If You Don’t Like the Weather, Wait a Few Minutes
I first heard this phrase when I moved to New England many years ago. The weather can be remarkably volatile: darn cold one day, then in the 60s the next even though there is snow still on the ground, only to plummet back to freezing rain the next. I think I recall all of this once happening on the same day. This captures how the stock market has been acting lately.
Each day brings something new. Some days every stock falls, other days they all surge, and some days, like Monday, undervalued stocks in the industrial, consumer and financial sectors jump (the Dow Jones Industrial Average gained 1%) while the Nasdaq slipped 2.4% - an enormous and historically unusual 3.4 percentage point gap, particularly as the indices went in opposite directions. Since February 12th, the Dow Jones Industrial Average has lifted by 1.1% while the Nasdaq has plunged by 10.5%, entering what the media call a correction.
Then, on Tuesday, the Nasdaq shot up over 4% (at least at the publishing deadline), while the Dow stocks rose a modest 0.8%. This almost entirely unwound Monday’s performance difference. Interest rates appear to be falling again. I can hardly wait until Wednesday!
The volatility seems to be centered around the twin themes of “the economic reopening will boost earnings” and “the economic reopening will boost inflation.” Covid case-count peaked in mid-January, and the “third wave” completely disappeared by late February. Talks in Washington on the stock-market-friendly $1.9 trillion stimulus package began in earnest around this time. Interest rates on the 10-year U.S. Treasury bond started ticking up on January 4th, but the stock market didn’t seem to notice until mid-February when yields hit 1.2%, then jumped to 1.6% this past Monday.
Former Covid-impaired stocks are the reopen winners – supported by the “reopening will boost earnings” force. Interest rates are still too low to offset the powerful rebound in their earnings. The pandemic winners, heavily represented by the Nasdaq index, are seeing their growth rates peak (and probably decline) while higher interest rates weigh on their elevated valuations. High interest rates make their in-the-distant-future earnings worth less. (But, if interest rates decline, the stocks could re-launch higher).
The future remains uncertain, and there are powerful forces hammering away at each other. Sentiment about which force will overpower the others shifts daily, hence the volatility.
The Cabot Undervalued Stocks Advisor names have been doing well. In the past week, the average recommended stock gained about 4%, while the S&P500 was flat. It’s been quite a year so far, and it is only early March. We remain optimistic on undervalued stocks.
Last week, we initiated a Buy recommendation on shares of London-based insurance company Aviva, plc (AVVIY). Several subscribers asked about the specific security we recommended and how an ADS works. Here’s a quick discussion:
U.S. investors should buy the AVVIY security, which has good daily trading volume. Because Aviva is based in London, its equities trade primarily on the London Stock Exchange. The company wants American investors, but most American investors don’t have direct access to the London market. So, companies like Aviva seek the help of a major American bank to make their shares tradable in the United States. The bank creates a security called an ADS, or American Depositary Share. The ADS is backed by actual shares, and U.S. investors can buy the ADS as if it were the actual shares. This is a common, standard and very established practice as long as the ADS is backed by a major bank like Citigroup, Bank of New York Mellon or JPMorgan.
The AVVIY ADS is sponsored by Citigroup. Each of the ADS is backed by 2 ordinary Aviva shares. To see how the share price in London is linked to the ADS price in the United States, you can do this:
- Go to Aviva’s investor relations website: https://www.aviva.com/investors, which shows the current share price in London: 398 pence.
- 398 pence x 100 = 3.98 British pounds.
- 1 British pound = $1.39, so the share price in dollars would be about $5.53/share.
- Each AVVIY ADS holds two shares, so 2 x $5.53 = $11.06, which is pretty close to the $10.96 price that AVVIY is trading at now.
Share prices in the table reflect Tuesday (March 9) closing prices. Please note that prices in the discussion below are based on mid-day March 9 prices.
Note to new subscribers: You can find additional color on recent earnings and other news on recommended companies in prior editions of the Cabot Undervalued Stocks Advisor on the Cabot website.
Send questions and comments to Bruce@CabotWealth.com.
UPCOMING EARNINGS RELEASES
None
THIS WEEK’S PORTFOLIO CHANGES
Tyson (TSN) – Raising price target from 75 to 82.
JetBlue (JBLU) – Raising price target from 19 to 22.
LAST WEEK’S PORTFOLIO CHANGES (March 3 letter)
Aviva, plc (AVVIY) – New Buy.
Dow (DOW) – Raising our price target from 60 to 70.
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 recently completed MyoKardia acquisition.
Bristol Myers’s fourth quarter report was encouraging, with earnings, adjusted for the Celgene acquisition, rising 20%. Bristol raised its full year 2021 earnings guidance by 2%, to a midpoint of $7.45, which would be about 16% higher than 2020 earnings. 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 35% of the company’s $136 billion market value. The balance sheet is solid.
There was no significant company news in the past week.
BMY shares were flat for the past week and have about 26% upside to our 78 price target. We remain patient with BMY shares.
The stock trades at a low 8.3x estimated 2021 earnings of $7.48 (unchanged from last week). On 2022 estimated earnings of $8.11 (also unchanged from last week), the shares trade for 7.6x. Either we are completely wrong about the company’s fundamental strength, or the market must eventually recognize Bristol’s earning power. We believe the earning power, low valuation and 3.2% 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.
JPMorgan upgraded Cisco to an “overweight” from “neutral” last week, helping lift the shares.
The shares trade at a low 14.9x estimated FY2021 earnings of $3.22. This estimate was unchanged in the past week. On FY2022 earnings (which ends in July 2022) of $3.43 (up a cent in the past week), the shares trade for 14.0x. On an EV/EBITDA basis on FY2021 estimates, the shares trade at a discounted 10.0x multiple. CSCO shares offer a 3.1% 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 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 $0.42/share quarterly dividend are well-covered by free cash flow.
Coca-Cola’s fourth quarter earnings grew about 6% from a year ago and were 12% higher than the consensus estimate. Revenues fell 5% from a year ago. 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%. The company’s announced $12 billion tax dispute cost estimate is likely a worst-case scenario and 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.
Perhaps indicative of Wall Street’s fickle mindset, RBC just upgraded their view of Coca-Cola shares to an “outperform” and raised their price target to 60 from 55. On January 4th, the company downgraded the shares to “sector perform”, calling the shares expensive at 55. We anticipate that they won’t be the only bank to rediscover Coca-Cola, as JPMorgan and Deutsche Bank still have a neutral view.
KO shares rose 3% in the past week. The stock has about 25% upside to our 64 price target. While the valuation is not statistically cheap, at 23.9x estimated 2021 earnings of $2.15 (unchanged in the past week) and 22.1x estimated 2022 earnings of $2.32 (unchanged 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).
Dow’s fourth quarter earnings were strong, with revenues and earnings well-ahead of the consensus estimate, due to higher prices (+2%) and volumes (+1%), along with 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. As a producer of a fundamental building block of the global economy, Dow is well-positioned for continued revenue and profit growth.
We’re seeing more comments (complaints) from manufacturers about the rising costs of various plastic inputs – many of which are provided by Dow. This would point to higher profits for Dow in coming quarters.
Dow shares rose 1% this past week and have about 12% upside to our recently raised 70 price target. The shares trade at 17.0x estimated 2022 earnings of $3.66, although these earnings are more than a year away. This estimate ticked up 1% again in the past week. Helping buttress confidence in the recovery, analysts raised their 2021 estimates by over 3% last week.
The high 4.5% 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. The spin-off will yield an $8-$9 billion cash inflow to Merck. Longer term, we see the company spinning out or selling its animal health business. Merck has a solid balance sheet and is highly profitable. With the new CEO, we see the company becoming more acquisitive to find additional growth products, which adds both risk and return potential to the Merck story.
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’s fourth quarter earnings increased about 17% from a year ago on a 5% increase in revenues. However, both were below consensus estimates. Core growth products Keytruda and Gardasil, as well as the animal health segment, produced good results that offered 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.
This past weekend, Merck reported positive test data on an experimental anti-viral drug, molnupirivir, that could be used as a treatment for patients with Covid. The announcement appears to have pushed up Merck’s shares – hopefully halting their recent sell-down.
For much of this year, we anticipate that the stock will be volatile or remain weak until the effects of the strategic 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 rose 4% this past week and have about 40% upside to our 105 price target. Valuation is an attractive 11.5x this year’s estimated earnings of $6.52 (up 5 cents this past week). Steadily increasing estimates should eventually attract quant-driven attention as upward estimate revisions are like catnip to stock-buying machines. Merck produces generous free cash flow to fund its current dividend as well as likely future dividend increases, although its shift to a more acquisition-driven strategy will slow the pace of increases. BUY.
Tyson Foods (TSN) is one of the world’s largest food companies, with nearly $43 billion in revenue. 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. Dean Banks, the new CEO, who previously was an Alphabet/Google executive, is starting to make necessary changes.
Tyson’s fiscal first quarter adjusted earnings rose a strong 28%, despite a 4% revenue decline. Forward full-year 2021 guidance was for flat/down earnings year as volumes and pricing were seen as subdued. Prepared Foods will likely see higher profits but this is a small segment for Tyson.
The poultry industry appears to be boosting its tech game: production is increasingly becoming automated and the entire supply chain – from procurement to final destination delivery – is entering the digital age. Recent efforts are also underway to shift poultry buying and selling to electronic trading platforms. New CEO Dean Banks’s tech background at Google would help Tyson’s develop a potential leadership role in this transition.
The stock rose 7% in the past week and briefly traded above our 75 price target. While the near-term outlook is mixed, the new management is likely being conservative with its forward guidance. With the mid-term demand and earnings prospects improving and valuation remaining reasonable, we are raising our price target to 82, pointing to 12% additional upside.
Valuation is attractive at 12.8x estimated 2021 earnings of $5.70. This estimate rose a cent in the past week. Currently the stock offers a 2.4% 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.
USB shares (like most bank shares) continue to trade with the 10-year Treasury yield. Rising interest rates combined with a stronger economy make the bank more valuable. The yield slipped modestly on Tuesday, to 1.54% from 1.60% on Monday, but up from 1.43% last week. For reference, the yield was 1.88% at year-end 2019, just before the pandemic. Short-term interest rates have remained essentially unchanged.
The shares rose 3% in the past week and have about 10% upside to our 58 price target.
Valuation is a modest 12.5x estimated 2022 earnings of $4.23. This estimate slipped a cent in the past week – surprising in the rising rate environment but likely a one-off and microscopic change which we nevertheless will be watching. On a price/tangible book value basis, USB shares trade at a reasonable 2.1x 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 3.2% dividend yield. BUY.
BUY LOW OPPORTUNITIES PORTFOLIO
Aviva, plc (AVVIY) – Based in London, England, Aviva is a major European insurance company specializing in life insurance, savings and investment management products. Its market cap is about $21 billion, and is expected to generate about $65 billion in revenues and about $2.8 billion in profits in 2020. Long a mediocre company, the frustrated board last July installed Amanda Blanc as the new CEO, with the task of fixing the business. She is aggressively refocusing the company on its core geographic markets (UK, Ireland, Canada), while putting its remaining geographies on the selling block. Recently, Aviva announced the sale of its operations in Turkey. The turnaround also includes improving Aviva’s product competitiveness, rebuilding its financial strength and trimming its bloated costs. The new leadership reduced the company’s dividend, but to a more predictable and sustainable level, along with what is likely to be a modest but upward trajectory.
Aviva reported healthy full year operating profit of £3.2 billion, roughly flat with a year ago but higher than consensus estimates. The company’s quarterly data is not directly provided, nor are the related estimates. We’re fine with this as the company is clearly shareholder-focused and making considerable progress with its strategic overhaul.
This overhaul is moving along rapidly. Aviva announced the sale of its Italy and France operations, with its Poland operations now on the block. These sales would convert non-strategic businesses to cash, which then could be directed to debt paydowns, share repurchases and dividends. Management is targeting £1.7 billion in debt reduction in the first half of 2021.
Aviva guided to greater than £5 billion in cumulative cash remittances between 2021-2023. As an insurance company, Aviva must retain specified amounts of cash at its subsidiaries – but excess cash above this minimum, after a cushion, can be remitted to the parent company. Cash remittances, particularly when backed by a publicly stated target, indicate surplus financial strength that can be returned to investors.
Aviva’s capital strength is improving, indicated by its Solvency II shareholder cover ratio at 202%. This ratio is based on a complex European regulatory measure of how much capital an insurance company holds compared to a minimum required amount of 100%. The company has stated that it will pay out any capital above a 180% ratio, which could mean a major share repurchase or special dividend to shareholders equal to as much as 15% of the company’s market value.
Stronger capital, higher cash remittances, lower debt and better profits suggest that the company may be able to raise its dividend more aggressively than the stated modest pace.
Aviva shares rose 7% last week and have about 27% upside to our 14 price target. The stock trades at 7.1x estimated 2021 earnings and about 89% of tangible book value. AVVIY shares offer an attractive and likely solid and recurring 5.3% dividend yield. BUY.
General Motors (GM) under CEO Mary Barra (since 2014) has transformed from a lumbering giant to a well-run and (almost) respected auto maker. The company has smartly exited many chronically unprofitable geographies (notably Europe) and trimmed its passenger car roster while boosting its North American market share with increasingly competitive vehicles, particularly light trucks. We consider its electric and autonomous vehicle efforts to be near industry-leading. We would say it is perhaps 75% of the way through its gas-powered vehicle turnaround, and is well-positioned but in the very early stages of its EV development. 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’ fourth quarter earnings were well ahead of estimates and provided some encouragement that the attractive long-term picture remains intact despite some near-term headwinds from tight semiconductor chip supplies. GM Financial continues to produce healthy profits. By 2025, GM will launch 30 new electric vehicles, reiterating comments made earlier this year. Full-year forward guidance was for adjusted earnings of between $4.50 and $5.25.
GM is close to committing to building a second battery factory, likely in Tennessee, in addition to the $2.3 billion facility in Lordstown, Ohio. The new facility makes strategic sense as GM wants to remain in control of its supply chain, at least until a full-fledged battery production industry is built out. Producing batteries also would give GM some optionality – they could produce batteries for other vehicles that don’t compete with its line-up, or for home battery back-up or many other uses. If other car makers can’t control their own battery production, GM would have a considerable strategic advantage. U.S.-based battery production may also attract strategic interest and financial support from the federal government, adding to its appeal.
From a historical perspective, this follows how the auto industry has evolved: originally nearly all sourcing, production and assembly was done in-house (vertically integrated). Then, as the supply chain matured and could safely be outsourced, the majors spun off or sold their component makers, including the enormous spin-off of Delphi Automotive in 1999. We see the battery business as a low-return operation – once its strategic value fades GM will likely spin this out, perhaps in a decade or two.
GM shares rose 3% in the past week, supported by the $1.9 trillion stimulus bill and improving Covid data. The shares have 14% upside to our 62 price target.
On a P/E basis, the shares trade at 8.7x estimated calendar 2022 earnings of $6.26 (unchanged this past week). The P/E multiple is helpful, but not a precise measure of GM’s value, as it has numerous valuable assets that generate no earnings (like its Cruise unit, which is developing self-driving cars and produces a loss), its nascent battery operations, its Lyft stake and other businesses with a complex reporting structure, nor does it factor in GM’s high but unearning cash balance which offsets its interest-bearing debt. However, it is useful as a rule-of-thumb metric and we will continue its use here.
Our 62 price target is based on a more detailed analysis of GM’s various components and their underlying valuation. 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.
JetBlue’s fourth quarter results were reasonable given the short-term depression in travel. The company’s $6.7 million daily cash burn rate was about what everyone 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.
There was no significant company news in the past week, but we see that TSA checkpoint travel numbers continue to show stability/strength in recent weeks. You can find the data here.
JBLU shares rose 8% this past week to above our 19 price target. We see incremental upside in the shares, as the valuation remains reasonable and the company’s post-recovery profits look likely to be higher than 2019 profits. Given this, we are raising our price target modestly to 22, implying another 10-11% upside from here. However, we are keeping JBLU shares on a short leash.
The stock trades at 10.1x estimated 2023 earnings of $1.96. This estimate slipped 5% in the past week. Increasingly, the company will likely reach a ‘full recovery’ in earnings in 2023 rather than 2022. We are watching the 2021 estimated loss per share to quantify near-term conditions. This estimate slipped to $(2.36), worse by 10 cents compared to a week ago. On an EV/EBITDA basis, the shares trade at 5.8x estimated 2023 EBITDA. HOLD.
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.
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. The shortfall appears to be directly related to the sluggish reopening of the European economies, along with higher commodity and marketing costs. Guidance appears conservative but investors weren’t interested, leading to a sell-off in TAP shares. We believe the reopening combined with already-sturdy cash flow will drive the shares higher later in the year. The company will likely reinstate its dividend later this year, which could provide a 3.0% yield.
There was no significant company news in the past week.
TAP shares lifted 5% in the past week and have about 25% upside to our 59 price target. Earnings estimates remain stabilized with no deterioration this past week. TAP shares trade at 11.4x estimated 2021 earnings of $3.87 (unchanged 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 8.6x 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.
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.
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.
There was no meaningful company news this past week.
ST shares were flat in the past week and have about 26% upside to our 75 price target.
The shares trade at 15.4x estimated 2022 earnings of $3.84 (unchanged). On an EV/EBITDA basis, ST trades at 13.3x estimated 2022 EBITDA. ST shares may be volatile so investors may want to buy a partial position now and buy more on pullbacks. BUY.
