*Next Issue: The next issue of Cabot Undervalued Stocks Advisor will be published on Thursday, June 3, 2021.
Yet Another Missive on Inflation?
We’ve written about inflation in the past two letters and promise that we’ll stop with this letter, unless some major news on this front emerges. Yet, what keeps us on the topic is commentary from brokerage firms and media outlets saying that the market is fully discounting the arrival of inflation. If inflation is here to stay, at perhaps a rate greater than, say, 3-4%, then the market is not discounting its arrival.
The Federal Reserve, for its part, is softening the market for a change in its interest rate policy. In the recently-released meeting notes, they said, “A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”
As an aside, we are imminently impressed with the Fed’s word-smithing abilities. The single sentence includes no less than nine hedging statements. Perhaps we will start counting these hedges, and get seriously worried when the number declines to only three!
Nevertheless, if inflation remains robust, the Fed will shift its stance from accommodating to fighting. The economy and capital markets are so flush with excess cash (and leverage at low interest rates to magnify this cash), and are so confident in their assumption of no change in this environment, that any meaningful policy shift would trigger a financial accident, at least. The rotation out of tech names that suffer from higher interest rates would likely create a wider swath of casualties. Phrases like, “these stocks are cheap relative to bonds,” when bonds are about as expensive as they can mathematically be in a rational world, will vanish from the lexicon.
Our focus on inflation isn’t to be alarmist. We aren’t predicting high inflation – we aren’t in the prediction business and most predictions turn out to be wrong, including ours. There are many legitimate reasons why inflation could actually be temporary – product/commodity supply always seems to rise up to meet demand (“the cure for high prices is high prices”) and the surging economy may fade once the extraordinary stimulus and reopening rush fades. If things unravel too quickly, we could see a recession in two years.
Our focus is on the horizon, to identify possibly dangerous risks, not just ten paces ahead. This helps build our awareness, to help avoid getting caught off-guard if the risks materialize. On the greed and fear meter, we have moved past the greed side and are now on the fear side.
Share prices in the table reflect Tuesday (May 25) closing prices. Please note that prices in the discussion below are based on mid-day May 25 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.
Included with each stock discussion below are summaries of each thesis and any recent earnings reports. For more lengthy commentaries on these, please refer to the issue that correspond to our “New Buy” rating or the issue immediately following the earnings release.
Send questions and comments to Bruce@CabotWealth.com.
UPCOMING EARNINGS RELEASES
May 27: Aviva plc (AVVIY)
TODAY’S PORTFOLIO CHANGES
New Buy: Otter Tail Corporation (OTTR)
LAST WEEK’S PORTFOLIO CHANGES
None
GROWTH/INCOME PORTFOLIO
New Buy: Otter Tail Corporation (OTTR) – Based in northwest Minnesota, this $2 billion market cap company is a rare combination of an electric utility and a manufacturing business. Otter Tail’s power operations have a solid and high-quality franchise, with a balanced mix of generation, transmission and distribution assets that produce about 75% of the parent company’s earnings. An accommodative regulatory environment is allowing the utility to continue to add capacity, although its projected rate base growth is likely to be incrementally slower than in prior years.
The manufacturing side includes four well-managed specialized metals and plastics companies. Here, stronger end-market growth should more than offset rising input prices.
Otter Tail’s sturdy balance sheet is investment grade, earnings and cash flow are growing and the company prides itself on steady dividend growth. The unusual utility/manufacturing structure might make the company a target for activists, as the two parts may be worth more separately, perhaps in the hands of larger, specialized companies. OTTR shares trade at about 11x adjusted 2021 EBITDA and 18.3x earnings, and offer an attractive 3.3% dividend yield. We are setting our price target at 57, about 20% above the current price. BUY.
Bristol Myers Squibb Company (BMY) is a New York-based 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).
The shares are attractive for two reasons. First, low expectations (low valuation) minimize the downside risk should the anticipated weak fundamentals actually arrive, yet if the fundamental reality is stronger than feared the shares offer considerable upside potential.
Second, Bristol is reducing its fundamental risk through a multi-pronged revenue-and-profit-replacement strategy. Bristol has a robust pipeline of internally-developed treatments that offer potentially sizeable new revenues. Additionally, its acquisitions of Celgene and MyoKardia, and potentially future acquisitions, provide new growth potential that complements Bristol’s research expertise. And, Bristol has signed agreements with several generics competitors, reflecting the strong underlying demand for its “key three” products, such that the primary issue is pricing, not volumes.
All-in, it is likely that the worst-case scenario is for flat revenues over the next 3-5 years. Any indication that revenues could sustainably grow should boost BMY’s share price considerably. Helping mitigating the risk, the company is aggressively cutting its costs, including a $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 $144 billion market value. The balance sheet carries $13 billion in cash and its debt is only 2x EBITDA.
The first quarter 2021 earnings report delivered mixed news, so investors will need to remain patient. Revenue growth was a positive 3%, and earnings rose 1% but fell 4% below the consensus. Management reaffirmed their full year guidance for high single-digit (maybe 7-8%) revenue growth and for earnings between $7.35/share and $7.55/share, although the $7.45 midpoint was below the $7.48 consensus estimate.
There was no significant company-specific news in the past week.
BMY shares rose 2% in the past week and have about 17% upside to our 78 price target. We remain patient with BMY shares.
The stock trades at a low 8.9x estimated 2021 earnings of $7.47 (up a cent from last week). On 2022 estimated earnings of $8.05 (unchanged), the shares trade at 8.3x. 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 2.9% dividend yield that is well-covered by enormous free cash flow make a compelling story. STRONG BUY.
Cisco Systems (CSCO) produces technology equipment (72% of revenues) that connects and manages data and communications networks, and also sells application software, security software and related services. As customers gradually migrate to cloud computing, Cisco’s equipment, and thus its one-stop-shop capabilities, are slowly becoming less valuable, leading to stagnant revenue growth and weak stock performance. To help restore growth, 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. 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.
Cisco reported modestly encouraging fiscal third quarter results, with adjusted earnings per share of $0.83, up 5% from a year ago and a cent higher than the consensus estimate. Revenues rose 7% compared to a year ago and were about 2% higher than consensus estimates. The numbers are moving in the right direction, but need to show more improvement before the turnaround can be considered a success.
Revenues grew for the first time in several quarters – encouraging in its own right as the company’s main challenge is to improve its relevance in its markets. Sales strength was broad-based and led by its best-positioned products (thankfully) and the improved uptake of its subscriptions. Subscriptions now account for 81% of software sales. Product orders grew 10%, the highest rate in nearly a decade.
We’re only “modestly encouraged” with the revenue progress. It’s positive, but after removing 1% for acquired revenues and 3% for the extra week, revenue growth was less impressive. Growth is occurring outside the “Enterprise” category – the segment was flat year/year compared to declines in the past – but we want to see outright growth in this segment.
More work is needed on profit margins. Gross margins and operating margins fell from a year ago. The company attributed a “normal” amount of the decline to price-related erosion and highlighted higher semiconductor costs and expedited shipping costs as meaningful contributors to the slippage. Their fourth quarter guidance points to continued margin weakness.
The company is spending on acquisitions ($5.5 billion in the quarter), so its free cash flow was suppressed. One frustration we have with large tech companies like Cisco is that they spend a lot of cash to repurchase shares, yet their share-count doesn’t decline. In the past nine months, Cisco spent $2.5 billion on repurchases while its fully-diluted share count was basically unchanged. This spending does not show up in the income statement, but equals nearly an entire quarter of Cisco’s net income. We recognize the merit of compensating tech talent in stock options/grants, and understand that most investors ignore this effect – it nevertheless isn’t a flattering practice for the company or its shareholders.
Forward guidance was adequate enough, although the $0.82/share EPS midpoint was about 3.5% short of consensus estimates. We have little doubt that Cisco will beat the estimate-at-the-time when fourth quarter earnings are announced. The company is moving forward and we’re staying with the position for now.
CSCO shares rose 1% in the past week and have about 3% upside to our 55 price target. While we generally would move the shares to a Hold, we believe Cisco’s earnings potential is higher than currently estimated, which leaves additional potential upside.
The shares trade at 16.6x estimated FY2021 earnings of $3.21 (down 3 cents in the past week). On FY2022 earnings (which ends in July 2022) of $3.42 (also down 3 cents), the shares trade at 15.6x. On an EV/EBITDA basis on FY2021 estimates, the shares trade at a discounted 11.6x multiple. CSCO shares offer a 2.8% 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.
Coca-Cola’s longer-term picture looks bright, despite the clouded near-term outlook due to the pandemic and the secular trend away from sugary sodas, its high exposure to foreign currencies and always-aggressive competition. 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.
Relatively new CEO James Quincey (2017) 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 first quarter results were encouraging, as the company’s revenues have nearly fully recovered from the pandemic. Still, investors will need to remain patient as on-premise sales remain subdued with consumers only slowly resuming their out-of-house activities. Adjusted earnings rose 8%. Free cash flow improved sharply to $1.4 billion, and the balance sheet remains strong. Coke re-affirmed its full-year guidance, which calls for 8-9% organic revenue growth and perhaps 8-12% comparable earnings per share growth.
The European Union has started a preliminary anti-trust investigation into Coca-Cola’s European operations. At this very early stage, it is nearly impossible to assess the concerns and implications, although initial reports suggest that the inquiry was due to complaints by major retailers and wholesalers. For now, we see limited impact on Coca-Cola, but recognize that governments in developed countries in general are stepping up their anti-trust scrutiny.
KO shares rose 1% in the past week and have about 17% upside to our 64 price target. While the valuation is not statistically cheap, at 25.1x estimated 2021 earnings of $2.18 (unchanged in the past week) and 23.2x estimated 2022 earnings of $2.36 (unchanged), the shares remain undervalued given the company’s future earning power and valuable franchise. Also, the value of Coke’s partial ownership of a number of publicly traded companies (including Monster Beverage) is somewhat hidden on the balance sheet, yet are worth about $23 billion, or 9% of Coke’s market value. This $5/share value provides additional cushion supporting our 64 price target. KO shares offer an attractive 3.1% 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 25%, 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. Generous free cash flow will partly be used to trim Dow’s debt.
First quarter results were strong, with adjusted earnings more than double the year-ago results and about 18% above the consensus of $1.15. Revenues rose 22% and were about 7% above consensus estimates. EBITDA rose 44%. Second quarter guidance was ahead of estimates and appears conservative. Dow’s balance sheet remains sturdy.
Two key questions for the Dow story: how much better can fundamentals get, and what will the company do with its vast free cash flow. Our view on the first is that conditions can get incrementally better over the next few quarters before capacity increases across the industry signal a cyclical peak. On the second, management’s cash flow priorities are to support the dividend, reduce its debt/pension liabilities, slowly ramp up capital spending, and repurchase shares. Current free cash flow readily supports all of these initiatives, so as long as the cycle remains robust investors can assume that debt paydown and share repurchases will continue. We are assuming no dividend increases, given the cyclicality of Dow’s business. We will continue our research into the company’s strategic use of its surplus cash.
There was no significant company-specific news in the past week.
Dow shares were flat this past week and are essentially at our 70 price target. For now, we suggest holding onto DOW shares, but we are reviewing the price target. The shares trade at 13.7x estimated 2022 earnings of $5.07 (unchanged this past week). The high 4.0% dividend yield adds to the shares’ appeal. HOLD.
Merck (MRK) – Pharmaceutical maker Merck focuses on oncology, vaccines, antibiotics and animal health. The shares sell at a significant discount to its peers, as Keytruda, a blockbuster oncology treatment representing about 30% of total revenues, will face generic competition in late 2028. Also, hanging over the stock is possible generic competition for its Januvia diabetes treatment starting in 2022, and the possibility of government price controls.
Keytruda remains an impressive franchise that is growing at a 20+% annual rate. The company is becoming more aggressive about replacing the potentially lost revenues, even though it has nearly seven years to accomplish this. The new CEO, previously the CFO, will likely accelerate Merck’s acquisitive program, which adds both risk and return potential to the Merck story.
The company will spin off its Organon business in early June. Longer term, we see Merck spinning out or selling its animal health business. Merck has a solid balance sheet and is highly profitable. Longer-term, the low valuation, strong balance sheet and sturdy cash flows provide real value. The 3.3% dividend yield pays investors to wait.
Merck’s first quarter earnings were lower than the market’s expectations, but our thesis remains unchanged. Sales of Keytruda (about a third of total sales) grew 19%, while Januvia (#2 product at about 10% of total sales) grew 1%. Gardasil fell 16%, attributed to changes in buying patterns in the U.S. and the timing of shipments to China. Sales for the Animal Health segment grew 17%. Merck’s earnings were weakened by the lower revenue and a modest narrowing of the gross margin. Net debt was essentially unchanged from year-end.
With a new CEO transitioning in, the company reiterated its commitment to the dividend but provided no meaningful color on capital allocation. Management provided full-year guidance that was unchanged other than a slight reduction of the currency tailwind, in effect fractionally raising underlying profit expectations.
Merck’s spin-off of its women’s health, biosimilars and various legacy branded operations, named Organon (OGN), will begin regular trading on June 3. When-issued trading began a few weeks ago – some quotation services show it trading at around $37-$38/share. We think the spin-off is a positive for Merck, as it trades away slow-growth operations for a $9 billion cash inflow. On June 2, MRK holders will receive 1 OGN share for every 10 MRK share held.
Our initial view of Organon is that it has uninspiring but not dour prospects. The stock’s appeal would depend heavily on the price. If it trades in the mid-30s, we would begin to find it attractive.
Organon produces an array of established branded treatments (~68% of revenues), women’s health products (~23% of revenues) and biosimilars (a type of generic drug, at about ~9% of revenues). Revenues for 2021 should be about $6.6 billion. Revenue growth will be modest, at perhaps 3%, as the company’s products face patent-expiry erosion and generally are slow-growth. The marquee product is the Nexplanon contraceptive, which generates about 11% of sales – a valuable franchise but one that faces generic competition starting in 2028. Nearly 80% of Organon’s sales are produced outside of the U.S., offering some protection against faster patent-related erosion. A key component of its strategy is to accelerate its revenue growth. EBITDA profits will likely be about $2.3 billion (35% margin) this year.
The management seems capable but untested as leaders of a public company. Debt will be elevated at almost 4x EBITDA. Organon will produce good free cash flow which it will use to pay down the debt, fund a reasonable dividend (at 20% of FCF, its annual dividend would be perhaps $1.60/share) and fund acquisitions.
There was no significant company-specific news in the past week.
Merck shares slipped 2% this past week. The shares have about 35% upside to our 105 price target. Valuation is an attractive 12.0x this year’s estimated earnings of $6.47 (unchanged 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 and Ball Park. 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 reported modestly discouraging fiscal second quarter results. Revenues were 4% above a year ago while adjusted earnings per share rose 68% from a year ago and was 16% higher than consensus estimates. However, the optically pleasing results were artificially boosted by hedging gains, leaving clean profits somewhat uninspiring. Pricing was strong across all segments. While the outlook for beef and pork is generally strong, the chicken segment is struggling with industry-wide and self-inflicted issues that the new chief operating officer is working to fix. Rising feedstock, labor and packaging costs are headwinds. The balance sheet has only incrementally improved since year-end.
There was no significant company-specific news in the past week.
TSN continues to trade just below our price target. As such, we are reviewing these Hold-rated shares. The stock was flat in the past week and has 2% 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 reasonable at 13.5x estimated 2021 earnings of $5.95 (up about 1% in the past week). Currently the stock offers a 2.2% dividend yield. HOLD.
BUY LOW OPPORTUNITIES PORTFOLIO
Arcos Dorados (ARCO) – Spanish for “golden arches,” Arcos Dorados is the world’s largest independent McDonald’s franchisee, operating over 2,200 restaurants and holding exclusive rights in 20 Latin American and Caribbean countries. Based in stable Uruguay and listed on the NYSE, the company produces about 72% of its revenues in Brazil, Mexico, Argentina and Chile. Arcos’ leadership looks highly capable, led by the founder/chairman who owns a 38% stake.
The pandemic has weighed on revenues, while the Venezuelan economic mess, political/social unrest, inflation and currency devaluations in other countries create profit headwinds and investor angst. The company is well-managed and positioned to benefit as local economies re-open. Debt is reasonable relative to post-recovery earnings, and the company is currently producing positive free cash flow, which buy it time until the recovery arrives.
Arcos reported a mixed quarter. Revenue fell 9% but rose 3.8% in constant currencies. The sharp depreciation of its local currencies, primarily the Brazilian real and Argentine peso, took 13 percentage points off of its US$-reported revenues compared to a year ago. EBITDA fell 18% in US$ but only 9.4% in constant currency after some reasonable adjustments. Local results showed improvement, which is part of our thesis on Arcos. Brazil struggled due to rising Covid-related restrictions but these are being lifted in early May. Net debt remained essentially unchanged from year-end.
There was no significant company-specific news in the past week.
ARCO shares slipped 5% this past week and have about 22% upside to our 7.50 price target. The stock trades at 20.6x estimated 2022 earnings per share of $0.30 (raised a cent, or about 3%, from a week ago). BUY.
Aviva, plc (AVVIY) – Based in London, England, Aviva is a major European insurance company specializing in life insurance, savings and investment management products. 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). Divestitures of its operations elsewhere, including across Asia and Europe, are nearly completed. 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 recurring dividend, but to a more predictable and sustainable level, along with what is likely to be a modest but upward trajectory.
Aviva’s surplus cash flow, partly from divestitures, will be directed toward debt reduction and the recurring dividend. As it is over-capitalized, Aviva will pay out potentially sizeable special dividends to shareholders.
There was no significant company-specific news in the past week.
Aviva shares slipped 2% this past week and have about 22% upside to our 14 price target. The stock trades at 7.5x estimated 2021 earnings per ADS of $1.53 (unchanged this past week) and about 93% of tangible book value. AVVIY shares offer an attractive and likely solid and recurring 5.1% dividend yield. BUY.
Barrick Gold (GOLD) – Toronto-based Barrick is one of the world’s largest and highest-quality gold mining companies. About 50% of its production comes from North America, with 32% from Africa/Middle East and 18% from Latin America/Asia Pacific. Our thesis is based on two points. First, that Barrick will continue to improve its operating performance (led by its new and highly capable CEO), continue to generate strong free cash flow at current gold prices, and return much of that free cash flow to investors while making minor but sensible acquisitions. Second, 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, a major acquisition and/or an expropriation of one or more of its mines.
Barrick reported encouraging first quarter results. Revenues rose 9% from a year ago, helped by higher gold prices and higher copper revenues, partly offset by a 10% decline in gold volumes. Adjusted EBITDA rose 23%, and overall free cash flow was strong, Barrick remains on-track to meet its full-year production guidance, and the balance sheet net cash position improved to $500 million. Barrick announced the first $0.14/share extra dividend, to be paid on June 15th, with two more later this year.
Earlier this week there was an attempted coup in Mali, home to Barrick’s giant Loulo-Gounkoto mine and some smaller side mining operations. Barrick owns an 80% interest in this mine, with the balance owned by the Mali government. This mine is a valuable source of cash to whomever is in power, and few companies have the ability to operate the mine and return cash to the government like Barrick can. However, there is always the risk of a renegotiation of the split. Currently the mine produces about 9% of Barrick’s annual gold output. Mali is holding presidential elections this coming February to return country to civilian rule, which perhaps is the catalyst for the unrest.
Barrick shares slipped 2% this past week and have about 10% upside to our 27 price target. The stock trades at a discount to our value estimate of 27, based on 7.5x estimated 2021 EBITDA and at a modest premium to its $25/share net asset value. Commodity gold ticked up to $1,882 this past week.
On its recurring $.09/quarter dividend, GOLD shares offer a reasonable 1.5% dividend yield. Barrick will pay an additional $0.42/share in special distributions this year, lifting the effective dividend yield to 3.2%. BUY.
General Motors (GM) – GM is making immense progress with its years-long turnaround from a poorly-managed post-bankruptcy car maker to a highly profitable gas and electric vehicle producer. We would say it is perhaps 85% of the way through its gas-powered vehicle turnaround, and is well-positioned but in the early stages of its EV development. GM Financial will likely continue to be a sizeable profit generator.
GM’s shares are at least partly trading on the prospects for President Biden’s $2 trillion infrastructure bill, which include as much as $100 billion in federal support for electric vehicles.
First quarter results were strong despite concerns over the semiconductor shortage. Automotive revenues were unchanged but higher vehicle prices drove adjusted net income to $2.25/share, sharply higher than the $0.62/share a year ago and the $1.05/share consensus estimate. GM Financial remains highly profitable. GM’s Automotive balance sheet remains sturdy, with cash of $19 billion fully offsetting automotive debt of $18 billion. We are wary of GM’s vast capital spending although we recognize the merits of high EV investments. The company reaffirmed its guidance for full-year EBIT of $10-11 billion. GM is fully-charged for both today’s environment and the EV world of the future, although much of its value is based on the unknown EV future.
President Biden’s pitch for $174 billion in EV subsidies, which he promoted last week, would be a noticeable positive for GM. We hope it would not subsidize weaker EV companies like Lordstown Motors, which said that it is sharply cutting its production forecast and risks running out of capital unless it receives new financing. The EV industry has many (too many) competitors, most of which will collapse. GM looks to be a highly-likely survivor and the sooner these competitors go away the better.
GM shares rose 2% this past week and have 9% upside to our 62 price target. We remain on the border of selling this stock, given the risks, but for now are keeping the Hold rating. On any meaningful strength in the shares, we could move to a Sell.
On a P/E basis, the shares trade at 8.6x estimated calendar 2022 earnings of $6.63 (up 2 cents 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 provides some indication of the direction of earnings estimates, and so 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.
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 is estimated to produce about 5% revenue growth and a 2% decline in per share earnings in 2021. Profit growth is projected to increase to a 5-8% 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 2.4% yield.
Molson Coors’ first quarter results were encouraging, as revenues and profits showed respectable resilience and were better than consensus estimates despite headwinds from the pandemic, winter storms and a cyber-security problem. Revenues fell 10% while underlying EBITDA fell 21%. The company maintained its full year guidance.
There was no significant company-specific news in the past week.
TAP shares rose 5% in the past week and are re-approaching our 59 price target. The shares trade at 15.0x estimated 2021 earnings of $3.87 (up a cent this past week). Estimates for 2022 rose another 2% this past week to $4.20.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 9.7x current year estimates, still among the lowest valuations in the consumer staples group and below other brewing companies.
As the shares are essentially at our price target and have largely fully-recovered from the pandemic, we are evaluating the position. Molson Coors is a stable company trading at a low valuation with contrarian appeal. However, the upside from here is less clear but still may be plenty interesting. 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, produces strong profits and free cash flow, has a reasonably sturdy balance sheet 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 trucking, 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 24%, driven by a cyclical rebound, then taper to a 6% rate in future years. Profit growth of 54% in 2021, also boosted by the recovery, is estimated to taper to about 10-20% in future years.
Sensata reported strong first quarter results, with adjusted earnings about 62% above year-ago results and 18% above consensus estimates. Revenues were a record-high, about 22% above year-ago revenues, and about 6% above consensus estimates. The company raised its full-year earnings guidance. Net debt was unchanged from the prior quarter as the company used surplus cash for acquisitions and capital spending.
There was no significant company-specific news in the past week.
ST shares rose 1% this past week and have about 30% upside to our 75 price target.
The stock trades at 14.3x estimated 2022 earnings of $4.04 (unchanged this past week). On an EV/EBITDA basis, ST trades at 12.6x estimated 2022 EBITDA. BUY.
Disclosure: The chief analyst of the Cabot Undervalued Stocks Advisor personally holds shares of every recommended security, except for “New Buy” recommendations. The chief analyst may purchase or sell recommended securities but not before the fourth day after any changes in recommendation ratings has been emailed to subscribers. “New Buy” recommendations will be purchased by the chief analyst as soon as practical following the fourth day after the newsletter issue has been emailed to subscribers.
