A Brief History of Valuation
With the stock market regularly surging to record highs, it may seem like an unusual time to focus on valuation. After all, many stocks are remarkably expensive on traditional measures, and even somewhat lofty on non-traditional measures. But valuation still matters, especially if the market loses its current luster (assuming that is even possible)!
The art of valuation has evolved over time. Some metrics legitimately are no longer relevant. Let’s take a brief look at the history of valuation to gauge where we are today.
Placing a reasonable valuation on a company requires transparency into its numbers and operations, and some intelligent estimate of its future prospects. In the early decades of the 20th century, investors had neither. Companies disclosed only what they wanted (often with meager and deceptive data), investors had limited insight into its plans and no control whatsoever over how a company was managed. Accepting these limitations, Benjamin Graham and David Dodd developed and popularized the “net-net” approach, immortalized in the 1934 book Security Analysis, which became the value investor’s bible. The net-net approach focused only on the balance sheet, where the numbers were generally the cleanest and which required no projections about the future. Even then, the analysis emphasized an extremely conservative view of those assets, valuing the business as if it would be liquidated. Fortunately, there often were plenty of bargains in attractive “net-net” stocks.
Transparency took a step forward (also in 1934) with the creation of the Securities and Exchange Commission (SEC). The SEC drove the gradual development and mandated use of standardized accounting methods, now called “generally accepted accounting principles,” or GAAP.
Following the second world war, upgraded disclosures along with the booming economy led to the dividend discount model. Popularized in the 1950s by professor Myron Gordon, this metric assumed that companies would survive and grow, and so they were worth a lot more than their net-net value. By the 1960s and 1970s, the P/E ratio rose to prominence. Investors rightly recognized that companies were clearly worth more than their dividends – payout ratios can be too conservative and other companies could acquire the earnings streams at a premium if they were undervalued.
The emergence of corporate raiders, hedge funds, activist investors and private equity investors, as well as steadily improving financial and other disclosures in the 1980s - 2000s, led to the popularity of the EV/EBITDA ratio. This metric focused on the value of the entire business relative to its operating cash flows. A company was seen, again, rightly so, as being worth more than its earnings. It was worth the cash it produced, which could be generated not only from earnings but from untapped borrowing power, hence the leveraged buyout, or LBO. Increasingly, the control of that cash flow was up for grabs, available not just to acquiring corporations but also to more aggressive and well-funded private investors. The loosening of the market for corporate control made public companies worth even more.
Today, the valuation landscape continues to evolve. Exceptional disclosures and visibility into company numbers and management’s plans allow investors to better understand the business. And immense amounts of capital available for buyouts, plus greater access to taking control of boards of directions through proxy voting, solidified the ability of private investors to monitor companies and determine their strategies. This allows investors to employ the most theoretically robust valuation approach – discounted cash flow analysis, or DCF.
And a new generation of technology companies with extremely high-growth prospects but with minimal earnings and few tangible assets are rendering traditional valuation metrics irrelevant. DCF analysis is a laborious and highly nuanced approach that involves estimating all of a company’s future cash flows, then discounting those back to their value today, or, their present value. Despite its theoretical merits, DCF analysis is highly dependent on assumptions (guesses?) about the distant future that can be wildly wrong.
We appear to be entering a “post-valuation” market – where valuation doesn’t matter anymore. What seems to be more important is the meme that circulates on Reddit or some other momentary trendiness metric. Maybe this is the next valuation metric: number of favorable “mentions.” At least one firm, Mentionlytics, helps users track this.
Valuations don’t matter, until they do. We’re staying grounded by using valuation approaches and inputs that make sense, including EV/EBITDA, with adjustments that can capture companies’ growth prospects.
As the sage of value investing once famously said, “In the short run, the stock market is a voting mechanism, but in the long run it is a weighing mechanism.” Our scales are ready.
Share prices in the table reflect Tuesday (February 16) closing prices. Please note that prices in the discussion below are based on mid-day February 16 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 24: ViacomCBS (VIAC)
THIS WEEK’S PORTFOLIO CHANGES
Sensata (ST) – New Buy
LAST WEEK’S PORTFOLIO CHANGES (February 10 letter)
Columbia Sportswear (COLM) – moving from Hold to Sell.
Terminix Global Holdings (TMX) – moving from Hold to Sell.
ViacomCBS (VIAC) – moving from Buy to Hold.
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 was modestly above the consensus estimate of $1.42. Revenue increased 10% when adjusted for the Celgene acquisition and was above the consensus estimate. 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. The balance sheet remains solid.
Overall, the story remains intact.
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 were flat for 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 8.0x estimated 2021 earnings of $7.46 (unchanged 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) generates 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.
The fiscal second quarter earnings report was generally bland on the surface, but underlying improvement appears around the corner. Cisco’s earnings grew 3% while revenues were flat. 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%. Commentators lamented yet another (fifth consecutive) revenue decline, but it was essentially flat, and combined with margin expansion, is adequate for now and an improvement from prior quarters. Also, Cisco’s revenues are dampened by an accounting treatment during the transition to a subscription model. 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. Cisco’s balance sheet remains solid, with $16 billion in cash net of debt.
CSCO shares slipped 4% in the past week, and have about 18% upside to our 55 price target. The shares trade at a low 14.5x estimated FY2021 earnings of $3.22. This estimate rose 4 cents in the past week, following the earnings report. On an EV/EBITDA basis on FY2021 estimates, the shares trade at a discounted 10.1x multiple. CSCO shares offer a 3.2% 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 the 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’ fourth-quarter earnings grew about 6% from a year ago and was 12% higher than the consensus estimate. Revenues fell 5% from a year ago and was in-line with estimates. The company’s recovery is making progress but remains subdued due to pandemic-related lockdowns. Revenues are approaching full recovery while earnings are higher as profit margins are expanding, helped by the company’s efficiency improvements and restructuring efforts.
Full-year 2021 guidance is for organic revenue growth of 7%-8% and adjusted earnings per-share growth of 9%-12%. This could well be conservative, particularly if the re-opening is strong this summer. The company alerted investors to a potential $12 billion settlement for its outstanding tax matter. This is a worst-case scenario and much higher than our initial estimate, but we see little chance of a final loss this large. Coke repaid about $11 billion in debt from cash on hand and will likely continue to generate robust free cash flow in 2021.
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 10:40 a.m. ET.
KO shares rose 2% in the past week, showing more recovery following downgrades from several brokerage firms around New Year’s. The stock has about 27% upside to our 64 price target. While the valuation is not statistically cheap, at 23.6x estimated 2021 earnings of $2.14 and 21.8x estimated 2022 earnings of $2.32 (both estimates ticked up in the past week), the shares are undervalued while also offering an attractive 3.2% 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%). 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.
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 is adding two new board members, Debra Dial and Luis Moreno, with three other board members retiring after the next annual meeting. These appear to be normal updates to the board following reasonable governance guidelines.
Dow shares rose 4% this past week and have 2% 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. If the stock breaches our price target for a reasonable amount of time, we will either raise the target or move the shares to a Sell.
The shares trade at 16.5x estimated 2022 earnings of $3.57, although these earnings are more than a year away. This estimate ticked up about 1% in the past week.
The high 4.8% 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. Longer term, we see the company spinning out or selling its animal health business. Merck has a solid balance sheet and is highly profitable.
Primary risks include its dependence on the Keytruda franchise which will face generic competition in late 2028, possible generic competition for its Januvia diabetes treatment starting in 2022, and the possibility of government price controls.
Merck reported a mixed quarter, with earnings rising about 17% from a year ago but falling about 5% below the consensus estimate. Revenues increased 5% from a year ago but were slightly lower than the consensus estimate. 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.
Guidance was favorable 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.
With the CFO stepping up to the CEO role as longtime CEO Ken Frazier retires, we see Merck becoming a more active acquirer. The company’s sturdy finances and its upcoming $8 billion to $9 billion cash inflow related to the Organon spin-off will add firepower for deals. This new direction adds incremental risk but also could add considerable opportunity (along with Merck’s likely sturdy pipeline) to alleviate Merck’s Keytruda risk.
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 1% this past week and have about 41% upside to our 105 price target. Valuation is an attractive 11.5x this year’s estimated earnings of $6.45 (unchanged this past week). The 3.5% dividend yield offers additional income-oriented investors. Merck produces generous free cash flow to fund this dividend as well as likely future dividend increases although its likely shift to a more acquisition-driven strategy will likely slow the pace of 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 reported first-quarter adjusted earnings per share of $1.94, increasing by 28% from a year ago and well ahead of the $1.50 consensus estimate. The primary difference from GAAP earnings was a $320 million accrual to settle price-fixing charges that rightfully embarrassed the company but hopefully are mostly behind them and reflective of a leadership that has been replaced. Revenues slipped by 4% as higher prices were more than offset by lower volumes. The consensus estimate looked for flat revenues. In the quarter, results were helped by higher prices across all food segments. A year ago, a production facility fire hurt profits, so this year the comparison was unusually favorable. Covid-related costs continue to weigh on earnings, as well. The company’s balance sheet remains strong.
TSN shares responded with a down day, likely due to the 2021 guidance that pointed to a flat/down earnings year compared to 2020. Management anticipates slightly positive/flat volumes for its beef, pork and chicken, flat pricing, and higher feed costs for chickens. Prepared Foods will likely see higher profits but this is a small segment for Tyson.
The stock fell 6% in the past week, giving up its previous surge, and has about 15% upside to our 75 price target. Valuation is attractive at 11.7x estimated 2021 earnings of $5.56. This estimate fell by about 3% this past week, reflecting the weaker Q2 earnings. Currently the stock offers a 2.7% 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 on consumer and commercial banking through its 2,730 branches in the midwestern, southwestern 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 1.28%, up from about 0.92% at year end and approaching its year-ago level of 1.56%. Short-term interest rates have remained essentially unchanged.
The shares rose about 2% in the past week and have about 19% upside to our 58 price target. Rising interest rates combined with a stronger economy make the bank more valuable.
Valuation is a modest 11.5x estimated 2022 earnings of $4.21. This estimate slipped by 1 cent this past week although the 2021 estimate increased by 3 cents. On a price/tangible book value basis, USB shares trade at a reasonable 2.0x 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
New Buy: Sensata Technologies (ST) is a $3 billion (revenues) producer of an exceptionally broad range (47,000 unique products) of sensors used by automotive, industrial, heavy vehicle and aerospace customers. These products are typically critical components, yet since they represent a tiny percentage of the end-products’ total cost, they generally can yield high profit margins. Also, they tend to have relatively high switching costs – vehicle makers are reluctant to switch to another supplier that may have lower prices but lower or unproven quality. Sensata is showing healthy revenue growth (+7% in the fourth quarter), produces strong profits and free cash flow, has a reasonably sturdy balance sheet (debt/EBITDA of about 3.5x) and a solid management team. The company was founded in 1916, owned by Texas Instruments for decades, and returned to public ownership in 2010.
The shares are appealing due to their low valuation and growth prospects. At the current price of about 59, the shares trade for 15.3x estimated 2022 earnings of $3.86. On an EV/EBITDA basis, ST trades at 10.1x estimated 2022 EBITDA.
Sensata’s growth prospects look appealing. The company is leveraged to the automobile cycle (about 60% of revenues), which provides cyclical growth, plus added growth as Sensata usually grows faster than the industry. It should benefit from overall economic growth as it serves heavy/off-road (trucking and construction), industrial and aerospace customers. As vehicles become more electrified, Sensata’s products will be used for more applications, further driving revenues. Recently, Sensata acquired Lithium Balance, which provides it with a valuable entre into the electric vehicle battery industry.
Risks include a possible automotive cycle slowdown, chip supply issues, geopolitical issues with China and difficulty integrating its acquisitions. The stock has jumped about 7% in recent days following the news of its recent acquisition. Investors may want to buy a partial position now and buy more on pullbacks. We are placing a 75 price target on Sensata Technology (ST) shares, which would produce a 25% gain. BUY.
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. Columbia’s strong results are enough to essentially prove that it will return to pre-pandemic levels of revenues and profits, and probably a bit higher, validating our initial thesis. Fundamentally, we see few problems with Columbia other than valuation. 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. 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 an encouraging fourth quarter that keeps the attractive long-term picture intact but includes some near-term one-off headwinds. Earnings were well-ahead of the 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. 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.
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 shares slipped 4% in the past week on the weaker near-term outlook. We see fair value at 62, so the shares have about 16% upside to our target price.
On a P/E basis, the shares trade at 8.5x estimated calendar 2022 earnings of $6.33 (down about 4% 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 proactive in managing the business, with a common-sense approach, and is well-positioned for a demand recovery. We will patiently wait.
JBLU shares rose 1% this past week and have 15% upside to our 19 price target. The stock trades at 17.1x estimated 2022 earnings of $0.97 and 9.0x estimated 2023 earnings of $1.84. Estimates were unchanged in the past week. The 2021 estimated loss per share remains 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 6.2x 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.
Molson reported disappointing fourth-quarter results, with adjusted earnings per share of $0.40 declining 60% from a year ago and falling well short of the $0.77 consensus estimate. Revenues of $2.3 billion fell 8% from a year ago and were about 5% below estimates.
Guidance appears conservative but investors weren’t interested, leading to the sell-off in TAP shares. We believe the reopening combined with strong cash flow will drive the shares higher later in the year. The company will likely re-instate its dividend later this year, which could provide a 3.2% yield.
The company had reasonable performance in the United States, which produces about two-thirds of its revenues. There, its branded sales grew about 2%, helped by stronger pricing. Outside of the U.S., sales were weak, with Europe revenues declining 39% on a constant-currency basis. The renewed lockdowns in the United Kingdom and elsewhere pulled down on-premise sales which constitute the bulk of European revenues.
Underlying EBITDA profits fell by 33%. Lower pricing in Europe plus higher aluminum can and transportation costs, combined with higher marketing spending, more than offset some price increases in the United States. On-premise sales carry higher margins, so fewer pub visits mean more profit pressure.
Cash flow was sturdy, and the company paid down about $1 billion in debt for all of 2020 – in a pandemic year, we’re OK with that. The cash balance remains healthy and Molson Coors retains its investment grade credit rating.
Guidance for 2021 was for essentially a repeat of 2020, with a 5% revenue increase producing unchanged EBITDA. We’re surprised at this, given the strong likelihood of the economic re-opening and the benefit to profit from higher volumes. We expect management is being very conservative in this guidance.
TAP shares fell 9% in the past week and have about 34% upside to our 59 price target. The shares are incrementally more attractive because of the price drop, not less. We see no change in the company’s longer-term prospects regardless of the earnings report, and now have a chance to buy more shares at a lower price.
Earnings estimates fell this past week, following the disappointing earnings report. TAP shares trade at 11.4x estimated 2021 earnings of $3.88 (down 8% this past week). 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 8.3x 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’ 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’ extensive reach, strong market position and strategic value to other, much larger media companies, and its low share valuation, make the stock appealing.
Online sports betting is a rapidly growing industry. ViacomCBS could participate though its valuable CBS Sports franchise and its stake in British gaming company Wm Hill. Interestingly, Wm Hill will be acquired by Caesars Entertainment, which creates both risk and opportunity.
VIAC shares lifted another 8% this past week. As the stock continues to surge, we are incrementally raising our price target to 65 (an additional 10% upside), and retaining our HOLD rating. The shares have returned to the pre-Covid price level and have relatively full valuation at our low target multiple, yet the company has more aggressively cut costs while accelerated its growth initiatives including Paramount+ and the possible acceleration of its sports gaming opportunity. We believe advertising revenues will continue to improve. In effect, we are raising our target earnings (EBITDA) multiple on the shares.
The company reports earnings next Wednesday, February 24, so unless the shares rise above our new target we will be holding them through earnings. Investors with large positions and large profits may want to reduce their positions by half at this point.
Valuation is currently at about 11.0x estimated 2022 EBITDA. On a price/earnings basis, VIAC shares trade at 12.9x estimated 2022 earnings of $4.59. ViacomCBS shares offer a sustainable 1.6% dividend yield. HOLD
