Cabot Undervalued Stocks Advisor Weekly Update

VACATION
I will be taking this next week off to attend to my family, May 22-28, and therefore not publishing a weekly update on May 28, nor any Special Bulletins. I’ll be returning emails in the evenings on most days.

STOCK PERFORMANCE
Last week, an investor asked me, “If there is a stock market sell-off and money is withdrawn from the market by an exodus from ETFs/mutual funds, how does one protect him/herself as fundamentals will not matter?”

My answer to that question can probably help many investors clarify their investment strategies and find productive ways to deal with stock market volatility.

The vast majority of stock investors are going to experience big drops in portfolio values during bear markets or market corrections, and there isn’t too much that we can do about it. So the key question becomes, “Are you brave enough to let your stocks recover in the coming months?”

There are a small percentage of stock investors who successfully use strict stop-loss disciplines, but I can’t recommend that style of investing to my broad subscriber base because very few investors really master the task. I know from experience that using stop-loss orders is a fine art that often causes investors a lot of angst.

Knowing in advance that our stocks will fall periodically, through no real fault of their own, here are a combination of investment strategies that I recommend:

1. Stick with high-quality companies, so that when your stock falls dramatically, you can retain confidence in the company in which you’re invested. As a hypothetical example, “XYZ Company (XYZ) is an excellent, growing company, and the share price just fell 30% for no good reason. I will hold my shares and await the rebound.”

2. Keep cash on hand, so that you can “buy low” during market downturns, thereby turning lemons into lemonade. “Wow, I’ve always wanted to own ABC Company (ABC), and the share price is down 25% this year. It’s now or never! Let’s buy some shares!” The same holds true for buying additional shares of the great stocks that you already own.

3. I don’t sell high-quality stocks during market downturns. But I do move most of them from Buy to Hold recommendations during the obvious price drops. Then I move them back to Buy recommendations when the price charts seem to indicate that they’re going to rebound soon. And with dividend stocks, you can lock in quite an attractive yield during market downturns, which I frequently point out to investors.

Over the short term, stock market action is driven by human behavior and news headlines. Over the longer term, stock market action is driven by corporate successes/failures and the economy. The more we are able to disassociate ourselves from the fear that emanates from short-term market moves, the more we’re able to sit back and ask ourselves, “How can I capitalize on this nonsense?”

Many of our stocks are still recovering from the steep stock market downturn that occurred in the fourth quarter of 2018. As long as their fundamentals (profits, valuation, etc.) remain strong, I’m going to give those stocks some rope and allow them to recover.

At this point in time, there have been 84 stocks that were bought and subsequently sold since the inception of Cabot Undervalued Stocks Advisor in October 2015, with an average holding period of 10.4 months.

The average annualized total return per completed stock trade has been 16.99%. (“Total return” includes dividends.) Prior to the fourth quarter of 2018, that figure was in excess of 23%, so you can see the short-term impact of a difficult stock market.

As long as I was analyzing the returns, I decided to review the beginning share prices vs. their ultimate performance. It’s not uncommon that I come across an investor who is convinced that they will make a higher percentage of profit on a lower-priced stock than they will on a higher-priced stock. Needless to say, I don’t share that belief. Think about it this way: If it were statistically true that a $20 stock has better chances of rising 30% than a $150 stock, then the Boards of Directors of every public company would be well aware of that phenomenon. They would then vote for a stock split—let’s say a 10-for-1 split—to bring the share price down from $150 to $15. But Boards of Directors rarely vote for stock splits! Amazon (AMZN) costs about $1,900, Goldman Sachs (GS) costs about $200, and Microsoft (MSFT) costs about $130. Therefore, it’s folly to believe that lower-priced stocks provide more capital gains, en masse, than do higher-priced stocks.

Here are the results of the aforementioned 84 transactions when viewed through the lens of “How did stocks of various starting prices perform?”

Within this group of 84 stocks, there were 34 that returned 20% or more profit, and five that lost 20% or more of their value. Eighteen of the winners began with share prices ranging from $50 to $160. So if you’ve always wondered whether you should test the waters by buying a stock that’s a higher price than what you’ve previously been used to, I will conclude by saying that I personally pay no attention to share prices whatsoever, as long as earnings growth, valuation and price charts all seem conducive to delivering capital gains. Be brave and stretch yourself.

Send questions and comments to Crista@CabotWealth.com.

PORTFOLIO NOTES
Be sure to review the Special Bulletin from May 16 in which I mentioned news, rating changes and/or price action on Carlyle Group LP (CG).

TODAY’S PORTFOLIO CHANGES
Commercial Metals (CMC) moves from Strong Buy to Hold.

LAST WEEK’S PORTFOLIO CHANGES
Baker Hughes, a GE Co. (BHGE) moved from Buy to Hold.
Carlyle Group LP (CG) joined the new Special Situations portfolio as a Strong Buy.
DowDuPont (DWDP) moved from Buy to Hold.
Royal Caribbean Cruises (RCL) moved from Strong Buy to Hold.
Schlumberger (SLB) moved from Buy to Hold.
Synchrony Financial (SYF) moved from Strong Buy to Hold.

UPDATES ON GROWTH PORTFOLIO STOCKS

Adobe Systems (ADBE) is a software company that’s changing the world through digital experiences. Adobe is reimagining Customer Experience Management (CXM) with Adobe Experience Cloud, the industry’s only end-to-end solution for experience creation, marketing, advertising, analytics and commerce. ADBE was featured in the May issue of Cabot Undervalued Stocks Advisor.

According to SEC filings of first quarter 2019 portfolio holdings, three large investment managers bought new positions in ADBE—Soros Fund Management, Appaloosa LP and Leon Cooperman—while Tiger Global Management sold 31% of their ADBE position and Jana Partners sold their entire position.

ADBE is a large-cap growth stock. Wall Street expects Adobe’s earnings per share (EPS) to increase aggressively by 42.2% in 2019 and 23.9% in 2020. The 2019 price/earnings ratio (P/E) is 35.8. This is a great stock for risk-tolerant growth investors and for buy-and-hold equity portfolios. ADBE recently began reaching all-time highs, and has pulled back a little after the breakout. Buy ADBE now. Buy.

CF Industries Holdings (CF – yield 2.8%) is one of the world’s largest producers of nitrogen products, serving customers on six continents. The company operates nine nitrogen production facilities in Canada, the U.K. and the U.S. CF Industries expects strong nitrogen demand through the current quarter, and to continue benefiting from low natural gas prices throughout 2019. Monitor natural gas prices here. Investors may access management presentations from last week on the website. CF will also present at the Bernstein 35th Annual Strategic Decisions Conference on May 30.

CF is a cyclical mid-cap aggressive growth stock. The company is expected to grow full-year EPS by 69% and 30% in 2019 and 2020, with corresponding P/Es of 20.2 and 15.5. The stock is ratcheting upward, in the middle of a six-month trading range. Strong Buy.

CIT Group (CIT – yield 2.7%) operates both a bank holding company and a financial holding company that provide financing, leasing and advisory services to small and middle market businesses, consumer markets, and the real estate and railroad industries. The company held its annual meeting of shareholders last week. Investors may access the company’s annual report on their website. CIT is an undervalued growth stock with an attractive dividend yield. The price chart is moderately bullish, with some upside resistance at 55, then lots of capital gain potential thereafter. Strong Buy.

Knight-Swift Transportation Holdings (KNX – yield 0.8%) – Hold.* (last review May 14)

Marathon Petroleum (MPC – yield 4.1%) – Hold.* (last review May 14)

Sanmina Corp. (SANM) designs and manufactures optical, electronic and mechanical products for original equipment manufacturers (OEMs) primarily in the communications networks, cloud solutions, industrial, defense, medical and automotive industries. Full-year earnings per share are expected to grow 49.3% in 2019 (September year end), and the P/E is 9.0. SANM is a small-cap growth stock. A May pullback brought SANM down toward four-month price support. This stock is appropriate for risk-tolerant aggressive growth investors. Strong Buy.

Southwest Airlines (LUV – yield 1.2%) is the largest U.S. domestic air carrier, transporting over 120 million customers annually to over 100 locations in the U.S., Central America and the Caribbean. Southwest is currently grounding its Boeing Max 737 jets through August. Investors may listen to Southwest’s webcast of its May 15 Annual Meeting of Shareholders. The company announced a quarterly dividend increase of 12.5% last week, from $0.16 to $0.18 per share, which was a smaller percentage increase than in recent years. Southwest also announced a new $2 billion share repurchase authorization.

In Berkshire Hathaway’s first-quarter filing with the SEC, it shows that the company sold some of their Southwest shares. That might initially sound bearish, however, it’s important to note that Berkshire sold a very small amount of their total LUV shares, and they still own 9.88% of Southwest’s outstanding stock. CEO Warren Buffett recently expressed regret that he inadvertently owned more than 10% of Delta Air Lines (DAL), and that he did not want to duplicate that error. Berkshire seems to therefore be trying to keep their stake in Southwest below a 10% threshold.

LUV is an undervalued large-cap stock. Wall Street expects full-year EPS to grow 6.4% and 15.3% in 2019 and 2020. The share price is in a neutral trading pattern. Buy.

Supernus Pharmaceuticals (SUPN) focuses on the development and commercialization of products for the treatment of central nervous system diseases and psychiatric disorders, including epilepsy and migraine. Supernus has five pipeline products, in various phases of clinical trials, which aim to treat ADHD, impulsive aggression, bipolar disorder, depression and severe epilepsy. Three of those pipeline drugs are expected to launch in 2020, 2021 and 2023.

SUPN is an undervalued small-cap growth stock that could appeal to traders and growth stock investors. The share price has been weak this month, although there’s been no correlating bad news. News headlines regarding socialist proposals from political candidates could depress healthcare stocks. Expect volatility. Strong Buy.

Voya Financial (VOYA – yield 0.1%) is a retirement, investment and insurance company serving millions of individuals and 49,000 institutional customers in the United States. Voya has $547 billion in total assets under management and administration. CEO Rodney O. Martin, Jr. recently stated, “We intend to increase our common stock dividend to a yield of at least 1% and we expect to do so beginning in the third quarter of 2019.” The dividend increase will spur institutional buying.

VOYA is an undervalued aggressive growth stock. Analysts expect full-year EPS to grow 36.4% and 14.5% in 2019 and 2020, and the current P/E is 9.6. The price chart remains relatively bullish. I anticipate VOYA performing better than the broader market for the balance of 2019. Strong Buy.

UPDATES ON GROWTH & INCOME PORTFOLIO STOCKS

Blackstone Group LP (BX – yield 5.3%*) is the world’s largest and most diversified alternative asset manager with $512 billion in client assets. The company deploys capital into private equity, lower-rated credit instruments, public debt and equity, real assets, secondary funds and real estate, all on a global basis. Blackstone will convert from a limited partnership to a corporation on July 1. Thereafter, Blackstone plans to continue paying variable quarterly payouts equaling 85% of cash earnings, as opposed to switching to a fixed quarterly payout.

BX is a growth & income stock. I expect BX to be added to the S&P 500 index at some point in time following its C-corp conversion, which will immediately spur buying activity among index-oriented institutional portfolios. In addition, since Blackstone is unquestionably the high-quality leader within its industry group, I expect a large number of actively-managed institutional portfolios to also take positions in BX.

The stock is now reaching all-time highs. I believe all types of equity investors should own BX right now. Strong Buy.
*The payout varies each quarter with the total of the last four announced payouts equaling $2.17 and yielding 5.3%.

Commercial Metals Company (CMC – yield 3.2%) is a recycler and manufacturer of steel and metal products, including rebar and fence posts. Last week, the U.S., Canada and Mexico announced that they will remove reciprocal tariffs on steel and aluminum, and also work to prevent steel dumping from other countries, i.e. the process by which foreign countries sell their often-lower-quality products below cost in an effort to gain market share and harm competitor companies. The U.S. will also lower tariffs on Turkish steel products—predominantly rebar—from 50% to 25%. Commercial Metals derives 60% of revenue from rebar products.

CMC is an undervalued aggressive growth stock with an attractive dividend yield. Analysts expect EPS to increase 26.2% and 23.4% in fiscal 2019 and 2020 (August year end). The 2019 P/E is low at 8.0. I’m moving CMC from Strong Buy to Hold as the market assesses the impact of changes in international steel trade and pricing. Hold.

Delta Air Lines (DAL – yield 2.6%) is a U.S. and international passenger and cargo airline that serves nearly 200 million people every year, flying to more than 300 destinations in over 50 countries. DAL is an undervalued growth & income stock. First-quarter 2019 SEC filings show billionaire Leon Cooperman establishing a new position in DAL with a purchase of 125,000 shares. Delta is expected to achieve 18.2% EPS growth in 2019, and the P/E is 8.1. The price chart weakened in May, and could easily languish in the near term. Strong Buy.

Dow Inc. (DOW – yield 5.6%) is the materials science division of DowDuPont (DWDP) that began trading as a separate company on April 2. Analysts currently expect Dow to report EPS of $4.47 and $5.36 in 2019 and 2020. I’m very pleased with the profit projections, the dividend yield and the moderate P/E (11.2). The stock is languishing. Patient investors can lock in the big dividend yield right now while awaiting an eventual upturn in the share price. Strong Buy.

DowDuPont (DWDP) – Hold.* (last review May 14)

Guess?, Inc. (GES – yield 2.6%) is a global apparel manufacturer, selling its products through wholesale, retail, ecommerce and licensing agreements. The company is growing revenues aggressively in Asia and significantly expanding in both Asia and Europe. GES is an undervalued, aggressive growth, small-cap stock. First-quarter results will soon be reported, but the date has not yet been announced. Analysts are expecting ($0.26) EPS and $536.6 million revenue. As is common among apparel retailers, Guess’s next three quarters are expected to be profitable, with the fourth quarter projected to deliver peak net income.

Wall Street expects full-year EPS to increase 23.5% and 19.0% in fiscal 2020 and 2021 (January year end). The 2020 P/E is 14.5. The company recently reduced the dividend payout and implemented a $250 million share repurchase plan.

The stock rose 25% in late April, then gave back most of those gains in May. GES shares never sit still. There’s price resistance at 23. I foresee strong prospects for capital appreciation in 2019 and 2020. Expect volatility. Buy.

Royal Caribbean Cruises (RCL – yield 2.2%) – Hold.* (last review May 14)

Schlumberger NV (SLB – yield 5.1%) – Hold.* (last review May 14)

Total S.A. (TOT – yield 5.5%) is a French multinational integrated energy company operating in over 130 countries. Total’s strengths are in the Middle East, Africa, North Sea and Deep Water. Total played a supporting role in Occidental Petroleum’s (OXY) agreed-upon plan to acquire Anadarko Petroleum (APC) by purchasing African energy assets from Anadarko for $8.8 billion. CEO Patrick Pouyanne commented last week, “In fact … we have been looking at these assets more than a year.” Total will host their annual shareholder meeting on May 29.

TOT is an undervalued, large-cap growth & income stock with a large dividend yield. Total is expected to see full-year EPS grow 10.5% and 13.3% in 2019 and 2020, and the 2019 P/E is 9.8. The stock recently fell below its two-month trading range. I plan to move my recommendation back to Buy after the price stabilizes. Patient investors who want to buy low and lock in a higher dividend should feel comfortable doing so. Hold.

UPDATES ON BUY LOW OPPORTUNITIES PORTFOLIO STOCKS

Abercrombie & Fitch (ANF – yield 3.1%) is a leading global specialty retailer of apparel and accessories for men, women and kids, operating under the Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands. On May 14, Abercrombie announced the elimination of the Chief Operating Officer position. Columbus Business First reported, “Abercrombie’s chief financial officer, chief information officer, head of global supply chain, and head of the transformation management office will all report directly to [CEO Fran] Horowitz.”

Abercrombie is expected to report a first-quarter loss of ($0.43), within a range of ($0.55)-($0.38), and $733.4 million revenue, with a range of $728.9-$743 million, on the morning of May 29. As is common among apparel retailers, Abercrombie’s next three quarters are expected to be profitable, with the fourth quarter projected to deliver peak net income.

ANF is a small-cap stock. Analysts expect EPS to grow 25.2% and 9.0% in fiscal 2020 and 2021 (January year end). The price chart remains generally bullish, with long-term resistance at 35-37. Buy.

Alexion Pharmaceuticals (ALXN) is a biopharmaceutical company that researches and manufactures treatments of severe and rare health disorders. Management will present at the UBS Global Healthcare Conference today (May 20) and at the RBC Capital Markets Annual Healthcare Conference tomorrow, May 21.

On May 13, Reuters reported, “Brokerage Cowen and Co’s quarterly survey shows that investors have lowered their Q2 performance expectations for biotech companies, compared with Q1. Among large-caps, Alexion Pharmaceuticals Inc is most favored to outperform Q2 expectations, while Biogen Inc is expected to be the worst performer, says Cowen.”

ALXN is an undervalued large-cap growth stock. Analysts now expect EPS to grow 19.6% and 13.4% in 2019 and 2020, and the P/E is 13.5 – rather low for a profitable biopharmaceutical company. The stock is trading between 125-142 since February. The next run-up could carry ALXN to long-term price resistance at 160. Buy.

Apple Inc. (AAPL – yield 1.7%) is a manufacturer and provider of many popular technology devices and services, including the iPhone, iPad, Mac, App Store, Apple Care, iCloud and more. Five new services will roll out in the coming months: Apple News+, Apple TV+, Apple TV Channels, Apple Arcade and Apple Card. There are over 1.4 billion active Apple devices globally, which provide a strong and growing revenue base for Apple Services.

Last week, the Supreme Court allowed antitrust lawsuits against Apple to go forward. (This decision by the court does not signify an opinion regarding guilt or innocence.) Consumers and app developers are now free to sue Apple on the questions of Apple’s monopoly with regard to apps being offered on iPhones, and also regarding app pricing. Such lawsuits will likely take many years to wind their way through the courts, and are not expected to have any near- or medium-term impact on the company.

The AAPL share price is exhibiting weakness on trade war jitters, and will probably climb to price resistance at 230 later this year. AAPL is a great stock for a high quality, buy-and-hold equity portfolio. Earnings growth is not always double-digit, but the company is a consumer products & services powerhouse and a cash machine. Strong Buy.

Axis Capital Holdings Ltd. (AXS – yield 2.7%) is a global provider of specialty lines insurance and treaty reinsurance with shareholders’ equity of $5.3 billion and locations in Bermuda, the United States, Europe, Singapore, Middle East, Canada and Latin America. Yesterday, Axis announced a refreshed brand, logo and website. AXS was featured in the May issue of Cabot Undervalued Stocks Advisor.

AXS is an undervalued, small-cap stock. Axis reported full-year 2018 EPS of $1.92 in 2018, and is expected to report $4.95 and $5.58 in 2019 and 2020. The stock broke free from a 13-month trading range in May. AXS could now rise to its March 2017 all-time high of 66 before resting again. Buy AXS now. Strong Buy.

Baker Hughes, a GE Co. (BHGE – yield 3.1%) – Hold.* (last review May 14)

Designer Brands Inc. (DBI – yield 4.9%) is a footwear, accessories and apparel retailer that operates Designer Shoe Warehouses and a variety of other brands of retail stores, totaling nearly 1,000 locations in 44 U.S. states and Canada, and ecommerce. The company is expected to report first quarter EPS of $0.42, within a range of $0.36-$0.44, and $873.8 million revenue, within a range of $853.4-$889.6 million, on the morning of May 30 (January year end).

DBI is an undervalued growth stock with a hefty dividend yield. The stock is at the bottom of a nine-week trading range, between 20-23.5. Buy DBI now. Strong Buy.

The Mosaic Company (MOS – yield 0.4%) is the world’s largest producer of finished phosphate and potash, supplying crop nutrients and animal feed ingredients via production facilities in the U.S., Canada, South America and the Asia-Pacific region. Management will present at Bernstein 35th Annual Strategic Decisions Conference on May 30.

The recent earnings press release outlines business costs and disruptions from new Brazilian regulations governing mine tailings dams. The company posted a 63-page Investor Information presentation last week. On page 14, the presentation gives a good recap of new Brazilian regulations governing mine tailings dams and Mosaic’s response to the situation. Mosaic’s goal is that “all mines are at full operating rates by the end of the third quarter.” On page 24, the company states that the dividend will be doubled this year to $0.20 per share.

Costs associated with the Brazilian situation have contributed to analysts adjusting 2019 earnings expectations downward, now reflecting a profit drop of 18% in 2019 and an increase of 36% in 2020. MOS is still an undervalued mid-cap growth stock. The price chart is currently bearish, and it is therefore not yet time to buy low. Hold.

Synchrony Financial (SYF – yield 2.4%) – Hold.* (last review May 14)

TiVo Corp. (TIVO – yield 4.5%) – Hold.* (last review May 14)

Universal Electronics (UEIC) – Hold.* (last review May 14)

UPDATES ON SPECIAL SITUATION STOCKS

Carlyle Group LP (CG – yield 6.0%) manages $221 billion, divided among real assets, corporate private equity, investment solutions and global credit. Carlyle Group joined the portfolio last week because the company is planning to make a near-term decision regarding whether they will convert from a limited partnership to a corporation, as four of their industry peers have announced since early 2018. A positive conversion decision could be both an immediate and a longer-term catalyst for share price appreciation, as we have seen (and continue to experience) with peers Ares Management (ARES), KKR & Co. (KKR), Blackstone Group LP (BX) and Apollo Global Management (APO).

Upon converting to corporations, the aforementioned companies become eligible for inclusion in institutional portfolios, pension funds, mutual funds, and stock market indexes that were not allowed to invest in limited partnership. That’s a lot of potential buying activity that could continue to increase their share prices for several years, until stock market treatment of alternative asset management stocks reaches a “new normal.” If Carlyle remains a limited partnership, very few institutional investors will be motivated to buy CG shares in the future, when they can more easily buy shares in BX, for example, without portfolio restrictions and with fewer income tax complications.

The company’s May 1 earnings conference call transcript brought this message from Co-CEO Kewsong Lee:
“I think it’s important to address our current thinking about Carlyle’s corporate structure. Over the past year, we’ve seen several firms in our peer group either announce or complete a conversion to a C corporation from their prior publicly-traded partnership status. At this point, we can say the following; we continue to seriously explore a conversion to a C corporation for Carlyle. The benefits we’ve seen from the conversions have not gone unnoticed. There are many complex operational moving parts in connection with the conversion and we intend to conclude our thinking with a decision in the not too distant future.”

It’s time for opportunistic investors to buy CG in anticipation of a potential near-term announcement that could boost the share price, both immediately and over a multi-year period. Strong Buy.
*The payout varies each quarter with the total of the last four announced payouts equaling $1.26 and yielding 6.0%.

* In order to focus attention on newsworthy changes in our portfolio stocks, I’m eliminating descriptions of Hold-rated stocks during weeks when there are no significant news announcements or changes in consensus earnings estimates. As a reminder, Hold does not mean Sell. Hold means that I am not recommending additional purchases of the stock today, either due to price chart action, earnings outlook, or stock valuation. I expect Hold-rated stocks to perform well in the coming months.