Pricing-in the Future
This week, we are rolling forward our valuation comments – generally dropping our valuation based on 2021 estimates, where appropriate, while adding commentary based on estimates for 2023. Most analysts project that all of their companies will have higher earnings in future years, so we take the 2023 estimates (which are over two years away) with a grain of salt. And, they almost certainly will be wrong – we just don’t know in which direction or by how much. However, these estimates are helpful in understanding the level and direction of consensus opinion, especially between earnings reports when there is usually little hard news or fundamental data at the company level to support estimate changes.
Even though we “roll forward” our earnings model, we don’t automatically roll forward our price targets. We base our targets on multi-year earnings and other metrics, so they are generally unaffected by adding 2023 consensus estimates.
Speaking of valuations, you probably have come across comments in the media about how some growth rate or other fundamental is “priced into a stock.” This, of course, means that the stock price reflects the consensus outlook – that investors already anticipate that growth rate or news or whatever. In general, as long as expectations exceed that consensus, the stock should do well.
Apple (AAPL) shares, at 154, have priced in a reasonably decent future as they trade at 26x estimated 2023 earnings of $5.86/share. This seems about right (although perhaps pricey for our taste), such that if the company can generate $6 or $7 in earnings instead, the shares may jump higher. The market is reasonably good at pricing in steady growth.
But, what about a company that has a binary earnings outlook? Take highly cyclical and leveraged coal miner Peabody Energy (BTU). At 18.80/share, the stock is pricing in an EBITDA1 of about $661 million next year (the consensus estimate), as it has put a 4.5x multiple on that EBITDA. For a company like Peabody, this multiple is a good normalized multiple.
But, what are the chances that Peabody actually earns anything close to $661 million? In 2018, it produced $1.3 billion in EBITDA, yet only two years later it earned a paltry $200 million. So, more likely, it will earn either close to $1.3 billion, or close to $200 million. Wall Street is awful about pricing in binary (and highly unpredictable) outcomes like this, so it tends to take the middle road. But the shares won’t likely stay flat over the next year, they will head sharply in one direction or the other.
The share price history reflects this: BTU shares peaked in 2018 at about 50/share and bottoming out in 2020 at about 1/share. BTU trades today at 18.76.
With BTU, pricing-in doesn’t mean much.
With Cabot Undervalued Stock Advisor stocks, most recommendations have narrow-enough outcome ranges to allow us to decently gauge what has or has not been priced in. Dow (DOW) has a bit of a binary outcome, but a range that is much narrower than Peabody’s. Dow has a much healthier balance sheet and much more stable volume and margin structure, and products that will likely be in good demand in five years.
- Earnings before interest, taxes, depreciation and amortization, which is a rough measure of cash operating profits.
Share prices in the table reflect Tuesday (September 7) closing prices. Please note that prices in the discussion below are based on mid-day September 7 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.
Today’s Portfolio Changes
None
Last Week’s Portfolio Changes
None
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.
Bristol will participate in Morgan Stanley’s 19th Annual Global Healthcare Conference, at 8am ET on Tuesday, September 14. The webcast will be open to the public and available on the Bristol-Myers investor relations website.
BMY shares fell 3% in the past week and have about 20% upside to our 78 price target. The shares continue their grind down from post-pandemic highs. We remain patient with BMY shares and continue to have strong conviction in the company’s underlying fundamentals.
The stock trades at a low 8.0x estimated 2022 earnings of $8.05 (down 2 cents in the past week) and 7.5x estimates of $8.64 for 2023. 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 3.0% 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.
On August 18, Cisco reported encouraging fiscal fourth-quarter results and provided favorable and longer-term guidance. The company’s fundamentals are improving, and management is helping boost investor confidence by providing more visibility. Earnings rose 5% from a year ago and were 1 cent above the consensus estimate. Revenues rose 8% compared to a year ago and were in line with the consensus estimate. Some of the year/year strength was due to pandemic-weakened orders a year ago, but clearly not all. Cisco shares are somewhat driven by revenues, with little need for expanding margins although this would help the shares’ valuation multiple. Cash flow – another key aspect of the story, was robust.
We are wary of Cisco’s practice of substituting acquisitions for internal R&D, as this in effect removes a lot of R&D expense from the income statement and thus artificially boosts profit margins. Acquisitions also provide instant revenue growth. Cisco can leverage its saleforce to accelerate the sales of acquired products, but this can obscure the growth (or lack thereof) of legacy products. This strategy will likely push us to sell the stock sooner than if its earnings were of higher quality.
There was no significant company-specific news in the past week.
CSCO shares were flat in the past week and have about 2% upside to our recently increased 60 price target.
The shares trade at 17.2x estimated FY2022 earnings of $3.43 (unchanged in the past week). On FY2023 earnings (which ends in July 2023) of $3.67, the shares trade at 16.1x. On an EV/EBITDA basis on FY2022 estimates, the shares trade at a 12.2x multiple. CSCO shares offer a 2.5% 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.
There was no significant company-specific news in the past week.
KO shares slipped 1% in the past week and have about 15% upside to our 64 price target.
While the valuation is not statistically cheap, at 22.9x estimated 2022 earnings of $2.43 (unchanged this past week) and 21.3x estimated 2023 earnings of $2.61, 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 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.
Dow will host an investor day on October 6, starting at 10am ET, which will be accessible via the Dow investor relations website.
The company will be likely to both benefit and suffer in minor terms from recent hurricanes. Its Gulf facilities were closed (reducing volume) but margins will be higher (as industry output temporarily declines).
Dow shares slipped 1% this past week and have 26% upside to our 78 price target. On estimated 2022 earnings of $5.94 (up 1% in the past week), the shares trade at a 10.4x multiple. On estimated 2023 earnings of $5.63 (slightly higher than 2021 estimated earnings), the shares trade at about 11x. That analysts believe that 2023 earnings will remain steady compared to 2021 is probably a binary compromise – as in reality they will likely be either a lot stronger or a lot weaker.
Analysts are somewhat pessimistic about 2022 earnings (they assume a 30% 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 4.5% 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.
Morgan Stanley downgraded MRK shares on Tuesday to “equal weight” on concerns that investors want to see the company find new products to offset future revenue loss from Keytruda and other patent expirations. We pay little/no attention to tactical ratings changes like this: the analyst still has an 85 price target (+13% from here, so they aren’t writing the stock off), their concern is widely understood by investors, and they are hosting Merck next Tuesday at the Morgan Stanley 19th Annual Global Healthcare Conference, so there may be some gamesmanship going on (downgrade today, upgrade after encouraging comments by the new CEO next week?). The stock was weak on the news, perhaps on selling by Morgan Stanley advisors unloading client shares. Investors can listen to Merck’s conference presentation, at 11am ET, on the Merck investor relations website.
Merck shares slipped 1% this past week and have about 32% upside to our 99 price target. Valuation is an attractive 11.7x estimated 2022 earnings of $6.45 and 10.9x estimated 2023 earnings of $6.91. We note that Keytruda’s patent expiration doesn’t happen until late 2028. If the company produces earnings close to these estimates and continues to provide evidence of solid post-Keytruda prospects, as we expect, the shares are considerably undervalued.
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, which 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.
Brokerage firm Maxim Group raised their estimates to above-consensus for Otter Tail as they anticipate that the hurricanes, steady demand and low resin supplies will continue to boost the company’s margins. We tend to agree – supplies seem to be staying tight and customers seem to be accepting the higher costs.
OTTR shares rose 1% this past week and have about 3% upside to our 57 price target. The stock trades at about 15.4x estimated 2021 earnings of $3.59 (up 10% as analysts bring their estimates in-line with the company’s guidance for about $3.58). On estimated 2022 earnings of $3.13, the shares trade at about 17.6x. Analysts are assuming that the plastics upcycle will face in 2022, weighing on earnings by about 13%. OTTR shares offer a 2.8% 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 reopen, 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.
On August 11, Arcos reported encouraging second-quarter results. Revenues rebounded sharply, with systemwide same store sales nearly equal to the two-year-ago period, despite many of its restaurants still under government capacity and operating hours restrictions. About 75% of all of its restaurants are in full operations with other partly opened. Adjusted EBITDA was strong but still shy of where a fully recovered Arcos would produce. Net financial debt increased as the company produced negative free cash flow. Once at full-strength, we would expect cash flow to be robust.
Macro issues will continue to move ARCO shares. We would like to see stability/strength in the Brazilian currency after its weakness since the pandemic. The pace of vaccinations in Brazil appears to be accelerating, which should boost economic results later this year, likely helping Arcos’ business. The political situation is edgier, as slow job growth increases the pressure on the president, Jair Bolsonaro, in advance of the October 2022 election. See additional comments in our September 1 letter.
The company will present at several conferences over the next week, including Morgan Stanley’s 24th Annual Latin America Conference on Monday, September 13 and Thursday, September 16. The webcast will be open to the public and available on the Arcos Dorados investor relations website.
ARCO shares rose about 3% this past week and have about 33% upside to our 7.50 price target.
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. The stock trades at 18.8x estimated 2022 earnings per share of $0.30 (up a cent from a week ago). The 2023 consensus estimate of $0.37 (up a cent), implying a 15.2x multiple. 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.
On Thursday, August 12, Aviva reported reasonable first half 2021 results. Operating profits rose 17% from a year ago (but missed the consensus estimate), with the increase due to the operating improvements and divestitures over the past year. A major reason for the “miss” was a discretionary charge to boost its legacy life insurance reserves – real money but more reflective of prior errors than going-forward results. The company is making important and meaningful changes to its core business.
Much of our interest in Aviva is in what it plans to do with its current and future excess capital, including the proceeds from its divestitures. So far, the company has recently raised its interim dividend by 5% to £0.0735/share (about $0.20 per ADS, as there are 2 underlying common shares per ADS, and the exchange rate is about $1.38) and will return at least £4 billion (about $5.5 billion) by 2H 2022, mostly through share buybacks. It will complete £750 million “immediately.” The balance of the divestiture proceeds will go toward debt paydown.
We anticipate that the company will pay a final (year-end) dividend of about twice its interim dividend, for a full-year total recurring dividend of about $0.61/ADS. On this, the shares would produce an annual dividend yield of about 5.4% – rather appealing in an era when AA-rated corporate bonds yield about 1.7%
There was no significant company-specific news in the past week.
Aviva shares rose 2% this past week and have about 23% upside to our 14 price target.
The stock trades at 9.2x estimated 2022 earnings per ADS of $1.24 (unchanged), which is lower than estimated 2021 earnings due to Aviva’s divestitures. Interestingly, the 2023 estimate is $1.38, implying a full recovery back to 2021 results. The stock trades at about 100% 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.
On August 9, Barrick reported mixed second-quarter results. Adjusted earnings rose 26% from a year ago and were about 12% above the consensus estimate. Despite a production issue, the company said it remains on track to meet full-year production guidance. Barrick continues to invest in new mining projects while maintaining a reasonable capital spending budget. We would have liked to have seen better results on volumes and costs. Barrick is a free cash flow story, so the negative free cash flow this quarter was disappointing and tipped the balance sheet back into a net debt position (compared to the net cash a quarter ago).
The threat of local governments taking control of gold mines remains. As the free world shrinks, autocratic governments become more assertive about taking assets from Western companies. Most of Barrick’s production comes from countries unlikely to expropriate, but takings at the margin will weigh on the shares.
There was no significant company-specific news in the past week.
Commodity gold prices slipped to $1,797/ounce while the 10-year Treasury yield ticked up to 1.37%. Gold prices seems range-bound for now.
Barrick shares slipped 1% this past week and have about 37% upside to our 27 price target. The price target is based on 7.5x estimated steady-state EBITDA and a modest premium to our estimate of $25/share of net asset value.
On its recurring $.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 (no clarity on 2022 special dividends), 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.
On August 4, GM reported strong results that were nevertheless held back by the chip shortage and a large $1.3 billion warranty expense. It appears that the company’s ability to generate ever-higher profits is maxed out. Future profits (adjusted for these one-time costs) will not likely be higher, but we see a tapering decay rate rather than a cliff. However, we also wonder about the timing and pace of eventual profits from electric vehicles and the return on GM’s vast capital outlay (the $35 billion in EV spending over the next five years is about $23 per GM share – money that would have been spent on dividends or repurchases in a former era). GM Finance and the overall balance sheet both look sturdy.
The shares reflect conservative but reasonably strong gas-powered vehicle profits but assign no value to the EV operations. This zero-value almost certainly is wrong, but the EV operations have no sales or profits, so the valuation is by definition speculative at this point. 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.
There was no significant company-specific news in the past week.
GM shares were flat this past week and have 41% upside to our 69 price target.
On a P/E basis, the shares trade at 7.0x estimated calendar 2022 earnings of $6.96 (unchanged this past week). On estimated 2023 earnings of $6.15, the shares trade for about 7.9x. 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 reinstated its dividend.
The company’s second-quarter report on July 29 was encouraging. Revenues rose 14% and 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 slipped 3% in the past week and have about 50% upside to our 69 price target. The shares trade at 10.7x estimated 2022 earnings of $4.31 (unchanged this past week) and 10.1x estimated earnings of $4.55 in 2023.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 8.0x estimated 2022 results, still among the lowest valuations in the consumer staples group and below other brewing companies. BUY
Organon & Company (OGN) was recently spun off from Merck. It specializes in patented women’s healthcare products and biosimilars, and also has a portfolio of mostly off-patent treatments. Organon will produce better internal growth with some boost through smart yet modest-sized acquisitions. It may 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. Investors have ignored the company, but we believe that Organon will produce at least stable and large free cash flows with a reasonable potential for growth. At our initial recommendation, the stock traded at a highly attractive 4x earnings.
On August 12, Organon reported encouraging results, reaffirmed their full-year guidance and initiated a $0.28/share quarterly dividend. Revenues rose 5% from a year ago and were about 4% above the consensus estimate. While the headwinds we highlighted in our initiation report remain in place, Organon highlighted on the conference call a wide range of initiatives and end-market trends that provide support for its positive outlook. Adjusted EBITDA of $627 million was about 12% above the consensus estimate.
Organon will present at Morgan Stanley’s 19th Annual Global Healthcare Conference on Monday, September 13 at 9:30am ET, available to investors through the Organon investor relations website.
OGN shares rose 3% in the past week and have about 31% upside to our 46 price target (using the same target as the Cabot Turnaround Letter). The shares trade at 5.9x estimated 2022 earnings of $5.98 (up 3 cents in the past week) and 5.7x estimated 2023 earnings of $6.18. This stronger 2023 estimate is consistent with our view that Organon can generate at least steady revenues and profits. Organon shares offer an attractive 3.2% dividend yield. 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 slipped 3% this past week and have about 30% upside to our 75 price target. The stock trades at 13.8x estimated 2022 earnings of $4.17 (unchanged this past week) and 12.6x estimated 2023 earnings of $4.55. We expect this 2023 estimate will move around a lot. On an EV/EBITDA basis, ST trades at 11.0x 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.
| Growth/Income Portfolio | |||||||
| Stock (Symbol) | Date Added | Price Added | 9/7/21 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Bristol-Myers Squibb (BMY) | 04-01-20 | 54.82 | 65.19 | 18.9% | 3.0% | 78.00 | Buy |
| Cisco Systems (CSCO) | 11-18-20 | 41.32 | 58.88 | 42.5% | 2.4% | 60.00 | Buy |
| Coca-Cola (KO) | 11-11-20 | 53.58 | 55.67 | 3.9% | 2.9% | 64.00 | Buy |
| Dow Inc (DOW) * | 04-01-19 | 53.50 | 61.87 | 15.6% | 4.5% | 78.00 | Hold |
| Merck (MRK) | 12-9-20 | 83.47 | 75.98 | -9.0% | 3.4% | 99.00 | Buy |
| Otter Tail Corporaton (OTTR) | 5-25-21 | 47.10 | 55.59 | 18.0% | 2.8% | 57.00 | Buy |
| Buy Low Opportunities Portfolio | |||||||
| Stock (Symbol) | Date Added | Price Added | 9/7/21 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Arcos Dorados (ARCO) | 04-28-21 | 5.41 | 5.65 | 4.4% | — | 7.50 | Buy |
| Aviva (AVVIY) | 03-03-21 | 10.75 | 11.26 | 4.7% | 5.2% | 14.00 | Buy |
| Barrick Gold (GOLD) | 03-17-21 | 21.13 | 19.85 | -6.1% | 1.8% | 27.00 | Buy |
| General Motors (GM) | 12-31-19 | 36.60 | 48.72 | 33.1% | — | 69.00 | Hold |
| Molson Coors (TAP) | 08-05-20 | 36.53 | 45.82 | 25.4% | — | 69.00 | Buy |
| Organon (OGN) | 06-07-21 | 31.42 | 35.64 | 13.4% | — | 46.00 | Buy |
| Sensata Technologies (ST) | 02-17-21 | 58.57 | 57.28 | -2.2% | — | 75.00 | Buy |
*Note: DOW price is based on April 1, 2019 closing price following spin-off from DWDP.
Buy – This stock is worth buying.
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.
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.