Starting next Monday, August 31, before the market opens, the Dow Jones Industrial Average will have a new look. Out goes ExxonMobil (XOM), Pfizer (PFE) and Raytheon Technologies (RTX), to be replaced by Salesforce.com (CRM), Honeywell (HON) and Amgen (AMGN). The change was heavily motivated by the 4:1 stock split by Apple (AAPL) which takes effect after the market close this Friday.
The Dow, of course, is the oldest and most widely recognized index of the stock market. Changes to its mix have supported its relevance, with five- and ten-year returns remaining roughly comparable to those of the S&P 500 Index.
This year, however, with the pandemic-driven changes to the economy, the S&P 500’s heavy mix of surging tech stocks has helped that index noticeably outperform the Dow. Year-to-date, the S&P 500 has generated a 7.6% total return compared to the meager 0.8% total return of the Dow. Without updating its membership, the Dow would risk being left behind even more in the future from the new economy.
While Microsoft and Apple are currently in both indices, the Dow has a smaller tech weighting. Also, the Dow does not include tech leaders like Amazon, Alphabet and Facebook, but instead holds weaker tech stocks like IBM and Cisco. Because the Dow is a price-weighted index (rather than a market cap weighted index like the S&P 500), Apple’s 4:1 split will reduce its effect on the Dow by 75% – Salesforce.com was added to partly offset this effect. The high share prices of Amazon (3307) and Alphabet (1588) precluded their ability to be added to the Dow. Both the Dow Jones index and the S&P indices are owned by S&P Global.
The changes will also help bolster the Dow’s exposure to healthcare, as Amgen’s weighting will be six times the weighting of Pfizer. ExxonMobil’s departure will leave Chevron as the sole energy sector member.
Do the changes make the Dow more vulnerable to a tech sell-off? Perhaps, as CRM’s valuation is high, at 70x adjusted per-share earnings (despite its huge $187 billion market cap, the company is still unprofitable on a non-adjusted, or GAAP, basis).
Not all changes to the index have made a difference. Walgreens Boots Alliance was added in June 2018, but the shares have fallen by 41% since its addition. It replaced GE, an original Dow member, whose shares have declined 48% over the same period.
These upcoming Dow changes provide some insight into the relevance of different market indices and the rationale behind their construction. It also highlights some of the flaws of each index – as no index is a perfect picture of the market or the economy. We generally prefer the broad S&P500 Index, although we still look beneath its surface numbers to better understand what is happening in the market.
Share prices in the table reflect Tuesday (August 25) closing prices. Send questions and comments to Bruce@CabotWealth.com.
TODAY’S PORTFOLIO CHANGES
ViacomCBS (VIAC) – New Buy
LAST WEEK’S PORTFOLIO CHANGES (August 19 bulletin)
NVIDIA (NVDA) – Moves from Hold to Retired.
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.
On August 25th, the company reached an agreement to sell its non-core MVE Biological Products business for $320 million in cash. The proceeds will be used to reduce Chart’s debt.
The shares have been relatively flat in the past week but have gained about 29% since the company reported second quarter earnings earlier in July. The valuation remains reasonable at 19.7x estimated 2021 earnings of $3.65 and 16.5x 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 second quarter results, with revenues increasing 15% from the prior year. 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 about 4% in the past week, while the Philadelphia Semiconductor Index (SOX) has moved upward.
For traders with sizeable profits, it might be time to trim out. For longer-term holders of MKSI, at 16.8x estimated 2021 earnings of $7.84, 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.
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 6th, the shares have gained 19%, hitting a record high close on August 24th.
Full-year earnings estimates for 2020 are now at $3.30, just below guidance, while 2021 estimates are at $4.02, up about 22% from the prior year. PWR shares trade at 15.3x 2020 earnings and 12.6x 2021 earnings.
With the stock trading over 50, traders may want to exit here. For long-term holders, Quanta stock looks well-positioned to continue to prosper, but you 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 strong second quarter earnings, supported by rising beef and pork prices, and absorbed a sizeable $340 million of direct Covid-related costs. The company is producing strong cash flow, and its balance sheet and liquidity remain healthy. New CEO Dean Banks (joined Tyson in 2017) brings fresh ideas and valuable technology and leadership experience gained at Google and elsewhere, although his very limited consumer products experience presents a bit of a risk.
TSN shares have traded essentially flat in the past week. The company has more work to do to convince investors that the future is brighter, particularly as it’s more of a commodity company (hence lower margins) compared to its food processor peers, but this quarter’s results should help.
Tyson’s 2020 estimate is $5.00/share and the 2021 estimate is $5.79. The shares trade at a relatively low 10.9x 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 grow 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/etc, 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 about 7% 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. Last week we reduced our rating to Buy.
UEIC shares trade at 12.2x estimated 2020 earnings of $3.57 and 10.1x estimated 2021 earnings of 4.31. The estimates appear to have bottomed out. We are staying with the Buy rating due to the shares’ relatively low valuation. 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 5th, 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 in the August 19th Bulletin for more 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.
Voya shares have moved up about 3% in the past week, mostly due to this past Monday’s market strength and favorable comments by Citi’s research analyst who raised their price target to 60 from 54. Stronger capital markets add to the value of its investment portfolio and help support its book value.
Insurance companies are generally valued on a price/book value basis. We have adjusted the book value calculation for AOCI (to remove the effects of market volatility): VOYA trades at a 1.3x multiple of its $38.83 adjusted book value per share. However, the more the company shifts away from insurance, the more its shares will trade on earnings. VOYA trades at 13.5x estimated 2020 per share earnings of $3.87 and 8.6x estimated per share earnings of $6.02. 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) was 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 8.5x estimated 2021 earnings of $7.43.
Recently, Bristol-Myers acquired Forbius, a privately-held cancer and fibrotic disease treatment company, for an undisclosed price.
One emerging but immeasurable risk cited by some analysts is increased drug price controls if the Democratic Party wins the White House.
BMY shares have remained relatively steady over the past week 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 3rd. AVGO shares trade fractionally below their all-time closing high of 333.64.
Broadcom is an undervalued growth and income stock as well as a useful trading stock. Full-year profits are expected to grow 1% to $21.44 in FY2020 and then by 12% to $24.02 in FY2021. The shares trade at a 13.9x multiple of estimated FY2020 earnings of $24.02. 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 two forces: 1) petrochemical prices, which are often correlated with oil prices and global growth, along with competitors’ production volumes, and 2) on-going efficiency improvements (a never-ending quest for all commodity companies to maintain their margins).
Dow’s second quarter earnings report was satisfactory. The company’s loss of $(0.26)/share was in line with consensus estimates. Management raised their cost-cutting program to $500 million and initiated a new $300 million program for 2021. Revenues were weak across the board and fell 24% to $8.4 billion, due to sluggish global economic conditions that saw little demand for Dow’s commodity chemicals. Cash flow was strong, and liquidity and the 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 3% 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 21.0x 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 16.5x, although this is two years away.
The high 6.1% 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 $42-44, the high 7.5% dividend yield appears safe for now.
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 13.3x estimated 2021 earnings reflects only partial recovery toward normalized earnings of around $4.00. At $4.00 in earnings, the shares trade at about 9.8x. TOT 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.
Columbia reported a reasonable second quarter. 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. Operating cash flow was a negative $37 million – relatively small so not particularly worrisome. The balance sheet remains sturdy, with $476 million in cash yet a minuscule $3 million (not billion) in total debt.
At quarter-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.
Columbia’s shares have continued to recover and are now about 5% above their price when we moved them to a Buy. Recent indications that the economy continues to re-open are helping to buoy the stock.
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 20.0x. 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 allows 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 released an encouraging quarterly report. Despite a 53% decline in revenues, operating profits were nearly breakeven and vastly better than consensus estimates. GM aggressively cut its costs yet continues to invest heavily in its electric vehicle programs.
The shares got a boost by a recent Deutsche Bank research report saying that GM’s Cruise unit, which is developing electric vehicles, is worth between $15 billion and $95 billion. However, some of the enthusiasm has faded, weighing recently on GM shares.
Current Wall Street estimates project EPS of $2.43 and $4.58 in 2020 and 2021, respectively. On the 2021 estimate, GM shares trade at a 6.5x multiple. GM remains an attractive cyclical stock for investors and traders. STRONG BUY.
Molson Coors Beverage Company (TAP) – The thesis for this company is straightforward – a reasonably stable company whose shares sell at a highly discounted price.
One of the world’s largest beverage companies, Molson Coors produces the highly-recognized Coors, Molson, Miller and Blue Moon brands as well as numerous local, craft and specialty beers. About two-thirds of its $10 billion in net revenues are produced in the United States, where it holds a 24% share of the beer market. Canada produces about 13% of its revenues, with the balance coming largely from Europe.
For a simple business, the company’s history is a bit complicated. In 2005, after years of speculation, two old-line brewing companies, Canada-based Molson (founded in 1786) and Colorado-based Coors (founded in 1873), combined in a 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 $2.4 billion in tax benefits. However, since then, the share price has collapsed to about 38, initially due to a lack of growth, weak post-merger integration and continued margin pressure, with more recent weakness coming from Covid-19 stay-at-home orders that temporarily dried up much of the company’s revenues. Elevated debt also weighs on the shares.
However, Molson Coors’ annual revenues will likely continue to remain relatively stable, backed by its highly-recognized and popular brands. While revenues will dip from about $10.6 billion last year to perhaps $9.6 billion this year, they will likely recover to $10.2 billion next year. Cash operating profits have also been steady at around $2.3 billion (dipping to perhaps $2.0 billion this year). The profit margin is a healthy 21%, helping the company to generate free cash flow of about $1.0 billion in a typical year. Encouragingly, even with the global closing of restaurants, pubs and sports venues due to the pandemic, 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 modestly elevated, at about 4.2x cash operating profits (compared to perhaps 3.5-4.0x being appropriate), it is partly offset by $800 million in cash and can be readily serviced by Molson Coors’ cash flow. The company has an investment grade credit rating, which it has pledged to keep, which is helping to keep the interest rate on its debt relatively low.
In October 2019, the company promoted its U.S. head to oversee the entire company. He is leading an efficiency program to cut as much as $150 million in annual run-rate costs, which includes more fully integrating the combined companies as well as accelerating new product introductions.
We anticipate that the company will resume paying a dividend mid-next year. Molson Coors had raised their dividend by 39% a year ago, as its cash flow had reached its targeted levels, but suspended it due to the pandemic. We think a $0.35 quarterly dividend is possible, providing a generous 3.8% yield on the current price.
TAP shares were recommended this Monday by Tim Lutts in Cabot Stock of the Week.
At about 38, the shares trade at a highly discounted 10.5x estimated 2020 earnings of $3.61/share, and about 9.8x estimated 2021 per share earnings of $3.87. On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 7.9x 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.
ViacomCBS (VIAC) is a major media and entertainment company, owning highly-recognized properties including Nickelodeon, Comedy Central, MTV and BET, the Paramount movie studios, Showtime and all of the CBS-related media assets. The company’s brands are powerful and enduring, typically holding the #1 market shares in the highest-valued demographic groups in the country. ViacomCBS’ reach extends into 180 countries around the world.
After years of rumors and in-fighting, Viacom and CBS, which were majority-owned by National Amusements, merged in late 2019. The recent passing of National Amusement’s chairman Sumner Redstone may lead to other strategic changes. Under the highly-capable CEO, Robert Bakish, who oversaw a successful turnaround at pre-merger Viacom, the newly combined company is now being overhauled to stabilize revenues, boost relevancy for current/future viewing habits and improve free cash flow. Central to the strategy is leveraging both the valuable content libraries and production capabilities of Viacom and CBS and the wide distribution provided by the CBS network.
Early progress is encouraging. Even though second quarter results were hurt by weak advertising during the pandemic, with revenues falling 12% from a year ago, cash operating profits actually rose by 8% and were about 27% higher than analysts’ estimates. Much of the expense decline came from lower production and programming costs - demonstrating some resiliency of profits even when revenues decline. Viacom raised its merger cost-savings target to $800 million from $750 million.
ViacomCBS is expanding its rapidly growing Pluto TV platform and is developing its CBS All Access subscription service into a “super service,” essentially a platform to compete against Netflix, Disney and others. A new international streaming service will start in early 2021.
Viacom’s debt is modestly elevated but readily serviceable. Investors also worry about the slow but steady secular shift away from cable TV subscriptions, which is pressuring advertising and subscription revenues. However, Viacom’s aggressive efforts to increase its relevancy, find different distribution outlets for its content and produce valuable new content should go a long way toward offsetting the shift. Similarly, much of the near-term advertising slowdown should be reversed with the (partial) return of sports and a recovery in the economy.
ViacomCBS shares are generally valued on an EV/EBITDA basis, which measures the value of the business (enterprise value, or market value plus debt less cash) relative to its cash operating profits. On this basis, the shares trade at about 7.2x estimated 2021 results – a low value considering the company’s assets and leadership. The shares have bounced sharply from their March lows yet remain 35% below their year-end price and well below their 2014 and 2017 highs. ViacomCBS shares offer a sustainable 3.5% dividend yield and look very attractive here. BUY.
SPECIAL SITUATION AND MOVIE STAR PORTFOLIO
Amazon.com (AMZN) shares were recently retired. Amazon remains nearly perfectly positioned for a pandemic world with its to-your-doorstep shopping marketplace and its Amazon Web Services (AWS) cloud business. However, the challenges of maintaining its growth rate, and valuation, have become as gargantuan as its revenues.
We recognize the risk of missing another potential surge in Amazon shares, and the difficulty of letting go of a small stake in a truly exceptional company. 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. Please see the August 12 Bulletin for more commentary. 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 spinoff 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 newfound 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 July was $623 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 3.2% dividend yield.
Equitable reported reasonably strong second quarter results. 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.
EQH shares have remained relatively strong in recent weeks. 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, trading at 4.9x estimated 2020 earnings of $4.42. The shares also trade only about 8% 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.
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.
Following its agreement 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 be losing a huge source of annual cash flow but also will be 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.
Marathon produced a sizeable $(1.33)/share loss in the second quarter due to weak refining and marketing operations. The retail, midstream and corporate segments produced results that were essentially the same as a year ago.
At about 36 (continuing their weakness), 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 $(3.02)/share, continuing a trend downwards. Estimates for 2021 earnings continue to weaken as they reflect the lower post-Speedway earnings power but not necessarily the lower debt, and now are $0.99/share
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.
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, these chips 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.
We moved NVDA shares to a Retired rating last week, just prior to their reporting (another) impressively strong report. Revenues grew sharply, partly due to the Mellanox acquisition. Adjusted earnings per share of $2.18 were 76% higher than a year ago and 11% ahead of estimates. The earnings growth was also partly driven by the acquisition. Curiously, NVDA shares hardly moved on the news – surprising to us as we wondered how market expectations could be so perfectly balanced in such a highly-popular and wildly expensive stock. Some of the restraint is likely due to one of our worries – less-than-inspiring results in its data center business.
With the share price rising by a factor of 25x since mid-2015, sporting a $310 billion market cap, trading at an all-time high, with a sky-high 50x P/E multiple on estimated fiscal 2022 earnings (which fell to a slightly less sky-high multiple after analysts increased their estimates following the earnings report), and receiving 31 “Buy” ratings from the 37 brokerage analysts that cover the stock, NVDA is clearly is not undiscovered.
We have no doubt that the company is exceptionally well-positioned in cloud-based computing (the biggest and most powerful secular trend in technology) and in a potentially similar position for autonomous vehicles and robotics in general. But while these fundamentals are overwhelmingly robust, the valuation and expectations appear to be so high as to already discount this. As the writer of a letter focused on undervalued stocks, we can’t in good conscience continue to recommend holding this stock. RETIRED.
