Climate Change
Just reading those words, “climate change,” is almost certain to light up emotions. Regardless of one’s opinions on the degree of urgency and which of a very wide range of proposed policies and actions should be taken, how could words about the end of the world as we know it not ignite emotions?
The updated climate change report1 issued recently by the United Nation’s Intergovernmental Panel on Climate Change stoked newer and stronger words and emotions across media, government officials and the public in general.
Opinion page comments from the Financial Times, usually a bastion of understatement and calm, state that “time is running short to avert ‘hell on earth’.” On the other side of the issue, opinion comments in The Wall Street Journal (not to mention a more energetic rebuttal in the New York Post) said that the update “doesn’t tell us much that’s not new since its last report in 2013, and some of that is less dire.” Other publishers, from The New York Times, Washington Post and elsewhere, provide additional commentary, often colorful.
From an investment perspective, of course, it is financially risky to let one’s emotions get entangled in the stock selection and asset allocation process. At one end of the emotional spectrum, for example, investors who fear imminent climate disaster may feel such an urgency that they sell most of their stock holdings or move aggressively into climate change beneficiaries. This is almost certainly a mistake.
On the other end, investors who believe that little or nothing will change will miss the shift underway in how companies and investors think and act. For example, the management of Exxon Mobil may not believe in climate change, but their board of directors now has three determined new members who will redirect the company’s priorities.
Basic investment fundamentals still apply – valuations, earnings, risks, opportunities, balance sheets, management. The market can behave emotionally and irrationally at times – successful investing has always been about avoiding emotions and using rational thought and analysis.
Another concept that has helped me more objectively look at stocks is to differentiate between what I think should happen and what I think will happen. We all have opinions about what policies should be enacted regarding climate change, the Fed, government spending, regulations and such, but unless we are very senior government officials, we are unlikely to have any say on those policies. Investing on what we believe should happen is a common and potentially expensive but avoidable mistake.
It’s more productive to focus on possible outcomes, on what will happen. Better yet, it’s probably best to avoid even this – particularly with politics. Guessing accurately about what will happen is remarkably difficult. At the Cabot Undervalued Stocks Advisor, we generally avoid incorporating our views on possible political outcomes, even though we have some strong opinions about “right” and “wrong.” We work to be aware of the debates and possible outcomes, but concentrate on individual stocks and their company-specific situations.
1. For the intrepid reader, the full report is 3,949 pages long, found at https://www.ipcc.ch/report/ar6/wg1/#FullReport and summarized in a more readable 42-page Summary for Policymakers and a two-page Headline Statements.
Share prices in the table reflect Tuesday (August 10) closing prices. Please note that prices in the discussion below are based on mid-day August 10 prices.
Note to new subscribers:
You can find additional color on our thesis, 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
Aug 11: Arcos Dorados (ARCO)
Aug 12: Aviva (AVVIY)
Aug 12: Organon & Co. (OGN)
Aug 18: Cisco Systems (CSCO)
Today’s Portfolio Changes
Bristol-Myers Squibb (BMY) – Moving the shares from Strong Buy to Buy.
Last Week’s Portfolio Changes
Cisco (CSCO) – Raising our price target from 55 to 60.
Growth/Income Portfolio
Bristol Myers Squibb Company (BMY) shares sell at a low valuation due to worries over patent expirations for Revlimid (starting in 2022) and Opdivo and Eliquis (starting in 2026). However, the company is working to replace the eventual revenue losses by developing its robust product pipeline while also acquiring new treatments (notably with its acquisitions of Celgene and MyoKardia), and by signing agreements with generics competitors to forestall their competitive entry. The likely worst-case scenario is flat revenues over the next 3-5 years. Bristol should continue to generate vast free cash flow, helped by a $2.5 billion cost-cutting program, and has a relatively modest debt level.
On July 28, Bristol reported encouraging second-quarter results with revenues growing 13% from the pandemic-weakened quarter a year ago. Revenues were 4% above the consensus estimate. One of the major debates on Bristol is its ability to grow revenues, so the “beat” is an indicator that we are on the right track.
Adjusted earnings per share of $1.93 rose 18% from a year ago and were slightly higher than the $1.90 consensus estimate. The company reiterated its full-year 2021 revenue and earnings guidance. Net debt was trimmed about 7% from the year-end – an important metric that we are watching.
There was no significant company-specific news in the past week.
BMY shares fell 3% in the past week and have about 16% upside to our 78 price target. The shares have moved near their 2020 pre-pandemic high and trade just below their 2018 high. We remain patient with BMY shares and continue to have strong conviction in the company’s underlying fundamentals. But, given the shares’ recent appreciation, they no longer warrant a Strong Buy rating. We are moving the shares to a Buy.
The stock trades at a low 9.0x estimated 2021 earnings of $7.49 (unchanged from last week). On 2022 estimated earnings of $8.07 (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. BUY
Cisco Systems (CSCO) is facing revenue pressure as customers migrate to the cloud and thus need less of Cisco’s equipment and one-stop-shop services. Cisco’s prospects are starting to improve under a relatively new CEO, who is shifting Cisco toward a software and subscription model and is rolling out new products, helped by its strong reputation and entrenched position within its customers’ infrastructure. 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.
There was no significant company-specific news in the past week.
CSCO shares fell 1% in the past week and have about 8% upside to our 60 price target.
The shares trade at 17.3x estimated FY2021 earnings of $3.21 (unchanged in the past week). On FY2022 earnings (which ends in July 2022) of $3.41 (down a cent), the shares trade at 16.3x. On an EV/EBITDA basis on FY2022 estimates, the shares trade at a 11.7x 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 yet nearly 40% of its revenues come from non-soda beverages across the non-alcoholic spectrum. Its global distribution system reaches nearly every human on the planet. Coca-Cola’s longer-term picture looks bright but the shares remain undervalued due to concerns over the pandemic, the secular trend away from sugary sodas, and a tax dispute which could cost as much as $12 billion (likely worst-case scenario). The relatively new CEO James Quincey (2017) is reinvigorating the company by narrowing its over-sized brand portfolio, boosting its innovation and improving its efficiency, as well as improving its health and environmental image. Coca-Cola’s balance sheet is sturdy, and its growth investing, debt service and dividend are well-covered by free cash flow.
On July 21, Coca-Cola reported encouraging second-quarter results, with adjusted earnings of $0.68/share, beating the consensus earnings estimate of $0.56 and much stronger than the $0.42 earned a year ago during the depths of the pandemic. Compared to two years ago, unit case volumes matched the two-year-ago level, not bad considering that parts of the global economy remained subdued. The company raised its full-year guidance for organic revenue growth, adjusted EPS and free cash flow. All in, a good quarter.
Competitor PepsiCo announced they will be launching “Hard Mountain Dew”, an alcoholic version of Mountain Dew, early next year. This follows Coke’s recent launch of Topo Chico hard seltzer in a joint venture with Molson Coors.
KO shares were unchanged in the past week and have about 12% upside to our 64 price target. The stock continues to reflect Coke’s earnings power even as the pandemic resurgence may delay a full return to normal in consumption patterns.
While the valuation is not statistically cheap, at 25.3x estimated 2021 earnings of $2.25 (flat in the past week) and 23.4x estimated 2022 earnings of $2.43 (flat), 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 2.9% dividend yield. BUY
Dow Inc. (DOW) merged with DuPont to create DowDuPont, then split into three companies in 2019 based on product type. The new Dow is the world’s largest producer of ethylene/polyethylene, the most widely-used plastics. Investors undervalue Dow’s hefty cash flows and sturdy balance sheet largely due to its uninspiring secular growth traits and its cyclicality. The shares are driven by: 1) commodity plastics 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). Investors worry about a cyclical peak and whether Dow will squander its vast free cash flow. We see Dow as having more years of strong profits before capacity increases signal a cyclical peak, and expect the company to continue its strong dividend, reduce its pension and debt obligations, repurchase shares slowly and restrain its capital spending.
On July 22, Dow reported a strong second quarter, with adjusted earnings of $2.72/share, about 16% above the consensus estimate of $2.35 and sharply higher than the $(0.26) loss a year ago in the depths of the pandemic. Management has an encouraging outlook for volumes and pricing and for its ability to generate higher profits on comparable revenues. While profits may be peaking in coming quarters, they will likely remain elevated rather than fall off sharply. Industry capacity increases are coming next year, but we do not see large price cuts from our current vantage point. We would like to see Dow generate more free cash flow, trim its debt and issue fewer stock options.
There was no other significant company-specific news in the past week.
Dow shares rose 1% this past week and have 24% upside to our 78 price target.
The shares trade at 10.7x estimated 2022 earnings of $5.87 (up two cents this past week). The estimate for 2021 earnings slipped two cents.
Analysts are somewhat pessimistic about 2022 earnings (they assume a 31% decline from 2021). 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 4.4% dividend yield adds to the shares’ appeal. In a prolonged downcycle, the dividend could be cut, but that could be years away and even then a cut isn’t a certainty if Dow can manage its balance sheet and down-cycle profits reasonably well. HOLD
Merck (MRK) shares are undervalued as investors worry about Keytruda, a blockbuster oncology treatment (about 30% of revenues), facing generic competition in late 2028. Also, its Januvia diabetes treatment may see generic competition next year, and like all pharmaceuticals it is at-risk from possible government price controls. Yet, Keytruda is an impressive franchise that is growing at a 20% rate and will produce solid cash flow for nearly seven more years, providing the company with considerable time to replace the potential revenue loss. Merck’s new CEO, previously the CFO, will likely accelerate Merck’s acquisition program, which adds both return potential and risks to the story. The company is highly profitable and has a solid balance sheet. It spun off its Organon business in June and we think it will divest its animal health sometime in the next five years.
On July 29, Merck’s reported satisfactory second-quarter results. Revenues grew 19% from a pandemic-weakened year-ago quarter (excluding favorable currencies) and were slightly ahead of consensus estimates. Keytruda sales were strong. Adjusted earnings increased 28% from a year ago but fell slightly short of the $1.33 consensus estimate. Higher costs led to the earnings “miss” but this seems more like analysts being too optimistic rather than any fundamental issues weighing on the company. Merck’s balance sheet and cash flow looked solid. The company raised its full-year revenue guidance, reiterated its confidence in its new product pipeline and is planning on small-to-large acquisitions.
There was no other significant company-specific news in the past week.
Merck shares slipped 2% this past week, and have about 32% upside to our 99 price target.
Valuation is an attractive 13.5x this year’s estimated earnings of $5.56 (up three cents in the past week). Merck produces generous free cash flow to fund its current dividend (now yielding 3.5%) 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) is a rare utility/industrial hybrid company, with a $2 billion market cap. The electric utility has 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, supported by an accommodative regulatory environment. The industrial side includes the Manufacturing and Plastics segments. Otter Tail has an investment grade balance sheet, produces solid earnings and prides itself on steady dividend growth. The unusual utility/manufacturing structure is creating a discounted valuation, which 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.
On August 2, Otter Tail reported strong second-quarter results, with earnings rising 141% from a year ago and were nearly double the consensus estimate. Full-year guidance was raised by about 40%. The profit surge was driven by the Plastics segment, as PVC resin supplies were exceptionally tight, largely due to the Texas winter storms, creating a PVC pipe shortage that allowed Otter Tail to sharply raise its PVC pipe prices. The company anticipated that these unusual conditions would last through 2021 but moderate into 2022. Electric segment profits rose a steady 5%. The company is progressing through its Minnesota rate case – we anticipate a benign outcome. Otter Tail’s balance sheet remains in good shape, although the steady expansion of its electric utility rate base continues to siphon off considerable cash flow.
There was no significant company-specific news in the past week.
OTTR shares were flat this past week after a sharp run-up last week. The stock has about 6% upside to our 57 price target. The stock trades at about 16.4x estimated 2021 earnings of $3.26 (up 6% reflecting the strong earnings report). This consensus is already stale, as it is 9% below the company’s guide for about $3.58 – it is possible but highly unlikely that the company would provide guidance that it would then miss. At this guide point, the stock trades at an attractive 15.0x multiple. The shares offer a 2.9% dividend yield. BUY
Buy Low Opportunities Portfolio
Arcos Dorados (ARCO), which is Spanish for “golden arches,” is the world’s largest independent McDonald’s franchisee. 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 shares are undervalued as investors worry about the pandemic, as well as political/social unrest, inflation and currency devaluations. However, the company is well-managed and positioned to benefit as local economies re-open, and it has the experience to successfully navigate the complex local conditions. Debt is reasonable relative to post-recovery earnings, and the company is currently producing positive free cash flow.
Arcos reports second-quarter results on Wednesday, August 11. The consensus earnings estimate is for a $(0.04)/share loss.
There was no significant company-specific news in the past week.
ARCO shares fell 4% this past week and have about 30% upside to our 7.50 price target. The stock will likely remain volatile until we have more clarity on its earnings and the effects of the pandemic, including the Delta variant, on its outlook. We remain steady in our conviction in the company’s recovery. The low share price offers a chance to add to or start new positions in ARCO.
The stock trades at 20.6x estimated 2022 earnings per share of $0.28 (unchanged from a week ago). The 2021 estimate remains unchanged at $0.04. The 2023 consensus estimate of $0.34 is also unchanged. We’ll no doubt see these estimates change following the earnings report later this week. BUY
Aviva, plc (AVVIY), based in London, is a major European insurance company specializing in life insurance, savings and investment management products. Amanda Blanc was hired as the new CEO last year to revitalize Aviva’s laggard prospects. She has divested operations around the world to aggressively re-focus the company on its core geographic markets (UK, Ireland, Canada), and is improving Aviva’s product competitiveness, rebuilding its financial strength and trimming its bloated costs. Aviva’s dividend has been reduced to a more predictable and sustainable level with a modest upward trajectory. Excess cash balances are being directed toward debt reduction and potentially sizeable special dividends.
There was no significant company-specific news in the past week.
Aviva reports first half 2021 earnings on Thursday, August 12. The consensus estimate is for £0.25/share, which translates into $0.69/ADS.
Aviva shares rose 3% this past week and have about 25% upside to our 14 price target.
The recurring quarterly dividend of $0.14/share produces a 5.2% yield. In an era that features investment grade bond yields of 1.6%, Aviva makes an interesting bond proxy, particularly given what appears to be a resilient base dividend. The likely upcoming special dividends on top of this add extra appeal.
The stock trades at 7.9x estimated 2021 earnings per ADS of $1.41 (down a cent purely on a change in the currency) and at about 96% of tangible book value. BUY
Barrick Gold (GOLD), based in Toronto, is one of the world’s largest and highest quality gold mining companies. About 50% of its production comes from North America, with the balance from Africa/Middle East (32%) and Latin America/Asia Pacific (18%). The market has little interest in Barrick shares. Yet, Barrick will continue to improve its operating performance (led by its new and highly capable CEO), 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. Also, Barrick shares offer optionality – if the unusual economic and fiscal conditions drive up the price of gold, Barrick’s shares will rise with it. Given their attractive valuation, the shares don’t need this second (optionality) point to work – it offers extra upside. Barrick’s balance sheet has more cash than debt. 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 mixed second-quarter results. Adjusted earnings of $0.29/share rose 26% from a year ago and were about 12% above the consensus estimate. A production issue reduced its Carlin (Nevada) mine output but the company said it remains on track to meet full-year total company production guidance. Barrick continues to invest in new mining projects while maintaining a reasonable capital spending budget.
While the company’s results were OK, we would have liked to have seen better. Compared to a year ago, gold prices were basically flat but gold volumes sold fell 13%, leading to an 8% decline in gold revenues. Copper revenues rose 28%, as a 64% increase in copper prices was weighed down by a 22% decline in volumes sold. Gold mining costs rose 5% while copper mining costs rose 27% – the net effect was that EBITDA was basically flat as well. Costs will likely rise in future quarters but some sizeable efficiency programs will be winding down that should yield partly-offsetting cost reductions.
Capital spending increased so free cash flow turned negative. Barrick is a free cash flow situation, so we expect at least positive free cash flow every quarter, particularly when commodity prices are elevated and the company touts its efficient operations. Helpfully, the company maintained its cost guidance for the full year. We note the upcoming year-end departure of the head of North American operations – a loss of talent but which we believe will be fully replaced.
The company declared its regular $0.09/share quarterly dividend and a $0.14/share special dividend to be paid on September 15. The special dividend is the second of three equal payments approved for this year. Barrick’s cash balance of $5.1 billion fell 9% from the prior quarter, such that its debt now fractionally exceeds its cash balance.
Barrick completed its sale of its interests in the Lagunas Norte mine in Peru for about $81 million. This offloads about $226 million in liabilities, improves Barrick’s overall portfolio and frees the company from what could have been deeper issues if Peru’s government becomes autocratic. Barrick is working to re-open the Porgera mine in Papua New Guinea.
The threat of local governments taking control of gold mines remains. Recently, Kyrgyzstan nationalized the Kumtor mine previously owned by Centerra Gold of Canada. While expropriation risks an unfavorable response from Western governments, the local countries often do not care. Most of Barrick’s production comes from countries unlikely to expropriate, but takings at the margin will weigh on the shares.
Barrick shares fell 8% this past week and have about 35% 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 prices fell about 4% to $1,733/ounce, likely weakened by the rise in yield, to about 1.34%, by the 10-year Treasury yield.
On its recurring $0.09/quarter dividend, GOLD shares offer a reasonable 1.8% dividend yield. Barrick will pay an additional $0.42/share in special distributions this year, lifting the effective dividend yield to 3.9%. BUY
General Motors (GM) is making immense progress with its years-long turnaround. It is perhaps 90% of the way through its gas-powered vehicle turnaround, and is well-positioned but in the early stages of its electric vehicle (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 the underlying value of its emerging EV business is unclear.
GM’s second-quarter earnings report complicates our investment decision-making, but we are retaining our Hold rating for now. The company reported very strong results, which would have been even higher but for the chip shortage and a large $1.3 billion warranty expense. These are probably temporary issues that we can mostly look through. However, it appears that the company’s ability to generate ever-higher profits is maxxed out after adjusting for these items, leading to our question about the future decay-rate from this peak. Also, as we learn more about the electric vehicle business, we wonder (doubt?) what the eventual profitability of these cars will be, and hence what kind of return the company will earn on its immense capital outlays.
From a valuation perspective, the shares are priced to reflect conservative but reasonably strong profits in the gas-powered vehicle segment (with the recognition that this is a cyclical industry) backed by a sturdy balance sheet and healthy profits at GM Financial, but have zero value assigned to the EV business.
We see GM producing strong gas-powered vehicle profits and cash flow for at least another year or two, although at a tapered downward trajectory. The chip shortage (and perhaps the rising input costs) will eventually ease, and the warranty costs will likely return to normal although the Chevy Bolt warranty issue may be a chronic one for the EV business (but that is outside of the value of the gas-powered car business). GM Financial will also likely continue to produce large profits.
It seems unreasonable that the EV business actually has zero value, given the investments made by highly credible partners like Honda, but it is nevertheless speculative. Investors have returned to their senses, at least partly, by assigning a near-zero value to independent EV makers but GM has the technical and financial firepower to be an end-game survivor.
Tesla is generating remarkably high manufacturing profits, but is helped by have zero legacy vehicle costs, zero dealer network costs and zero advertising costs. Once their new factories are filled, they may be more likely to cut prices to expand their sales volumes rather than further boost their margins, potentially shrinking the profit pool for GM and other EV producers. We also wonder whether GM’s high EV investment is more defensive (zero or negative rate of return) rather than offensive (decently positive rate of return).
We’re keeping GM a Hold for now, as the risk/return balance isn’t as favorable as we would like for the Cabot Undervalued Stocks Advisory. But, we need to think more about this stock. The valuation is too low to warrant a sale, and the fundamentals are by no means deteriorating. Yet, the upside is now murkier for the gas-powered business and especially the EV business. We don’t see a future “blow-up” and the most likely course for the fundamentals and shares is a grinding upward move.
It seems that investors had hoped for a huge “beat-n-raise” but were caught off guard by the warranty expense and effects of the chip shortage on future production, pushing the share price down sharply on the earnings date. This seems more like an emotional reaction by short-term traders than a fully rational analysis by long-term investors.
In terms of the numbers, GM reported adjusted earnings of $1.97/share compared to a $(0.50)/share loss a year ago and the $2.25/share consensus. The company raised its full-year EBIT guidance by a generous 19%, and raised their EPS guidance by 21% to $5.90 (midpoint). The cash flow guidance was unchanged due to unpredictability of working capital and chip arrivals. Most analysts had higher estimates for the full year, so these estimates now will be coming down.
Automotive profits were a record high $2.9 billion, even as volumes were restrained due to the chip shortage and the company had a huge $1.3 billion unexpected warranty expense. GM lost market share in most categories except North American trucks, which smartly became a production priority, where it gained share.
GM Financial continued to generate large profits, earning $1.6 billion, compared to $226 million a year ago and $1.2 billion in the first quarter of this year. For the trailing four quarters, GM Financial has produced a remarkably high 35.5% return on tangible equity.
The company continued to invest heavily in EVs and AVs, as it wants the #1 market share in North America. Management anticipates profit margins will be similar to or higher than on gasoline engines. Anytime GM, or any capital-intensive cyclical company, aims for the #1 market share, we almost instinctively add “… at the expense of profits.”
GM is hosting an October 6-7 investor update which should feature more color on their gas-powered and EV profit outlook. As we expected, GM did not reinstate its previously suspended dividend.
GM shares fell 7% this past week and have 28% upside to our 69 price target due to the complicated and weak-versus-expectations quarter.
On a P/E basis, the shares trade at 7.8x estimated calendar 2022 earnings of $6.95 (down 1% this past week). The 2021 estimate fell 7% due to the quarter missing estimates. 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) is one of the world’s largest beverage companies, producing the highly recognized Coors, Molson, Miller and Blue Moon brands as well as numerous local, craft and specialty beers. About two-thirds of its revenues come from the United States, where it holds a 24% market share. Investors worry about Molson Coors’ lack of revenue growth due to its relatively limited offerings of fast-growing hard seltzers and other trendier beverages. Our thesis for this company is straight-forward – a reasonably stable company whose shares sell at an overly-discounted price. Its revenues are resilient, it produces generous cash flow and is reducing its debt. A new CEO is helping improve its operating efficiency and expand carefully into more growthier products. The company recently re-instated its dividend.
The company’s second-quarter report on July 29 was encouraging. Revenues rose 14%, powered by a resurgence in Europe. Revenues were about 4% ahead of the consensus estimate. Adjusted net income rose 2% from a year ago and was 17% above the consensus estimate. However, adjusted EBITDA fell 1%, as the company spent more on marketing and battled rising transportation, brewery and packaging materials costs. Beating the revenue and earnings estimates is important as it supports our view that investors don’t fully appreciate the resiliency in Molson’s business. The company reaffirmed its 2021 full-year guidance. Molson’s debt balance is unchanged from year-end but cash is starting to accumulate.
There was no significant company-specific news in the past week.
TAP shares rose 3% in the past week and have about 36% upside to our 69 price target.
The shares trade at 12.6x estimated 2021 earnings of $4.01 (up a cent this past week). Estimates for 2022 were unchanged.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 8.4x current year estimates, still among the lowest valuations in the consumer staples group and below other brewing companies. BUY
Organon & Company (OGN) is a mid-sized ($6.3 billion revenues) S&P 500 pharmaceutical producer that was recently spun-off from Merck. About 80% of its sales come from outside of the United States. The shares are undervalued, as Organon is a new company with little following, it faces patent expirations, particularly with its Nexplanon product, and as it is under pricing pressure in China from government buying programs. The market sees several years of 3-4% revenue decay, or worse.
We have a more favorable outlook. In the Women’s Health Segment (23% of revenues), Nexplanon has a highly valuable franchise with solid 10% growth potential yet has a more resilient revenue stream than the market is giving it credit for. The segment’s fertility treatments are well-positioned to grow, particularly in China. Organon’s Established Brands segment (68% of revenues) is a collection of nearly 50 mostly off-patent therapies, of which only about a tenth of its revenues face patent expirations over the next four years. Much of the Chinese revenue pressures are in the past. The Biosimilars segment (9% of revenues) has solid double-digit growth potential as it rolls out new treatments. Organon will boost its growth through smart yet modest-sized acquisitions and perhaps eventually divest its Established Brands segment. The management and board appear capable, the company produces robust free cash flow, has modestly elevated debt and will pay a reasonable dividend.
Organon reports its second-quarter results on Thursday, August 12. The consensus estimate is $1.43/share.
There was no significant company-specific news in the past week.
OGN shares rose 1% in the past week and have about 54% upside to our 46 price target (using the same target as the Cabot Turnaround Letter).
The shares trade at 5.0x estimated 2021 earnings of $5.98 and 5.0x estimated 2022 earnings of $5.92. These are remarkably low valuations. Estimates were unchanged this past week. The company has yet to report as an independent company. Curiously, the consensus estimate for 2023 is a more robust $6.23.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 7.3x current year estimates, also quite low. BUY
Sensata Technologies (ST) is a $3.8 billion (revenues) producer of nearly 47,000 highly-engineered sensors used by automotive (60% of revenues), heavy vehicle, industrial and aerospace customers. About two-thirds of its revenues are generated outside of the United States, with China producing about 21%. Investors undervalue Sensata’s durable franchise. Its sensors are typically critical components that generally produce high profit margins. Also, as the sensors’ reliability is vital to safely and performance, customers are reluctant to switch to another supplier that may have lower prices but also lower or unproven quality. Sensata has an arguably under-leveraged balance sheet and generates healthy free cash flow. The relatively new CEO will likely continue to expand the company’s growth potential through acquisitions.
Once a threat, electric vehicles are now an opportunity, as the company’s expanded product offering (largely acquired) allows it to sell more content into an EV than it can into an internal combustion engine vehicle. Risks include a possible automotive cycle slowdown, chip supply issues, geopolitical issues with China, currency and over-paying/weak integration related to its acquisitions.
On July 27, Sensata reported encouraging second-quarter results. Its earnings were sharply higher than the pandemic-weakened results a year ago and about 10% above the consensus estimate. Revenues were 72% higher than a year ago and were also above estimates. The company raised its full-year revenue and earnings guidance. Cash flow was robust and net debt increased modestly to fund the Xirgo acquisition.
There was no significant company-specific news in the past week.
ST shares rose about 1% this past week and have about 26% upside to our 75 price target. The stock trades at 14.3x estimated 2022 earnings of $4.17 (unchanged this past week). On an EV/EBITDA basis, ST trades at 11.1x estimated 2022 EBITDA. BUY
| Growth/Income Portfolio | |||||||
| Stock (Symbol) | Date Added | Price Added | 8/10/21 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Bristol-Myers Squibb (BMY) | 04-01-20 | 54.82 | 67.32 | 22.8% | 2.9% | 78.00 | Buy |
| Cisco Systems (CSCO) | 11-18-20 | 41.32 | 55.59 | 34.5% | 2.6% | 60.00 | Buy |
| Coca-Cola (KO) | 11-11-20 | 53.58 | 56.77 | 6.0% | 2.9% | 64.00 | Buy |
| Dow Inc (DOW) * | 04-01-19 | 53.50 | 63.14 | 18.0% | 4.4% | 78.00 | Hold |
| Merck (MRK) | 12-9-20 | 83.47 | 75.06 | -10.1% | 3.5% | 99.00 | Buy |
| Otter Tail Corporaton (OTTR) | 5-25-21 | 47.10 | 53.28 | 13.1% | 2.9% | 57.00 | Buy |
| Buy Low Opportunities Portfolio | |||||||
| Stock (Symbol) | Date Added | Price Added | 8/10/21 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Arcos Dorados (ARCO) | 04-28-21 | 5.41 | 5.86 | 8.3% | 0.0% | 7.50 | Buy |
| Aviva (AVVIY) | 03-03-21 | 10.75 | 11.15 | 3.7% | 5.3% | 14.00 | Buy |
| Barrick Gold (GOLD) | 03-17-21 | 21.13 | 19.84 | -6.1% | 1.8% | 27.00 | Buy |
| General Motors (GM) | 12-31-19 | 36.60 | 54.26 | 48.3% | — | 69.00 | Hold |
| Molson Coors (TAP) | 08-05-20 | 36.53 | 51.27 | 40.4% | — | 69.00 | Buy |
| Organon (OGN) | 06-07-21 | 31.42 | 30.37 | -3.3% | — | 46.00 | Buy |
| Sensata Technologies (ST) | 02-17-21 | 58.57 | 59.61 | 1.8% | — | 75.00 | Buy |
*Note: DOW price is based on April 1, 2019 closing price following spin-off from DWDP.
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.
Strong Buy – This stock offers an unusually favorable risk/reward trade-off, often one that has been rated as a Buy yet the market has sold aggressively for temporary reasons. We recommend adding to existing positions.
Buy – This stock is worth buying.
Hold – The shares are worth keeping but the risk/return trade-off is not favorable enough for more buying nor unfavorable enough to warrant selling.
Sell – This stock is approaching or has reached our price target, its value has become permanently impaired or changes in its risk or other traits warrant a sale.
Note for stock table: For stocks rated Sell, the current price is the sell date price.