“Lord, Please Make Me Chaste – But Not Yet.”
This quote is from St. Augustine, a highly influential saint in the third and fourth centuries, who also had a few very human traits. In his autobiography, Confessions, he recalled his now-famous quote, noted in the headline above.
As value investors in a remarkably robust (exuberant) stock market, full valuation impels us to want to sell a stock. Such is the case with General Motors. On most conventional metrics, the stock is fairly priced. Through the courtesy of several friends, we’ve seen some of the math that Wall Street analysts use to justify prices well over $100/share and find them laughable, at best. As GM shares burst again through our price target, we were on the razor’s edge of selling.
However, we are also seeing GM undergo a major change – perhaps one of the most impressive turnarounds in American corporate history. Their conventional gas-powered vehicle operations are on an altogether different level than the GM of a decade ago. One needs to look no further than their greatly reduced breakeven volumes, helped no doubt by decisions to exit problem-markets like Europe and Russia, and the step-up in the quality and appeal of GM’s vehicle roster. In an economy juiced by generous government stimulus, low interest rates and tight supplies, we see this business becoming even more profitable.
GM also has laid the groundwork for the future of the transportation industry. While early and murky, we see GM and Tesla creating a form of duopoly in North American electric vehicles. Yes, there are competitors, but we don’t see them as threats that would derail that duopoly, particularly as GM and Tesla extend their leads. FedEx’s deal with GM under the BrightDrop agreement illustrates this momentum.
Another source of potential value for GM (and likely Tesla and perhaps Apple) is the streaming data services that customers might pay for on a monthly basis. Who would have thought, 30 years ago, that we would happily give up free radio and television to pay $150/month for streaming music/videos/ESPN/Disney/Netflix? Similarly, we happily pay $600 for a new phone every few years and $150/month for service to that phone. While it may seem like a stretch today, precedent says we will happily pay $150/month for some kind of service to our cars. As a value investor, I recognize the much-higher multiple that should be ascribed to those recurring and low-capital-intensity profits.
Our analysis ascribes little value to autonomous vehicles. While thrilling to consider, we view the reality of widespread adoption of AVs to be at least a decade or two away, likely longer. It took the smartphone a decade to make major inroads, and they don’t run over pedestrians or require complicated insurance and legal rules. Similarly, we put little value on Ultium, GM’s nascent battery business. This will ultimately become a capital-intensive, low-margin business.
GM shares carry risks, of course. Higher gasoline prices, higher corporate income taxes, new mileage regulations, and higher steel and other costs may weigh on revenues and profits. Any disappointments in its current operations, any hiccups along the way to the EV and AV future, along with any lessening of investor sentiment toward the company or the market in general, could sharply reverse the surge in GM shares. As EVs become more widely adopted, sales of gas-powered vehicles will fall, pressing on the fixed-cost profit structure. We also know that competitors won’t cede the market. Volkswagen, Chinese producers, and many others will continue their fight for market share over the coming decades. As we’ve learned from last year, the future is unpredictable, so the market’s current confidence in seeing green lights for the coming months, years and decades may be misplaced.
Some inspiration for not selling GM just yet comes from Howard Marks, the highly regarded value investor who built and runs Oaktree Capital Management. In his recent memo, available here, he provides some sensible rationale for evolving one’s thinking about technology.
So, we are raising our price target on GM to 62 yet are keeping the shares on a short leash. We “reserve the right to change our mind at any time” and thus move GM shares to a Sell even if they don’t reach 62. But in a surging stock market, and with GM’s remarkable progress in both conventional and new vehicles, let’s not get chaste, just yet.
Share prices in the table reflect Tuesday (January 19) closing prices. Please note that prices in the discussion below are based on mid-day January 19 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
January 20: U.S. Bancorp (USB)
January 28: Dow, Inc. (DOW)
January 28: JetBlue (JBLU)
THIS WEEK’S PORTFOLIO CHANGES
General Motors (GM) – raising price target from 49 to 62.
LAST WEEK’S PORTFOLIO CHANGES (January 13 letter)
Bristol-Myers Squibb (BMY) – raising from Buy to Strong Buy.
ViacomCBS (VIAC) – raising our price target from 43 to 48.
Columbia Sportswear (COLM) – reducing from Buy to Hold.
Terminix Holdings (TMX) – reducing from Buy to Hold.
Equitable Holdings (EQH) – reducing from Hold to Sell.
GROWTH/INCOME PORTFOLIO
Bristol-Myers Squibb Company (BMY) is a New York-based global biopharmaceutical company. In November 2019, the company acquired Celgene for a total value of $80.3 billion. 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.
There was no meaningful news on the company this past week.
BMY shares rose about 2% in the past week and have about 17% upside to our 78 price target.
The stock trades at a low 8.9x estimated 2021 earnings of $7.45 (down a cent from last week). Bristol’s fundamental strength, low valuation and 2.9% dividend yield that is well-covered by enormous free cash flow makes a compelling story. STRONG BUY.
Cisco Systems (CSCO) generated about 72% of its $48 billion in revenues from equipment sales, including gear that connects and manages data and communications networks. Other revenues are generated from application software, security software and related services, providing customers a valuable one-stop-shop. Cisco is shifting toward a software and subscription model and ramping new products, helped by its strong reputation and its entrenched position within its customers’ infrastructure.
The emergence of cloud computing has reduced the need for Cisco’s gear, leading to a stagnant/depressed share price. Cisco’s prospects are starting to improve under CEO Chuck Robbins (since 2015). The company is highly profitable, generates vast cash flow (which it returns to shareholders through dividends and buybacks) and carries $30 billion in cash, double the $14.6 billion in total debt.
Under a new agreement, Cisco has agreed to pay $115/share to acquire Acacia Communications, a price that is 64% higher than the 18-month-ago agreement for $70/share. The total price will be about $4.5 billion, an incremental $1.9 billion above the original deal. Acacia’s negotiating tactic using claims about the lack of Chinese approval were successful. The incremental cost isn’t a major concern to Cisco, given its $190 billion market value, while providing Cisco with a valuable technology maker. One risk is that some of Acacia customers are also Cisco competitors will defect to another supplier. Cisco no doubt knows this and has factored it into its integration plans.
CSCO shares were flat in the past week, and have about 22% upside to our 55 price target. The shares trade at a low 14.3x 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 10.0x multiple. CSCO shares offer a 3.2% dividend yield. BUY.
Coca-Cola (KO) is best-known for its iconic soft drinks but nearly 40% of its revenues come from non-soda brands across the non-alcoholic spectrum, including PowerAde, Fuze Tea, Glaceau, Dasani, Minute Maid and Schweppes. Its vast global distribution system offers it the capability of reaching essentially every human on the planet.
While near-term outlook is clouded by pandemic-related stay-at-home restrictions, secular trends away from sugary sodas, high exposure to foreign currencies (now perhaps a positive) and always-aggressive competition, Coca-Cola’s longer-term picture looks bright. Relatively new CEO James Quincey (2017), a highly regarded company veteran with a track record of producing profit growth and making successful acquisitions, is reinvigorating the company by narrowing its oversized brand portfolio, boosting its innovation and improving its efficiency. The company is also working to improve its image (and reality) of selling sugar-intensive beverages that are packaged in environmentally-insensitive plastic. Coca-Cola is supported by over $21 billion in cash which offsets much of its $53 billion in debt. Its growth investing, debt service and $0.41/share quarterly dividend are well-covered by free cash flow.
There was no meaningful news on the company this past week.
KO shares fell 4% in the past week, following its decline last week on downgrades from several brokerage firms. We understand the issues (post-Covid recovery is delayed, tax matter may require a sizeable fine, more cyclical stocks are in vogue) and remain confident in Coke’s future. The tax issue, discussed in last week’s CUSA, will likely be an overhang on the stock for several months, however.
The stock has about 32% upside to our 64 price target. While the valuation is not statistically cheap, at 23.0x estimated 2021 earnings of $2.10 and 21.1x estimated 2022 earnings of $2.29 (the two estimates ticked down in the past week), the shares are undervalued while also offering an attractive 3.4% dividend yield. BUY.
Dow Inc. (DOW) merged with DuPont in 2017 to temporarily create DowDuPont, then split into three companies in 2019 based roughly along product lines. The new 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 sold, largely driven by global economic conditions, and 3) ongoing efficiency improvements (a never-ending quest of all commodity companies to maintain their margins).
There was no meaningful news on the company this past week.
Dow shares fell about 4% this past week and have 6% upside to our 60 price target. Without any additional positive news, we are reluctant to increase our price target, yet we’re also reluctant to sell too soon in this strong market. The shares trade at 17.1x estimated 2022 earnings of $3.32, although these earnings are two years away. This estimate ticked up about 3% in the past week.
The high 4.9% 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) – Pharmaceutical maker Merck focuses on oncology, vaccines, antibiotics and animal health. Keytruda, a blockbuster oncology treatment representing about 30% of total revenues, holds an impressive franchise that is growing at a 20+% annual rate. Merck is not a front-runner in Covid-19 vaccines but has a treatment for hospitalized patients with severe or critical Covid-19 cases.
To tighten its focus, Merck will spin off its Women’s Health business, along with its biosimilars and various legacy brands, by mid-year 2021. These businesses currently generate roughly 15% of Merck’s total revenues yet comprise half of its product roster. Merck also recently divested its stake in vaccine maker Moderna. 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. Merck has a solid balance sheet and is highly profitable.
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.
On Tuesday, the U.S. Supreme Court rejected Merck’s appeal of a lower court ruling regarding a patent infringement case against Gilead Sciences. As such, Merck will not be able to collect damages from Gilead. The case had little impact on Merck shares but Gilead shares jumped on the news.
Merck shares slipped 2% this past week and have about 26% upside to our 105 price target. Valuation is an attractive 13.2x this year’s estimated earnings of $6.31 (estimate unchanged this past week). The 3.1% 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 its future is brighter, particularly as it is more of a commodity company (and hence has lower margins) compared to its food processor peers.
Tyson 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.
There was no meaningful news on the company this past week.
The stock slipped about 2% in the past week and has about 18% upside to our 75 price target. Valuation is attractive at 11.2x estimated 2021 earnings of $5.71. This estimate was unchanged in the past week. Currently the stock offers a 2.8% dividend yield. BUY.
U.S. Bancorp (USB), with a $70 billion market value, is the one of the largest banks in the country. It focuses 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.
USB shares remain out of favor due to worries about a potential surge in pandemic-driven credit losses and weaker earnings due to the low interest rate environment.
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. Also, unlike the prior cycle, home mortgage lending today is a source of credit strength. U.S. Bancorp has a solid capital base, bolstered by its sizeable credit loss reserves of over 2.6% of total loans. The bank maintains one of the best expense control ratios in the industry.
The bank will report earnings pre-market on January 20. The current consensus estimate is $0.94/share.
The shares fell about 2% in the past week and have about 20% upside to our 58 price target. Valuation is a modest 11.6x estimated 2022 earnings of $4.18. This estimate rose about 2 cents this past week. 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. Currently the stock offers an appealing 3.5% dividend yield. 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.
There was no meaningful news on the company this past week.
Columbia’s shares rose about 2% this past week and have about 9% upside to our 100 price target. Valuation is 25.1x estimated 2021 earnings of $3.67 (estimate unchanged from last week). On 2022 estimated earnings of $4.64 (unchanged), the valuation is a more reasonable 19.8x. For comparison, the company earned $4.83/share in 2019. We recently moved the shares to a Hold as they are approaching our 100 price target. HOLD.
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. Equitable was spun-off from former French insurance parent AXA in 2018, although AXA still owns just under 10% of Equitable. With its newfound independence, Equitable is free to pursue new opportunities.
Last week, we moved EQH shares to a Sell, as they essentially reached our 28 price target. From here, the risk/reward appears unfavorable. We don’t see any particular fundamental issues at Equitable, and the 2.5% yield continues to offer some appeal. EQH shares rose 16% since the original recommendation and 43% since the CUSA analyst change at the end of June. SELL.
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. GM’s balance sheet is sturdy, with Automotive segment cash exceeding Automotive debt. Its credit operations are well-capitalized but may yet be tested as the pandemic unfolds.
GM shares surged 9% by mid-day Tuesday as the company reported that Microsoft is making an equity investment in Cruise, the self-driving vehicle business that is majority-owned by GM. Also, Microsoft will become a long-term strategic partner to Cruise, providing its expertise to help bring Cruise products to the market. Microsoft’s Azure network will become Cruise’s provider of cloud and edge computing capacity. While autonomous cars are generating a lot of investor excitement, we believe the wide-spread adoption of self-driving cars is likely a decade or two away, and the wide-spread adoption of self-driving trucks is at least a decade away. GM is in a great position to be a leader, but the horizon is too far away to ascribe much present-value to these operations.
We are raising our price target on GM to 62 from 49. Please see our opening note for more commentary. HOLD.
JetBlue Airlines (JBLU) is a low-cost airlines company. Started in 1999, the company serves nearly 100 destinations in the United States, the Caribbean and Latin America. The company’s revenues of $8.1 billion in 2019 compared to about $45 billion for legacy carriers like United, American and Delta, and were about a third of Southwest Airlines ($22 billion). Its low fares and high customer service ratings have built strong brand loyalty, while low costs have helped JetBlue produce high margins. Its TrueBlue mileage awards program, which sells miles to credit card issuers, is a recurring source of profits.
We believe consumers (and eventually business travelers) are likely to return to flying. JetBlue has aggressively cut its cash outflow to endure through the downturn. Although its $4.8 billion debt is elevated, its $3.6 billion cash balance gives the airline plenty of time to recover. JBLU shares carry more risk than the typical CUSA stock.
JBLU shares rose 4% this past week and have 26% upside to our 19 price target. The stock trades at 14.0x estimated 2022 earnings of $1.08 (this estimate rose a cent over the past week and is volatile based on Covid case trends). Interestingly, the 2021 estimated loss per share expanded by 40%, to $(1.21) as near-term Covid case trends have pushed a recovery out a quarter or more. On an EV/EBITDA basis, the shares trade at 5.6x 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 an overly-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 produces relatively few of the fast-growing hard seltzers and other trendier beverages. 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-year, perhaps at a $0.35/share quarterly rate, which would provide a generous 2.7% yield.
The Times of India, a respected media outlet, reported that Molson Coors intends to exit the country. Molson Coors confirmed its intention to exit but didn’t provide any further details. We would view an exit favorably.
TAP shares rose 5% in the past week and have about 13% upside to our 59 price target. Estimates ticked upward again this past week. TAP shares trade at 12.4x estimated 2021 earnings of $4.23. 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 8.8 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 ServiceMaster Brands, the company changed its name to Terminix. The company 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 2020. 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. The company’s balance sheet is in good condition. Major risks include the possibility of higher litigation expenses, strong competition, and possible execution risks by the new leadership. TMX shares carry more risk than typical CUSA stocks.
Terminix announced that it added David Frear to its board of directors. Frear was the CFO of satellite radio provider Sirius XM and is currently on the boards of various NASDAQ exchanges. We think this is a strong addition to the Terminix board.
Terminix shares slipped about 2% in the past week and have 9% 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 36.6x, but we recognize that these types of companies generally are valued on EV/EBITDA. On this basis, the shares trade at about 19x EBITDA.
Last week, as the shares approached our price target, we reduced our rating to HOLD.
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. The company 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.
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 sporting events 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.
There was no meaningful news on the company this week.
VIAC shares lifted another 6% this past week after their 15% surge the prior week and have about 11% upside to our recent-raised 48 price target.
Valuation is currently at about 9.6x estimated 2021 EBITDA, which we believe undervalues the company’s impressive leadership and assets. On a price/earnings basis, VIAC shares trade at 10.2x estimated 2021 earnings of $4.24 (the estimate slipped about 2% from a week ago). ViacomCBS shares offer a sustainable 2.2% dividend yield and look attractive here. BUY.
