With all of our stocks now having price targets assigned to them, we thought we’d share with you some of our process behind how we set those price targets.
In setting the targets, we typically use the formula: valuation multiple x earning power = price target.
When determining the multiple, we look at the company’s valuation history and how that compares to its fundamentals, including revenue and profit levels and growth, changes in its business and capital mix, and other metrics including its leadership and culture. These help us understand how the stock has been valued by the market and what has driven that valuation. We also compare the valuation to those of its peer companies, both today and in the past. An implicit assumption in this process is that over time the market sets reasonably accurate valuation ranges for a stock.
Similarly, we assess the company’s current and prospective fundamentals. This helps us determine its future earning power. It also helps shape our opinions about whether the past valuation is still relevant to its future valuation.
An important aspect of our price target setting is understanding the company’s history. This provides us with context behind its current situation and shapes our view of its future prospects. One rule of thumb is that the longer the holding period, the further back in time we want to explore. If we plan to hold a stock for 2 years, it makes sense to us to know more than just the most recent quarterly results.
For example, with Universal Electronics, when we inherited the position upon our assumption of the CUSA in July, we wanted to understand not only why the stock had fallen from its year-end price of 52, but also why it had surged from about 12 to nearly 80 in the four years from 2012-2016 and then subsequently fell by 70%. Understanding the role of remotes and cord-cutting over this sweep of time was immensely valuable as it provided the context for why the shares were collapsing even as the company was producing record revenues.
Similarly, with Broadcom, we ended up going all the way back to its inception within Hewlett-Packard a half-century ago to better understand how it came to be the Broadcom of today. This helped shed some light on why it’s a bit of an oxymoron – a diversified technology conglomerate that still relies on a single customer for 20% of its revenues. Given this history, we recognized that a high multiple is not appropriate for Broadcom, despite its reputation as a momentum-driven tech stock.
There are two other side benefits of history. First, knowing a company’s history puts each day’s newsflow into context to help us separate the real news from the noise and better evaluate short-term share price movements. And second, we admit to being history and market junkies. We simply enjoy learning about the companies, what makes them tick, who is leading the effort and where they are attempting to move forward.
This past week was another relatively quiet week for news, except for perhaps GM which is in the middle of its now-problematic Nikola negotiations. With the September quarter ending today, most companies will enter their “quiet period.” This is a twilight zone when they know the quarter’s results but can’t risk sharing any of that information, either directly or indirectly, with the market. Most companies take the safer approach of simply not communicating.
The third quarter earnings season starts in a few weeks. Once we get the schedule, we’ll include it in this letter.
Share prices in the table reflect Tuesday (September 29) closing prices. Send questions and comments to Bruce@CabotWealth.com.
TODAY’S PORTFOLIO CHANGES
None
LAST WEEK’S PORTFOLIO CHANGES (September 23 letter)
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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.
There was essentially no news on the stock this past week.
GTLS shares rose about 2% in the past week and remain in the middle of their near-term trading range. The shares have about 14% upside to our 79 price target.
The current valuation remains reasonable at 22.2x estimated 2021 earnings of $3.12 and 17.1x estimated 2022 earnings of $4.06. Estimates have stabilized. We continue to like Chart’s prospects. 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. MKS recently promoted 13-year company veteran Dr. John T.C. Lee to CEO.
There was essentially no news on the stock this past week.
After falling sharply in the early September tech selloff, MKSI shares ticked up about 2% in the past week, returning to a good correlation with the Philadelphia Semiconductor Index (SOX). The shares have about 17% upside to our 130 price target.
Valuation remains reasonable at 14.1x estimated 2021 earnings of $7.83. The estimate is unchanged from last week.
Traders might want to nibble here. Tech price momentum is notoriously hard to trade but the shares seem to have found a floor of sorts. 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. We view this company as high-quality, well-run and resilient. Quanta achieved record annual revenues, operating income and backlog in 2019, and reported strong second-quarter 2020 results. The company is pursuing a multi-year goal of increasing margins while maintaining low capital intensity. Dividend payouts and share repurchase activity have continued uninterrupted during the pandemic.
There was essentially no news on the stock this past week. About the only company-specific item was that Quanta raised $1.0 billion in notes, at a very favorable 2.9% yield and maturing in 2030, to repay maturing term loans. The notes received an investment grade credit rating.
PWR shares moved up about 5% in the past week and are approaching their highs. The stock currently has about 16% upside to our 61 price target.
The stock trades at 15.8x estimated 2020 earnings of $3.34 and about 13.0x estimated 2021 earnings of $4.07. The estimates have ticked up fractionally in the past week. Quanta looks well positioned to continue to prosper. 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. Second quarter results were strong. The company has more work to do to convince investors that the future is brighter, particularly as it is more of a commodity company (and hence has lower margins) compared to its food processor peers.
New CEO Dean Banks (joined Tyson in 2017, officially takes CEO role on October 3) has already made some staffing moves.
Our recent research into wholesale chicken pricing found that domestic prices are at or near long-time lows. Total domestic consumption remains relatively stable although the mix has shifted (at-home consumption remains robust, but restaurant/food service consumption has declined meaningfully). However, the export markets have been particularly weak. Mexico, China and Japan are major destinations for exported chicken. As the U.S. is a large exporter, the weaker demand has flooded the domestic market, pressuring prices. We anticipate that chicken production will slow, and perhaps some smaller producers will go bankrupt, helping to alleviate the glut. While the market may remain out of balance through the winter, the following spring should bring robust restaurant demand. Also, any interim chicken pricing improvements would bolster Tyson shares.
U.S. pork exports to China have surged, which indirectly lends support to Tyson’s domestic pork operations.
TSN shares slipped about 1% this past week and are just above their bottom of their 58-65 trading range. The stock has 27% upside to our 75 price target.
Tyson currently trades at 11.8x estimated 2020 earnings of $4.99/share and 10.0x estimated 2021 earnings of $5.87. Both estimates remain unchanged from last week. Currently the stock offers a 2.9% dividend yield. While the shares may take some time to recover, we are staying with the name. 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.
For UEIC shares to start a sustained move upward, their revenues need to stop declining and turn (even if slightly) positive. While expanding profit margins help, the shares aren’t 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.
UEIC shares rose fractionally in the past week, and have 25% upside to our 47 price target.
UEIC shares trade at 10.5x estimated 2020 earnings of $3.57 and 8.7x estimated 2021 earnings of 4.31. The estimates remain unchanged from last week and appear to have bottomed out.
We are patient for now with UEIC shares because of the larger opportunity set on the horizon, potential for better results in the third and/or fourth quarter, and the increasingly low valuation. BUY
Voya Financial (VOYA) is a U.S. retirement, investment and insurance company serving 13.8 million individual and institutional customers, with $606 billion in 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, which should allow it to use some of its excess capital to repurchase shares. Strong earnings and cash flows, lower capital intensity and share repurchases should help boost its share price to our 62 target (32% implied upside).
There was essentially no news on the stock this past week.
Voya shares rose 2% in the past week. The shares will likely continue to move with the overall market, reflecting theoretical changes in the value of its investment portfolio, and thus its book value. However, the company is relatively well-hedged, and the fixed income markets remain sturdy, limiting the effects on Voya’s balance sheet strength. The stock has about 30% upside to our 62 price target.
VOYA trades at 12.9x estimated 2020 per-share earnings of $3.69 and 7.9x estimated per-share earnings of $6.02. Both estimates ticked down a few cents from the prior week. BUY
GROWTH & INCOME PORTFOLIO
Bristol-Myers Squibb Company (BMY) is a New York-based global biopharmaceutical company. In November 2019, the company acquired Celgene for a total value of $80.3 billion, including $35.7 billion in cash and $40.4 billion in stock. We are looking for Bristol-Myers to return to overall revenue growth, both from resilience in their key franchises (Opdivo, Revlimid and Eliquis) and from new products currently in their pipeline. We also want to see the company execute on its $2.5 billion cost-cutting program.
As part of the Celgene deal, Bristol-Myers issued contingent value rights (CVRs) whose value depends on whether Bristol-Myers receives FDA approval for three specified drugs by March 2021. The outcome is binary – either the company gets all three approvals on time (yielding $9/CVR in value to investors) or it does not (yielding a total loss for investors). One of the three milestones has been achieved. These CVRs are publicly traded, so anyone can buy them.
While we are investors, we also recognize the merits of speculative bets – and want to understand the payoff ladder to see if the bet is worthwhile. The Bristol-Myers CVR to us is a pure speculation, as we have no realistic way of evaluating the odds of approval. With no way of assessing the odds, we can’t effectively gauge the merits. This follows the logic of the Kelly Criterion (a fascinating and very useful approach).
But, for those with an interest in a high-risk, high-potential return security, CVR might fit the bill. At the approximately $2.08 price, the payoff is roughly 4.3x in a “win.” If the odds tilted to, say, 10:1, for investors with the ability to readily absorb a full loss, it could look appealing. Each person would want to decide for themselves whether to take this bet. As it is a highly unusual security issued by a major company whose common stock we recommend, we thought we would at least bring it to your attention.
One emerging but unmeasurable risk cited by some analysts is increased drug price controls following the U.S. presidential election. While initially this looked more likely if the Democratic Party won the White House, it is now looking more likely even in a Republican re-election as the president is increasingly pressing for more price controls.
There was little to no meaningful news from Bristol-Myers this past week.
BMY shares have ticked up about 2% in the past week and have about 30% upside to our 78 price target.
The stock trades at a low 8.0x estimated 2021 earnings of $7.46 (estimate is unchanged from last week). The generous 3.0% dividend yield is well-covered by the company’s enormous $13.5 billion in free cash flow likely this year. STRONG BUY
Broadcom, Inc. (AVGO) designs, develops and markets semiconductors (about 72% of revenues) that facilitate wireless communications. The company’s foundation is its #1 industry position in high performance RFIC (radio frequency integrated circuits), whose use in high-end smartphones has driven Broadcom’s growth and profits. About 25% of total revenues come from chips that go into high-end smartphones, with Apple providing about 20% of Broadcom’s total revenues. The company also provides software that runs technology infrastructure including telecom and corporate networks (about 28% of total revenue).
AVGO shares rose about 1% in the past week and are just below their record high close of 375. They have held their value in a sloppy market. The stock has about 13% upside to our 410 price target.
The shares trade at 16.5x estimated FY202 earnings of $22.02 and 14.4x estimated FY2021 earnings of $25.22. Both earnings estimates ticked up in the past week. The shares pay a 3.5% dividend yield. 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) ongoing efficiency improvements (a never-ending quest for all commodity companies to maintain their margins).
Dow’s second-quarter earnings report was satisfactory, with revenues down 24% and profits turning negative, reflecting the sluggish economic conditions in the period. Cash flow was strong, and liquidity and the balance sheet remain sturdy. Dow will weather the downturn but its outlook is more subdued than we anticipated.
The recent hurricanes appear to be providing a modest improvement in plastics prices, incrementally but perhaps not materially helping Dow.
Dow shares fell about 3% this past week and have about 29% upside to our 60 price target.
The shares trade at a reasonable 15.9x estimated 2022 earnings of $2.93, although this is two years away. We note that this earnings estimate ticked up fractionally since last week. Valuation on estimated 2020 earnings of $0.85 is less meaningful as this assumes no recovery.
The high 6.0% dividend yield is particularly appealing for income-oriented investors. It has a small risk of a cut if the economic and commodity cycles remain 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, including its 51% stake in SunPower (SPWR) and its holdings of recent spinoff Maxeon Solar Technologies (MAXN). Overall, the alternative energy initiatives 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. The company maintains its confidence in its ability to pay its dividend as long as oil prices are above $40/barrel. With Brent prices at about $40-$41, the high 9.1% dividend yield appears moderately safe for now although the shares are beginning to imply a cut.
TOT shares have been volatile this week with the net effect of declining about 4%. Investors worry about an economic recovery that isn’t as strong as previously expected. Brent crude (the London-based benchmark) prices increased most of the past week but fell yesterday to about $40. West Texas Intermediate crude (the U.S. benchmark) had risen to the low-$40 range but similarly fell yesterday to about $39. While WTI prices should be of minimal relevance to Total’s earnings, we note that most U.S. traders probably watch the WTI more closely, and thus trade TOT shares based on WTI.
Total’s shares have about 29% upside to our 43 price target.
TOT shares trade at 11.5x estimated 2021 earnings of $2.89 and 7.9x estimated 2022 earnings of $4.20. We would consider the 2022 estimate to reflect “normalized” earnings.
The 2021 estimate ticked down a cent in the past week.
Given the increasingly volatile commodity prices, we are now less likely to want to add to our position on weakness. The shares appear to have reached long-term support at 33. The company’s ADRs trade on the NYSE with one TOT share equal to one ordinary share. 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.
Recent financial results were weak but better than consensus estimates. The balance sheet remains sturdy, with $476 million in cash yet a minuscule $3 million (not billion) in total debt.
Columbia’s shares dipped 3% again this past week. The shares have about 12% more upside to our 100 price target.
The shares currently trade at 21.5x estimated 2021 earnings of $4.16. The earnings estimate is unchanged from last week. For comparison, the company earned $4.83/share in 2019. 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. 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, the size of credit losses in its GM Financial unit and news related to new technologies.
We continue to like GM under Mary Barra’s leadership. The recently announced deals with Honda Motors and Nikola indicate that the company is moving forward with new initiatives as well as continuing to improve its core business. We are big believers in the “addition by subtraction” strategy that she is pursuing. For decades the company was geographically and organizationally over-extended, seeking growth for growth’s sake. But it ended up stuck in chronically unprofitable and ungovernable operations in too many markets. With the global car-producing industry in a secular over-capacity position, Barra has smartly led GM to exit Europe, India, Russia, Thailand and Australia since taking the reins in 2014.
GM commented yesterday that the Nikola deal has not yet officially closed, even as it is having “continuing discussions” with the electric truck maker. Nikola originally stated that they expected the deal to close by September 30 (today), but the agreement can be terminated up to December 3rd if not finalized by then. With all of the very disappointing news and sharp drop in Nikola’s shares, GM’s proposed 11% stake is now worth about half its originally proposed value.
GM is likely working to reduce their risks (as in “costs”) surrounding the deal. Perhaps the biggest cost is reputational, partly because it makes GM’s due diligence appear lacking, but also because the Nikola brand may be permanently damaged. GM probably hoped to combine the “good” Nikola brand with GM’s engineering to produce a valuable business. With the brand now tainted, that hope may be beyond recovery.
California’s governor said that he will ban new gas-powered vehicle sales in the state starting in 2035. We think this proposed ban has almost zero chance of happening as planned. Not only is there a slim chance that the electricity infrastructure will be ready, there are also tall legal challenges, not to mention that these cars may be prohibitively expensive for most people. If it is actually implemented, we think the biggest effect would be a huge boost to sales for car dealers in neighboring states where the gas-powered sales ban would not be in effect. However, we recognize that gas-powered cars probably won’t be dominant forever, and that other countries have announced similar bans, so the California plan is yet another shot across the bow for gas-powered cars.
This past week, GM shares fell about 3%. The stock has about 53% upside to our 45 price target. The target price implies 8.2x multiple on 2022 estimated earnings of $5.50.
GM shares trade at 11.2x estimated 2020 earnings of $2.56 and 6.4x estimated 2021 earnings of $4.49. Both estimates are unchanged from a week ago. 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.
Investors’ primary worry about Molson Coors is its lack of meaningful (or any) revenue growth as it has relatively few of the fast-growing hard seltzers and other trendier beverages in its product portfolio. So, the key is for revenues to be stable or slightly positive – rapid growth is not necessary for the stock to work as this is a revenue and cash-flow stability story.
Any indication that it is building its “alternative” beverage capabilities would be positive, as would resilience/recovery in its core beer volumes. Other concerns, like its modestly elevated (but investment grade) debt and the size/stability of its free cash flow, generally stem from the revenue debate. Recent financial results have been encouraging. A new CEO is overseeing efforts to improve execution.
We anticipate that the company will resume paying a dividend mid-next year. A $0.35/share quarterly dividend is possible, which would provide a generous 4.2% yield on the current price.
This past week the company announced an exclusive agreement with Coca-Cola to produce and distribute an alcoholic version of Coke’s Topo Chico sparkling water. The new hard seltzer will begin U.S. distribution next year. We think this incremental deal highlights the company’s creative (and low-risk and low-cost, compared to an acquisition) approach to boosting its relevance.
TAP shares slipped 1% in the past week, although they jumped about 4% intra-day yesterday on the Coca-Cola news. The shares have about 76% upside to our 59 price target.
The shares trade at 9.3x estimated 2020 earnings of $3.62 and 8.6x estimated 2021 earnings of $3.88. Both estimates are unchanged in the past week. These valuations are remarkably low. One way to look at this low multiple is to think about what it implies about investors’ views on earnings. If investors applied a very conservative 12x multiple on 2021 earnings, it suggests that investors expect about $2.81 in earnings that year. We think it is highly unlikely that earnings would drop 22%, or even drop at all. It is almost bizarre that a company like Molson Coors trades with such low expectations.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 7.6x estimates, 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 momentum-driven market, TAP shares have considerable contrarian appeal. Patience is the key with Molson Coors shares. We think the value is solid although it might take a year or two to be recognized by the market. STRONG 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. Viacom and CBS re-merged in late 2019 and are now under the capable leadership of former Viacom CEO Robert Bakish.
Viacom is being overhauled to stabilize its revenues, boost its relevancy for current/future viewing habits and improve its free cash flow. Its challenges include the steady secular shift away from cable TV subscriptions, which is pressuring advertising and subscription revenues. The pandemic-related reductions in major sports are also weighing on VIAC shares. However, ViacomCBS’ extensive reach, strong market position and strategic value to other, much larger media companies, and its low share valuation, make the stock appealing.
VIAC shares slipped about 2% this past week and have about 48% upside to our 43 price target.
ViacomCBS shares trade at about 7.4x estimated 2021 EBITDA, which we believe undervalues its impressive leadership and assets. On a price/earnings basis, VIAC shares trade at 6.3x estimated 2021 earnings of $4.62 (estimate is unchanged from last week). ViacomCBS shares offer a sustainable 3.3% dividend yield and look attractive here. BUY
SPECIAL SITUATION AND MOVIE STAR PORTFOLIO
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. Acquired by French insurer AXA in 1992, Equitable began its return to independence with its 2018 initial public offering as part of a spinoff. AXA currently owns less than 10% of Equitable. With its newfound independence, Equitable is free to pursue new opportunities.
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. While this year’s profits will decline about 9% due to higher mortality costs, they will likely recover sharply next year. Equitable expects to continue delivering a 50-60% payout ratio through dividends and share repurchases.
EQH shares rose about 2% this past week and have about 53% upside to our 28 price target. The shares still trade below their 20 IPO price. Part of the weakness is likely due to the sloppy equity markets, which may pressure the value of the company’s investment portfolio, and thus its book value. However, the company seems to have a fairly effective hedging program that would mitigate much of the effect of any market downturn. We also note that the fixed income markets remain an anchor of stability. However, investors hoping for rising interest rates saw much of that hope dashed by the Fed’s new priority, which has been described as “low rates forever”. Higher interest rates would increase the profitability of Equitable’s insurance book, so the dimming prospects for higher rates is weighing on the shares, as well.
Like many insurance companies, investors often value Equitable on a book value basis. On this basis, EQH shares trade at 64% of its $28.68 tangible book value, a considerable discount. We note that the book value will likely move around some in the third and fourth quarter, depending on the timing of the mark-to-market of its private equity investments and other factors.
EQH shares are also undervalued on earnings, trading at 4.1x estimated 2020 earnings of $4.42 (estimate is unchanged from a week ago). While the shares may trade in sync with the overall stock market, given its investment-driven operations, we see more upside than downside. The shares offer a 3.7% dividend yield. 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.
If California bans gas-powered vehicle sales as proposed, it would significantly depress demand for gasoline, and thus reduce the volumes of oil that are refined. The resulting excess capacity would drag down refining margins and profits for most of the country’s refiners, like Marathon. As noted in our GM comments, we think this proposed ban is highly unlikely to happen, but points to an eventual future free of gas-powered vehicles, even if that future is decades away.
MPC shares fell about 5% in the past week. Although the shares have 39% upside to our 41 price target, the uncertainty around the margin outlook keeps us, for now, from raising the shares to a Buy rating.
The shares will continue to trade near-term around the pace of the re-opening of the economy, on oil prices and refiner margins, and possibly on any hurricane-related sentiment (the season technically runs until November 30).
The shares trade at 9.6x estimated 2022 earnings of $3.08. That year would be a reasonable proxy for “normalized” even though it is two years away. Estimates are for a loss of $(3.51) this year and a profit of $0.33 in 2021. Both years’ estimates continue to decline as the recovery is being pushed out.
Like most energy stocks, MPC offers a useful vehicle for traders: its economics are closely tied to oil prices yet the company has stabilizing operations like its refining and MPLX midstream businesses. The large and pending cash inflow from the Speedway sale provides additional balance sheet stability and downside protection relative to most other energy companies. The 7.9% dividend yield looks reasonably sustainable. HOLD
