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Value Investor
Wealth Building Opportunites for the Active Value Investor

August 17, 2022

Over the past three years, special purpose acquisition companies, or SPACs, went from an obscure way for sketchy companies to become publicly traded to an extraordinarily trendy way for sketchy companies to become publicly traded.

Over the past three years, special purpose acquisition companies, or SPACs, went from an obscure way for sketchy companies to become publicly traded to an extraordinarily trendy way for sketchy companies to become publicly traded.

In a typical SPAC deal, a shell company which has no operations completes an initial public offering. The cash raised in this first stage is held in trust, to be used in the second stage to buy an as-yet-unnamed private company. Once acquired, the private company becomes a publicly traded company. Investors trust that the SPAC’s cash hoard will be used sensibly, but in essence they give the SPAC management a blank check. History has shown that most of these deals turn out well for the SPAC management but poorly for the SPAC investor.

In nearly every year, total annual SPAC deals were less than $4 billion. However, starting in 2017, volume jumped to over $10 billion. Once the pandemic struck, annual totals for SPAC deals soared exponentially, reaching $162 billion in 2021. Everyone from so-called “SPAC King” Chamath Palihapitiya to rock star Jay-Z to tennis star Serena Williams got involved in backing SPACs.

True to speculative bubble form, the value of the underlying assets in the SPAC bubble proved vaporous. Today, the typical SPAC is either struggling to find a suitable acquisition target or has seen its shares collapse by 70% or more following a completed deal. Adding a few nails to the coffin are newly proposed rules by the SEC that could strictly limit the enthusiastic forecasts that SPAC managements could otherwise provide – in essence relegating SPACs to the same rules as traditional IPOs.

So, R.I.P. SPACs is in the near future.

Fortunately, investors with an intense desire for financial market speculation have other outlets. Meme stock trading has returned, as almost sure-thing future bankruptcy stock Bed Bath and Beyond (BBBY) has seen its stock surge from 4.70 to over 28 this month.

Share prices in the table reflect Tuesday (August 16) closing prices. Please note that prices in the discussion below are based on mid-day August 16 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.

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Today’s Portfolio Changes
State Street Corporation (STT) – New Buy.

Last Week’s Portfolio Changes

Upcoming earnings reports
Wednesday, August 17: Cisco Systems (CSCO)
Friday, August 26: Big Lots (BIG)

Growth/Income Portfolio
New Buy: State Street Corporation (STT) – Based in Boston, State Street is the world’s largest custodian bank, with $38 trillion in assets under custody/administration. In its early days, State Street provided back-office services for investment managers, including holding securities for safekeeping and processing of investment fund transactions. Over time, the bank added middle-office and front-office services, including client reporting, electronic trading and full enterprise solutions for investment managers. Today, all of these services comprise about 56% of the bank’s revenues.

The industry has consolidated into four dominant firms, including #2 Bank of New York Mellon, and JPMorgan and Citigroup, due to the economies of scale that allow larger firms to offer more and better services at lower costs. A recent indicator of these economies is that State Street acquired the back-office operations of Brown Brothers Harriman (BBH), adding $5.4 trillion in assets under custody/administration, as BBH wanted to focus on its core investment management activities.

The bank’s State Street Global Advisors subsidiary is a major issuer of index exchange traded funds (ETF), with $3.5 trillion in assets under management. SSGA produces about 17% of total revenues. In addition, the bank earns interest income on its portfolio of investments, which contribute about 16% of total revenues. The balance of revenues is produced from foreign currency transactions.

Shares of this well-managed, high-quality bank are out of favor with investors. Since reaching 104 in January, the shares have declined about 30% and are essentially unchanged since 2007. Near-term concerns include the bank’s fee sensitivity to stock and bond markets, cost pressures from wages (about half of total expenses), travel and other expenses, the likely loss of some cash deposits as customers shop around for higher returns on their short-term cash balances, and potential integration issues with the BBH combination. Longer-term concerns include slow industry revenue growth along with steady pricing pressure from competitors.

While we acknowledge these issues, 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 8.6x estimated 2023 earnings. This is below what we believe is a fair valuation at about 11x. The valuation on tangible book value (TBV), at about 1.9x, is also at the low end of its post-financial crisis valuation range. We place a more appropriate valuation at about 2.1x TBV based on likely 2023 tangible book value. We also find the 3.4% dividend yield appealing. For STT shares, we have a 94 price target, up about 25% from the current price. 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.

While Cisco shares’ round-trip from our initial recommendation at 41.32 to 64 and back to around 46 is frustrating, this is not the time to sell the stock. The fundamentals remain reasonably stable and likely to tick back upward, and profits seem likely to improve, as well. The shares will likely come back to life as earnings reports show favorable growth and profit trends, so investors will need some patience. If we have a recession in global tech spending, Cisco would likely feel the downturn but not as severely as other technology companies due to the mission-critical nature of its products and services.

The company is scheduled to report earnings this Wednesday, August 17 (after press time), with a consensus earnings estimate of $0.82/share.

CSCO shares rose 4% in the past week and have 41% upside to our 66 price target. The valuation is attractive at 9.5x EV/EBITDA and 13.9x earnings, the shares pay a sustainable 3.2% dividend yield, the balance sheet is very strong and Cisco holds a key role in the basic plumbing of technology systems even if its growth rate is only modest. 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 CEO James Quincey (since 2017) is reinvigorating the company by narrowing its over-sized 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 3% in the past week and have 6% upside to our 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. HOLD

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.

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

The quarterly dividend appears readily sustainable and provides an appealing 5.0% yield. The shares trade at a low 4.8x EV/EBITDA multiple. Barring a deep recession, collapse in oil prices or a surge in supply, Dow’s fundamental earnings picture seems solid.

Dow shares rose 6% in the past week as recession fears increased. The shares have 39% 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 six 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 2021 and we think it will divest its animal health segment sometime in the next five years.

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

Merck shares rose 1% in the past week and have about 9% upside to our 99 price target. The company has a strong commitment to its dividend (3.0% 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. While the shares have pulled back, we are retaining our Hold rating as rising interest rates reduce the upside potential value of its shares. HOLD

Buy Low Opportunities Portfolio
Allison Transmission Holdings, Inc. (ALSN) – Allison Transmission is a mid-cap ($3.8 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 August 3, Allison reported good results compared to a year ago but which fell short of consensus estimates. The company reiterated its full-year adjusted EBITDA and adjusted Free Cash Flow guidance although it incrementally narrowed the range. We view this as a confidence-builder in the full-year outlook, but beyond year-end the outlook is murkier. Allison continues to see healthy demand, particularly in its core North American On-Highway segment (about half of sales) which posted a 13% increase in revenues. All segments but Defense (4% of sales) showed reasonably positive sales growth, as well. Operating profits rose 12%, as higher prices and lower overhead spending more than offset elevated materials costs and higher engineering spending.

Allison’s cash flow remains healthy although weaker than a year ago as the company’s working capital consumed more cash. The balance sheet is strong. As the company continues to repurchase its shares, the share count continues to decline, down 11% from a year ago.

Allison shares rose 5% in the past week and have 22% upside to our 48 price target. The stock pays an attractive and sustainable 2.1% dividend yield to help compensate investors while waiting for the recovery. 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 re-open. 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 an 11.7% rate), currency and the chances that a socialist might win this year’s Brazilian presidential elections, will continue to influence ARCO shares.

On August 10, Arcos reported strong results that illustrate the quality of the franchise and its management. Revenues rose 54% ex-currency and were about 8% above estimates. Comparable sales rose 48%, which drove most of the revenue growth. Earnings of $0.07/share increased from $0.02 a year ago but fell short of the $0.14 consensus estimate. Adjusted EBITDA of $91 million set a second-quarter record, increased 94% and was 6% above the consensus estimate. The adjusted EBITDA margin of 10.3%, which excludes the hyper-inflationary Venezuelan market, exceeded the company’s pre-pandemic margin.

The company continues its disciplined new restaurant openings (opened 12 free-standing units and two others) and its disciplined approach to its overall business. Digital sales continue to climb and now comprise more that 40% of total revenues. We are impressed with Arcos’ commitment to technological and daily innovation. With the sharp recovery in EBITDA, Arcos’ net leverage ratio has declined to about 1.1x.

Despite the strong earnings, ARCO shares slipped 7% in the past week and have 16% upside to our 8.50 price target. The weakness appeared to be related to investor disappointment in the earnings relative to estimates, but this seems to be more of a case of overzealous estimates rather than underperformance by the company. Given this, we have no change in our rating on the shares. 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.

On August 10, Aviva reported robust first-half results, with operating profits of £0.19/share exceeding the consensus estimate of £0.17. Adjusted for the divestitures and assuming that the overly complicated but valuable share buyback scheme had occurred at year-end, Aviva’s per-share earnings would have been an even more impressive £0.24.

Revenue metrics were also encouragingly strong, with 6% growth in new premiums and net asset inflows into its wealth management business equal to 7% of its assets.

Investors were caught off-guard by the strong earnings and capital position as well as the management’s confidence in the outlook. Also, the full-year dividend guide of £0.31/share was reiterated and management comments about a steadier cadence of share buybacks was a positive surprise. AVVIY shares jumped 14% on the day. The Aviva story is starting to play out well.

Operating profit of £829 million rose a surprisingly strong 14% from a year ago. The company is making steady progress in its U.K./Ireland Life Insurance business while other segments had incrementally weaker profits. Controllable costs (-19% across all segments) was a major contributor to the higher operating profits. Lower interest expense from a healthier balance sheet helped, as well.

Aviva shares rose 12% in the past week following the earnings update and have about 26% upside to our 14 price target. Based on management’s estimated dividend for 2023 (which we believe is highly credible), the shares offer a generous 7.5% yield. Based on this year’s actual dividend, the shares offer an attractive 5.0% dividend yield. 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.

On August 2, Barrick reported second-quarter earnings of $0.24/share, down 17% from a year ago but 8% above the $0.22 consensus estimate. Revenues slipped 1% from a year ago as gold volumes sold fell 3% but were mostly offset by the 2% increase in its realized gold price (the price it received, which can vary from the market price). Barrick’s gold production costs rose, which weighed on earnings. The company reiterated its full-year gold and copper production guidance. Overall, the Barrick story remains on track, but rising costs will likely require the company to incrementally lower its earnings guidance for the year.

The balance sheet carries $636 million in cash in excess of its debt. Barrick’s capital spending is rising, partly to expand its mine in the Dominican Republic, which is absorbing much of its incremental free cash flow. The company repurchased $182 million in shares in the quarter and declared a $0.20/share quarterly dividend, which includes the $0.10 regular dividend and a $0.10 performance dividend based on its new payout rules.

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

Over the past week, commodity gold ticked down 1% to $1,788/ounce. The 10-year Treasury yield rose to 2.85%.

The US Dollar Index, another driver of gold prices (the dollar and gold usually move in opposite directions), was essentially flat at 106.56. The dollar remains exceptionally strong.

Barrick shares rose another 2% in the past week. The shares have about 62% 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. Our bullish case for Big Lots rests with its loyal and growing base of 22 million rewards members, its appeal to bargain-seeking customers, the relatively stable (albeit low) 5.5% cash operating profit margin, its positive free cash flow, debt-free balance sheet and low share valuation at 3.1x EV/EBITDA and 7.3x per-share earnings based on conservative January 2023 estimates.

Our thesis was deeply rattled by the company’s dismal first-quarter results. Offloading its bloated inventory will require sharp discounts, which will weigh on profits while the $271 million in new borrowing ramps up the risk. 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.

Big Lots shares rose another 19% this past week, supported recently by a surprisingly strong earnings report from Walmart. The shares have bounced 42% since dipping below $19/share in July and have 34% upside to our recently reduced 35 price target.

Big Lots reports second-quarter results on Friday, August 26. The company has considerable inventory to work through and we have limited visibility into its progress in the quarter. Walmart’s news is partly encouraging, in that they were able to move merchandise by discounting its prices. Yet Walmart has a steady flow of customers that buy weekly groceries at its stores, and a more staples-oriented product array whereas Big Lots is more discretionary. However, Big Lots is adept at buying surplus goods at sizeable discounts from suppliers – the past quarter may have been a bonanza as retailers like Walmart cancelled billions of dollars of orders from suppliers, leaving Big Lots in a reasonably strong position to buy up that volume. And, Big Lots is adept at pricing these types of goods to move quickly through its stores.

Our discipline has us staying with Big Lots at least through its earnings report. Strong results could easily propel the shares much higher, whereas dour expectations are still somewhat priced into the shares.

Nevertheless, Big Lots is not out of the woods yet. We would consider the dividend to be unsustainable and caution that investors should not count on any dividends from Big Lots. 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.

This past week, the yield spread between the 90-day T-bill and the 10-year Treasury note, which approximates the drivers behind Citi’s net interest margin, widened modestly to 0.25%, or 25 basis points. There are 100 basis points in one percent.

A recession would likely increase Citi’s credit losses, a flatter yield curve would weigh on its net interest margin, and weaker capital markets would mean fewer investment banking revenues.

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

Citi shares trade at 68% of tangible book value. This immense discount, which assumes a dim future for Citi, appears to be misplaced.

Citi shares rose 5% in the past week and about 56% upside to our 85 price target. Citigroup investors enjoy a 3.7% dividend yield and perhaps another 3% or more in annual accretion from the bank’s share repurchase program once it reaches its new target capital ratio and if a slowing/stalling economy doesn’t meaningfully increase its credit costs. 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 reinstated its dividend.

On August 2, the company reported in-line results and guidance, but the shares tumbled as investors worried that slowing industry volumes, and perhaps that Molson’s push into premium brands has come at the wrong moment as consumers start to trade down. The decline in the share price does not diminish our appetite for the stock.

Revenues rose 2.2% excluding currency changes and adjusted earnings fell 25%. The company re-affirmed its full year revenue, profit and free cash flow guidance. Prices rose 7% but volumes fell 5%. Volumes for the industry as a whole were weak, so it appears that Molson gained share. The company said that it is roughly balanced between premium brands and lower-priced brands – a mix that is more sensible today as many consumers are trading down due to inflation and the weak economy. Profits slipped due to sharply higher materials, transportation and energy costs.

TAP shares rose 2% in the past week and have about 22% 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 9.1x estimated 2022 results, still among the lowest valuations in the consumer staples group and below other brewing companies. The 2.7% dividend yield 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.

On August 4, the company reported earnings of $1.25/share, down 27% from a year ago but about 5% higher than the $1.19 consensus estimate. Revenues were down 1% but were about 3% above estimates. Adjusted EBITDA of $512 million fell 18% but was 8% above estimates. Organon is still early in its turnaround as we wait for tangible evidence that the fundamentals are moving in the right direction.

For revenues, the quarter pointed to a slow but steady grind forward. Excluding currency headwinds, volumes looked good with a 5% growth rate. The company fractionally trimmed its full year revenue guidance and took 2 percentage points out of its Adjusted EBITDA margin guidance. The profit cut was due to higher R&D costs from its acquisitions. Overall, the company is making progress.

Sales in the Women’s Health segment ticked up but Biosimilars revenues rose 42%. Established Brands sales rose 4%. Management was optimistic about stronger sales for the core Nexplanon product later this year and for revenues from other new treatments. Organon continues to marginally chip away at its debt.

OGN shares fell 1% in the past week and have about 48% 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 3.6% 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.

Sensata’s second-quarter results were reasonable but weakening end markets, higher materials costs, higher R&D spending and supply chain disruptions will weigh on profits in upcoming quarters. Financially the company is sound, with healthy but lower free cash flow and a reasonably sturdy balance with modestly elevated debt. Its financial capacity to make acquisitions is now somewhat limited – a positive in our view (but this is an out-of-consensus view) as Sensata would benefit from slowing its pace, especially as the electric vehicle market is changing so quickly.

Overall, the Sensata investment remains sharply under water as its revenue growth is challenged by new economic cycle pressures on top of the post-pandemic supply chain issues. The company is well-positioned for the post-recession, electric vehicle environment, but investors will have to wait for perhaps a year for that to arrive. The shares are still worth holding onto given their now-low valuation and ability to financially endure the downturn.

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

ST shares rose 5% in the past week and have about 65% 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 subscribers.

Growth/Income Portfolio
Stock (Symbol)Date AddedPrice Added8/16/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Cisco Systems (CSCO)11-18-2041.3246.7713.2%3.2%66.00Buy
Coca-Cola (KO)11-11-2053.5865.0321.4%2.6%69.00Hold
Dow Inc (DOW) *04-01-1953.5056.114.9%5.0%78.00Buy
Merck (MRK)12-9-2083.4790.598.5%3.0%99.00Hold
State Street Corp (STT)8-19-2274.5374.48-0.1%3.4%94.00New Buy
Buy Low Opportunities Portfolio
Stock (Symbol)Date AddedPrice Added8/16/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Allison Transmission Hldgs (ALSN)02-22-2239.9939.05-2.4%2.2%48.00Buy
Arcos Dorados (ARCO)04-28-215.417.3636.0%2.2%8.50Buy
Aviva (AVVIY)03-03-2110.7511.123.4%5.0%14.00Buy
Barrick Gold (GOLD)03-17-2121.1316.85-20.3%2.4%27.00Buy
BigLots (BIG)04-12-2235.2427.31-22.5%4.4%35.00Hold
Citigroup (C)11-23-2168.1054.18-20.4%3.8%85.00Buy
Molson Coors (TAP)08-05-2036.5356.4854.6%2.7%69.00Buy
Organon (OGN)06-07-2131.4231.18-0.8%3.6%46.00Buy
Sensata Technologies (ST)02-17-2158.5745.56-22.2%1.0%75.00Buy

*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 2022
EPS Estimate
Current 2023
EPS Estimate
Change in
2022 Estimate
Change in
2023 Estimate
P/E 2022P/E 2023
CSCO 46.80 3.36 3.540.0%0.0% 13.9 13.2
KO 64.87 2.46 2.610.0%0.0% 26.4 24.9
DOW 55.92 8.01 6.670.0%0.0% 7.0 8.4
MRK 90.52 7.37 7.460.0%0.0% 12.3 12.1
STT 74.53 7.14 8.62nana 10.4 8.6
Buy Low Opportunities Portfolio
Current 2022
EPS Estimate
Current 2023
EPS Estimate
Change in
2022 Estimate
Change in
2023 Estimate
P/E 2022P/E 2023
ALSN 39.37 5.50 6.100.0%0.0% 7.2 6.5
ARCO 7.35 0.46 0.55-9.8%0.0% 16.0 13.4
AVVIY 11.10 1.10 1.327.0%1.9% 10.1 8.4
GOLD 16.70 1.01 1.06-0.8%-0.7% 16.6 15.7
BIG 26.09 (2.43) 2.260.0%0.0% (10.7) 11.5
C 54.45 7.29 6.930.1%-0.1% 7.5 7.9
TAP 56.47 3.94 4.19-0.3%-0.9% 14.3 13.5
OGN 31.11 4.95 5.460.0%0.0% 6.3 5.7
ST 45.50 3.40 4.000.0%0.0% 13.4 11.4

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