We are mostly through the bulk of earnings season and it has been enlightening, particularly as we learn about the pandemic’s effects on profits. Earnings season should be a period when company results can be clearly measured, especially since we are dealing with numbers. This clarity, however, is often not forthcoming, sometimes to a ridiculous degree.
As is widely known, regulations require companies to report their earnings using GAAP, or generally accepted accounting principles. While the assumptions that produce these numbers are perhaps a lot looser than widely recognized, GAAP results have the merits of following carefully prescribed rules and of being audited by (presumably) independent accounting firms.
Yet, companies adjust these GAAP results to more favorably tell their story. We’re all familiar with the extreme and justifiably ridiculed “community-based EBITDA” metric that WeWork conjured up, just prior to its pre-IPO collapse.
More relevant to Cabot Undervalued Stocks Advisor readers are the confusing second-quarter results from Voya Financial (VOYA). The insurance company reported a GAAP loss per share of $(0.55), which through a series of adjustments was transformed into “normalized adjusted operating earnings” of $1.09/share.
We will (mostly) accept that some of Voya’s adjustments have merit, including the $(0.72)/share loss from discontinued operations related to their life insurance divestiture. Others were more of a smoothing of earnings that took liberties with reality. The $(0.20)/share adjustment for stranded costs from the life insurance divestiture is a removal of real costs. We understand the concept: these are expenses that Voya will bear for a just a few more quarters, and disclosing their size helps investors understand Voya’s ongoing profitability. But until the business is sold and these costs go away, they are part of the company’s earnings.
With all the adjustments that nearly every company makes, perhaps the most useful approach is to treat adjusted earnings like EPA mileage numbers for cars. As long as the process is consistently applied, we can use the numbers to gauge performance, not so much as an absolute measure (your actual mileage may vary significantly), but more as a relative measure. Voya’s “normalized adjusted operating earnings per share” this past quarter increased 3% from a year ago—a better indicator of how the company is doing than the swing from the year-ago $1.51 GAAP profit to the $(0.55) GAAP loss this quarter.
However, we don’t want to fully and blindly accept these adjusted earnings as reality any more than we would accept that 23 miles-per-gallon EPA estimate when deciding whether we should skip the upcoming highway exit instead of refilling our empty gas tank.
Share prices in the table reflect Tuesday’s (August 11) closing prices. Send questions and comments to Bruce@CabotWealth.com.
TODAY’S PORTFOLIO CHANGES
Amazon (AMZN) – Moves from Hold to Retired.
Universal Electronic (UEIC) – Moves from Strong Buy to Buy
LAST WEEK’S PORTFOLIO CHANGES (August 5 letter)
Molson Coors Beverage Company (TAP) new Buy.
Nvidia (NVDA) moves from Buy to Hold
GROWTH PORTFOLIO
Chart Industries (GTLS) is a leading global manufacturer of highly-engineered equipment used in the production, transportation, storage and end-use of liquid gases (primarily atmospheric, natural gas, industrial and life sciences gases). Its equipment cools these gases, often to cryogenic temperatures that approach absolute zero. Chart has no direct peers, offering turnkey solutions with a much broader set of products than other industry participants. The company was featured in “Cabot’s 10 Best Stocks to Buy and Hold for 2020.”
The company generates positive free cash flow and is prioritizing reducing its modestly elevated debt from its 2019 cash acquisition of Harsco’s Industrial Air-X-Changers business, as well as continuing its sizeable cost-savings program.
While second-quarter sales growth was flat and adjusted per-share earnings fell about 7% from a year ago, the results were sharply higher than consensus estimates, with per-share earnings of $0.63 compared to the $0.41 estimate. Revenues were about 7% above consensus. The company reinstated its earnings guidance for full-year 2020 that was above estimates. Chart provided encouraging updates on its cost savings programs and described new initiatives and orders in hydrogen-based energy equipment. Overall, the company is performing well in an otherwise difficult economy.
Chart shares have gained 35% since the company reported second-quarter earnings earlier in July. The valuation remains reasonable at 20.4x estimated 2021 earnings of $3.67/share and 17.2x estimated 2022 earnings of $4.36. The shares look poised to continue their recovery. BUY
MKS Instruments (MKSI) generates about 49% of its revenues from producing critical components that become part of equipment used to make semiconductors. MKS’ products are generally in the stronger segments of this currently healthy market. While MKSI shares closely track the broad semiconductor indices, the expansion of its Advanced Markets segment, including its 2016 acquisition of Newport Corporation, as well as its 2019 acquisition of semiconductor-related Electro Scientific Industries, may allow its shares to break out. The company recently promoted 13-year company veteran Dr. John T.C. Lee to CEO.
MKS reported strong results on July 29. Revenues increased 15% from a year ago and were about 11% higher than consensus estimates. The company continues to benefit from strong demand for semiconductor equipment. Adjusted earnings per share of $1.62 were 49% higher than a year ago and about 37% above consensus estimates. Operating and free cash flow, which hit record levels, are helping the company whittle down its debt. Its debt balance, net of cash, was $223 million, down from $360 million at year-end. Management said that new export rules from the Department of Commerce won’t have a significant impact on the company’s financial results. The ESI acquisition added incrementally but its full potential has yet to be realized.
The company raised its 3Q guidance substantially: new guidance is for revenues of $560 million (midpoint of range) and adjusted earnings per share of $1.75 (midpoint).
MKSI shares have pulled back since eclipsing their previous all-time high set in 2018 and now trade below their pre-earnings price of 124.91. The shares have reverted to tracking the Philadelphia Semiconductor Index (SOX).
For traders with sizeable profits, it might be time to trim out. For longer-term holders of MKSI, at 15.5x estimated 2021 earnings of $7.80, we consider the shares reasonably undervalued. HOLD
Quanta Services (PWR) is a leading specialty infrastructure solutions provider serving the utility, energy and communication industries. Their infrastructure projects have meaningful exposure to highly predictable, largely non-discretionary spending across multiple end-markets, with 65% of revenues coming from regulated electric, gas and other utility companies. Quanta achieved record annual revenues, operating income and backlog in 2019, and is pursuing a multi-year goal of increasing margins. Dividend payouts and share repurchase activity have continued uninterrupted during the pandemic.
We view this company as high-quality, well-run and resilient. The market views PWR shares as a safe haven in an unpredictable market and economy, helping the shares to fully recover from their March 2020 lows. The new 15-year contract to operate and modernize Puerto Rico’s energy grid is an encouraging positive as the company is seeking to shift toward a capital-light, recurring profit model. Quanta Services was featured in the July monthly issue of Cabot Undervalued Stocks Advisor.
Quanta reported strong second-quarter results, with per share earnings of $0.74 more than doubling its year-ago results. Earnings were 57% above the consensus estimate. From a quality perspective, Quanta removes a lot of costs from their reported earnings to arrive at adjusted earnings – it’s not uncommon to see their adjusted results be 50% higher than reported results. One not-acceptable adjustment: stock-based compensation, or stock options. Few companies make this adjustment anymore. And, for Quanta, it boosted adjusted earnings above GAAP profits by 30% - much too large to ignore.
In the quarter, core electric power segment revenues rose 2% but segment profits increased 15%. Pipeline & Industrial segment revenues fell 35% and segment profits fell 70% as energy customers reduced their spending. Results from Latin America operations, which are being closed and were removed from adjusted net income, showed a $15 million loss. Corporate expenses of $92 million were 10% higher than a year ago. The $92 million in corporate expenses seems high – equal to 42% of the combined profits of the other segments.
Overall, the company is executing its growth strategy relatively well. The company raised its full-year 2020 earnings guidance by 4% and announced a $100 million share buyback program. Since the report on Aug 6, the shares have gained 16% to an all-time high.
Full-year earnings estimates for 2020 are now at $3.30, just below guidance, while 2021 estimates are at $4.01, up about 21% from the prior year. PWR shares trade at 15.1x 2020 earnings and 12.4x 2021 earnings.
With the stock trading near $50, traders may want to exit here. For long-term holders, Quanta stock looks well-positioned to continue to prosper, but may want to wait for a pullback after the surge in price to establish new positions. BUY
Tyson Foods (TSN) is one of the world’s largest food companies, with over $42 billion in revenues last year. Beef products generate about 36% of total revenues, while chicken (31%), pork (10%), and prepared/other contribute the remaining revenues. It has the #1 domestic position in beef and chicken with roughly 21% market share in each. Its well-known brands include Tyson, Jimmy Dean, Hillshire Farms, Ball Park, Wright and Aidells. As only 13% of its sales come from outside the United States, Tyson’s long-term growth strategy is to participate in the growing global demand for protein.
Tyson reported a strong second quarter. Revenues fell 8% from a year ago but was about 5% ahead of consensus estimates. Adjusted per share earnings of $1.40 was 46% higher than the $0.96 consensus. Profits benefitted from higher beef and pork prices, although these were partly offset by weak results in chicken and prepared foods. Tyson absorbed $340 million of direct Covid-related costs. The company is producing strong cash flow, and its balance sheet and liquidity remain strong.
Tyson promoted president Dean Banks to the CEO role. Banks joined Tyson in 2017, bringing valuable technology and leadership experience gained at Google and elsewhere. While he has very limited consumer products experience, which presents a bit of a risk, we like his outsider experience and 2-year evaluation period at Tyson.
TSN shares have continued to move upward since the report and are chipping away at their peer-lagging returns this year. The company has more work to do to convince investors that the future is brighter, particularly as more of a commodity company (and hence lower margins) compared to its food processor peers, but this quarter’s results should help.
Tyson’s 2020 estimate is now higher, reflecting the quarter’s higher earnings, at $5.00/share, but the 2021 estimate ticked down to $5.79 from $5.83 a week ago. The shares trade at a relatively low 11.3x estimated 2021 earnings and offer a 2.6% dividend yield. BUY
Universal Electronics (UEIC) is a major producer of universal remote controls that subscription broadcasters (cable and satellite), TV/set top box/audio manufacturers and others provide to their customers. The company pioneered the universal remote, named the “One for All’”, which was quickly adopted by consumers after its launch in 1986. Since then, the company has expanded into a range of remote control devices for smart homes, safety and security and other residential and commercial applications, driven by its proprietary technology. The company has a global roster of customers, with about 40% of sales produced outside the United States. Comcast is a 10%+ customer and they hold warrants for up to 5% of Universal’s shares.
Strong and steady revenue and earnings growth drove the shares to over 80 by mid-2016, from only about 12 in mid-2012. However, the shares have stumbled sharply from their peak. Falling numbers of cable TV subscribers have pressured the company’s P/E multiple despite revenues and profits that keep (slowly) increasing.
The company reported second-quarter adjusted earnings of $0.89/share that were about 5% ahead of the $0.85 consensus estimate. While adjusted earnings per share reached a record $1.70 in the first six months of the year, revenues continue to weaken. Revenues were hurt by falling numbers of new cable subscribers, which the company attributes to the difficulties that cable installation technicians had in entering homes during the Covid pandemic.
Earnings have continued to growth because the company has expanded its gross margins, partly by selling more higher-margin QuickSet-enabled devices (proprietary technology that allows installation without technician visits) and partly by turning away lower-profit revenues (so, another source of revenue pressure, but a good one). The stronger dollar has reduced its import costs from China, where much of its products are made. Also, the company is generating more royalty revenues, which essentially are 100% gross margin revenues. Universal is also cutting its overhead costs while reinvesting more in research and development – both are the right moves. Operating margins reached 9.5% in the quarter and the company guided 3Q operating margins to 10%.
For UEIC shares to start a sustained move upward, their revenue growth needs to stop declining. While expanding profit margins help, the shares aren’t quite cheap enough for this to make much of a difference yet. Stable/rising revenues could come from a recovery in net cable subscriptions, particularly upon the return of live sports (a major driver of new subscriptions) or when in-home installations resume. Another source of revenue growth may come from upgraded products that allow better control of set top boxes that manage a wide range of media including cable, Netflix and other streaming services, and other digital technologies. Also, the company is expanding into Alexa-like home devices which could boost revenue growth.
With these issues seeing no resolution in the second quarter, UEIC shares have fallen 10% since the report.
Broadly, Universal’s growth requires a successful transition on several fronts, which will not be easy, but the company is in a strong incumbent position to succeed. We are patient for now because of the larger opportunity set on the horizon and the reasonable chances for better near-term results. However, the shares no longer warrant a Strong Buy and we are reducing our rating to Buy.
UEIC shares trade at 12.3x estimated 2020 earnings of $3.57 and 10.2x estimated 2021 earnings of 4.31. We note that the estimates continue to weaken. BUY.
Voya Financial (VOYA) is a U.S. retirement, investment and insurance company serving 13.8 million individual and institutional customers. Voya has $603 billion in total assets under management and administration. The company previously was the U.S. arm of Dutch financial conglomerate ING Group, from which it was spun off in 2013. Voya has several appealing traits. Even though it is well-capitalized, it is migrating toward a capital-light model, taking a major step in this direction by selling its life insurance business, which should close in the third quarter. Some of the released capital could be used to repurchase shares. Also, it won’t be a cash tax payer for as many as five years due to its deferred tax assets. Voya is generating considerable free cash flow. And, its diversified and highly-regarded product base offers steady long-term revenue strength.
Voya reported modestly disappointing second-quarter results on August 5, with per share adjusted earnings of $0.15 missing estimates of $0.86. After other adjustments totaling $0.94, the company said it had “normalized” adjusted operating earnings of $1.09/share. (See our opening comments on Voya’s adjustments). At its core, Voya is slowly growing, but the weak economy continues to weigh on growth in its retirement and group benefits segments. The company is well-capitalized and has a relatively low-risk balance sheet (which will be even lower once its life business sale is completed). Voya won’t pay much in taxes for years (due to deferred tax assets).
Near-term issues for Voya are the eventual total size of its Covid-related claims, the size of the positive impact of rising equity markets and the potential markdowns on its other investment assets.
After dipping on the earnings news, Voya shares have ticked up to about 3% above the pre-release price.
Insurance companies are generally valued on a price/book value basis: VOYA trades at a 0.68x multiple. However, the more it shifts away from insurance, the more it will trade on earnings. VOYA trades at 13.6x estimated 2020 per share earnings of $3.81 and 8.6x estimated per share earnings of $6.05. STRONG BUY.
GROWTH & INCOME PORTFOLIO
Bristol-Myers Squibb Company (BMY) is a global biopharmaceutical company. Following its controversial acquisition of Celgene for $74 billion in November 2019, the merged company markets a long list of pharmaceuticals, including Revlimid, Eliquis and Opdivo, which treat cardiovascular, oncology and immunological diseases. The company expects revenue and profit growth to come from four areas: sales volume increases from current products, development and launch of new medicines, life cycle management and synergies from the Celgene acquisition. Bristol-Myers’ financial priorities include debt repayment, investment in innovation, share repurchases and annual dividend increases. Investors will want to be aware that the Celgene deal raised Bristol-Myers’ debt to over $46 billion – a manageable sum yet elevated compared to peers.
The company reported good-enough second-quarter results with adjusted per share earnings of $1.63, which were 38% higher than a year ago. Earnings were about 10% higher than consensus estimates. The GAAP loss per share of $(0.04) were adjusted to exclude acquisition-related charges and other adjustments of close to $3.9 billion. We’ll generally accept the concept that the adjustments remove an artificial and apparently recurring non-cash charge, such that the adjusted earnings are more like cash earnings.
Revenue growth was flat on a merger-adjusted basis and in-line with consensus estimates. Drug wholesalers reduced their purchases during the quarter, due to lower patient demand (fewer doctor visits during the pandemic) and due to efforts to reduce their inventories, which weighed on growth. Much of this effect should reverse in the next two quarters.
Bristol-Myers raised their full-year earnings guidance by 6 cents, or about 1% ... so small as to be irrelevant, but at least it was in the right direction. Management commentary pointed to improved growth prospects in 2021. While debt remains essentially unchanged since year-end, the cash balance has increased to $22 billion from $16 billion, reflecting strong cash generation. This cash flow is an important part of the Bristol-Myers story, particularly with the shares trading at a low 8.2x estimated 2021 earnings of $7.44.
Yesterday, the company’s Opdivo cancer treatment showed promising clinical study results and was also approved for certain uses in Canada.
BMY shares have risen about 6% since the earnings were announced, and are now only fractionally below their year-end price. The shares provide a generous 2.9% yield, well-covered by its enormous $13.5 billion in free cash flow likely this year. STRONG BUY.
Broadcom (AVGO) is a global technology leader that designs, develops and supplies semiconductor and infrastructure software solutions that serve the world’s most successful companies. CFO Tom Krause expects to continue paying the dividend and paying down debt in 2020 (none of which is maturing this year), even under poor economic conditions. Share buybacks and M&A activity are on the back burner for now.
The company reports earnings on September 3. Following a 6% share price jump in the wake of strong results from Apple (a 20% customer), the shares have faded slightly in the past week and are now at their January 24 prior all-time closing high of 324.
Broadcom is an undervalued growth and income stock as well as a useful trading stock. Full-year profits are expected to grow 1% and 12% in FY2020 and FY2021, respectively. The shares trade at a 13.4x multiple of estimated FY2020 earnings of $24.10. HOLD.
Dow Inc. (DOW) is a commodity chemicals company with manufacturing facilities in 31 countries. In 2017, Dow merged with DuPont to temporarily create DowDuPont, then split into three parts in 2019 based on the newly-combined product lines. Today, Dow is the world’s largest producer of ethylene/polyethylene, which are the world’s most widely-used plastics. Dow is primarily a cash-flow story driven by petrochemical prices, which often are correlated with oil prices and global growth, along with competitors’ production volumes.
Dow’s second quarter earnings were satisfactory. Revenues fell 24% to $8.4 billion, a tad better than consensus estimates, with weakness across all four of Dow’s product groups. Volumes fell by 14% and pricing fell by 9%, reflecting sluggish global economic conditions that saw little demand for Dow’s commodity chemicals. The per share loss of $(0.26) was in line with estimates.
Cash flow was strong, as the company released cash tied up in working capital. Dow increased its 2020 cost-cutting program to $500 million and initiated a 2021 cost-cutting program of another $300 million. The company’s liquidity and balance sheet remain sturdy. The company maintained its dividend (now yielding 6.6%) and appears both committed and capable of retaining it. Dow will weather the downturn but its outlook is more subdued than we anticipated.
Dow shares have moved up about 6% over the past week as investors have become more supportive of undervalued cyclical stocks.
Analysts expect full-year 2020 EPS of $0.74 and full-year 2021 earnings of $2.18. Valuation at 20.4x estimated 2021 earnings is becoming less meaningful as the recovery is not likely to fully arrive until 2022 or so. On estimated 2022 earnings, the shares trade at a more reasonable 16.1x, although this is two years away.
The high 6.3% dividend yield is particularly appealing for income-oriented investors. It has a small risk of a cut if the cycle remains subdued, although management makes a convincing case that the dividend will be sustained. HOLD.
Total S.A. (TOT), based in France, is among the world’s largest integrated energy companies, with a global oil and natural gas production business, one of Europe’s largest oil refining/petrochemical operations, and a sizeable gasoline retail presence. The company is also expanding somewhat aggressively into renewable and power generation business lines, which may either be highly profitable or value-destructive. While low energy prices have hurt Total like all integrated producers, the company’s low production costs (management claims its costs are below $30/barrel), efficient operations and sturdy balance sheet position it well relative to its peers. Also, the company’s production growth profile may still be among the best in the industry despite sharp capital spending reductions.
Total reported adjusted 3Q earnings of $0.03/share, an encouraging result given the sharp declines in oil and gas prices and the shriveling of refining margins. Operating cash flow was reasonably healthy at $3.1 billion, and free cash flow net of asset buy/sales was $947 million. The company reiterated its confidence in its ability to maintain its dividend as long as oil prices are above $40/barrel. With Brent prices reasonably steady at $44, the high 7.5% dividend yield appears safe for now.
Updated consensus estimates point to full-year EPS of $1.47 and $2.95 in 2020 and 2021, respectively. The company’s ADRs trade on the NYSE with one TOT share equal to one ordinary share. The P/E multiple of 13.5x estimated 2021 earnings reflects only partial recovery toward normalized earnings of around $4.00. The shares remain rangebound but have ticked upward in recent days. Value, growth and income investors should add to positions below 38. HOLD.
BUY LOW OPPORTUNITIES PORTFOLIO
Columbia Sportswear (COLM) produces the highly-recognizable Columbia brand outdoor and active lifestyle apparel and accessories, as well as SOREL, Mountain Hardware, and prAna products. For decades, the company was successfully led by the one-of-a-kind Gert Boyle, who passed away late last year. The Boyle family retains a 36% ownership stake and Gert’s son Timothy Boyle remains at the helm.
In its second quarter report, Columbia’s sales fell 40% compared to a year ago, driven by high levels of store and wholesaler closures. Net income turned to a $(0.77)/share loss compared to a $0.34/share profit a year ago. However, both sales and earnings were better than consensus estimates.
At quarter’s end, nearly all of their owned stores were open. Trends in the third quarter are showing meaningful improvement compared to the second quarter. Inventories are higher than a year ago, but the company commented that it is well-positioned for winter gear whereas that can’t be said of some of its competitors. Columbia’s new mobile app is ready for launching, and it is introducing several new products. The company is on track to reduce its operating costs by $100 million, or about 4% of revenues, this year. The company is likely to remain healthy as consumers seek its highly relevant products.
Operating cash flow was a negative $37 million, much of which reflected an increase in inventories. The balance sheet remains sturdy, with $476 million in cash yet a miniscule $3 million (not billion) in total debt.
Columbia’s shares have fully recovered their post-earnings decline, helped by investors shifting toward more cyclical stocks as there appears to be more progress on a Covid vaccine and as government relief appears more likely (but not guaranteed).
Full year estimates are $2.05 and $4.21 for 2020 and 2021, respectively. For comparison, the company earned $4.83/share in 2019. On next year’s estimates, the shares trade at a P/E of 19.0x. The stock has appeal for value investors and for growth investors with patience for what might be a slower recovery than other growth stocks. Traders will find COLM shares appealing given their sensitivity to consumer and economic re-opening trends. BUY.
General Motors (GM) under CEO Mary Barra (since 2014) has transformed from a lumbering giant to a well-run and (almost) respected auto maker. The company has smartly exited many chronically unprofitable geographies (notably Europe) and trimmed its passenger car roster while boosting its North American market share with increasingly competitive vehicles, particularly light trucks. We consider its electric and autonomous vehicle efforts to be near industry-leading. GM’s much-improved North America cost structure allow it to remain profitable at perhaps an 11 million vehicle industry volume. Its GM Credit operations are well-capitalized but will be tested in the pandemic. The shares will remain volatile based on the pace of the economic re-opening, U.S.-China relations, its successes in improving its relevance to Chinese consumers, and the size of credit losses in its GM Financial unit.
GM had an encouraging quarterly report last week, reporting a $(0.50)/share adjusted loss that was vastly better than the consensus estimate for a loss of $(1.78)/share. Despite a 53% decline in revenues, operating profits were nearly break-even, reflecting the company’s aggressive cost-cutting efforts. GM remains fully-committed to investing in all-electric cars and other promising technologies. Much of the $9 billion in negative cash flow in the automotive segment reflected the build-up of inventory as part of the production ramp-up. GM Financial’s credit metrics were steady. GM’s market share increased and dealer inventories are lean. The company’s liquidity and balance sheet remain healthy. Overall, an encouraging report.
Earlier this week the company announced that its young and promising CFO is departing after two years in the role to join payments tech company Square as their CFO. While disappointing, GM should have no trouble finding a capable replacement.
GM shares jumped 10% in the past week as investors gain some appreciation for its post-pandemic positioning. Current Wall Street estimates project EPS of $2.43 (2x the prior estimate of $1.21) and $4.58 in 2020 and 2021, respectively. GM remains an attractive cyclical stock for investors and traders. STRONG 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% share of the beer market. Canada-based Molson (founded in 1786) and Colorado-based Coors (founded in 1873) combined in a 2005 merger of equals. In 2016, the company completed its multi-step acquisition of Miller’s global operations.
Enthusiasm for its post-consolidation prospects drove TAP shares to over $110 in October 2016. Supporting the stock was a modestly favorable revenue outlook, substantial opportunities to reduce redundant costs and inefficiencies and $2.4 billion in tax benefits. However, since then, the share price has collapsed, initially due to a lack of growth, continued margin pressure and more recently as Covid-19 stay-at-home orders temporarily dried up much of the company’s revenues. Elevated debt also weighs on the shares.
The appeal of Molson Coors is two-fold: it is a reasonably stable company selling at a remarkably discounted price.
Molson Coors has highly-recognized and relevant brands which help it produce annual revenues of around $10 billion. Cash operating profits have also been steady at around $2.2 billion, with free cash flow running about $1.0 to $1.2 billion a year. Results this year have been dampened by the global closing of restaurants, pubs and sports venues due to the pandemic, but even with this disruption, second quarter sales fell only 15% from a year ago. Cost-cutting measures and a temporary pullback in marketing spending allowed the company to generate an increase in quarterly profits compared to a year ago.
While its $8.7 billion debt is elevated, it is partly offset by $800 million in cash and can be readily serviced by Molson Coors’ cash flow. The company suspended its dividend in May to provide financial flexibility during the pandemic and to fund debt paydowns that will help it maintain its investment grade credit rating.
The company has a new CEO, who is leading a program to accelerate new product introductions while also boosting efficiency.
At just over 38, the shares trade at a highly discounted 10.5x estimated 2020 earnings of $3.65/share, and about 10x estimated 2021 per share earnings of $3.82. On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 8.1x estimates. This is among the lowest valuations in the consumer staples group and well below other brewing companies. For investors looking for a stable company trading at an unreasonably low valuation in a strong momentum-driven market, TAP shares have considerable contrarian appeal. BUY.
SPECIAL SITUATION AND MOVIE STAR PORTFOLIO
Amazon.com (AMZN) remains nearly perfectly positioned for a pandemic world with its to-your-doorstep shopping marketplace and its Amazon Web Services (AWS) cloud business that is well-positioned for a digitized world. Other Amazon’s innovations and forays into new industries are disrupting established global businesses.
However, the challenges of maintaining its growth rate have become as gargantuan as its revenues. To keep growing at an acceptable pace, Amazon needs to add $100 billion in new revenues a year (and expand that number at 20% or more each year). If/when revenue growth decelerates, the valuation multiple (currently at 49x estimated 2022 earnings) will likely come under pressure. AWS revenues are already decelerating and the marketplace revenues will probably slow again after the pandemic uplift fades.
We recognize the risk of missing another potential surge in Amazon shares, particularly in the difficulty of letting go of a small stake in a truly exceptional company that has few rivals in history (notably Apple, Microsoft, the old Standard Oil monopoly) on the scale of its profits and that has generated a stunning amount of wealth for its investors.
But, just as the best time to leave a party is before it gets “too late,” it is also the most difficult time. As we can no longer say Amazon is undervalued, that time has arrived. We are retiring Amazon shares. RETIRED.
Equitable Holdings (EQH) owns two principal businesses: Equitable Financial Life Insurance Co. and a majority (65%) stake in AllianceBernstein Holdings L.P. (AB), a highly-respected investment management and research firm.
Equitable, with a 161-year history, was acquired by French insurer AXA in 1992. Starting in 2018, AXA began to spin off Equitable with an initial public offering of part of its ownership. Part of the motivation behind the spin-off was to fund AXA’s $15 billion acquisition of insurer XL Group Ltd. Through subsequent stock sales, AXA currently owns less than 10% of Equitable. With its new-found independence, Equitable is free to pursue opportunities that it was unable to as a subsidiary of AXA.
The company is well-capitalized and has significant liquidity. Its diverse, high-quality investment portfolio is hedged against adverse changes in interest rates and equity markets. AllianceBernstein’s assets under management (AUM) as of June was $600 billion. While this year’s profits will decline about 13% due to higher mortality costs, they will like recover next year. Equitable expects to continue delivering a 50-60% payout ratio through dividends and share repurchases. The shares offer a 3.1% dividend yield.
Equitable reported reasonably strong second quarter results last week. Adjusted per share earnings of $1.00 were about 15% higher than the consensus estimate of $0.87. Overall, the company is delivering good profits within a stable business. The company continues to have a solid balance sheet with excess capital that it is returning through dividends and share repurchases to its investors.
Book value per share, excluding AOCI, fell to $28.68. “AOCI” is an accounting term for “accumulated other comprehensive income.” In effect, AOCI includes unrealized gains and losses in the company’s securities portfolio, which can be highly volatile. The gains and losses in these assets often offset increases and decreases in liabilities elsewhere in the portfolio. So, removing AOCI tends to produce a “core” or “recurring” measure of book value.
While Equitable’s book value (ex-AOCI) fell 24% in the quarter, this was mostly a reversal from the sharp 47% increase in the first quarter, both due to the unusual market volatility. Compared to year-end, Equitable’s book value (ex-AOCI) rose a 12%, and compared to a year ago the book value (ex-AOCI) rose about 1%. These are more indicative of the underlying trends in the value of Equitable’s business.
Like many insurance companies, investors value Equitable on a book value basis. On this basis, EQH shares trade at 75% of its $28.68 book value, still a considerable discount.
EQH shares are undervalued on earnings, with a 2020 P/E of 5.0x. EQH shares also trade just above their 20 IPO price, which was a disappointment at the time relative to the 24-27 price range that bankers had targeted. Since then Equitable has arguably become a better company and any sale of AllianceBernstein is likely to unlock further value. EHQ shares are appropriate for dividend investors, growth investors and traders. While the shares may trade in sync with the overall stock market, given its investment-driven operations, we see more upside than downside. STRONG BUY.
NVIDIA (NVDA) is the pioneer and leading designer of graphics processing unit (GPU) chips, which initially were built into computers to improve video gaming quality. However, they were discovered to be nearly ideal for other uses that required immense and accelerated processing power, including data centers and artificial intelligence applications such as professional visualization, robotics and self-driving cars. In April, NVIDIA completed the $6.9 billion acquisition of Mellanox Technologies, an innovator in high-performance interconnect technology routinely used in supercomputers and hyperscale data centers. NVIDIA’s data center business now represents about 50% of total revenues.
NVIDIA is a high-P/E, aggressive growth/momentum stock. Its shares have increased 17x since the start of 2015 and now trade essentially at their all-time high. Part of the reason behind the gains is that cloud-based computing is the biggest secular trend in technology, and the most powerful. No one knows how large the industry will ultimately become, but “larger than it is today” seems like the correct answer for many days and years into the future. Until this open-ended growth appears to peak, it would be difficult to bet against it. The only question for momentum investors is when to stop betting on it. The valuation of 44x estimated fiscal year 2022 earnings is high and on the edge of astronomical, particularly for a company its size.
Wall Street expects EPS to grow 21% in fiscal 2022 (January year-end) compared to fiscal 2021. The company reports its earnings in September. We are keeping our rating at HOLD, despite the very high valuation. We are closer to moving to a “Retired” but are reluctant to move too quickly. NVDA shares are on a short leash.
Marathon Petroleum (MPC) is a leading integrated downstream energy company and the nation’s largest energy refiner, with 16 refineries, a majority interest in midstream company MPLX LP, 10,000 miles of oil pipelines, and product sales in 11,700 retail stores.
Marathon announced a definitive deal to sell its Speedway retail gas station chain to the Japanese company Seven & i Holdings, the parent of the 7-Eleven chain for $21 billion in cash. Marathon will receive $16.5 billion in net proceeds. Related to the deal, Marathon entered into a long-term supply agreement to provide 7.7 billion gallons of fuel to Speedway. The deal is worth slightly more, at $25.40/share in after-tax proceeds, than our $24.00 estimate.
Post-sale, Marathon will be losing a huge source of annual cash flow but also shedding as much as 30% of its $32 billion in debt (including debt of its MPLX pipeline subsidiary). Some of the proceeds will likely be returned to shareholders through share repurchases. Also, the company will likely have a leaner cost structure as it is closing two unprofitable refiners and cutting close to $1 billion in operating expenses.
Following the deal news, Marathon reported its second-quarter earnings. Weak refining and marketing operations led to a $(1.33)/share loss, compared to a profit of $1.73/share a year ago. The loss compared to estimates for a much larger $(1.76/share) loss. Adjusted EBITDA, a measure of cash operating profits, fell 89%, to $653 million, compared to a year ago.
All of the decline in profits was produced by the refining and marketing segment, as the retail, midstream and corporate segments produced results that were essentially the same as a year ago. Lower throughput volumes and lower crack spreads (margins) drove the weakness.
At about 37, MPC shares are interesting and appealing but not enough to warrant a return to a Buy rating. We are working through the numbers and management commentary for more clarity on the post-sale Marathon. Meanwhile, the shares offer a reasonably sustainable 6.3% dividend yield.
The shares will continue to trade near-term around the pace of the re-opening of the economy, on overall oil prices and the currently wide refiner margins. Its earnings recovery appears to be slower in coming, reflected in declining earnings estimates.
Wall Street analysts are forecasting a 2020 full-year loss of $(3.00)/share, continuing a trend downwards. Estimates for 2021 earnings fell sharply, now at $1.22/share, but this increasingly reflects the post-Speedway earnings power but not necessarily the lower debt or share count.
Like most energy stocks, MPC offers a useful vehicle for traders: its economics are closely tied to oil prices yet the company has a more stable business, with its refining, MPLX midstream, and retail operations that dampen its volatility and provide more downside protection relative to pure exploration or energy service companies. HOLD.
