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Value Investor
Wealth Building Opportunites for the Active Value Investor

August 24, 2022

In late 1991, two storm systems and Hurricane Grace combined to produce some of the most violent open seas conditions on record. One monitoring buoy in offshore Nova Scotia reported a 100.7-foot wave (picture a 10-story building), a record for the region. In 1997, Sebastian Junger wrote the book The Perfect Storm and in 2000 it was made into a movie starring George Clooney and Mark Wahlberg.

Like “The Perfect Storm,” But Not That Part
In late 1991, two storm systems and Hurricane Grace combined to produce some of the most violent open seas conditions on record. One monitoring buoy in offshore Nova Scotia reported a 100.7-foot wave (picture a 10-story building), a record for the region. In 1997, Sebastian Junger wrote the book The Perfect Storm and in 2000 it was made into a movie starring George Clooney and Mark Wahlberg.

The title is now heavily quoted (overly so) whenever unusual conditions conspire to produce a disaster. We’ll grant that the current stock market probably meets those conditions. But, to us, among the most memorable and relevant scenes in the movie is when, after an extended and intense battle with the storm, the fishing boat Andrea Gail finds herself in calmer waters lit by rays of sunshine. For a moment, it appears that the boat and its crew will survive. Inexperienced crew member Bobby says, “Skip, we’re gonna make it.”

But then, the sky darkens, the mind-bending wind resumes its terrifying screams, and the Andrea Gail must once again face the storm’s anger. Captain Tyne somberly replies, “she’s not gonna let us out.” Minutes later, a massive wave overturns the boat and it sinks to the bottom of the ocean. There are no survivors.

That’s how the stock market is starting to feel.

Rays of hope since mid-June have helped propel the stock market upward to regain about half of its year-to-date losses. The sunshine of a friendlier Federal Reserve policy combined with the calming effect of steady and low jobless claims no doubt eased investors’ worries about the raging inflation and recession storms.

We’re fairly sure that in this case, Bobby is right, we’re gonna make it. But we can’t dismiss the possibility that we are only at the calm eye of the storm, and that we’ll soon enough feel more like grizzled veteran Captain Tyne – battling raging waves and extreme winds.

The Big Lots boat will give us news about how it is faring this coming Friday. We’re already a bit seasick after only a short voyage. Stormy waters have made for rough sailing and some on-taking of water. We’re not handing out the life jackets, though – on either Big Lots or stocks in general.

Share prices in the table reflect Tuesday (August 23) closing prices. Please note that prices in the discussion below are based on mid-day August 23 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
The Cola-Cola Company (KO) – Moving from Hold to Sell.

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

Upcoming earnings reports
Friday, August 26: Big Lots (BIG)

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.

On August 17, Cisco reported adjusted fiscal fourth-quarter earnings of $0.83/share, down 1% from a year ago but 1% above the consensus estimate. Revenues were flat but were about 2% above consensus. Going into the report, market sentiment on Cisco shares was pessimistic, so the above-consensus results provided enough encouragement that the shares jumped about 6% on the news. We remain on board with the Cisco position.

Cisco is grinding through the secular and near-term supply chain and other headwinds yet is supported by resilient yet flattish demand for its products and services. The company will likely continue to show modest revenue growth. Guidance for fiscal 2023 is for 2-4% growth, about the same pace as this past year, which seems reasonable to us. If anything, management is likely being conservative with their guidance, as they are well aware of the share price penalties of missing estimates. Supporting their outlook: annualized recurring revenues continue to increase, up 8% in the quarter, and the backlog continues to grind upward (+2% in the quarter). Overall, the transformation to subscriptions is making progress, albeit slowly.

The company is sacrificing gross margins, partly due to elevated supply chain costs, to help boost revenue growth. The adjusted gross margin shrank to 63.3% from 65.6% a year ago. More efficient operations are mostly offsetting this, as operating expenses fell by 1.2 percentage points.

Cisco is showing its cash generation powers with its nearly $4 billion in combined dividends and share repurchases in the quarter. For the year, the company returned $14 billion to shareholders (about 7% of its market value). Since a year ago, the share count is down 2.4%. The balance sheet has $9.8 billion in cash in excess of debt – this is about $3 billion lower than a year ago as Cisco used some of its cash for dividends and buybacks. We’re fine with this use of excess cash. We also note, encouragingly, that Cisco seems to be slowing its pace of acquisitions, which not only conserves cash and shares but also shows that the company can increase revenues organically without relying on “buying” revenues through acquisitions.

CSCO shares rose 2% in the past week, powered by strong earnings that overcame a weak market and have 38% upside to our 66 price target. The valuation is attractive at 9.6x EV/EBITDA and 13.5x 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, bolstered by the CEO’s (promoted in 2017) efforts to reinvigorate the company. Coca-Cola’s balance sheet is sturdy, and its growth investing, debt service and dividend are well covered by free cash flow.

We are moving the shares from Hold to Sell. The shares trade only modestly below their all-time high and have essentially reached our price target. We see little fundamental reason to increase our price target at this point. Our decision to sell is not an indication of any fundamental problems with the company – it is performing quite well – but primarily one of valuation. We would be more than pleased to repurchase the stock if the price fell noticeably.

Since our initial Buy recommendation in November 2020, the shares have produced a 25% total return. SELL

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 5.1% yield. The shares trade at a low 4.7x 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 slipped 1% in the past week and have 41% 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) that 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 fell 1% in the past week and have about 10% upside to our 99 price target. The company has a strong commitment to its dividend (3.1% 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

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 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, 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 contributes 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 dividend yield appealing.

State Street shares fell 5% in the past week and have about 33% upside to our 94 price target. The company’s dividend (3.6% 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 ($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 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’s 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 fell 3% in the past week and have 27% upside to our 48 price target. The stock pays an attractive and sustainable 2.2% 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 increased sharply but fell short of the $0.14 consensus estimate.

The company continues its disciplined new restaurant openings, and we are impressed with its commitment to technological and daily innovation. With the sharp recovery in EBITDA, Arcos’ net leverage ratio has declined to about 1.1x.

ARCO shares jumped 3% in a difficult market this past week and have 12% upside to our 8.50 price target. The rebound appears to be some recognition that the selloff a week ago following earnings was not warranted. 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. Investors were caught off-guard by the strong earnings and capital position as well as the management’s confidence in the outlook. Aviva reiterated its full-year dividend guidance for £0.31/share. The Aviva story is starting to play out well.

Aviva shares gave back 9% in the past week and have about 38% 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 8.2% yield. Based on this year’s actual dividend, the shares offer an attractive 5.5% 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 $1,767/ounce. The 10-year Treasury yield rose to 3.00%. The U.S. Dollar Index, another driver of gold prices (the dollar and gold usually move in opposite directions), resumed its drive upward, reaching 108.18, a 20-year high. The dollar index peaked in July 2001 at about 121 – a level not entirely out of reach in this cycle but one that would further pressure already-strained emerging and other countries.

Barrick shares fell 3% in the past week and have about 65% 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 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 reports on Friday, August 26. The company has considerable inventory to work through and we have limited visibility into its progress. Walmart and Target are aggressively selling down their excess inventory. These companies have a steady flow of regular customers whereas Big Lots offers more discretionary purchases. However, Big Lots is adept at buying surplus goods at sizeable discounts – the past quarter may have been a bonanza as retailers like Walmart canceled 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.

Retailer Macy’s shares jumped on Tuesday – they reported earnings that beat estimates even as they warned about the profit impact of offloading surplus inventory. We view this as an incremental positive for Big Lots but mostly this is tea-leaf reading, especially with Big Lots reporting in only a few days. Our discipline has us staying with Big Lots at least through its earnings report.

Big Lots shares fell 14% this past week, giving back much of their recent bounce. The shares are now fully captive to the gravity well of Friday’s earnings – investors are positioning based on their view of how the earnings will turn out. We have no idea what the company will report (neither does anyone else). 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 fractionally to 0.26%.

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. However, a recession and tighter capital markets would likely weed out some competitors like buy-now-pay-later companies, crypto payment services and digital-only banks. Also, tech talent may become more available at reasonable wages and potential technology company acquisition targets would likely be cheaper. Citi might emerge from a recession even stronger.

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

Citi shares trade at 64% of tangible book value. This immense discount, which assumes a dim future for Citi, appears to be misplaced. For comparison, beleaguered Credit Suisse, which faces potential collapse, trades at 31% of tangible book value. One could accurately say that Citi is more than 2x as healthy as Credit Suisse.

Citi shares fell 6% in the past week and about 66% upside to our 85 price target. Citigroup investors enjoy a 4.0% 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 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 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 reaffirmed 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 dipped 1% in the past week and have about 24% 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 9.0x 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. Organon continues to marginally chip away at its debt.

OGN shares fell 4% in the past week and have about 54% 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 3.7% 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.

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 fell 7% in the past week and have about 76% upside to our 75 price target. Our price target looks optimistic in light of the broad market selloff, 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 Added8/23/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Cisco Systems (CSCO)11-18-2041.3247.4114.7%3.2%66.00Buy
Coca-Cola (KO)11-11-2053.5864.2720.0%2.6%69.00New Sell
Dow Inc (DOW) *04-01-1953.5055.624.0%5.0%78.00Buy
Merck (MRK)12-9-2083.4790.208.1%3.1%99.00Hold
State Street Corp (STT)8-19-2274.5370.77-5.0%3.6%94.00Buy
Buy Low Opportunities Portfolio
Stock (Symbol)Date AddedPrice Added8/23/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Allison Transmission Hldgs (ALSN)02-22-2239.9937.43-6.4%2.2%48.00Buy
Arcos Dorados (ARCO)04-28-215.417.5138.8%2.1%8.50Buy
Aviva (AVVIY)03-03-2110.7510.10-6.0%5.5%14.00Buy
Barrick Gold (GOLD)03-17-2121.1316.21-23.3%2.5%27.00Buy
BigLots (BIG)04-12-2235.2423.71-32.7%5.1%35.00Hold
Citigroup (C)11-23-2168.1050.95-25.2%4.0%85.00Buy
Molson Coors (TAP)08-05-2036.5355.8853.0%2.7%69.00Buy
Organon (OGN)06-07-2131.4229.92-4.8%3.7%46.00Buy
Sensata Technologies (ST)02-17-2158.5742.25-27.9%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 47.66 3.53 3.81-0.3%0.5% 13.5 12.5
KO 64.10 2.46 2.610.0%0.0% 26.1 24.6
DOW 55.38 8.01 6.640.0%-0.4% 6.9 8.3
MRK 90.02 7.37 7.460.0%0.0% 12.2 12.1
STT 70.87 7.12 8.55-0.3%-0.8% 10.0 8.3
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 37.71 5.75 6.684.5%9.5% 6.6 5.6
ARCO 7.56 0.46 0.550.0%0.0% 16.4 13.7
AVVIY 10.12 1.08 1.32-2.2%0.0% 9.4 7.7
GOLD 16.34 1.03 1.062.3%0.0% 15.8 15.4
BIG 23.62 (2.43) 2.260.0%0.0% (9.7) 10.5
C 51.07 7.29 7.180.0%3.6% 7.0 7.1
TAP 55.73 3.94 4.190.0%0.0% 14.1 13.3
OGN 29.88 4.97 5.470.4%0.2% 6.0 5.5
ST 42.50 3.40 4.000.0%0.0% 12.5 10.6

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