Just like that, the stock market emerged from its dark mood of October 30th to surge 8.6% in six trading days, with reinvigorated optimism following the evaporation of the election cloud and news of a very promising Covid vaccine.
Yesterday’s shift in sentiment was earth-shaking. Value-oriented sectors like energy (+14.3%) and financials (+8.2%), long in the market’s trash bin, crushed the high-momentum communications (-.9%) and technology (-.7%) sectors in what was nearly a single-day record for the divergence. The spread in performance might stand out if it happened over a full year. Interestingly, performance of all of the other seven S&P 500 sectors held within a narrow band of +3.4% to -0.3%. The equal-weighted S&P 500, in which all stocks are weighted the same, unlike the S&P 500 Index in which stocks are weighted according to their market caps, gained 4.3%.
While the lifting of the election overhang no doubt helped, most of the performance spread was almost certainly due to the news that Pfizer’s Covid vaccine appears to be 90% effective in clinical trials. This is a remarkable achievement. However, there is a lot of ground to cover between these trials and everyone returning to fully liberated activities without masks. Even if we have green lights the entire way, it might take a year or more. A lot can happen in that time – related to the pandemic or any other of a long list of possible changes and disruptions. Nevertheless, this news is exceptionally encouraging.
We took the opportunity to pocket some profits on the price spike. The Sells were based almost solely on price targets, although with Voya we lost some confidence in the numbers that investors use to value the shares (the company otherwise remains in good shape).
This week we added a new Buy recommendation, Coca-Cola (KO), which would greatly benefit from a re-opening of the world’s economies as well as operating and strategic improvements led by its relatively new CEO.
With the shrinkage of the “Growth Portfolio” to two stocks, we are combining that group with the “Growth and Income Portfolio”, with a new name of “Growth/Income Portfolio.”
Share prices in the table reflect Tuesday (November 10) closing prices. Please note that prices in the discussion below are based on mid-day November 10 prices.
Send questions and comments to Bruce@CabotWealth.com.
Upcoming Earnings Releases
November 16: Tyson Foods (TSN)
THIS WEEK’s Portfolio changes
Coca-Cola Company (KO) – new Buy
MKS Instruments (MKSI) – from Hold to Sell
Total S.A. (TOT) – from Hold to Sell
Universal Electronics (UEIC) – from Buy to Hold
Voya Financial (VOYA) – from Buy to Sell
Equitable Holdings (EQH) – from Strong Buy to Buy
General Motors (GM) – from Strong Buy to Buy
Molson Coors (TAP) – from Strong Buy to Buy
Marathon Petroleum (MPC) – from Buy to Hold
LAST WEEK’S PORTFOLIO CHANGES (November 4 letter)
Columbia Sportswear (COLM) – from Hold to Buy
Marathon Petroleum (MPC) – from Hold to Buy
GROWTH/INCOME PORTFOLIO
NEW BUY:
Coca-Cola (KO) is one of the world’s largest beverage companies. While it is best known for its iconic soft drinks, the company has a strong portfolio of non-soda brands, including PowerAde, Fuze Tea, Glaceau, Dasani, Minute Maid and Schweppes. Nearly 40% of its revenues now come from non-soda products across the non-alcoholic spectrum, including juice/dairy/plant beverages, water/hydration drinks, tea and coffee, and energy drinks.
Its global distribution system of 30 million customer outlets offers it the capability of reaching essentially every human on the planet. This allows it access to growing emerging countries where its market share has considerable potential to expand.
Relatively new CEO James Quincey, who took the helm in 2017, is a highly regarded company veteran with a track record of producing profit growth and making successful acquisitions. The January 2019 acquisition of coffee shop chain Costa Coffee, while perhaps ill-timed only a year in front of the pandemic, still offers considerable potential.
To improve its global operating efficiency, Coca-Cola is reorganizing its business unit structure, creating nine operating units, integrating its platform of services to leverage its skills and costs, and culling its vast portfolio of over 400 brands to focus on its highest-priority offerings. To help improve its image among customers and investors, the company is stepping up its environmental and sustainability efforts while also working to reduce sugar consumption.
Coca-Cola has a sturdy balance sheet, with its $53 billion in debt well-covered by cash flow and partly offset by over $21 billion in cash/equivalents. Its $0.41/share quarterly dividend is also well-covered by solid free cash flow, and the company is committed to growing this dividend. It is targeting a 75% payout (of free cash flow) over time. The dividend yield is currently a respectable 3.0%.
Third quarter results, which were depressed by pandemic-laden volumes, were nevertheless encouraging, with revenues and earnings coming in higher than estimates, suggesting that investors don’t fully appreciate the company’s fundamentals. While near-term outlook is clouded by pandemic-related stay-at-home restrictions, the secular trend away from sodas, high exposure to foreign currencies and always-aggressive competition, the longer-term picture looks bright.
KO shares remain about 12% below their February 2020 highs, while the company has arguably become more valuable. We are placing a 64 price target on the stock, about 18% above the current price. BUY
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.
Like most biopharma companies, Bristol frequently issues news releases regarding its various treatments. Unless they meaningfully either strengthen or weaken our view on the company, we likely won’t comment on them here.
On Thursday, Bristol reported encouraging third quarter results. Adjusted per share net income of $1.63 rose 39% from a year ago and was about 10% above consensus estimates. Revenues also were ahead of estimates and grew 6% pro forma for the Celgene and other transactions. Most of its key treatments produced good revenue growth. Bristol raised its full-year earnings guidance by an incremental 2% and reaffirmed its 2021 guidance of $7.30 (midpoint), which would produce about 16% earnings growth.
The company generated $2.2 billion in cash from operations and reduced its debt net of cash by $1.2 billion. Debt net of cash will increase again soon, however, with the $13.1 billion cash acquisition of MyoKardia. Overall, the company is making good fundamental progress and its shares remain undervalued.
BMY shares rose 4% in the past week. The shares have about 22% upside to our 78 price target.
The stock trades at a low 8.6x estimated 2021 earnings of $7.46 (estimate up 5 cents from last week). The 2.8% 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).
We don’t expect a 5G “supercycle” but healthy new iPhone purchases, helped by strong wireless telecom carrier support, will be supportive for Broadcom.
There was essentially no news last week from Broadcom.
AVGO shares rose 3% in the past week. The stock has about 13% upside to our 410 price target.
The shares trade at 16.5x estimated FY2020 earnings of $22.05 and 14.4x estimated FY2021 earnings of $25.22. The 2022 estimate ticked up a cent in the past week. The shares pay a 3.6% 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 three forces: 1) petrochemical prices, which are often correlated with oil prices and global growth, along with competitors’ production volumes; 2) volume of chemicals sold, largely driven by global economic conditions, and 3) ongoing efficiency improvements (a never-ending quest for all commodity companies to maintain their margins).
Dow’s third quarter earnings report (October 22) was encouraging with per share earnings down 45% from a year ago but well ahead of the consensus estimate. Operating EBITDA, a scrubbed measure of cash operating profits excluding the various charges and gains, fell 20% from a year ago, largely due to the weaker sales but partly offset by cost-cutting. Management commented that demand in China is basically back to pre-Covid levels, and provided an encouraging overall outlook.
Dow is making progress with its strategic goals. Free cash flow was healthy and, along with proceeds from asset sales, has allowed Dow to reduce its debt net of cash by 12%. This is fairly impressive given everything that has happened this year.
There was essentially news on Dow in the past week.
Dow shares rose about 9% this past week and have about 13% upside to our 60 price target.
The shares trade at a 16.9x estimated 2022 earnings of $3.14, although this is two years away. This estimate is unchanged for the week.
Valuation on estimated 2020 earnings of $1.40 is less meaningful as this assumes no recovery.
The high 5.3% dividend yield is particularly appealing for income-oriented investors. Dow currently is more than covering its dividend and management makes a convincing case that it will be sustained. However, there is a small risk of a cut if the economic and commodity recoveries unravel. HOLD
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.
On Monday, we moved MKS Instruments (MKSI) to Sell, as the shares touched our 130 price target. We don’t see any imminent problems with MKS, particularly given their favorable earnings report last week. However, we see little justification for raising our price target.
Based on mid-day Monday prices, MKSI shares have produced a 13% price return since our new coverage began on June 30. SELL
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 power generation, aiming for a strong position in a low-carbon world that they project could arrive by 2050.
On Monday, we moved TOTAL (TOT) to a Sell. The Hold-rated company saw its share price surge nearly 16% in mid-day trading, approaching our 43 price target. Total is doing many things right, but also is heavily exposed to commodity oil prices.
The dividend is very appealing, but perhaps half of it (we think if they needed to cut it, they would cut it in half, not fully suspend it) is at risk should oil prices stay below $40 (Brent). Even with the encouraging Covid vaccine news, Brent oil prices have rebounded to only $43.50 or so – not much margin for error.
Based on mid-day prices, the shares have produced a sizeable 40% loss since the initial recommendation in September 2018. While possible, we don’t see the shares having a high-enough chance of returning to the 60 price range in the foreseeable future to merit a continued Hold rating. Since our new coverage began on June 30, the shares have produced a flat total return. SELL
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. 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.
Tyson announced plans to expand its international production by building new plants in China and Thailand and expanding its Netherlands operations. This appears to be the first move by the new CEO and is consistent with the company’s global expansion strategy. Tyson reports earnings next Monday, with a consensus estimate of $1.19.
The shares rose 7% in the past week to the middle of their 58-65 trading range. The stock has 24% upside to our 75 price target.
Tyson currently trades at 12.0x estimated 2020 earnings of $5.03/share and 10.3x estimated 2021 earnings of $5.85. The 2021 estimate ticked down a cent in the past week. Currently the stock offers a 2.8% 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.
Universal’s third quarter earnings report was mildly encouraging. Adjusted per share earnings of $0.92 was slightly above the consensus estimate of $0.91. In making the adjustments, the company excluded several costs that arguably should not have been removed, including legal expenses to pursue a patent infringement suit against a competitor and costs related to relocating a manufacturing facility. These are normal costs for a tech manufacturer.
Nevertheless, using consistent adjustments, the company is making progress with cutting costs, as both its gross and operating margins expanded. Also, their efforts to produce higher-value controllers (clickers) seem to be helping them charge higher prices, and licensing revenues were likely higher, both of which have contributed to their wider gross margin.
Revenues were down 24% from a year ago (in line with estimates) as the company continues to struggle with returning to growth. A recurring trend during the pandemic is that fewer cable TV subscribers are switching their providers (they don’t want a cable technician in their home), so there are fewer change-overs in clickers. However, more providers are introducing self-install, which should lead to higher subscriber turnover and hence more clicker sales. Universal appears to be well positioned to benefit from this change. Also, Universal is developing clickers for use with streaming, over-the-top and other multi-input services that consumers are adopting.
Fourth quarter revenue guidance for an 11% year-over-year decline points to some tapering of the decline rate. Fourth quarter earnings guidance of $.98 (midpoint) is about 9% above 4Q 2019 results.
Universal continues to generate free cash flow, and its balance sheet has more cash than debt.
Improvements are coming, slowly, at Universal.
UEIC shares rose 14% in the past week, and have 7% upside to our 47 price target.
UEIC shares trade at 12.3x estimated 2020 earnings of $3.59 and 10.2x estimated 2021 earnings of $4.30. The 2020 estimate ticked up this past week while the 2021 estimate slipped by a cent.
The recent surge in its share price has reduced the upside potential such that we are moving the shares to a Hold. While there may be a larger opportunity on the horizon, we want to see more tangible evidence. HOLD
Voya Financial (VOYA) is a U.S. retirement, investment and insurance company serving 13.8 million individual and institutional customers. The company previously was the U.S. arm of Dutch financial conglomerate ING Group, from which it was spun off in 2013.
Voya reported a complicated quarter that was mildly disappointing. Adjusted earnings of $0.30/share were 62% below the year-ago result and well below the $1.38 consensus estimate. However, in addition to the usual plethora of charges relating to market and other assumptions, the company took additional charges relating to its insurance book. Excluding these charges, the company earned $1.19. The company guided to stronger fourth quarter earnings of $1.43/share, above the current consensus estimate of $1.39.
On Monday, we moved our rating on Voya to a Sell. We are disappointed in the chronically low quality of its earnings. Their practice of running above-industry-norms levels of charges through the income statement essentially suggests that investors should ignore these higher charges. And, even when ignoring these charges, the company didn’t meet consensus expectations in the quarter. Its guidance for the fourth quarter, while higher than estimates, could similarly be subject to so many adjustments as to make the results meaningless.
If we lose confidence in the earnings, we lose confidence in the valuation. The consensus estimate for 2020 fell to $3.01 due to the weak third quarter. Estimates for 2021 fell to $5.94 by two cents, not a meaningful number except that we now lack confidence in what that estimate actually means. On this murky 2021 estimate, the valuation of 8.5x becomes problematic.
The paltry 1.2% dividend yield provides little incentive to hold the shares.
While Voya has several appealing traits – it is well capitalized and migrating toward a capital-light model which should allow more share repurchases – these aren’t enough to offset the low earnings quality. We see little risk in its delayed sale of the life insurance book, but if this for some reason isn’t completed then Voya would be tainted.
We are moving Voya shares to a Sell. We don’t see any imminent risk, but see no reason to linger, either. The shares have produced an 8% total return since our new coverage began on June 30. SELL
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 disappointing third quarter results, with adjusted earnings per share down about 46% from a year ago and about 25% below the consensus estimate. Revenues fell 23% and were about 9% below estimates. Adding to investor frustration, the company’s fourth quarter outlook was discouraging: sales were guided to about 2% below consensus estimates and earnings were guided to about 20% below consensus estimates. The shares fell sharply on the news.
The company said that orders continued to strengthen in the fourth quarter, raised its cost-cutting goal to $100 million this year and announced the retirement/replacement of its chief operating officer and other senior operations executives. Columbia’s balance sheet remains solid, holding $315 million in cash and no debt, providing it with considerable financial flexibility.
As price-sensitive investors, we moved Columbia shares back to a BUY. Columbia’s long-term earning power appears unimpeded but is being pushed out into the future. Also, we think the company is being exceptionally conservative with its forward guidance, given the wide range of uncertainties and the danger that another significant “miss” would more severely damage their credibility.
Columbia’s shares rose 1% this past week. The shares have about 26% more upside to our 100 price target.
The shares trade at 21.1x estimated 2021 earnings of $3.77. The earnings estimate was unchanged from last week. For comparison, the company earned $4.83/share in 2019. 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.
AllianceBernstein shares (AB) are modestly attractive in their own right. Potential investors may want to wait for another share price pullback before starting/adding to AB positions. Our October 14th note has more color on AllianceBernstein.
This past week, Equitable reported good third quarter results, with adjusted per share earnings of $1.24, which was 9% below a year ago but 5% higher than consensus estimates. Group Retirement results were notably strong. Investment asset inflows were positive. Equitable added to its excess capital and liquidity base. Overall, while its large variable annuities book may be vulnerable to market pullbacks, the company continues to slowly but steadily prove its stability and strength while returning cash to shareholders.
As an insurance company, Equitable’s earnings have large adjustments to reflect changes in market and economic assumptions, as well as market hedges, that affect the present value of its future payouts. These adjustments can change significantly from quarter to quarter, but as long as the assumptions are conservative and the company has a strong capital base, the adjustments generally are not concerning. Such is the case with Equitable.
The company will likely continue its generous return of cash to shareholders, targeting a 50-60% of earnings payout ratio in the form of combined dividends and share repurchases. Its recently announced agreement to transfer the financial risk on $12 billion of its retirement-income annuities to Venerable Holdings will add additional flexibility to repurchase an incremental $500 million in shares in 2021, on top of their previous repurchase commitments. Book value per share, excluding intangibles, fell 7% to $26.63. Book value including intangibles rose 32% to $36.05.
EQH shares rose about 8% in the past week and have about 16% upside to our 28 price target.
Like many insurance companies, investors often value Equitable on a book value basis. On this basis, EQH shares trade at 91% of their $26.63 tangible book value, a modest discount. We note that the book value will likely move around some in future 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 5.4x estimated 2020 earnings of $4.50 (up about 1% from a week ago). The shares offer a 2.8% dividend yield. With the run-up in the share price, we are trimming our rating to 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. We would say it is perhaps 75% of the way through its gas-powered vehicle turnaround, and is well positioned but in the very early stages of its EV development. Its GM Financial operations are well-capitalized but may be tested as the pandemic unfolds. Near-term, the shares will trade based on progress with a federal stimulus plan, the pandemic, the general U.S. economic outlook, trends in light vehicle sales, its progress with alternative vehicles and of course its earnings.
GM produced a remarkable third quarter. Adjusted earnings of $2.83/share were 65% higher than the pre-pandemic earnings a year ago and nearly double the $1.43 consensus estimate. From a different perspective, the company’s revenues were the same as a year ago, but the $5.3 billion in adjusted operating profits was $2.3 billion, or 78%, higher. GM North America profits grew by $1.3 billion and GM Financial profits rose by $500 million. GM International, including China, and Cruise showed profit increases as well. The Automotive segment generated $9 billion in free cash flow, partly offsetting $7.6 billion in negative free cash flow in the first half of the year. Compared to the pandemic-stricken $(500) million loss in the second quarter, GM has produced a remarkable recovery.
The profit increase came partly from a favorable comparison against the labor strike a year ago, yet were also due to improvements in operating efficiency and higher pricing this year (including lower incentives), as new and used vehicle inventories have been low. Highly profitable truck sales have remained robust and GM gained market share in North America.
Inventories remain lean, as strong U.S. demand means that vehicles are often sold within a few days of arriving on dealer lots.
Much of GM Financial’s profit increase was driven by higher used vehicle prices as well as lower credit losses. Delinquencies fell to 2.9% from 4.2% a year ago.
GM’s balance sheet is impressive. Automotive segment cash exceeds Automotive debt again, after repaying about $5.2 billion in debt while actually increasing its cash balance in the quarter. GM Financial’s capital position remains sturdy.
On the conference call, GM discussed its impressive array of electric vehicle and autonomous vehicle initiatives. There are many – we won’t go through all of them here – so the key takeaway is that the company continues to aggressively develop its capabilities, and clearly has the necessary financial capacity. GM spoke only briefly about Nikola, saying that discussions continue. GM showed no interest in spinning off its alternative vehicle operations.
The company said it would likely reinstate its dividend in mid-2021. It also urged investors to not extrapolate the strong 3Q results, as costs and cash flow demands will rise in the fourth quarter and next year. Overall, the company’s outlook is for a strong 2021, with perhaps a return to the $6.50 earnings per share range that it would otherwise have earned this year.
This past week, GM shares rose about 15%, and have gained about 54% since the end of June. The stock has about 10% upside to our 45 price target. The target price implies 8.2x multiple on 2022 estimated earnings of $5.50.
GM shares trade at 8.5x estimated 2020 earnings of $4.83 and 7.1x estimated 2021 earnings of $5.71. The 2020 estimate jumped about 72% on the strong 3Q results and 4Q commentary. The 2021 estimate increased by about 19%. GM remains an attractive cyclical stock, but with the price surge, we are reducing our rating to 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.
Marathon reported encouraging third quarter results (on Nov. 2), with an adjusted net loss per share that was much better than expectations. Better refining margins and volumes, as well as strong cost-cutting, drove the results. The company gave encouraging fourth quarter guidance although it may have to reach to achieve it. Helping its outlook, Marathon is on track to reach and possibly exceed its $1.4 billion cost-cutting target. Its MPLX pipeline partnership is showing good performance, as well.
With its $16 -$17 billion in Speedway proceeds, plus about $1 billion in unrelated tax refunds, Marathon plans to pay down its debt to about $3-$4 billion, net of cash on hand, then use some of the remaining balance to repurchase its shares. We estimate that the company could repurchase 20-30% of its shares, depending on the share price, over the next year or two.
Our timing of raising MPC shares to a Buy last week turned out to be fortuitous (sometimes the word “lucky” is inserted here), as the shares have risen 15% since then. The shares now have 12% upside to our 41 price target.
MPC shares will trade near-term around progress on a federal stimulus plan, the pace of more vaccine updates, the economic recovery and gasoline/jet fuel consumption, on oil prices and on refiner margins. The reasonably strong likelihood of the Senate remaining in Republican control (the Georgia run-off elections in January will provide the final verdict) reduces the chances of meaningfully higher corporate income tax rates. We can’t adequately estimate the chances of a ban on fracking, given the murky regulatory nature of this practice.
The shares trade at 14.1x estimated 2022 earnings of $2.59. This estimate slipped about 8% from a week ago. The 2022 estimate is a reasonable proxy for “normalized” even though it is two years away. Estimates are for a loss of $(3.50) this year and a loss of $(0.83) in 2021. Both of these two estimates slipped lower this past week.
The 6.3% dividend yield looks reasonably sustainable unless economic conditions remain subdued for an extended period. Given the sharp recent gains and the new risk/reward trade-off, we are moving MPC shares to a 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 3.3% yield on the current price.
Molson Coors third quarter results (on Oct 29) showed that the company is making progress with its turnaround and that investors underestimate this progress. Net revenues of $2.75 billion fell 3.1% from a year ago, but were about 4% better than consensus estimates. Adjusted per share earnings of $1.62 were nearly 60% better than estimates. Underlying EBITDA of $713 million was 1% higher than a year ago and 26% higher than estimates.
The company produced generous cash from operations and reduced its debt by $266 million. In many ways, these are the most two important statistics for the Molson Coors story – if cash flows and debt repayment remain healthy, eventually the company’s underlying value will become obvious to the market, as will its ability to pay a respectable dividend.
TAP shares rose 9% in the past week and have jumped about 28% from their September and October lows. The shares have about 39% upside to our 59 price target.
The shares trade at 10.1x estimated 2020 earnings of $4.18 and 10.2x estimated 2021 earnings of $4.16. Both estimates rose from last 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, 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. With the recent price move, we are reducing the shares to a 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 5th.
Terminix shares fell sharply last year due to new disclosures about its legal liability from deficient termite treatments. These liabilities will likely cost the company upwards of $100 million or more.
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. In August, Brett Ponton, former head of Monro (MNRO) joined as the new CEO. 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 reported third quarter adjusted per share earnings of $0.26, on revenues of $512 million. Revenues increased 10% from a year ago, with residential revenues increased 4% while commercial revenues fell 3%. Acquired franchises and European franchises provided growth as well. Adjusted EBITDA of $98 million was healthy.
The quarter had several unusual expenses, including $3 million for ServiceMaster costs that will be going away and a $49 million change for an important settlement of its Alabama termite litigation. This settlement, along with reasonably estimated future costs, should “ringfence” the company’s exposure. Assuming no other new claim groups, this issue (which gave us the buying opportunity in the shares) appears to now be resolved.
With its sole focus on pest control, a capable new CEO making operational improvements, a litigation overhang removed and a clean balance sheet, the outlook for Terminix is improving.
Terminix shares fell by about 4% in the past week and have 23% remaining upside to our 57 price target.
Reliable consensus earnings estimates are not yet available, but we anticipate that 2022 estimates will settle at around $1.60/share. This would put the TMX multiple at a high 29.0x, but we recognize that these types of companies generally are valued on EV/EBITDA. On this basis, the shares trade at about 16.4x 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 sub-par 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
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.
Viacom reported a reasonably good third quarter, with adjusted profits of $0.91/share down 17% from a year ago, but about 14% above consensus estimates. Revenues fell 9% but were slightly higher than estimates. Revenues were weakened by the 33% drop in content licensing. Advertising revenues fell 6% but that was much-improved from the 27% year/year drop in the second quarter. Highly encouraging: affiliate revenues rose 10% - these are fees that the company receives from cable TV operators and similar distributors, as well as revenues from its new streaming services. Paramount Studio’s revenues fell to nearly zero due to closures of movie theaters.
Viacom is shifting away from advertising (currently about 36% of revenues) and affiliate fees (currently about 39% of revenues), toward content licensing – essentially renting its vast library of movies, TV shows and other content to third-party firms like Netflix and others. Viacom is building out its own streaming channel (Paramount+) and other new distribution channels, which are generally showing fast growth. Ultimately, we think the company should be acquired by a major competitor, given its valuable businesses and content library, as well as its bite-sized market cap of about $20 billion.
The company generated $1.4 billion in operating cash flow and $1.3 billion in free cash flow. The cost-cutting program is well underway and boosting cash flow. However, cash flow ultimately needs to be higher. So far this year, ViacomCBS has reduced its debt net of cash by about $1.5 billion, or 8%. Cash remains robust at $3 billion.
Expectations are low for ViacomCBS. We believe the turnaround will be successful but may take a while.
VIAC shares slipped by about 4% 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 the company’s impressive leadership and assets. On a price/earnings basis, VIAC shares trade at 6.6x estimated 2021 earnings of $4.38 (estimate slipped about 6% from a week ago). ViacomCBS shares offer a sustainable 3.3% dividend yield and look attractive here. BUY
