Brief comments
Today’s opening note is relatively brief – we’ll return next week with our regular comments on topics relevant to value investors.
The market seems to have settled into complacency. We’re in a period after first-quarter earnings reports and government statistics indicate a surging economy, yet investors rightfully wonder if or when the Fed will raise interest rates and are starting to consider what happens after the post-pandemic boom.
As contrarians, we continue to troll through lists of out-of-favor stocks. One is close to home – Merck’s recently spun-out Organon business. Investors have aggressively dumped the shares, to the point that we believe offers an attractive investment. Like all value investments, “price” creates the opportunity. We aren’t particularly sanguine about Organon’s future, but at the right price the shares are worth purchasing. And, the lower the price, the more appealing. At Tuesday’s mid-day price of around 29, it is definitely interesting. If it went below 20, we probably would consider mortgaging the family farm to buy more shares.
One topic on which we’ve received several questions: how much of a particular stock should one buy? Position size is perhaps just as critical as what to buy and sell. We’ll talk about this more in coming weeks.
Other:
Several companies are presenting at investor conferences in coming weeks, including Cisco, who is at Cowen’s Technology, Media and Telecom conference on June 9th. Investors can access replays at each company’s (not the brokerage firm’s) investor relations website.
Share prices in the table reflect Tuesday (June 8) closing prices. Please note that prices in the discussion below are based on mid-day June 8 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.
TODAY’S PORTFOLIO CHANGES
Organon (OGN) – New Buy (spin-off from MRK)
Dow (DOW) – Raising price target from 70 to 78
General Motors (GM) – Raising price target from 62 to 69
MolsonCoors Beverage Company (TAP) – Raising price target from 59 to 69
Merck (MRK) – Reducing price target from 105 to 99
Tyson (TSN) – Moving from Hold to Sell
LAST WEEK’S PORTFOLIO CHANGES
None
GROWTH/INCOME PORTFOLIO
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 mitigate 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.
Bristol was sued for $6.4 billion for allegedly slow-walking its efforts to gain FDA approval of the third of three required treatments that would have then triggered a $6.4 billion cash payout under its contingent value rights, or CVRs. The CVRs were issued in connection with Bristol’s 2019 acquisition of Celgene for $80 billion. These and other CVRs are highly controversial: the issuing company has both the incentive and the power to prevent payouts. The outcome of this lawsuit is impossible to determine. Bristol may press their case and either fully win or fully lose, or perhaps settle with investors for some fraction of the $6.4 billion. For reference, a full $6.4 billion payout, or perhaps $5 billion after-tax benefits, would be about $2.30/share.
BMY shares slipped 3% in the past week and have about 23% upside to our 78 price target. We remain patient with BMY shares.
The stock trades at a low 8.5x estimated 2021 earnings of $7.47 (unchanged from last week). On 2022 estimated earnings of $8.05 (unchanged), the shares trade at 7.9x. 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 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 (although much less when removing a 4% benefit for an extra week and for acquisitions) and were about 2% higher than consensus estimates. Fourth guidance was good enough but was slightly shy of consensus estimates. The numbers are moving in the right direction but need to show more improvement before the turnaround can be considered a success. More work is needed on profit margins, which continue to slip.
There was no significant company-specific news in the past week.
CSCO shares rose 3% in the past week and have about 1% 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 16.9x estimated FY2021 earnings of $3.21 (unchanged in the past week). On FY2022 earnings (which ends in July 2022) of $3.42 (up a cent), the shares trade at 15.9x. On an EV/EBITDA basis on FY2021 estimates, the shares trade at a discounted 11.8x multiple. CSCO shares offer a 2.7% 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 reaffirmed its full-year guidance, which calls for 8-9% organic revenue growth and perhaps 8-12% comparable earnings per share growth.
There was no significant company-specific news in the past week.
KO shares rose 1% in the past week and have about 15% upside to our 64 price target. While the valuation is not statistically cheap, at 25.5x estimated 2021 earnings of $2.18 (unchanged in the past week) and 23.6x 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 is 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 3.0% 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.
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: conditions are remarkably strong now yet are likely to improve as domestic and global industrial and consumer goods production continues to rebound. This may last at least a few quarters, perhaps longer, before capacity increases across the industry signal a cyclical peak.
On the second, in Dow’s presentation at the Bernstein Strategic Decisions Conference (replay and transcript available at Dow’s investor relations website), the company emphasized its commitment to the dividend and to debt and pension obligation reductions. Dow said it will repurchase shares to cover the dilution from stock options – we do not like creeping dilution but nevertheless we view these repurchases as a misreported expense line item that inflates Dow’s profit margins (nearly all companies do this, unfortunately).
So far, Dow is keeping the constraints on its capital spending, limiting growth spending (as opposed to “maintenance” spending which is required to keep the business running) to about $1.6 billion this year. Dow said it will spend incrementally above this amount on initiatives to reduce its carbon emissions – from a financial perspective these often are 100% rate-of-return investments (a total write-off), but clearly help the planet and may be more than fully offset by a higher share price to the extent that investors view the company more favorably.
We are raising Dow’s price target from 70 to 78, due to the improvement in its operating fundamentals (which are mostly cyclical but partly reflect longer-term gains in efficiency) and its balance sheet (more enduring).
Dow shares slipped 2% this past week. The shares trade at 13.4x estimated 2022 earnings of $5.17 (up about 2% this past week). The estimate for 2021 earnings rose nearly 6%. Analysts are somewhat pessimistic about 2022 earnings matching 2021 earnings (they assume a 20% decline). If the 2022 estimate continues to tick up, the shares will likely follow, although Dow’s cyclical earnings and investor fears of an eventual downcycle will ultimately limit Dow’s upside. The high 4.1% 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 acquisition program, which adds both risk and return potential to the Merck story.
The company spun off its Organon business on June 2nd. 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 3.6% 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.
Post-spinoff, Merck has $9 billion in incremental cash from the Organon dividend. Its revenues will decline by about $6.3 billion yet will have faster growth. Its profit margins will initially decline, but should fully recover, plus some, helped by the gradual elimination of redundant Organon stranded costs. We are reducing our Merck price target by $6/share, from 105 to 99, to reflect the spinoff and to incorporate a slightly more conservative valuation multiple.
Merck shares slipped 2% this past week. The shares have about 37% upside to our new 99 price target.
Valuation is an attractive 11.4x this year’s estimated earnings of $6.31 (down about 3% to reflect the spinoff). 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
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.
There was no significant company-specific news in the past week.
OTTR shares rose 1% in the past week and have about 17% upside to our 57 price target. The stock trades at about 18.7x estimated 2021 earnings of $2.61 (unchanged this past week) and offer an attractive 3.2% dividend yield. 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.
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.
We are moving TSN shares from Hold to Sell. The stock essentially reached our 82 price target, although it has slipped back about 6% since. We see little justification in raising our price target from here, particularly given the revolving door leadership problem. The valuation is reasonable, but not interesting enough. The shares produced an 11% loss since our initial recommendation in December 2019, but have gained 32% from June 30, 2020 when the chief analyst position changed over. SELL
BUY LOW OPPORTUNITIES PORTFOLIO
New Buy: Organon & Company (OGN) is Merck’s spinoff of its women’s health, biosimilars and various legacy branded operations. The transaction was completed after the market closed on June 2. MRK holders received one OGN share for every 10 MRK shares held. The new company is now included in the S&P 500 Index.
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.
Since the spin off, the shares have fallen sharply, by about 20%. While we are not particularly enthusiastic about Organon’s long-term prospects (“uninspiring but not dour” as we described last week), the discounted price makes the shares appealing.
The sell-off appears to be mostly technical: many Merck investors have little interest in holding yet another pharma company facing patent erosion risks. And, given Organon’s much-smaller market cap (perhaps $8 billion) compared to Merck’s $185 billion, large-cap fund managers have no incentive to keep OGN shares. A fund manager with a 3% weight in MRK would receive only a 13 basis point (or, 0.13%) weight in OGN – resulting in an easy order of “just dump it” to the trading desk. Hence, our opportunity.
We are placing a $37 price target on Organon shares. Our timing may be off by a few days – the stock might fall again, or it might bounce – with spinoffs there is no definitive way to pick the exact bottom. BUY
Arcos Dorados (ARCO) – Spanish for “golden arches,” Arcos Dorados is the world’s largest independent McDonald’s franchisee, operating over 2,200 restaurants and holding exclusive rights in 20 Latin American and Caribbean countries. Based in stable Uruguay and listed on the NYSE, the company produces about 72% of its revenues in Brazil, Mexico, Argentina and Chile. Arcos’ leadership looks highly capable, led by the founder/chairman who owns a 38% stake.
The pandemic has weighed on revenues, while the Venezuelan economic mess, political/social unrest, inflation and currency devaluations in other countries create profit headwinds and investor angst. The company is well-managed and positioned to benefit as local economies reopen. Debt is reasonable relative to post-recovery earnings, and the company is currently producing positive free cash flow, which buy it time until the recovery arrives.
Arcos reported a mixed quarter. Revenue fell 9% but rose 3.8% in constant currencies. The sharp depreciation of its local currencies, primarily the Brazilian real and Argentine peso, took 13 percentage points off of its US$-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 were unchanged this past week and have about 13% upside to our 7.50 price target. The stock trades at 22.1x estimated 2022 earnings per share of $0.30 (unchanged 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 refocusing the company on its core geographic markets (UK, Ireland, Canada). 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.
The company’s first-quarter trading update (sales and capital strength only, no profit update) was encouraging, yet more improvement is needed. Capital strength continues to improve, even as the company set aside funds for dividends and repaid some of its debt. With its ambitious global divestiture program now completed, Aviva can now fully concentrate on improving the performance of its remaining core businesses.
Highly respected European activist investor Cevian has acquired a 5% stake in Aviva. The activist is pressing Aviva to return £5 billion to investors, a higher number than the company has talked about. Cevian also said that Aviva shares, in three years, should be trading at nearly double the current price with twice the current dividend. Cevian’s presence is an almost unalloyed positive for shareholders.
Aviva shares rose 2% this past week and have about 17% upside to our 14 price target. The stock trades at 7.8x estimated 2021 earnings per ADS of $1.53 (unchanged this past week) and at about 97% of tangible book value. AVVIY shares offer an attractive and likely solid and recurring 4.8% 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.
There was no significant company-specific news in the past week.
Barrick shares slipped 4% this past week and have about 16% upside to our 27 price target. The price target is based on 7.5x estimated 2021 EBITDA and a modest premium to its $25/share net asset value. Commodity gold slipped fractionally to $1,895/ounce.
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 3.3%. 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 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.
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.
GM provided some encouraging commentary on the semiconductor shortage, which strongly implied some upside to second-quarter results.
A quieter announcement but one with potentially much higher long-term value is that GM will offer its OnStar Guardian security services to anyone in the U.S. and Canada, not just owners of GM vehicles. The mobile phone app is designed to alert first responders in the case of a vehicle emergency, and provide access to roadside assistance and other services, for $15/month. OnStar currently has somewhere around 1 million paid subscribers and has the potential to become an industry-standard. This could provide a highly valuable and large annuity-like profit stream for GM in coming years.
We are raising our price target on General Motors (GM) from 62 to 69. The company’s fundamentals remain robust, even as its core earning power (gas-powered trucks and cars) is suppressed due to the chip shortage. EV competition from start-ups is fading, although Ford is showing renewed vigor. GM’s impressive management and earning power, its positioning to be a winner in the eventual EV future (we see the industry transition as gradual and occurring slower than the consensus which implies an aggressive adoption rate for EVs), and its undervaluation on reasonably conservative metrics warrant the higher price target. We are keeping the Hold rating as the new target represents only a 10% increase from the current price.
GM shares rose 6% this past week and have 10% upside to our new 69 price target.
On a P/E basis, the shares trade at 9.4x estimated calendar 2022 earnings of $6.67 (up four 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, and its 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. 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 1% decline in per-share earnings in 2021. Profit growth is projected to increase to a 5-9% rate in future years. Weakness this year is closely related to the sluggish reopening of the European economies, along with higher commodity and marketing costs. The company will likely reinstate 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.
We are raising our price target on MolsonCoors (TAP) from 59 to 69: The company continues to make progress with its new product development and its efficiency initiatives and is likely to see additional volume growth as its geographic markets fully open following the pandemic. TAP shares still do not adequately reflect the company’s value and earning potential.
TAP shares rose 5% in the past week and have about 13% upside to our new 69 price target. The shares trade at 15.7x estimated 2021 earnings of $3.89 (up two cents this past week). Estimates for 2022 were up three cents to $4.23.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 9.9x current year estimates, still among the lowest valuations in the consumer staples group and below other brewing companies. 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. Generally, favorable news about the easing of the semiconductor shortage is favorable to Sensata.
ST shares rose 1% this past week and have about 24% upside to our 75 price target.
The stock trades at 14.9x estimated 2022 earnings of $4.06 (up 2 cents this past week). On an EV/EBITDA basis, ST trades at 12.9x 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.
