Peak FANGMAN
There’s no doubting the dominance achieved by mega-tech companies like Facebook, Amazon, Netflix, Google and the other members of the “FANGMAN” club (Microsoft, Apple and Nvidia). Over the past decade or two, these have created entirely new industries, grown to unprecedented size and rewarded shareholders with vast profits. And, like all of the technology companies that preceded them, they have reached their peak potential.
In their earlier growth stages, each of these companies faced few if any capable competitors. As pioneers, their innovations provided products and services that met untapped demand – most customers didn’t even know they needed them until these companies offered them. In 2004, how many people felt their social lives were left barren without Facebook? Few people that same year would say they were unable to get through the day without a fully-charged smartphone within easy reach. Streaming was perhaps a form of fresh-water fishing.
Inevitably, though, all markets reach their peak size. While it is impossible to say how much larger the markets of each of the FANGMAN companies’ offerings are, it is unlikely that they are double their current respective sizes. There are 5 billion mobile phone users on the planet, 3.5 billion social media users and 4.4 Internet users – with only 7.5 billion people on the planet, the remaining untapped market is small and difficult to capture compared to what it was five or 10 years ago. This implies revenue deceleration to the point of sluggish growth and eventual decline.
Just as powerful is the role of competition. Vast growth and wide profit margins invite new companies that offer better and/or cheaper variants, which chip away at the incumbents’ prospects. Netflix had essentially zero competitors for its early streaming initiatives. Today, there are more than a dozen well-financed competitors with highly appealing content looking to capture some of the profit pool. While these newer services are expanding the market, Netflix’ market share is under pressure. Its recent crackdown on password sharing was unthinkable in its early days; today it is increasingly necessary to plug the revenue leakage.
Even near-monopolies like Google’s in advertising are vulnerable. We think it is only a matter of time before jealous competitors and frustrated advertisers find new ways to reach consumers, thus chipping away at the incumbent’s market power.
An additional driver of many of these companies was the rollout of 4G wireless technology. Their products captured the benefits that higher 4G speeds had over clunky 3G speeds. Once 5G rolls out, the “old school” 4G beneficiaries could lose their relevance.
Franchise erosion can come from internal changes, as well. Amazon once was a place where consumers could buy goods for low prices from trusted sellers, saving time from having to visit a physical store. But today, more customers are shopping online elsewhere as the Amazon “trust” factor has become heavily diluted by dubious sellers with dubious tactics. It can take more time to become confident with an Amazon purchase than it would going to the store. More consumers are doing “reverse show-rooming”… going to Amazon for ideas, then buying directly from the producer, particularly as producers have aggressively upgraded their e-commerce programs.
Greater government regulation is another headwind. In their early days, these giants had essentially zero pressure from anti-trust regulators, taxation authorities, privacy advocates and other powerful forces. In addition to explicit anti-trust pressures in the United States, Facebook, for example, is now paying for news content in Australia – how long will it be before news outlets elsewhere demand their share? Regulatory actions impede growth and profitability.
Even more threatening, innovators are creating new products and services that the incumbents can’t match. Long the e-commerce leader in China, Alibaba is now #2, behind upstart Pinduoduo. Social media preferences change rapidly – how long will Instagram, WhatsApp, Pinterest and others, once the hottest on the market, be able to fend off Telegram, MeetUp and Reddit? A vast proliferation of new products means some will become the next generation of winners – the incumbents can only hope to play catch-up.
Does all of this mean that the FANGMAN stocks are destined to crash? Not necessarily. The companies are exceptionally well-funded, meaning that they can protect their franchises from these forces for years. And, cash flow and cash piles at Apple ($76 billion) and Microsoft ($132 billion), for example, can finance large share repurchases to bolster their stocks. Cost-cutting can also help preserve margins, although this would crimp internal innovation. Most likely, the shares will stop their previously-inexorable increases and remain flat for years, as their slowing earnings growth leads to multiple compression. Eventually, investors will lose interest and the shares will trail off.
Then, perhaps, they will become undervalued enough to re-appear in the Cabot Undervalued Stocks Advisor. We’ll be waiting, patiently.
Share prices in the table reflect Tuesday (March 23) closing prices. Please note that prices in the discussion below are based on mid-day March 23 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
TODAY’S PORTFOLIO CHANGES
None
LAST WEEK’S PORTFOLIO CHANGES (March 17 letter)
New Buy: Barrick Gold (GOLD)
GROWTH/INCOME PORTFOLIO
Bristol Myers Squibb Company (BMY) is a New York-based $142 billion (market cap) global biopharmaceutical company with over $45 billion in revenues. In recent years it has divested several major businesses to focus on high-value pharmaceuticals. BMY shares sell at a low absolute valuation and a sharp discount relative to peers due to worries over upcoming patent expirations for Revlimid (starting in 2022) and Opdivo and Eliquis (starting in 2026). With this overhang, as well has having many other faster-growing biotech companies to choose from, investors currently have little interest in Bristol Myers shares.
The shares are attractive for two reasons. First, the low valuation provides a very appealing risk/reward trade-off. Low expectations are already built into the share price, likely minimizing the downside risk should the anticipated weak fundamentals actually arrive. And, if the fundamental reality is stronger than feared, the shares provide considerable upside potential.
Second, Bristol is taking smart and aggressive steps to minimize its fundamental risk. Left untreated, the patent expirations could potentially leave Bristol with sharply lower revenues and profits, so its revenue-and-profit-replacement strategy is the correct one, other than a pure wind-down (another fascinating and viable strategy but not one contemplated here).
Bristol is taking a multi-step approach with its strategy. First, it is working to lengthen its patent protection window for its core products. Deals with generics producers to slow new competition for Revlimid, as well as its partnership agreement with Pfizer last year to expand its Eliquis franchise, help taper the likely size and pace of revenue declines in these franchises. And, these “key three” products have strong underlying demand (their current revenue growth remains robust), indicating that pricing, not volumes, is the primary risk. This demand provides Bristol with considerable flexibility to continue to defend its revenues with new treatment combinations and variations.
Additionally, the company’s acquisitions of Celgene ($80 billion in late 2019) and MyoKardia ($13 billion in late 2020) provide attractive new products with considerable growth potential that complement Bristol’s research expertise. Bristol is using its currently-hefty free cash flow to pay down much of the debt incurred in these deals.
Lastly, Bristol has a robust pipeline of internally-developed treatments that offer potentially sizeable new revenues.
All-in, it is very likely that the worst-case scenario for Bristol Myers is flat revenues over the next 3-5 years, with a healthy likelihood of at least some incremental growth. Any indication that revenues can sustain the patent expirations should boost BMY’s share price considerably.
Also mitigating the risk, the company is aggressively cutting its costs, including the announced $2.5 billion efficiency program.
Earnings for 2021 are estimated to increase 16%, although tapering to 6-8% in future years. The company is positioned, backed by management guidance, to generate between $45 billion and $50 billion in cash flow over the three years of 2021-2023. This sum is equal to 35% of the company’s $136 billion market value. The balance sheet carries $16 billion in cash and its debt is only 2x EBITDA.
Regulators in the United States, Canada and Britain are exploring a joint effort to examine proposed pharmaceutical industry mergers. Also, the anti-trust environment in general is likely to tighten. We see only a limited effect, however, on Bristol’s ability to expand its product portfolio.
BMY shares ticked up about 2% in the past week and have about 24% upside to our 78 price target. The stock hasn’t moved much in over a year, yet the company continues to generate about $7/share in free cash flow, about $2 of which is paid out in dividends. We remain patient with BMY shares.
The stock trades at a low 8.4x estimated 2021 earnings of $7.49 (unchanged from last week). On 2022 estimated earnings of $8.06 (down 2 cents), the shares trade for 7.8x. Either we are completely wrong about the company’s fundamental strength, or the market must eventually recognize Bristol’s earnings stability and power. We believe the earning power, low valuation and 3.1% 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.
While fiscal second-quarter earnings were bland on the surface, the company looks positioned to start showing revenue growth. With low investor expectations, any revenue growth is helpful. Cisco’s balance sheet remains solid.
There was no significant company news in the past week.
CSCO shares rose 1% in the past week and have about 10% upside to our 55 price target.
The shares trade at a low 15.6x estimated FY2021 earnings of $3.22 (unchanged in the past week. On FY2022 earnings (which ends in July 2022) of $3.43 (unchanged), the shares trade for 14.6x. On an EV/EBITDA basis on FY2021 estimates, the shares trade at a discounted 10.6x multiple. CSCO shares offer a 2.9% 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 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 subdued near-term revenue and profit outlook is somewhat driven by pandemic-related lockdowns, particularly outside of the United States. Consensus estimates point to 10% revenue and earnings-per-share growth in 2021. Another overhang is the tax dispute that could cost as much as $12 billion – we don’t see an immediate resolution but consider $12 billion to be a worst-case scenario. Coke will likely continue to generate robust free cash flow in 2021.
The risk of fresh lockdowns and delayed re-openings in Germany and possibly other European countries will likely push out the full recovery of Coca-Cola.
KO shares were flat 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 22.0x estimated 2022 earnings of $2.33 (unchanged), 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 continues to participate in the economic recovery. For 2021, analysts estimate revenue growth to be 14%, aided by higher prices and volumes. The strong U.S. dollar may be a modest headwind as it makes revenues produced in other currencies less valuable when translated into dollars. Generous free cash flow will partly be used to trim Dow’s debt.
There was no significant company news in the past week.
Dow shares slipped 2% this past week and have about 13% upside to our recently-raised 70 price target. The shares trade at 16.5x estimated 2022 earnings of $3.75, although these earnings are more than a year away. This estimate ticked up about 2% in the past 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 earnings for 2021 and 2022 are estimated to increase by about 10%.
Merck files its Form 10 registration statements with the government. These forms describe the to-be-spun-off Organon operations. On May 3, Merck will provide an investor presentation further describing the business. This should help us assess the underlying value in the spin-off.
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 3.4% dividend yield pays investors to wait.
Merck shares were flat this past week and have about 37% upside to our 105 price target. Valuation is an attractive 11.8x this year’s estimated earnings of $6.51 (down a cent this past week). 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 2021 earnings (ends in September) are estimated to increase about 1%, but accelerate to the 10% range in future years. Fiscal 2021 will be hindered by subdued volumes and pricing. The Prepared Foods segment will likely see higher profits but this is a small segment for Tyson. Faster domestic and neighboring country (Mexico in particular) re-openings should help lift chicken and other meat prices and volumes.
There was no significant company news in the past week.
The stock fell 3% in the past week and have 11% upside to our recently raised 82 price target. While the near-term outlook is mixed, the new management is likely being conservative with its forward guidance.
Valuation is attractive at 13.0x estimated 2021 earnings of $5.69 (estimate decreased 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 JPMorgan, 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.
U.S. Bancorp’s 2021 earnings are expected to increase about 25% compared to the pandemic-weakened 2020 results, with future earnings growth of perhaps 9-11%.
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 currently sits at 1.69%. For reference, the yield was 1.88% at year-end 2019, just before the pandemic. Short-term interest rates have remained essentially unchanged.
During the market meltdown last year, the Federal Reserve eased a rule for calculating banks’ capital requirements. The rule required banks to set aside reserves for its holdings of Treasury securities and its deposits at the Federal Reserve – easing this rule provided banks with lower capital requirements and thus allowed them to lend more generously at a time when the economy needed it. By not extending this easing, banks now need to hold more reserves.
This rule makes no sense to us. The purpose of reserves is to absorb losses. Treasuries and deposits at the Fed hold zero risk … does the Federal Reserve truly believe that these holdings actually carry credit risks? Nor is the risk of a value decline from rising interest rates much if any of a risk – Fed deposits are redeemable at par and banks hold mostly short-term Treasuries that carry miniscule risk of loss of principal. A mystery, for sure.
The upshot is that banks may be incented to sell their Treasuries. To the extent that they own 2-10-year Treasuries, their selling would boost yields. We see little actual effect.
USB shares were flat in the past week and have about 8% upside to our 58 price target.
Valuation is a modest 12.7x estimated 2022 earnings of $4.23 (up a cent in the past week). On a price/tangible book value basis, USB shares trade at a reasonable 2.2x multiple of the $24.85 tangible book value. This ratio ignores the value of the bank’s payments, investment management and other service businesses that have low tangible book values but produce steady and strong earnings. For perspective, JPMorgan, considered the highest quality and best-managed bank, with sizeable capital markets operations, trades at 2.4x tangible book value. Currently, USB stock offers an appealing 3.1% 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. 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 re-focusing 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, Italy and France. 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. Management is targeting £1.7 billion in debt reduction in the first half of 2021 and 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.
There was no significant company news in the past week.
Aviva shares were flat this past week and have about 28% upside to our 14 price target. The stock trades at 6.9x estimated 2021 earnings per ADS of $1.58 (increased by 2 cents this past week) and about 89% of tangible book value. AVVIY shares offer an attractive and likely solid and recurring 5.3% dividend yield. BUY.
Barrick Gold (GOLD) – Barrick is one of the world’s largest and highest quality producers of gold. Based in Toronto, Canada, the company has mining operations around the world, with about 50% of production in North America, 32% in Africa and the Middle East and 18% in Latin America and Asia Pacific. The company also has smaller copper mining operations. Barrick’s market capitalization is about $37 billion.
This stock is not only out of favor (a classic contrarian trait), but is also not infrequently looked upon with doubt, disdain and discredit. The entire gold mining industry isn’t immune to such views, either. But the gold mining industry, and certainly Barrick, has lost the loose-spending and often murky culture of decades ago. After a long struggle with disappointing profitability and low returns on capital, today’s gold mining industry is one of restraint, transparency and financial discipline.
Barrick’s chairman is a former Goldman Sachs president, hardly someone who would wantonly waste shareholder money. Since taking the chairman’s seat in 2014, his signature achievement over the subsequent 4½ years was slashing costs and paying down Barrick’s entire $13 billion of net debt.
Barrick’s shares surged in 2019 and early 2020 by the combination of rising gold prices and the arrival of a highly capable new CEO, Mark Bristow, in January 2019. Bristow joined Barrick when it acquired Randgold Resources, a major South African mining company that he founded. He is highly regarded for his ability to manage portfolios of gold mines, reduce costs and navigate the complicated process of operating mines in less-developed countries that yearn for the revenues that gold mines (which obviously can’t be relocated) generate. Impressively, in his first year at Barrick, Bristow created a joint venture that combined Barrick’s and Newmont Mining’s Nevada gold mines into a single world-class operation, generating large cost and productivity improvements.
Since their mid-2020 peak at around $2,000/ounce, gold prices have slipped about 15% to $1,730/ounce. Barrick’s shares have slid over 30% - not completely surprising as mining company stocks magnify the moves in the underlying commodity. With the fall-off in the share price, Barrick shares now have considerable appeal.
Our thesis is based on two points. First, that Barrick will continue to generate strong free cash flow at current gold prices, continue to improve its operating performance and return much of that free cash flow to investors while making minor but sensible acquisitions. Demonstrating its commitment, the company will pay $0.42/share in special distributions this year, in addition to its regular $0.09/share quarterly dividend. Barrick’s balance remains solid, with its $5.2 billion in debt fully offset by its cash balance.
Second, that Barrick shares offer optionality – if the enormous fiscal stimulus, rising taxes and heavy central bank bond-buying produces stagflation and low interest rates, then the price of gold will move upward and lift Barrick’s shares with it. Given their attractive valuation, the shares don’t need this second (optionality) point to work – it offers extra upside.
Major risks include the possibility of a decline in gold prices, production problems at its mines, making a major acquisition and/or an expropriation of one or more of its mines.
At about 20, Barrick shares trade at a sizeable discount to our value estimate of 27, based on 7.5x estimated 2021 EBITDA and on a modest premium to its $25/share net asset value. The combined dividends this year will produce a 3.7% yield. Although the company may not pay a special dividend next year, it could raise its recurring dividend to provide an above-market yield. We think Barrick has a much better future than the market is assuming.
There was no significant company news in the past week.
Barrick Gold was featured in Cabot’s Stock of the Week on Monday.
Barrick shares slipped 2% this past week and have about 34% upside to our 27 price target. On its recurring $0.09/quarter dividend, GOLD shares offer a reasonable 1.8% 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 automaker. 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 is estimated to produce about 14% higher revenues in 2021, but earnings are expected to increase only about 6% (to about $5.21) due to near-term headwinds from tight semiconductor chip supplies. GM Financial will likely continue to be a sizeable profit generator.
President Biden may be favoring a proposal to require the phase-out of the sale of gas-powered cars by some future date, perhaps 2035. It is impossible to say today how such a policy would impact GM’s value, although any acceleration of EV adoption should help GM, as its under-funded and behind-the-curve competitors would fall away more quickly. However, such a mandate would be unprecedented in its sweeping impact on the U.S. economy, would face immense logistical hurdles and could easily be repealed or diluted by future administrations of either party. Sales of EVs will eventually fully replace sales of gas-powered cars at some point in the future, but we see little likelihood of this happening over the next 15 years.
China’s new policy of banning Tesla vehicles for military use is intriguing. If it is a first step, future steps could include ultimately banning sales of vehicles made by any non-Chinese company. We see little likelihood of this outcome but are placing it as a marker to watch.
The semiconductor chip shortage was worsened by a fire at a chip factory in Japan owned by Renesas Electronics. The (relatively) good news is that damage was minimal – and will mostly require the cleaning of the particle-free environment inside the facilities.
GM shares slipped 1% in the past week, and have 9% upside to our 62 price target.
On a P/E basis, the shares trade at 9.0x 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 $4.4 billion debt is elevated, its $2.0 billion cash balance gives the airline plenty of time to recover. JBLU shares carry more risk than the typical CUSA stock.
JetBlue’s revenues currently are projected to take until 2023 to fully recover to their 2019 level. EBITDA (earnings before interest, taxes, depreciation and amortization, which is a measure of cash operating earnings), is estimated to fully recover by 2022. JetBlue has improved its cost structure during the pandemic, helping rebuild profits sooner than revenues.
TSA traffic remains strong. Our informal research into airfares points to elevated prices over the next month or two, suggesting that lower volumes doesn’t necessarily mean lower revenues and profits. Demand even with high prices appears robust this year.
JetBlue launched a $650 million 5-year convertible senior note offering, which pushed down its shares on Monday. Hedge funds typically sell short a company’s shares to arbitrage an upcoming convertible offering, and also the convertible offering creates dilution potential.
The company is considering moving its headquarters from New York to Florida. We believe that a sizable motivation is the lower operating and tax costs in Florida.
JBLU shares fell 6% this past week and have about 13% upside to our recently raised 22 price target. We are keeping JBLU shares on a short leash.
The stock trades at 9.5x estimated 2023 earnings of $2.06. This estimate ticked up by 1% in the past week. We are watching the 2021 estimated loss per share to quantify near-term conditions. This estimate improved to $(2.45), by 2 cents, compared to a week ago. On an EV/EBITDA basis, the shares trade at 5.4x 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 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 is estimated to produce about 5% revenue growth and a 1% decline in earnings in 2021. Profit growth is projected to increase to a 5-6% rate in future years. Weakness this year is closely related to the sluggish re-opening of the European economies, along with higher commodity and marketing costs. The company will likely re-instate its dividend later this year, which could provide a 2.9% yield.
The risk of fresh lockdowns and delayed re-openings in Germany and possibly other European countries will likely push out the full recovery of Molson Coors.
TAP shares lifted 1% in the past week and have about 21% upside to our 59 price target. Earnings estimates remain stabilized, with a 1-cent decline in the 2021 estimate but a 1-cent increase in the 2022 estimate. TAP shares trade at 12.6x estimated 2021 earnings of $3.87.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 8.9x 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.
Revenues this year are projected to increase by about 16%, driven by a cyclical rebound, then taper to a 6% rate in future years. Profit growth of 48% in 2021, also boosted by the recovery, is estimated to taper to about 14% in future years.
There was no meaningful company news this past week.
ST shares slipped 5% this past week. The shares can twitch with the prices of other chip stocks, and weakness in the auto industry outlook can also weigh on the shares. ST shares have about 26% upside to our 75 price target.
The stock trades at 15.5x estimated 2022 earnings of $3.85 (down a cent this past week). On an EV/EBITDA basis, ST trades at 12.9x estimated 2022 EBITDA. BUY.
