How to Invest in Bubble Times
Last week, we outlined four ingredients of a market bubble that were usefully outlined in a recently published book1”and briefly described how it clearly appears that our stock market is in a bubble. These ingredients include easy trading of assets, cheap and easy money, rising speculative fervor and an appealing narrative.
What makes bubbles difficult for value investors is that price and valuation become increasingly disconnected, not just for a few stocks, but for nearly all stocks. Some stock prices become complete strangers to their realistic valuation, like GameStop recently, while others distance themselves to only a casual acquaintance. In most bubbles, the disconnect goes both ways: some stocks become amazingly over-valued, others amazingly under-valued.
So, how does a value-focused investor invest during a bubble? We think there are at least four approaches.
The first strategy is to invest using the same strategy as in normal times. This can appear to be simpler than adapting to the bubble, but can lead to damaging mistakes. As humans, it takes immense discipline to stay the course. One example: watching just-sold stocks surge to new highs, leading investors to repurchase them in hopes of catching the next upward move. But, if a stock is overvalued at 75, it’s probably overvalued at 100.
The second strategy is to fully exit the market by going to cash. While this has understandable appeal, as in, “I don’t understand the market these days, this thing is going to crash, so I’m out,” can lead to wealth-damaging market timing. Too often, market timers exit years early, only to jump back in after the market continues to surge and perhaps right before a sharp sell-off. Investors tempted to exit might trim their equity exposure (but not by too much) if for no other reason than to take some edge off.
A third strategy is to follow legendary investor George Soros’s approach, who recently said, “When I see a bubble forming, I rush to buy, adding fuel to the fire.” With this approach, the investor abandons all pretenses of valuation-oriented stock-picking and instead rides the hot names. While this may work for investing legends with sophisticated risk-control processes and a team of capable traders, it isn’t a great strategy for anybody else as it can produce catastrophic losses. Nevertheless, many investors adopt this approach, aggressively putting new money into the hot names, which helps drive the bubble higher.
A fourth strategy is to invest both slower and faster. Slower, to research and understand the underlying value of individual stocks. This takes time. Yet, faster – pouncing when sentiment pushes individual share prices to irrational lows compared to their underlying value, and selling when positive sentiment pushes up prices to levels that are overly exuberant compared to the underlying value.
In general, you might hold onto your positions just a little longer than usual to capture some extra upside. And, you might leave just a little extra cash aside to protect your portfolio should the market slide. You will forego some profits, but this extra cash provides some firepower to use if the market drops. Similarly, pay attention to your asset mix. If stocks surge, your equities will become a larger portion of your total capital base, so you may want to trim this along the way to maintain your targeted mix.
It’s valuable to spend some time thinking specifically about what you are going to do, and then write it down. Days pass only one day at a time, providing plenty of opportunity to think during a possibly multi-year bubble.
- Boom and Bust: A Global History of Financial Bubbles by William Quinn and John Turner, 2020.
Share prices in the table reflect Tuesday (February 9) closing prices. Please note that prices in the discussion below are based on mid-day February 9 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
February 10: Coca-Cola (KO)
February 10: General Motors (GM)
February 11: Tyson (TSN)
February 11: Molson Coors (TAP)
February 12: ViacomCBS (VIAC)
THIS WEEK’S PORTFOLIO CHANGES
Columbia Sportswear (COLM) – moving from Hold to Sell
Terminix Global Holdings (TMX) – moving from Hold to Sell
ViacomCBS (VIAC) – moving from Buy to Hold
LAST WEEK’S PORTFOLIO CHANGES (February 3 letter)
None
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 and then sustain 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 now-completed MyoKardia acquisition.
Bristol Myers reported adjusted earnings of $1.46/share, which was 20% higher than a year ago when adjusted for the Celgene acquisition and were modestly above the consensus estimate of $1.42. Revenues increased 10% when adjusted for the Celgene acquisition and were stronger than the consensus estimate. Overall, the story remains intact.
Bristol took a $11.4 billion charge-off related to the MyoKardia merger, leading to a large $4.45/share loss. We have mixed views on the accounting behind this charge-off. Writing off 87% of an acquisition’s purchase price on the first day looks awkward even as the accounting is legitimate. It also makes any return-on-equity calculation meaningless. However, it also prevents new and large amortization charges that would further distort the company’s reported earnings.
Bristol raised their full year 2021 earnings guidance by 2%, to a midpoint of $7.45. The company reaffirmed their longer-term financial targets for a low to mid-single digit revenue growth rate and low-mid 40s% non-GAAP operating margin. The company expects to generate between $45 billion and $50 billion in cash flow over the three years of 2021-2023. This sum is equivalent to 25% of the company’s $195 billion market value. The company also reaffirmed their longer-term financial targets.
In the quarter, Bristol’s drug portfolio showed good growth. Its top three treatments, Revlimid (+152%), Eliquis (+12%) and Opdivo (+2%), had encouraging growth.
Bristol’s balance sheet remains solid, with $16 billion in cash helping to offset the $51 billion in debt (much of which funded the Celgene and MyoKardia acquisitions).
The market seems unimpressed with nearly all biopharma companies lately, including Bristol. There may be fears of more price controls following the change-over in U.S. presidents. BMY shares fell 4% in the past week and have about 30% upside to our 78 price target. We remain patient with BMY shares.
The stock trades at a low 8.1x estimated 2021 earnings of $7.46 (up a cent from last week). Bristol’s fundamental strength, low valuation and 3.3% 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 has a very strong balance sheet.
In a generally bland quarter on the surface, Cisco reported $0.79/share in second quarter earnings after the market closed on Tuesday, up 3% from a year ago and ahead of the $0.76/share consensus estimate. Revenues of $12.0 billion were unchanged from a year ago and were slightly ahead of consensus estimates. The company guided for third quarter revenue growth of 3.5% to 5.5% and non-GAAP earnings of $0.80 to $0.82 per share. Cisco raised its dividend by 1 cent, or 3%.
The shares are weak in pre-market trading on Wednesday as investors pull back on the shares following their 6% jump in the days prior to the report. Commentators are saying that the company showed the fifth straight quarter of revenue declines. While the revenue technically fell, the 0.37% slippage is close enough to be called “flat” and is greatly improved from larger declines in recent quarters. For our purposes, the quarter showed revenue stability and margin expansion – and that is adequate for now.
As Cisco transitions to a subscription model, the accounting can dampen its revenue growth. However, this effect is partly offset by rising deferred revenues, which grew 12% in the quarter. About 76% of Cisco’s software revenue is now sold on a subscription basis. Product orders remain subdued but positive at +1%. From our perspective, any growth here is helpful.
Importantly, the operating margin improved to 34.4% from 33.7% a year ago. Gross margins expanded modestly while operating costs as a percent of sales fell fractionally. In the prior quarter, margins contracted fractionally, so the recent improvement is important. Operating cash flow declined by 22% from a year ago.
Cisco’s balance sheet remains solid, with $16 billion in cash net of debt.
On February 10, investors can listen in on the company’s presentation at the Goldman Sachs Technology and Internet Conference, which can be accessed through Cisco’s investor relations page. The presentation starts at 8:00am EST.
CSCO shares rose 6% in the past week and have about 13% upside to our 55 price target. The shares trade at a low 15.4x estimated FY2021 earnings of $3.17. This estimate was unchanged in the past week. On an EV/EBITDA basis on FY2021 estimates, the shares trade at a discounted 10.8x multiple. CSCO shares offer a 3.0% dividend yield. We continue to like Cisco. 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 a sturdy balance sheet. Its growth investing, debt service and $0.41/share quarterly dividend are well-covered by free cash flow.
Coca-Cola reported adjusted fourth quarter earnings of $0.47/share, about 6% higher than a year ago and 12% higher than the $0.42 consensus estimate. The company reports earnings as adjusted for acquisitions/divestitures and selected non-recurring costs. Revenues fell 5% from a year ago and was in-line with estimates.
The recovery at Coca-Cola is making progress. Revenues are approaching full recovery while earnings are higher as profit margins are expanding. Operating income, adjusted for acquisitions/divestitures and currency changes, grew 14% from a year ago, indicating that the company’s efficiency and restructuring efforts are succeeding.
The company guided full-year 2021 organic (excluding acquisitions/divestitures) revenues to grow by about 7%-8%, which is encouraging and reflects the re-opening of the global economy as well as some currency tailwinds. Guidance also called for comparable adjusted earnings per share to increase by about 9%-12% - encouraging as well as the company returns to healthy growth.
One noticeable negative is that the company now expects to pay as much as $12 billion to settle its outstanding tax matter. This is much higher than we anticipated, but if it fully puts the issue in the past, then it removes an overhang and we’ll accept that. Going forward, the company’s effective tax rate could increase by about 3.5 percentage points, creating a modest but permanent drag on profits. Coca-Cola will continue to aggressively fight the claim, so perhaps they are setting low expectations with their comments.
On February 19, investors can listen in on the company’s presentation at the Consumer Analyst Group of New York (CAGNY) Virtual Conference, which can be accessed through Coca-Cola’s investor relations page. The presentation starts at 10:40am EST.
KO shares rose 2% in the past week, showing some recovery following downgrades from several brokerage firms around New Year’s. The stock has about 29% upside to our 64 price target. While the valuation is not statistically cheap, at 23.7x estimated 2021 earnings of $2.10 and 21.8x estimated 2022 earnings of $2.28 (the 2021 estimate ticked up a cent in the past week), the shares are undervalued while also offering an attractive 3.3% 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 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).
On January 28, Dow reported fourth quarter earnings of $0.84/share, well-ahead of the consensus estimate of $0.67/share. Overall, a strong quarter for Dow. Revenues grew 5% compared to a year ago, with higher prices (+2%) and volumes (+1%), helped by a modest currency tailwind (+2%).
The company and its markets have moved beyond the pandemic, as volumes reached pre-pandemic levels in all of Dow’s operating segments. As its commodity chemicals are widely used across the global economy, this is encouraging even as the news is filled with grim Covid statistics. Dow’s Sadara joint venture with Saudi Arabia has turned the corner, producing sizeable profits and will no longer require cash infusions. Overall free cash flow was strong, and Dow reduced its net debt during the year. The company provided a moderately encouraging 2021 outlook, with higher revenues and profits, along with another $1 billion in net debt reduction.
There was no meaningful news on the company this past week.
Dow shares rose 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 16.0x estimated 2022 earnings of $3.54, although these earnings are more than a year away. This estimate ticked up about 1% 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. 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.
To tighten its focus, Merck will spin off its Women’s Health, biosimilars and various legacy branded operations, to be named Organon, by mid-year 2021. These businesses currently generate roughly 15% of Merck’s total revenues yet comprise half of its product roster. We estimate that Organon is worth about $3.75 per MRK share.
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 although it won’t likely happen in 2021. 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.
Merck reported adjusted earnings per share of $1.32, a 17% increase from a year ago but about 5% below the $1.39 consensus estimate. Revenues increased 5% from a year ago and were slightly lower than consensus estimates.
The core growth products, Keytruda and Gardasil, as well as the animal health segment, produced good results that offer encouragement for the next few years, at least. Merck’s vaccine-related products generally were weak, however this might be excusable when fewer patients visited doctors due to the pandemic. Profits were incrementally pressured by a weaker mix of sales (more lower-margin treatments sold relative to higher-margin treatments) and some currency headwinds along with higher research and development spending.
Guidance was positive and appears conservative, but also included a minor favorable change in how some amortization is treated (which will make the adjusted earnings a tad more flattering) and embedded some optimism on currency changes and doctor visits.
Merck has some strategic changes ahead. Longtime CEO Ken Frazier announced his retirement, to be replaced by the CFO Rob Davis. At the start of the year, a new head of research and development – a key role in a pharma company – started at Merck. Also, the company added a new board member. The upcoming spin-off of the Organon business should re-set expectations for Merck as a faster-growing and more-specialized company but one that relies more on Keytruda and Gardasil. A more detailed investor update on Organon is ahead. Based on management’s comments we expect the value to be about $3.75 per Merck share. This spin-off might have appealing value traits in its own right.
The Keytruda franchise (about 32% of sales) remains strong – it grew 28% in the quarter – although investors wonder how Merck will replace it when generic competition arrives in 2028 or so. We view Merck as fully capable of developing additional treatments in its own robust pipeline as well as perhaps buying outside treatments/companies to replace the eventually lost Keytruda revenues, with as much as seven years to accomplish this.
For much of this year, we anticipate that the stock will be volatile or remain weak until the effects of the changes are more clearly seen. Longer-term, the low valuation, strong balance sheet and sturdy cash flows provide real value. The 3.5% dividend yield pays investors to wait.
Merck shares slipped 4% this past week and have about 41% upside to our 105 price target. Valuation is an attractive 11.6x this year’s estimated earnings of $6.45 (estimate increased about 2% this past week). The 3.5% dividend yield offers additional attractiveness for 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.
The company will report its earnings on February 11, with the consensus earnings estimate at $1.50.
The stock rose 7% in the past week and has about 9% upside to our 75 price target. Valuation is attractive at 12.0x estimated 2021 earnings of $5.71. This estimate ticked up by 2 cents this past week. Currently the stock offers a 2.6% 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.
Recent fourth quarter earnings were healthy and reflect the bank’s enduring strength in its profitability, capital and credit reserves. The shares fell on the news, in line with most other banks, as investors expected more encouraging near-term results and a faster recovery.
The interest rate environment is improving, as the 10-year Treasury yield is now 1.15%, up from about 0.92% at year end. The yield reached 1.20% on Tuesday. Short-term interest rates have remained essentially unchanged.
The shares rose about 8% in the past week and have about 22% upside to our 58 price target. Rising interest rates combined with a stronger economy make the bank more valuable.
Valuation is a modest 11.3x estimated 2022 earnings of $4.22. This estimate was unchanged this past week. On a price/tangible book value basis, USB shares trade at a reasonable 1.9x multiple of the $24.85 tangible book value. 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.
Columbia’s fourth quarter results were stronger than investors expected, with earnings of $1.44/share, down only 14% compared to a year ago and 12% higher than the consensus $1.29 estimate. Revenues of $916 million fell 4% from a year ago but were about 5% higher than estimates. Columbia shares jumped 13% in the past week, reflecting the strong earnings.
The strong results are enough to essentially prove that Columbia will return to pre-pandemic levels of revenues and profits, and probably a bit higher, validating our initial thesis. The market is more fully pricing in this recovery, with the shares trading at just over 20x what could be $5.00/share in earnings in 2022. As such, we are moving COLM to a SELL, with a 27% profit since our initial recommendation in July 2020.
Fundamentally, we see few problems with Columbia other than valuation. It is returning to a growth footing, making good progress with its ecommerce platform execution and controlling costs. Inventory levels looks clean and the balance sheet carries $792 million in cash with no debt. Forward guidance points to 2021 revenues nearly equivalent to those of the pre-pandemic 2019 although earnings would be about 17% lower. Also, the company reinstated its modest $0.26/quarter dividend at the same level as before the pandemic and raised its share buyback to $482 million.
Risks, other than the elevated valuation, include possible structural headwinds that could permanently impair the value of its retail store base, as well as slower-than-expected sales growth once the pandemic stimulus programs expire. 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.
General Motors reported fourth quarter earnings of $1.93/share, compared to the strike-weakened $0.05 from a year ago and well ahead of the $1.64 consensus estimate.
Automotive revenues grew 25% from a year ago – impressive during a pandemic. Much of the profit growth came from higher prices that nearly offset the drag from lower volume. GM Financial continues to generate healthy profits.
The company’s forward guidance for full year 2021 adjusted earnings of between $4.50 and $5.25, however, was weaker than the consensus estimate of $6.04 – a shortfall of about 19%. Most of the reduction is due to the computer chip shortage that will require the company to curtail production in vehicles other than its highly profitable full-sized pickup trucks. We think some of the profit reduction is also due to higher prices GM will pay to secure its chip supplies.
GM’s earnings slide deck highlighted its commitment to electric and other alternative vehicles and initiatives. By 2025, the company will launch 30 new electric vehicles, reiterating comments made earlier this year.
Overall, based on our initial review, an encouraging quarter that keeps the attractive long-term picture intact but has some near-term one-off headwinds.
GM shares rose 6% in the past week, retuning the shares to close at a new all-time, post-IPO high. We see fair value at 62, so the shares have about 11% upside to our target price.
On a P/E basis, the shares trade at 8.5x estimated calendar 2022 earnings of $6.56 (up about 1% this past week). We recently raised our price target on GM to 62 from 49. Please see the January 20, 2021 Cabot Undervalued Stocks Advisor 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.
On January 28, JetBlue reported reasonable fourth quarter results. The loss of $(1.53)/share compared to a profit of $0.56/share in the pre-pandemic fourth quarter last year and was better than the consensus estimate. Revenue fell 67% from a year ago to $661 million, but was slightly better than the consensus estimate. However, investor expectations for the eventual recovery are being pushed out.
The company’s reported daily cash burn rate was $6.7 million – about what was expected. JetBlue will revert to reporting EBITDA, so investors will also focus on this metric, although we will continue to pay close attention to cash outflows. The company’s $3.1 billion in cash offers plenty of reserves until revenues ramp up to a break-even cash burn rate, likely in early 2022. If customer demand in 2022 fully reaches the 2019 level, JetBlue should produce larger profits than in 2019 due to its now-lower cost structure. The company sounds pro-active in managing the business, with a common-sense approach, and is well-positioned for a demand recovery. We will patiently wait.
JBLU shares rose 12% this past week and have 18% upside to our 19 price target. The stock trades at 16.6x estimated 2022 earnings of $0.97 (this estimate fell 1 cent in the past week) and 8.8x estimated 2023 earnings of $1.84. The 2021 estimated loss per share continues to widen, now at $(2.51) as near-term Covid case trends have pushed a recovery out a quarter or more. On an EV/EBITDA basis, the shares trade at 6.4x 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 it 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 2.9% yield.
Molson Coors reports earnings on February 11th, with the consensus earnings estimate at $0.77/share.
TAP shares were unchanged in the past week and have about 21% upside to our 59 price target.
Earnings estimates increased a few cents this past week. TAP shares trade at 11.6x estimated 2021 earnings of $4.22. 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 8.5x 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.
We are moving Terminix to a SELL. While the stock has not reached our price target, we believe the risk/reward is no longer favorable, partly due to information that we have recently learned about the company. We see no imminent problems nor any fraud or other inappropriate conduct, but believe that the turnaround will be more complicated and volatile, with a less-attractive three-year endgame than we anticipated.
Our exit of Terminix produced about an 8% profit. SELL.
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 $34 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 8% this past week. As the stock continues to surge past our recently increased price target (again), we are re-evaluating it for either another increase or a sale. For now, we are moving the shares to a HOLD.
Clearly the fundamentals and outlook have improved. Advertising is starting to recover and the company’s streaming service, relaunched with fanfare during the Super Bowl as Paramount+, offers evidence that Viacom is remaining relevant. Our review will balance these fundamentals against the valuation.
Valuation is currently at about 10.2x estimated 2022 EBITDA. On a price/earnings basis, VIAC shares trade at 11.9x estimated 2022 earnings of $4.59. ViacomCBS shares offer a sustainable 1.8% dividend yield. HOLD.
