The stock market had a decent week, gaining about 5% since our last letter. While market commentators have ascribed a range of reasons for the strength, including new hope for a federal stimulus package, a growing consensus about the outcome of the presidential election, and perhaps some modestly increased optimism in what had become a sense that the economic recovery was faltering.
Any or all of these may be behind the market’s uplift – they make intuitive sense. But humans are uniquely programmed to find patterns and explanations where there may be none. There are so many players (both humans and machines) across the globe that move money in and out of stocks for countless reasons that most near-term market moves are just noise. Similarly, the noise provides us with no guidance about what the market will do this week, or next week.
This perhaps dismissive view of explanations for short-term market moves is a big reason why we use a valuation and price target discipline. Several of our recommended stocks had awful chart patterns in recent weeks. It’s easy to get either scared out or worn out of these types of positions. TAP touched lows not seen since the 2009 financial crisis, while EQH fell sharply in early September. However, TAP has rebounded to just below our “cost” and EQH has essentially fully recovered its losses. The valuation and price target discipline helped give us the conviction to sit tight or even add to our positions.
Some of our recommended stocks have continued to weaken and we are watching, as noted, their valuation and fundamentals closely to weigh whether they are worth keeping.
Other stocks, like Quanta Services, have fundamentals that appear stronger every time we look at them. We are generally reluctant to raise price targets but are considering an increase with PWR. The shares were highlighted in this week’s Cabot Stock of the Week (we included the expanded discussion in this letter).
The market is seeing accelerated deal activity. Morgan Stanley is acquiring Eaton Vance, electric utility NextEra approached Duke Energy about a combination and Advanced Micro Devices apparently is about to reach a deal to acquire semiconductor company Xilinx. All of these seem sensible. IBM announced a plan to spin off its tech services segment – we have our doubts about the value-creating chances of this, but it has legitimate potential.
Speculative deal activity is rising, as well. When sports and Hollywood figures launch trendy business ventures, our skepticism antennae are raised. News that basketball superstar Shaquille O’Neal is co-leading a SPAC (special purpose acquisition company) initially struck us as a prime example. Speculative new SPAC issues are coming at perhaps the most aggressive pace in living memory. Yet, we happen to be fans of Mr. O’Neal, and will readily admit that his business acumen is under-rated – shares of pizza chain Papa John’s International (PZZA) have surged since he joined their board of directors in March 2019.
This is a fascinating and profitable time to be an active investor in the stock market.
Share prices in the table reflect Tuesday (October 13) closing prices. Please note that prices in the discussion below are based on mid-day October 13 prices. Send questions and comments to Bruce@CabotWealth.com.
Upcoming Earnings Releases
October 22: Dow, Inc. (DOW)
October 22: Chart Industries (GTLS)
October 22: MKS Instruments (MKSI)
October 29: Columbia Sportswear (COLM)
October 29: Molson Coors Beverage Company (TAP)
October 30: Total S.A. (TOT)
TODAY’S PORTFOLIO CHANGES
Bristol-Myers Squibb (BMY) – from Hold to Buy
Terminix (TMX) – new Buy
LAST WEEK’S PORTFOLIO CHANGES (October 7 letter)
Bristol-Myers Squibb (BMY) – from Strong 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 our “Cabot’s 10 Best Stocks to Buy and Hold for 2020” report.
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.
Brokerage firm Credit Suisse raised their price target for GTLS to 80 from 72. Otherwise, there was essentially no news on the stock this past week.
GTLS shares rose about 4% in the past week and remains close to its year-to-date high. The shares have about 8% upside to our 79 price target.
The current valuation remains reasonable at 23.6x estimated 2021 earnings of $3.10 and 19.2x estimated 2022 earnings of $3.82. Estimates have ticked down this past week. We continue to like Chart’s prospects but are watching as it approaches our price target. 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.
MKSI shares rose 7% this past week, continuing their correlation with the Philadelphia Semiconductor Index (SOX). The shares have about 9% upside to our 130 price target.
Valuation remains reasonable at 15.2x estimated 2021 earnings of $7.83. The estimate is unchanged from last week. HOLD
Quanta Services (PWR), based in Houston, Texas, is a mid-cap provider of specialized engineering and technical services to the electrical power, telecom and natural gas pipeline industries. Over 65% of its revenues are produced from regulated electric, gas and other utility companies. Quanta emphasizes highly predictable, non-discretionary installation, upgrade, maintenance and repair contracts that provide it with a healthy flow of recurring revenues. While construction contracts produce about half of its revenues, these are primarily lower-risk transmission, distribution and substation projects that are essential to its customers.
Quanta’s strategic priorities emphasize growing its base business, increasing its margins and creating new growth platforms. It is migrating toward low capital-intensity contracts, helping reduce its risks. The company recently was awarded a major $6 billion, 15-year service contract to upgrade and maintain Puerto Rico’s national electric grid, which could add $0.25/share in annual earnings starting in 2021, along with the potential for performance-based profits and additional ancillary projects.
The company is well-positioned to benefit from growing demand for renewable energy, including solar, wind and hydro-powered electricity generation, as it provides critical services to integrate these into the power grid.
The company’s small (about 5% of revenue) telecom operations continue to grow sharply, with future growth prospects bolstered by the transition to 5G-based infrastructure.
The company is exiting its small but problematic Latin American operations, which should reduce a modest overhang on its share.
We like that the company has strong engineering roots (critical to maintaining its expertise and focus) and is led by long-time employees who have risen through the ranks, proving their capabilities along the way. Quanta was created by John Colson, who had joined PAR Electrical Contractors in 1971 as a young engineer carrying stakes for a survey team. Colson eventually became president and then owner of PAR, and in 1997 combined it with three other contracting firms to form Quanta Services. Quanta completed its initial public offering in 1998, grew rapidly from new contracts and over 200 acquisitions and is now an $11 billion (revenues) member of the S&P 500. The current CEO was president of a telephone pole line maintenance company when Quanta acquired it in 2001. An important component of the company’s strategy is ongoing training of its craft-skilled labor force.
Second-quarter results were encouraging. Per-share earnings of $0.74 were well ahead of the $0.47 consensus. While overall revenues fell 12%, the decline was expected by investors and driven by Quanta’s Pipeline and Industrial operations (about 32% of revenues). This segment has struggled with project cancellations and weaker demand from energy companies, but conditions appear to be stabilizing.
The company increased its operating margins, produced strong cash flow and increased its contract backlog. With the healthy first-half results, newly-raised full-year guidance and better conditions likely ahead, analysts have begun to increase their 2021 estimates again.
Quanta’s balance sheet is strong with only $1.4 billion in debt, which is partly offset by $531 million in cash. Net debt is a low 0.9x estimated 2021 cash operating profits. Recently, the company replaced its variable rate term loans with a low, 2.9% fixed rate note that isn’t due until 2030, providing considerable financial flexibility. The company’s growth and financial strength has allowed them to reduce their share count by 35% over the past six years. A new $500 million share repurchase authorization, in addition to a small $0.05/share quarterly dividend, should continue Quanta’s favorable use of surplus capital.
Primary risks include customer concentration (34% of revenues come from its top 10 customers), its fixed-price construction contracts and weak energy prices.
Quanta was featured on Monday as Cabot’s Stock of the Week. Also, it was favorably discussed in this past weekend’s Barron’s, highlighting its role in the shift to renewables, its revenue growth potential and its widening margins.
PWR shares moved up about 7% and continue to reach new highs. The stock has essentially reached our 61 price target, but given the fundamental strength of its operations we are reviewing this for a potential increase.
The stock trades at 18.2x estimated 2020 earnings of $3.35 and about 14.9x estimated 2021 earnings of $4.07. The estimates are unchanged in the past week. On estimated 2021 EBITDA, the shares trade at an 8.9x EV/EBITDA multiple. For now, despite its price relative to our target, we are retaining our Buy rating. 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 officially took the CEO role on October 3. Given his lack of industry experience but strengths in technology, we will be watching what changes he makes.
The price-fixing scandal continues to expand as the Department of Justice indicted six poultry industry officials last week. Our view is that the issue will weigh on the industry’s share prices until it is resolved, and that Tyson will not incur significant penalties or reputational damage, especially relative to Pilgrim’s Pride (its former CEO was indicted) and other companies that appear to be at the center of the problem. Tyson received a subpoena in 2019, and found that some of its employees apparently had been involved with price-fixing. The company voluntarily disclosed its findings to the investigators and is cooperating. Tyson’s current CEO was a senior Tyson officer during the alleged price-fixing time period, but we believe that he had no role, largely due to his having no industry ties (he came from the technology industry) and likely strong resistance to collusion.
TSN shares were unchanged this past week and are just above the bottom of their 58-65 trading range. The stock has 28% upside to our 75 price target.
Tyson currently trades at 11.7x estimated 2020 earnings of $5.01/share and 10.0x estimated 2021 earnings of $5.91. Both estimates are 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.
There was no meaningful news this week for UEIC.
UEIC shares rose about 4% in the past week, and have 19% upside to our 47 price target.
UEIC shares trade at 11.1x estimated 2020 earnings of $3.56 and 8.8x estimated 2021 earnings of 4.31. The 2020 estimate ticked down from last week.
We are patient for now with UEIC shares because of the larger opportunity on the horizon, potential for better results in the third and/or fourth quarters, 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. For Voya’s upcoming earnings report, we expect some higher costs related to Covid mortality and write-offs related to lower interest rates. We anticipate an update on the pending closing of its life insurance business. When completed, Voya will likely step up its share repurchases.
Voya shares were unchanged 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 25% upside to our 62 price target.
VOYA trades at 13.3x estimated 2020 per-share earnings of $3.73 and 8.3x estimated per-share earnings of $5.96. The 2020 estimate rose but the 2021 fell this past 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. We see most of these initiatives remaining intact after it completes the MyoKardia acquisition.
We are returning BMY shares to a BUY following its deal to acquire MyoKardia (MYOK), a biotech company, for $13 billion in cash. The 225/share price is a large 61% premium to MYOK’s prior closing price and a steep 210% premium to its year-end closing price of 72.89.
As we outlined last week, we have mixed views on this deal. We like Bristol’s efforts to acquire promising new treatments, but are wary of the very expensive price and its willingness to part with some of its cash hoard in the pursuit of growth that is speculative. The mavacamten treatment has tremendous promise but is not yet FDA-approved. Should the anticipated approval not arrive, Bristol may have wasted most of our $13 billion.
Our willingness to move to a Buy on BMY shares is due solely to the (relatively) small $13 billion cost, with emphasis on “relative”. Bristol has $34 billion in cash on hand and $47 billion in debt that is readily-serviceable by its vast free cash flow. For perspective, the $13 billion is about $5.77 per Bristol-Myers share. Had the purchase price been, say, $35 billion, our interest in BMY would evaporate and we would have moved it to a Sell.
As such, we are wary of further large deals that may be ahead for BMY.
BMY shares rose about 7% in the past week. The shares have about 27% upside to our (unchanged) 78 price target.
The stock trades at a low 8.3x estimated 2021 earnings of $7.41 (estimate fell one cent from last week). The generous 2.9% dividend yield is well covered by the company’s enormous $13.5 billion in free cash flow likely this year. 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).
Apple has unofficially disclosed, and will officially announce on Tuesday (after our publication deadline) four new 5G iPhones and perhaps other upgrades/new products. We are enthusiastic about the adoption of 5G telecom technology as it will eventually provide an entirely new range of as-yet-unpredictable new services. However, this might take another 5-10 years to fully roll out. This round of 5G phones will be helpful to Apple, and thus supportive of Broadcom’s chip sales. It won’t likely result in an immediate surge but perhaps more of a steady but initially modest tailwind.
AVGO shares rose 5% in the past week to new highs. The stock has about 8% upside to our 410 price target.
The shares trade at 17.3x estimated FY2020 earnings of $22.05 and 15.1x estimated FY2021 earnings of $25.20. Both estimates ticked up in the past week. The shares pay a 3.4% 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).
The company said its cost-cutting programs are on track, and that it will take a $500-600 million restructuring charge in the third quarter.
Brokerage firm Morgan Stanley raised their price target for Dow by 15% to 52, and commented on their optimism for stronger chemical prices next year as demand increases but supply growth peaks. Brokerage firm Jefferies modestly raised its estimates for Dow on encouraging signs of a global economic recovery.
Dow shares rose about 2% this past week and have about 23% upside to our 60 price target.
The shares trade at a reasonable 16.3x estimated 2022 earnings of $3.01, although this is two years away. Valuation on estimated 2020 earnings of $1.00 is less meaningful as this assumes no recovery, although we note that this 2020 estimate was only $0.85 last week.
The high 5.7% 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.
TOT shares remained unchanged this past week. Brent crude (the London-based benchmark) prices have settled in the $42 range after touching $43.50 late last week. Total’s shares have about 25% upside to our 43 price target.
TOT shares trade at 11.9x estimated 2021 earnings of $2.89 and 8.2x estimated 2022 earnings of $4.19. We would consider the 2022 estimate to reflect “normalized” earnings. The 2020 estimate ticked up in the past week but the 2021 estimate slipped slightly.
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 bounced off of 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
New Buy: Terminix Global Holdings (TMX) is both a new company and an old company. While the name “Terminix” is one of the largest and most widely recognized names in pest control, the company previously was obscured inside of the ServiceMaster conglomerate. With the sale of its ServiceMaster Brands operations recently completed, the company changed its name to Terminix and started trading under the TMX ticker symbol on October 5.
Founded in 1929, ServiceMaster expanded into carpet cleaning in 1952 (one of the nation’s first franchise businesses), eventually adding a wide range of home and commercial services including pest control, lawn/ weed control, maid services, disaster restoration and warranties. Following its go-private acquisition in 2007 by a private equity firm, ServiceMaster divested its TruGreen business and returned to public ownership in 2014.
However, despite numerous attempts and leadership changes to make it work, the diversified services model proved unsuccessful. A part-way step, the 2018 spin-off of the American Home Shield business as Frontdoor (FTDR), wasn’t sufficient. Further, the company failed to acknowledge costly litigation from deficient termite treatments that will cost the company upwards of $100 million or more. When this issue was disclosed to investors in 2019, the shares fell 40%.
In early 2020, the company fully addressed its problems by removing the CEO, announcing plans to divest its non-pest control operations, and ring-fencing the termite treatment liabilities. These steps should allow the company to put its difficult past behind it.
Two additional changes added considerable appeal to ServiceMaster: In August, Brett Ponton, former head of Monro (MNRO) joined as the new CEO. And, in September, the company announced a deal to sell the ServiceMaster Brands segment (all of its non-pest control operations) for a high $1.6 billion.
Ponton brings considerable public company CEO experience to Terminix. His leadership at Monro led to sales growth and a strong recovery in its share price. Our expectation is that he will bring sales growth, operational efficiency and integrity to Terminix, ultimately leading to a higher share price.
Terminix has stable and recurring revenues in a product that is not vulnerable to secular erosion. The services are generally recession-resistant although commercial services will likely remain weak until restaurants fully re-open. The company’s profit margins will expand from better operational efficiency, aided by the rollout of an upgraded technology platform.
We expect the newly focused company to generate annual sales growth in the 3-4% range over the next few years, in line with the industry. In the most recent quarter, the pest control segment reported modest revenue growth but expanding margins, and management guided for stronger revenue growth and margin expansion in the third quarter. The company also announced a new $400 million share repurchase program.
Terminix generates strong free cash flow and has a sturdy balance sheet. With the $1.1 billion in proceeds from its recent divestiture, Terminix repaid about $800 million in debt, including its expensive high yield bonds that otherwise would mature in 2024. The balance sheet currently has about $940 million in debt, partly offset by $600 million in cash. Total debt to cash operating profits is about 2.5x, very reasonable given its steady revenues and large cash reserves.
We are setting a 57 price target, about 30% higher than the current price. This is based on a 20x EV/EBITDA multiple on 2022 EBITDA of about $400 million. Peer company Rollins (ROL) trades at a high 44x multiple – a level we do not believe is likely for TMX. Reliable earnings per share estimates are not yet available, but we anticipate that 2022 estimates will settle at around $1.60/share. This would put TMX’s multiple at a high 27.5x, but we recognize that these types of companies generally are valued on EV/EBITDA.
Major risks include the possibility of new disclosures that would significantly increase the company’s litigation expenses, difficult industry competition that may exert pricing pressure, and possible execution risks by the new leadership. TMX shares carry more risk than typical CUSA stocks, but if its litigation and subpar margins are behind them, we see a clear path to a higher stock price.
With a reasonable valuation, solid balance sheet, renewed focus and better revenue and margin outlook, there is a lot to like about Terminix. BUY.
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.
There was essentially no news on Columbia in the week. We note that other apparel companies like Levi Strauss has strong earnings reports, suggesting that Columbia will have a similarly favorable report.
Columbia’s shares rose 3% this past week. The shares have about 8% more upside to our 100 price target.
The shares currently trade at 22.2x estimated 2021 earnings of $4.17. The earnings estimate increased by one cent from a week ago. 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
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. Equitable has continued its share repurchase program through the pandemic.
The news that Morgan Stanley is acquiring money manager Eaton Vance sent Alliance Bernstein’s shares surging 14% this past week. Combined with news that activist Trian Partners has taken a 9.9% stake in money managers Invesco and Janus Henderson Group, it appears that a round of industry consolidation may be underway.
AllianceBernstein’s shares (AB) are modestly attractive in their own right. While the recent price surge has removed much of their appeal, the company has several rare strengths: positive asset inflows that should produce organic revenue growth, meaningful cost-cutting opportunities, a low ~10% tax rate due to its partnership structure, and a highly-regarded research business that generates steady income and boosts the firm’s overall reputation. The valuation at about 10.7x estimated earnings is reasonable, and supported by a high 7.6% dividend yield. Some investors avoid AB due to its partnership structure which requires investors to report K-1 income on their tax returns. Also, the company distributes nearly all of its net income, so the dividend isn’t a fixed dollar amount.
We currently don’t expect much change in Equitable’s ownership stake in AllianceBernstein. Buying the remaining stake would be potentially expensive and may entail the loss of the favorable tax rates. And, Equitable receives steady cash flows with minimal capital requirements, so it may be reluctant to part with its stake.
There was essentially no other news on Equitable this past week. For Equitable’s upcoming earnings report, we expect some higher costs related to Covid mortality and write-offs related to lower interest rates.
EQH shares rose about 7% this past week and have about 36% upside to our 28 price target. The shares trade just above their 20 IPO price.
Like many insurance companies, investors often value Equitable on a book value basis. On this basis, EQH shares trade at 73% 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 quarters, 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 4.6x estimated 2020 earnings of $4.46 (estimate is up 4 cents 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 3.3% dividend yield. STRONG 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.
No definitive news has emerged yet on the outcome of the Nikola negotiations. We think that GM will likely retain the partnership but take a higher equity stake either directly or through some type of warrants.
GM’s sales in China increased by about 13% in the third quarter, the company’s first quarterly sales growth in the country in two years. In the United States, the National Highway Traffic Safety Administration is investigating three claims that GM’s Chevy Bolt, its all-electric vehicle, has a propensity to catch on fire.
This past week, GM shares rose about 5%. The stock has about 41% upside to our 45 price target. The target price implies 8.2x multiple on 2022 estimated earnings of $5.50.
GM shares trade at 11.9x estimated 2020 earnings of $2.67 and 7.0x estimated 2021 earnings of $4.57. Both estimates ticked up from a week ago. GM remains an attractive cyclical stock. 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.
There was essentially no news on Marathon Petroleum this week.
MPC shares rose about 2% 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.
MPC 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 9.5x estimated 2022 earnings of $3.09. That year would be a reasonable proxy for “normalized” even though it is two years away. Estimates are for a loss of $(3.76) this year and a profit of $0.12 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 8.0% dividend yield looks reasonably sustainable. HOLD
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 3.9% yield on the current price.
Brokerage firm Guggenheim upgraded TAP shares last week to a “Best Idea,” highlighting an improving longer-term outlook due to the Topo Chico and Yuengling joint ventures. The firm also wrote favorably about Molson Coors’ recession-resistant products and the shares’ compelling valuation. Guggenheim raised their price target to 62 from 58.
TAP shares rose 2% in the past week. The shares have about 66% upside to our 59 price target.
The shares trade at 9.8x estimated 2020 earnings of $3.62 and 9.1x estimated 2021 earnings of $3.89. The 2020 estimate held steady while the 2021 estimate ticked up a cent in the past week. These valuations are remarkably low.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 7.9x 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.
The recent announcement that Disney is accelerating the development of their streaming business may be weighing on Viacom’s shares.
VIAC shares slipped about 3% this past week and have about 55% upside to our 43 price target.
ViacomCBS shares trade at about 7.6x estimated 2021 EBITDA, which we believe undervalues the company’s impressive leadership and assets. On a price/earnings basis, VIAC shares trade at 6.0x estimated 2021 earnings of $4.60 (estimate ticked down from a week ago). ViacomCBS shares offer a sustainable 3.5% dividend yield and look attractive here. BUY
