/2131.4223.56-25.00%4.80%46Buy
Sensata Technologies (ST)2/17/2158.5741.42-29.30%1.10%75Buy

*Note: DOW price is based on April 1, 2019 closing price following spin-off from DWDP.

Buy – This stock is worth buying.
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.
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.

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
CSCO 45.28 3.52 3.810.0%0.0% 12.9 11.9
CMCSA 32.18 3.63 3.810.8%-0.3% 8.9 8.4
DOW 50.07 6.38 4.33-0.6%-0.5% 7.8 11.6
STT 76.77 7.20 8.140.1%0.0% 10.7 9.4
Buy Low Opportunities Portfolio
Current
price
Current 2022
EPS Estimate
Current 2023
EPS Estimate
Change in
2022 Estimate
Change in
2023 Estimate
P/E 2022P/E 2023
ALSN 43.22 5.24 5.890.0%0.0% 8.2 7.3
ARCO 7.46 0.45 0.550.0%0.0% 16.6 13.6
AVVIY 10.05 1.04 1.290.0%0.0% 9.7 7.8
GOLD 15.68 0.80 0.79-4.8%-6.5% 19.6 19.8
BIG 18.54 (4.56) 0.700.0%-27.8% (4.1) 26.5
C 46.37 7.09 6.85-1.8%-0.4% 6.5 6.8
GTES 11.39 1.14 1.17-4.2%-5.6% 10.0 9.7
TAP 51.54 3.90 4.14-2.0%-0.5% 13.2 12.4
OGN 23.99 4.93 4.950.4%-4.8% 4.9 4.8
ST 41.81 3.32 3.680.0%0.0% 12.6 11.4

Current price is yesterday’s mid-day price.
CSCO: Estimates are for fiscal years ending in July of 2023 and 2024

Bruce Kaser has more than 25 years of value investing experience in managing institutional portfolios, mutual funds and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company.