While pulling back a bit from the sharp jump on Monday, November 9th, the market rebounded on additional encouraging Covid vaccine results this week. While it is impossible to accurately predict the producer, timing, effectiveness and uptake of a vaccine, it is becoming clearer that scientists are getting a handle on Covid. Investors find this rightfully encouraging and are bidding up the shares of likely post-pandemic winners, particularly those traditionally labeled “value” stocks. Recent comments from president-elect Biden calling for additional relief packages adds fuel to the market’s enthusiasm.
While these unloved stocks are surging, mega-cap pandemic-oriented winners have stalled. Since their peak on September 2, the FANGMAN stocks (Facebook, Apple, Netflix, Google, Microsoft, Amazon, Nvidia) have slipped an average of 7%. Despite the outsized weight of these stocks, the S&P 500 has held its value (unchanged) while an equal-weighted S&P 500 index (as opposed to market cap weighted) has gained nearly 8% over the same period.
The stunning revival of value stocks has removed much of their appeal. In recent weeks, we have taken the opportunity to exit some stocks that have reached our price targets.
However, many stocks continue to look attractive. One such company is Cisco Systems (CSCO), our new recommendation this week. Cisco is an undervalued tech equipment and services giant with a new leadership team working to rejuvenate its revenue growth. The shares remain down year-to-date, and offer a low-valuation/high-dividend-yield antidote to the FANGMAN stocks. Read more about this company in our note below.
Share prices in the table reflect Tuesday (November 17) closing prices. Please note that prices in the discussion below are based on mid-day November 17 prices.
Note to new subscribers: You can find additional color on recent earnings and other news on recommended companies in prior editions of the Cabot Undervalued Stocks Advisor on the Cabot website.
Send questions and comments to Bruce@CabotWealth.com.
Upcoming Earnings Releases
December 10: Broadcom (AVGO)
THIS WEEK’s Portfolio changes
Cisco Systems (CSCO) – new Buy
General Motors (GM) – from Buy to Hold
Universal Electronics (UEIC) – from Hold to Sell
Marathon Petroleum (MPC) – from Buy to Sell.
LAST WEEK’S PORTFOLIO CHANGES (November 11 letter)
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
GROWTH/INCOME PORTFOLIO
New Buy: Cisco Systems (CSCO) is a $48 billion (revenues) technology equipment and services company. About 72% of revenues are from equipment sales. Its Infrastructure Platforms segment produces routers, switches and other gear that connect and manage corporate, government, telecom and other data and communications networks. The Applications segment offers a range of software and related services with a growing emphasis on cloud migration. The Security segment provides a full suite of network, email and cloud software and services to control access and minimize external threats. Cisco leverages its one-stop-shop breadth of products, software and services to provide customized packages that match each customer’s needs.
Founded in 1984, Cisco emerged as a dominant provider of internet gear, becoming one of the Silicon Valley tech darlings during the late 1990s dot-com bubble.
However, due to its then-extreme overvaluation, as well as stagnant revenue growth (essentially zero growth in the past eight years), Cisco’s share price is now only about half its March 2000 peak. In recent years, the company’s core business has struggled against the rising adoption of cloud computing, which reduces the need for Cisco’s gear. CSCO shares remain down 12% year-to-date and down 25% from their recent high in mid-2019.
Cisco’s prospects are starting to improve, with changes that started at the top. In 2015, the company promoted veteran Chuck Robbins into the CEO role, starting a slow but steady process to reinvigorate its operations. A new CFO, Scott Herren, who previously helped lead a rebuilding of Autodesk in ways very similar to what Cisco is doing, will start in December.
Cisco is accelerating its efforts to remain relevant and increase its value. To provide more recurring revenues and reduce its dependence on one-time equipment sales, Cisco is shifting its business mix to a software and subscription model. Progress is encouraging, with 78% of software now sold on a subscription basis, compared to 71% only a year ago. Software sales are a source of growth (albeit slow) and now comprise 28% of total revenues.
A critical source of stability is Cisco’s strong reputation and its entrenched position within its customers’ infrastructure. As long as it can stay close enough to competitors’ offerings, the company should retain these valuable intangible assets.
The company has ramped up its cloud-based offerings after lagging in this critical category. Also, its Webex video conferencing (like Zoom, only more secure, robust, and innovative) has 600 million participants in the most recent quarter, nearly twice the March level. Overall, the cadence of new products and services across the board appears to be accelerating under Robbins’s leadership.
Financially, Cisco is highly profitable. Its adjusted gross margin is wide, at about 65%, and its net profit margin at nearly 27% is impressive. The company produced $15.4 billion in cash flow from operations last year (fiscal year ended in July) and will likely repeat that rate in the current year. This strength supports share buybacks and a generous dividend that yields 3.4%.
Its balance sheet carries $30 billion in cash, double the $14.6 billion in total debt. This cash hoard may be utilized to make acquisitions or to accelerate its share repurchase program. In per-share terms, the excess cash of about $3.55/share is equal to over 8% of Cisco’s market capitalization.
Cisco clearly has its challenges. While second quarter guidance points to a 1% revenue decline, revenues fell 9% in the most recently completed first quarter. Cisco has a lot of work to do to convince investors that it can successfully navigate the secular changes in technology gear demand, along with overcoming near-term signing delays due to the pandemic.
While the shares jumped about 8% in the past week on stronger than expected first quarter results and on the shift by investors into value stocks, CSCO shares remain undervalued, trading at a low 13.6x earnings and 9.3x EV/EBITDA. The generous dividend yield and fortress balance sheet provide considerable valuation support. As the market recognizes the company’s improving transition, we believe the shares should trade at our 55 price target. 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 the MyoKardia acquisition.
Like most biopharma companies, Bristol frequently issues news releases regarding its various treatments. Unless they either meaningfully strengthen or weaken our view on the company, we likely won’t comment on them here.
Bristol recently reported encouraging third quarter results, with adjusted per share net income rising 39% from a year ago and about 10% above consensus estimates. Revenues were also 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. Cash flow remains robust. Debt net of cash has increased again, as the $13.1 billion cash acquisition of MyoKardia was completed on Tuesday, November 17. Overall, the company is making good fundamental progress and its shares remain undervalued.
The company received an endorsement from Berkshire Hathaway, which reported a new 1.3% position in BMY shares. Otherwise, it was a quiet news week.
BMY shares were flat in the past week. The shares have about 21% upside to our 78 price target.
The stock trades at a low 8.6x estimated 2021 earnings of $7.47 (estimate up 1 cent 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 5% in the past week. The stock has about 8% upside to our 410 price target.
The shares trade at 17.3x estimated FY2020 earnings of $22.02 and 15.1x estimated FY2021 earnings of $25.21. Both estimates ticked down slightly in the past week. The shares pay a 3.4% dividend yield. HOLD
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 $5 billion acquisition of Costa Coffee in January 2019, while perhaps ill-timed only a year in front of the pandemic, still offers considerable potential. It added nearly 3,900 coffee shops throughout Europe, China, India, and the Middle East, giving Coca-Cola a valuable entre into coffee as well as a new channel to expand its distribution.
To improve its global operations, Coca-Cola is reorganizing to become more effective and more efficient. The former 17 business units are being concentrated into nine operating units, with a stronger emphasis on building the connections between these units. Product category teams will focus on improving marketing as well as introducing new and innovative beverages. Innovation efforts will be more clearly driven by their ability to either significantly increase the number of new drinkers, their frequency of consumption, or the value (profit) per consumption. The company is also culling its vast portfolio of over 400 brands by 50% to focus on its highest-priority offerings.
To capture more of the value of Coca-Cola’s vast global scale, back-office administrative services are being centralized and standardized across the system. A sizeable round of staffing reductions (about 4,000) should lead directly to lower costs, as well.
All of these changes should accelerate the number and success rate of new products while expanding the overall profits of the company.
While Coca-Cola has much more ground to cover to improve its image (and reality) of selling sugar-intensive beverages that are packaged in environmentally-insensitive plastic, the company is accelerating its efforts. Eighteen of its top 20 brands, including Coke Zero, are now either low/no sugar or offer a low/no sugar option, with 29% of its total volume now in low/no sugar beverages. The company’s packaging has risen from only 3% recyclable to 88% recyclable, with many additional programs in place to further improve.
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 3.1%.
Recent results point to a recovery from pandemic-depressed volumes. While second quarter global volumes fell 16%, and revenues fell 28%, third quarter volumes fell only 4% while revenues were only 9% below the prior year. Management commentary points to continued improvements in October. Third quarter revenues and profits were higher than consensus estimates, suggesting that investors don’t fully appreciate the strength of the company’s fundamentals.
Impressively, Coca-Cola’s comparable operating profit margin increased to 30.4% from 28.1% a year ago, despite lower revenues. When the higher-margin away-from-home business returns when restaurants, stadiums, and other venues re-open, the company’s margins could expand further. Comparable earnings per share fell only 2% compared to a year ago.
While near-term outlook is clouded by pandemic-related stay-at-home restrictions, the secular trend away from sugary sodas, high exposure to foreign currencies, and always-aggressive competition, the longer-term picture looks bright.
KO shares are not statistically cheap at 25x 2021 estimated earnings, but they are undervalued. They remain about 11% below their February 2020 high, while the company has arguably become more valuable.
There was no significant news this week for Coca-Cola. KO was featured as the Cabot Stock of the Week on Monday.
KO shares slipped 1% in the past week. The stock has about 20% upside to our 64 price target.
The shares trade at 25.3x estimated 2021 earnings of $1.89 and 23.0x estimated 2021 earnings of $2.11. The shares pay a 3.1% dividend yield. BUY
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 was encouraging: per share earnings fell 45% 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 no news on Dow in the past week.
Dow shares rose about 1% this past week and have about 11% upside to our 60 price target.
The shares trade at a 17.1x estimated 2022 earnings of $3.16, although this is two years away. This estimate rose 2 cents this past week.
Valuation on estimated 2020 earnings of $1.40 is less meaningful as this assumes no recovery.
The high 5.2% 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’s products are generally in the stronger segments of this currently healthy market.
Earlier this month, 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.
MKSI shares 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. We recently moved the shares to a Sell. The stock surged nearly 16% on the Pfizer Covid vaccine news, approaching our 43 price target. Total is doing many things right, but is also 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). At the sell date, Brent oil prices were about $43.50 – not much margin for error.
The shares 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 reported good fourth quarter results on Monday. Revenues of $11.5 billion rose 5% from a year ago, while per share earnings of $1.81 were 50% higher than a year ago. Both numbers were ahead of consensus estimates, with earnings vastly higher (+52%) than the consensus estimate of $1.19. Overall volumes increased 6% while pricing was down about 1%.
Much of the sales growth was driven by the calendar quirk that put an extra week into Tyson’s fourth quarter compared to the year-ago quarter. Adjusted for this, sales fell 2%, with volumes down about 1.5% and prices down about 0.5%. Revenues from stronger beef (+3%) and pork (+1%) offset weaker chicken (-8%) and prepared food (-2%) sales. Beef sales were helped by a favorable comparison to a year-ago production facility fire, while chicken prices fell 6% due to the glut of product.
The adjusted operating profit margin of 9.0% was considerably stronger than the year-ago 6.3% margin. But for $200 million of direct Covid costs, margins would have been another 1.7 percentage points higher. The wider margins were driven by favorable pricing in beef and pork.
Tyson provided guidance for 1.4% sales growth in fiscal 2021, with more normal (slower) growth in beef and pork but some recovery in prepared foods. Chicken segment profits will likely remain subdued, but new leadership there should help results. Possibly higher grain and freight costs will be at least partly offset by efficiency-boosting programs. Overall, it looks like Tyson’s annual earnings power is around $6.25/share, better than the $5.64 for fiscal 2020 and higher than most pre-Covid years.
The company raised its dividend by 6% to $0.445 per quarter. Tyson repaid about $690 million in debt, helping trim its already-reasonable leverage.
Tyson’s recovery will remain volatile from quarter to quarter but is on the right track.
The shares rose 6% in the past week to the high side of its 58-65 trading range. The stock has 17% upside to our 75 price target.
With its fiscal year now completed (ended Sept 3), we look to fiscal 2021 results. On this basis, Tyson currently trades at 11.3x estimated 2021 earnings of $5.70. This estimate ticked down 3% in the past week. Currently the stock offers a 2.6% 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.
We are moving Hold-rated UEIC shares to a Sell, as the shares have surged to about 4% above our 47 price target. We see limited near-term risk to Universal but are reluctant to raise our price target either. For investors who purchased the shares at their recommendation price of 57 over four years ago, the 14% loss has no doubt been frustrating. For more recent buyers, the gains have been robust.
More color on our rationale: While its third quarter results were mildly encouraging, the company continues to struggle with revenue growth (down 24% in the quarter). Its guidance for only an 11% decline in the fourth quarter is a positive but largely factored into the shares at this point.
At 11.4x a generous 2021 consensus estimate of $4.30 in earnings, the stock is no longer cheap. Also, Universal excludes from its adjusted costs some sizeable expenses that we believe are legitimate costs. This weakens our confidence in the company’s earnings base and thus its valuation. There is no guarantee, of course, that the stock has topped out, but from here, we see more risk than reward. SELL
Voya Financial (VOYA) is a U.S. retirement, investment and insurance company serving 13.8 million individual and institutional customers. Earlier this month, we moved our rating on Voya to a Sell. We are disappointed in the chronically low quality of its earnings. The company’s 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 most recent 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 20% 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. And the paltry 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 isn’t completed for some reason Voya would be tainted.
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. Fourth quarter outlook was also discouraging, helping produce a sharp decline in the stock.
The company said that orders continued to strengthen in the fourth quarter, raised its cost-cutting goal to $100 million this year, and announced personnel changes in several key operational roles. Columbia’s balance sheet remains solid.
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.
There was no meaningful news regarding the company this past week.
Columbia’s shares rose 3% this past week. The shares have about 20% more upside to our 100 price target.
The shares trade at 22.2x 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. Our October 14th note has more color on AllianceBernstein.
Equitable’s third quarter results were good, with adjusted per share earnings falling 9% but were 5% higher than consensus estimates. 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.
The company is 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.
There was essentially no news on Equitable this past week.
EQH shares fell about 1% in the past week and have about 14% 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 92% of its $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 $4.53 (up about 1% from a week ago). The shares offer a 2.8% dividend yield. 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, with adjusted earnings increasing 65% from 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. 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. However, the company discouraged investors from extrapolating these strong results as costs and cash flow demands will increase in the fourth quarter. Yet its 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.
The company continues to make progress with its impressive array of electric and autonomous vehicle initiatives.
GM’s balance sheet is sturdy, with Automotive segment cash exceeds Automotive debt again. GM Financial’s capital position remains sturdy.
Last Friday, GM warned that it is recalling almost 69,000 all-electric Bolt cars (all 2017-2019 models) due to a software glitch that may ignite the battery. The company appears to have found the underlying cause, and fires occurred in only five cars, so the effect on future sales would seem to be minimal. Also, GM is slowing production at several factories due to parts shortages. We see the shortage as a temporary issue although it bears watching.
This past week, GM shares rose about 3%, and have gained about 67% since the end of June. The stock has about 7% upside to our 45 price target.
GM shares trade at 8.9x estimated 2020 earnings of $4.77 and 7.2x estimated 2021 earnings of $5.84. The 2020 estimate slipped modestly this past week while the 2021 estimate increased modestly. With the price surge, we are reducing our rating to HOLD
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.
We are moving MPC shares to a Sell as the shares have essentially reached our price target. MPC stock has surged 37% this month. While industry conditions and outlook have improved, much of that improvement is already factored into our price target. And, conditions improved from being heavily depressed to being only depressed. For at least the near-term and possibly the next year, there is considerable risk that conditions don’t actually improve much from here, and they may deteriorate. We note that consensus estimates are starting to tick down again. Also, there is heightened regulatory risk from the change-over in the U.S. presidency.
We recognize that there is also a chance that industry conditions improve a lot further. The future is of course unknowable, so with the shares no longer selling at a large discount, our valuation-driven edge has faded. SELL
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, indications of new revenues from alternative beverages, as well as resilience/recovery in its core beer volumes, would be positive. 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 3.1% yield on the current price.
Molson Coors recent results showed that the company is making progress with its turnaround and that investors underestimate this progress. Net revenues fell 3.1% but were about 4% better than consensus estimates. Adjusted per share earnings were nearly 60% better than estimates. Underlying EBITDA was 1% higher than a year ago and 26% higher than estimates.
The company produced generous cash from operations and reduced its debt in the quarter. In many ways, these are the two most important statistics for the Molson Coors story.
There was essentially no news regarding the company this past week.
TAP shares rose 5% in the past week and have jumped about 40% from their September and October lows. The shares have about 31% upside to our 59 price target.
The shares trade at 10.7x estimated 2020 earnings of $4.21 and 10.8x estimated 2021 earnings of $4.17. Both estimates ticked up from last week. These valuations are low.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 8.1x 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 fully recognized by the market. 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 was previously 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. 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. 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.
Unusual expenses totaling $52 million weighed on the quarter, but likely won’t hold back future results. The settlement of its Alabama termite litigation removes a legal and financial overhang on the shares. Along with its new focus on pest control, its new and capable CEO, and its clean balance sheet, the outlook for Terminix is improving.
There was essentially no news regarding the company this past week.
Terminix shares rose about 5% in the past week and have 15% 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 30.9x, but we recognize that these types of companies are generally valued on EV/EBITDA. On this basis, the shares trade at about 17.4x 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’s 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’s extensive reach, strong market position, 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 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 are 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 may 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.
There was essentially no news regarding the company this past week.
VIAC shares rose about 9% this past week and have about 31% 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 7.6x estimated 2021 earnings of $4.34 (estimate slipped 1% from a week ago). ViacomCBS shares offer a sustainable 2.9% dividend yield and look attractive here. BUY
