Three Classic Quotes for the Coming Year
With the turn of the calendar only a few days ahead, just about every investor is mapping out their market views for the coming year. Some do this formally, like Wall Street brokerage firms who publish their opinions on where the S&P 500 and interest rates will finish next year and their outlooks for all sorts of economic and financial indicators. Others will informally develop their views and expectations for the coming year.
We, of course, have our view: +7% total return for the S&P 500, with value stocks outperforming growth stocks, and a modest uptick in inflation and interest rates. Our track record on predicting the market and the economy, however, is about as good as everyone else’s: it accurately reflects a quote by the highly regarded economist of the mid-late 20th century, Ken Galbraith, who said, “the only function of economic forecasting is to make astrology look respectable.”
Are the forecasts therefore worthless? We say: not at all.
Each person’s forecast tells them something very valuable: where their biases are. Wall Street analysts are clearly biased toward optimism. Currently, analysts at 14 of the largest brokerage firms all project that the market will have a positive year, despite the fact that about a third of the time the S&P 500 has a negative year. This down-year record excludes periods like 2020 which saw an intra-year 30% plunge. Some analysts expect returns of greater than 15% – quite a statement following the huge gains over the past few years – while other analysts have more pedestrian expectations for only a 1% increase.
Some individual investors share this penchant for optimism (“perma-bulls”), while others are perma-bears. I know one successful investor whose market expectations consistently range from “down 20%” to “end of the world.” Many will expect the next year to be a repeat of the current year, while others make detailed mathematical projections. Most everyone will probably be wrong, but the point is to know where each of our biases are.
The next part is equally important – looking not for justification that we may be right, but looking for where we will be wrong. Holding to an incorrect forecast (is this a redundant term?) in either direction can get us crushed. A quote attributed to Mark Twain captures the idea: “What gets us into trouble is not what we don’t know. It’s what we know for sure that just ain’t so.”
Broadly, investors expect a strong economy next year that brings with it another healthy stock market. Speculation is high. It’s easy to see why optimism is high and easy to follow the flow.
This reminds us of a quote from a classic baseball movie, “Field of Dreams.” In the movie, the legendary player Shoeless Joe Jackson coaches a young batter, Archie Graham, about what to look for on the next pitch:
Shoeless Joe Jackson: The first two were high and tight, so where do you think the next one’s gonna be?
Archie Graham: Well, either low and away, or in my ear.
Shoeless Joe Jackson: He’s not gonna wanna load the bases, so look low and away.
Archie Graham: Right.
Shoeless Joe Jackson: But watch out for in your ear.
So, for 2021, it’s OK to expect another strong market, but watch out for a few wild pitches and curve balls aimed at your head.
Share prices in the table reflect Tuesday (December 29) closing prices. Please note that prices in the discussion below are based on mid-day December 29 prices.
Note to new subscribers: You can find additional color on each recommendation, their recent earnings and other related news in prior editions of the Cabot Undervalued Stocks Advisor on the Cabot website.
Send questions and comments to Bruce@CabotWealth.com.
UPCOMING EARNINGS RELEASES
None in December.
THIS WEEK’S PORTFOLIO CHANGES
U.S. Bancorp (USB) – new Buy.
LAST WEEK’S PORTFOLIO CHANGES (December 16 letter)
No changes.
GROWTH/INCOME PORTFOLIO
New Buy Recommendation: U.S. Bancorp (USB) is a Minneapolis-based bank. With $540 billion in assets and a $70 billion market value, it is the one of the largest commercial banks in the country. Its focus is on consumer and commercial banking through its 2,730 branches in the Midwest, southwest and western United States. It also offers a range of wealth management and payments services. Unlike majors JP Morgan, Bank of America and Goldman Sachs, U.S. Bancorp has essentially no investment banking or trading operations.
Like many banks, U.S. Bancorp is out of favor with investors. The shares remain 22% below their year-end 2019 price as investors worry about a potential surge in credit losses due to Covid-related shut-downs as well as the profit-draining low interest rate environment. U.S. Bancorp’s third quarter non-performing assets (a measure of the dollar amount of assets that are not current with interest and principal payments) are 30% larger than a year ago. How high this balance ultimately climbs is unknown but investors are concerned that losses will accelerate once federal income support and stimulus funding is removed.
The bank’s capital level (technically, the Common Equity Tier 1 capital ratio, or CET1), fell to 9.4% of assets compared to the year-ago level of 9.6%. Its net interest margin was a modest 2.67% in the third quarter, compared to 3.02% a year ago. The bank generates profits on the difference between the interest rate it can earn on its lending and the interest rate it pays for its deposits. The low interest rate environment, driven by the Federal Reserve’s policy, is suppressing this difference. Given the Fed’s current guidance, low interest rates could be here for a long time.
However, U.S. Bancorp is one of the best-run banks in the country. Long known for conservative lending, its non-performing assets are only 0.41% of its total assets, lower than most peers and only modestly higher than a year ago. The bank has set aside reserves for bad loans equal to 2.61% of total loans – a remarkably high amount and equal to 6.3x its balance of non-performing assets. Unlike the prior cycle, where home mortgage lending produced industry-rattling losses, home mortgage lending today is a source of credit strength. While U.S. Bancorp’s capital ratio fell compared to a year ago, it remains robust, particularly given its sizeable credit reserves. Importantly, U.S. Bancorp maintains a tight cost control culture.
Overall, we see little risk to the bank’s financial health from the likely continued rise in credit losses.
While low interest rates compress the bank’s profits, we believe these profits are as weak as they are likely to get. Any increase in interest rates would help boost lending profits – an outcome that we believe is somewhat likely.
USB shares trade at a modest 11.4x estimated 2022 earnings of $4.05. On a price/tangible book value basis, USB shares trade at a not-modest 2.0x multiple, but this ratio ignores the value of its payments, investment management and other service businesses that have low tangible book values but produce steady and strong earnings.
We are assigning a 58 price target on USB, pointing to about 25% upside. The shares pay an attractive 3.6% dividend yield. Recent guidance from the Fed will allow banks to start repurchasing shares, although we don’t expect U.S. Bancorp to be active in buybacks until the third quarter of 2021 when visibility on credit losses is clearer. 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 which will likely remain intact with 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.
There was no meaningful news on the company this week.
BMY shares fell 1% in the past week and have about 27% upside to our 78 price target.
The stock trades at a low 8.2x estimated 2021 earnings of $7.47 (unchanged from last week). With its recently increased dividend, BMY now has a 3.2% dividend yield. This dividend is well-covered by the company’s enormous free cash flow. BUY.
Broadcom, Inc. (AVGO) designs, develops and markets semiconductors 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 moved Broadcom to a Sell on December 2, as the shares essentially reached our 410 price target. We see no imminent issues for the company, as it appears to be reasonably well-positioned in the chip market. The company seems committed to and capable of paying its generous dividend.
However, we see some meaningful risks. Broadcom’s more recently acquired businesses, like CA (Computer Associates) and Symantec, may create a drag on growth as well as a limit on AVGO’s earnings multiple. Broadcom’s strategy of paying down excessive debt is great for value investors, but for the company to inspire growth investors it needs to show an ability to produce faster revenue growth. But the balance sheet may preclude deals big enough to accomplish that for at least the next year or perhaps more, and acquisition targets don’t appear to be cheap, either. The Apple exposure is a risk given that that company has discontinued using Intel’s chips in favor of its own, and we wonder if this strategy puts RFIC chips at risk eventually.
While estimates for 2021 show modestly respectable revenue (+8.4%) and earnings growth (+15%), estimates beyond that are lackluster (at 4% and 7%, respectively, for 2022). While the company’s earnings report on December 10th could drive growth estimates higher, the risk/return from a stock price perspective is unfavorable.
And, given the shares’ valuation on both an absolute basis and relative to its peers, we are similarly reluctant to raise the price target from here.
Where could we be wrong? If the company is able to leverage its other businesses to sell more chips, and if it becomes well-positioned to benefit from 5G’s roll-out, the shares could drive considerably higher.
AVGO shares produced a 31% total return (including dividends) from both the December 2019 initial recommendation and since June 30, 2020. SELL.
Cisco Systems (CSCO) is a $48 billion (revenues) technology equipment and services company. About 72% of revenues are from equipment sales, including gear that connects and manage data and communications networks, along with application software, security software and related services. Cisco provides a valuable one-stop-shop for its customers.
Cisco’s share price is now only about half its March 2000 peak, partly due to excessive overvaluation then. More recently, the shares reflect Cisco’s struggle in its core business against the rising adoption of cloud computing, which reduces the need for Cisco’s gear. Cisco’s prospects are starting to improve, with CEO Chuck Robbins in the CEO seat (since 2015), starting a slow but steady process to reinvigorate its operations. An impressive new CFO joined in December 2020.
Cisco is shifting its business mix to a software and subscription model and ramping new products, helped by its 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. Cisco is highly profitable and generates vast cash flow, which it returns to shareholders through its dividend and share buybacks. The balance sheet carries $30 billion in cash, double the $14.6 billion in total debt.
An article in The Wall Street Journal described Cisco’s recent decision to terminate its “smart city” initiative. This program, launched in 2016, offered cities the potential to connect buildings, streets and other components through the internet and 5G. While we believe this will eventually happen, it won’t likely be for a decade or more, so Cisco was thinking clearly but was too early (often mistaken for being wrong). We view the pullback not as a weakness but as an acknowledgement of reality – critical in any turnaround. This acknowledgement is more impressive in that the program was once highly touted by the current CEO.
CSCO shares were flat in the past week and have about 22% upside to our 55 price target. The shares trade at a low 14.2x estimated FY2021 earnings of $3.16. This estimate was unchanged in the past week. On an EV/EBITDA basis on FY2021 estimates, the shares trade at a discounted 9.9x multiple. CSCO shares offer a 3.2% dividend yield. BUY.
Coca-Cola (KO) is best-known for its iconic soft drinks yet also 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 vast and deep global distribution system offers it the capability of reaching essentially every human on the planet.
Relatively new CEO James Quincey (2017), is a highly-regarded company veteran with a track record of producing profit growth and making successful acquisitions. To improve its global operations, Coca-Cola is reorganizing to become more effective and more efficient, refocusing its innovation efforts and culling its portfolio of over 400 brands by 50% to focus on its highest-priority offerings. Coke is also centralizing and standardizing back-office administrative services. The company is working to improve its image (and reality) of selling sugar-intensive beverages that are packaged in environmentally-insensitive plastic.
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.
Coca-Cola’s sturdy balance sheet carries $53 billion in debt that is well-covered by cash flow and partly offset by over $21 billion in cash. The $0.41/share quarterly dividend is also well-covered by solid free cash flow.
Barron’s recently featured the company in an article about its “Top Stock Picks for the New Year”, with favorable comments similar to our thesis.
KO shares rose 3% in the past week. The stock has about 18% upside to our 64 price target.
While the valuation is not statistically cheap, at 25.5x estimated 2021 earnings of $2.12 and 23.2x estimated 2022 earnings of $2.33 (estimates unchanged in the past week), they are undervalued while also offering an attractive 3.0% dividend yield. BUY.
Dow Inc. (DOW) merged with DuPont in 2017 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, 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 and the company is making progress with its strategic goals.
There was no meaningful news on Dow in the past week.
Dow shares slipped about 1% this past week and have about 11% upside to our 60 price target.
The shares trade at 16.9x estimated 2022 earnings of $3.21, although this is two years away. This estimate was unchanged in the past week.
Valuation on estimated 2020 earnings of $1.42 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.
Merck (MRK) – With $47 billion in revenues, Merck is a major pharmaceutical company that focuses on oncology, vaccines, antibiotics and animal health. The company is among the many developing a Covid vaccine. Keytruda, a blockbuster oncology treatment representing about 30% of total revenues, holds an impressive franchise that is growing at a 20+% annual rate. The relatively new Lynparza and Lenvima cancer treatments offer considerable promise, as well. While Merck’s growth is currently driven by Keytruda, the company has a strong pipeline of upcoming products that should be additive to revenues and profits.
Merck also has a sizeable animal health business that generates about 10% of total sales. Revenues in this segment grew 9% in the most recent quarter.
The company’s third quarter results were encouraging, with management raising their full-year revenue and earnings guidance.
To create more shareholder value, Merck is narrowing its strategic focus. In 2021, it will spin off its Women’s Health business, along with its biosimilars and various legacy brands. These segments currently generate roughly 15% of Merck’s total revenues yet comprise half of its product roster. Merck also recently divested its stake in Moderna, the producer of a promising Covid treatment. And, given the high valuations of other animal health businesses like Elanco and Zoetis, we would not be surprised to see Merck spin off or divest its animal health business in the future.
Merck’s financial condition is robust. Its $29 billion in debt is partly offset by $7 billion in cash and is readily serviceable by the company’s $17 billion in operating profits.
Primary risks include its dependence on the Keytruda franchise, possible generic competition for its Januvia diabetes treatment starting in 2022, and the possibility of government price controls.
Barron’s recently featured the company in an article about its “Top Stock Picks for the New Year,” with favorable comments similar to our thesis. One interesting point was they suggested that Merck’s Gardasil franchise may be worth $100 billion (compared to Merck’s market cap of about $200 billion).
Merck is not a front-runner in developing Covid-19 vaccines, but has developed a treatment for hospitalized patients with severe or critical Covid-19 cases. The company recently signed a $356 million contract with the U.S. government for up to 100,000 doses of the experimental MK-7110 treatment. Proceeds from the contract will be dedicated to further development of the treatment. Last month, Merck paid $425 million to gain control of OncoImmune, the company that developed the drug.
Merck shares rose about 1% this past week and have about 31% upside to our 105 price target.
MRK shares trade at an attractive 12.8x next year’s estimated earnings of $6.28 (estimate unchanged in past week).
The 3.2% dividend yield offers additional income-oriented investors. Merck produces generous free cash flow to fund this dividend as well as likely future dividend increases. 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. 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.
Based on its good fourth quarter results, 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 recently raised its dividend by 6% to $0.445 per quarter. Tyson’s recovery will remain volatile from quarter to quarter but is on the right track.
Tyson named a new head of investor relations. Megan Britt joins from Corteva and DuPont. The “IR” role provides a valuable link between the company and professional money managers, in effect helping craft the company’s message and image to investors. An effective IR person can also provide critical feedback to management about what investors are focusing on. Bringing in an experienced IR head from a major company with a well-developed IR program may help Tyson improve its relationship with Wall Street and help improve its earnings multiple.
The shares fell about 1% in the past week and have about 18% upside to our 75 price target.
TSN shares currently trades at 11.1x estimated 2021 earnings of $5.69. This estimate was unchanged in the past week, reflecting the weaker outlook. Currently the stock offers a 2.8% dividend yield. Given the stock’s recent decline, we are not making any changes to our rating or price target. BUY
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.
After a disappointing third quarter, after which the stock fell sharply, as price-sensitive investors we raised COLM shares back to a Buy. We think the company low-balled its guidance, with its long-term earnings power impeded but pushed out into the future. It also announced personnel changes in several key operational roles. Columbia’s balance sheet remained solid.
Holiday retail sales were reported to be +2.4% from a year ago, based on online and in-store spending using all forms of payments. This growth was slightly below estimates from the National Retail Federation for a +3.6% to +5.2% increase. The results were described as being disappointing, but given everything that has happened this year, we consider this aggregate estimate to be a positive. As an aggregate estimate, it is meant to include all of retail except vehicles and gasoline, so it will not necessarily be a valid indicator for any particular company. However, we are not highly optimistic that Columbia had a strong quarter given the importance of mall-based stores, which had a weak holiday showing. Still, expectations are fairly low and we see no reason to offload the stock.
Columbia’s shares fell about 2% this past week and have about 15% upside to our 100 price target.
The shares trade at 23.7x estimated 2021 earnings of $3.67. The earnings estimate fell about 1% 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. It continues to de-risk and de-capitalize its balance sheet, most recently with its agreement to transfer the risk on $12 billion of variable annuities to a third party. Its diverse, high-quality investment portfolio is hedged against adverse changes in interest rates and equity markets. Equitable’s lower capital requirements is helping it continue its share repurchase program. The company is targeting a 50-60% of earnings payout ratio in the form of combined dividends and share repurchases.
AllianceBernstein shares (AB) are modestly attractive in their own right, partly due to their high 8.3% dividend yield. Prospective investors should be aware that the shares represent a limited partnership interest, may produce K-1 taxable income, and have other tax implications. Our October 14th note has more color on AllianceBernstein. AB shares continue to remain relatively strong.
While Equitable’s large variable annuities book may be vulnerable to market pullbacks, the company continues to slowly but steadily prove its stability and strength.
There was no meaningful news on the company this past week.
EQH shares rose 1% in the past week and have about 12% upside to our 28 price target. The market’s volatility likely incrementally pressured the shares, as the company’s book value is in many ways treated like a leveraged and hedged investment fund.
We recently reduced EQH shares to a Hold as they approached our 28 price target. We won’t likely return the shares to a Buy unless the stock fades meaningfully further. The valuation is no longer compelling at 94% of tangible book value, although on earnings the shares look attractive (at 4.8x estimated 2021 earnings of $5.22 (unchanged in the past week). The shares offer an attractive 2.7% dividend yield. HOLD.
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 another 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. 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. GM’s balance sheet is sturdy, with Automotive segment cash exceeding Automotive debt again. GM Financial’s capital position remains sturdy.
If true, rumors about Apple launching an electric vehicle in 2024 could rattle the industry. Apple has vast financial resources, a top-notch reputation for quality/ease of use/innovation and clear technological prowess. Such a competitor would change the dynamics of the industry and create a worthy rival for Tesla, GM and all electric vehicle producers and wanna-be’s. However, we think their entrance is unlikely unless they can outsource the capital-intensive production (perhaps to Magna?). Another variant is that Apple could partner with Tesla or other producer(s) to have the Apple operating system (OS) or entertainment/communications system built into the manufacturer’s cars – essentially making the car an iPhone. There are lots of possibilities here.
GM recently sold its car-making factory in Russia to Hyundai. Whether Hyundai can succeed there is debatable, given how difficult it can be for any car maker to operate there. Yet, while the transaction size is likely small (GM closed the factory in 2015 when it left the Russian market), the deal points to the increasing ambitions of competitors like Hyundai to fill in markets where former powerhouses like GM used to participate.
Competitor Nissan is struggling for its future, as it faces strategic difficulties from years of management disarray. It remains a laggard in electric vehicle technology and profits from its one-size-fits-all product roster will likely struggle as car markets become more regionalized based on local regulations and consumer preferences. GM’s approach of exiting distant and difficult markets (like Russia) reflects this trend.
GM shares rose 1% this past week and have about 18% upside to our recently-raised 49 price target.
GM shares trade at 7.0x estimated 2021 earnings of $5.98. This estimate was unchanged this past week. Our 49 price target can be thought of as assuming a 7x multiple of $7.00 in earnings. The 2022 estimate is already at $6.49, so a few strong quarters (which GM is capable of) would likely raise estimates enough for the shares to reach our target. HOLD.
JetBlue Airlines (JBLU) is a low-cost airlines company. Started in 1999 from JFK Airport in New York City, the company has grown to now serve nearly 100 destinations in the United States, the Caribbean and Latin America. The company’s revenues of $8.1 billion last year compared to about $45 billion for legacy carriers like United, American and Delta, and were about a third the revenues of Southwest Airlines ($22 billion).
Its low fares and high customer service ratings (with among the highest customer satisfaction ratings in the industry) have built a strong brand loyalty. Low costs, including its point-to-point route structure, have helped JetBlue produce high margins in prior years, particularly relative to the legacy carriers. Its TrueBlue mileage awards program is a recurring source of revenues, as it sells miles to credit card issuers.
The pandemic has sent JetBlue, and the entire industry, into a near-term depression. Its available seat miles (ASM – a measure of how may seats an airline flies) were only 42% of its year-ago level. Like its peers, JetBlue parked many of its jets, flew others less-frequently, and took middle seats off the market. On its in-service planes, it filled less than half of its available seats with passengers in the third quarter, further weighing on revenues which fell 76% in the quarter.
To help reduce its $6 million/day cash burn (cash outflows from operating losses and capital spending), JetBlue is aggressively cutting its costs. Also, per-gallon fuel prices are 40% cheaper than a year ago, easing what typically is its second-highest expense.
We think consumers are increasingly likely to return to flying. Good news on a Covid vaccine, the continued economic recovery, and pent-up demand are starting to bring back passengers, particularly the leisure traveler. Business travelers are more likely to be slower to return to air travel. Your chief analyst is one such leisure travel venturer, flying non-stop from Boston to San Diego recently (full disclosure: on JetBlue) with no Covid issues. JetBlue’s route base and customer profile make it likely to be among the first to see a step-up in traffic.
JetBlue’s cash balance of $3.6 billion, bolstered by a recent equity raise (which led to us recuing our target to 19 from 20), gives it plenty of time to recover. The company’s debt is somewhat elevated at $4.8 billion. While JBLU shares have jumped recently, and near term it remains vulnerable to rising quarantine risks in the Northeast, its longer-term outlook is promising.
The shares carry more than the usual amount of risk, given uncertainties from the pandemic, fuel costs, labor issues, the ever-present risk of irrational competition and the overall economy.
News of a variant of the coronavirus in the U.K., which has led to tight travel restrictions there and potentially new restrictions elsewhere, has pressured airline stocks. Offsetting this is the now-signed U.S. federal stimulus and support bill that provides an additional $15 billion in support to airlines.
JBLU shares rose 4% this past week and have 28% upside to our 19 price target.
The stock trades at 14.0x estimated 2022 earnings of $1.06 (this estimate is unchanged over the past week and is volatile based on Covid case counts). On an EV/EBITDA basis, the shares trade at 5.5x estimated 2022 EBITDA. BUY.
Molson Coors Beverage Company (TAP) – The thesis for this company is straight-forward – 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. Our view is that the company’s revenues are resilient, it produces generous cash flow and is reducing its debt, traits that are value-accretive and underpriced by the market. A new CEO is helping improve its operating efficiency and expand carefully into more growthier products.
We anticipate that the company will resume paying a dividend mid-next year, perhaps at a $0.35/share quarterly rate, which would provide a generous 3.1% yield.
Molson Coors recent results showed that the company is making progress with its turnaround and that investors underestimate this progress.
Weekly sales data from Nielson point to continued healthy domestic and international volumes. These trends should help support TAP shares and provide encouragement for the upcoming earnings report.
TAP shares rose 2% in the past week and have about 30% upside to our 59 price target.
Estimates for 2020-2022 continue to move up and down by a few cents from week to week. TAP shares trade at 10.9x estimated 2021 earnings of $4.18. This valuation is low, although not the stunning bargain from a few months ago.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 8.2 current year 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 a low valuation, TAP shares continue to have contrarian appeal. Patience is the key with Molson Coors. 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 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. The divestiture cleans up the company’s balance sheet. Terminix appears to have fully addressed its legal liability from deficient termite treatments, removing an overhang on its shares. A new CEO, Brett Ponton, former head of Monro (MNRO), joined in August. 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.
There was no meaningful news related to the company this past week.
Terminix shares slipped about 3% in the past week and have 14% remaining upside to our 57 price target.
Reliable consensus 2022 earnings estimates appear to be settling at around $1.43/share. This would put the TMX multiple at a high 34.8x, but we recognize that these types of companies generally are valued on EV/EBITDA. On this basis, the shares trade at about 17.8x 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 and strategic value to other, much larger media companies, and its low share valuation, make the stock appealing.
As part of its overhaul, 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.
There was no meaningful news this week related to the company.
VIAC shares rose about 5% this past week and have about 17% upside to our 43 price target. Optimism about a recovery in advertising revenues next year is helping buoy the shares.
ViacomCBS shares trade at about 8.4x estimated 2021 EBITDA, which we believe undervalues the company’s impressive leadership and assets. On a price/earnings basis, VIAC shares trade at 8.5x estimated 2021 earnings of $4.32 (unchanged from a week ago). ViacomCBS shares offer a sustainable 2.6% dividend yield and look attractive here. BUY.
