“Sixty percent of the time, it works every time”
This quote, uttered by the cad Brian Fantana in the movie “Anchorman,” refers to the presumed efficacy of a pungent cologne. The statistic is so absurd that even dim-witted Ron Burgundy replies, “that doesn’t make sense.”
With investors struggling to make sense of the current market volatility amid too many rapidly changing conditions, it can be tempting to find comfort in statistics. I recently read in Barron’s (as a long-time subscriber, I have a lot of respect for this publication) that, “after falling into bear-market territory… the Nasdaq has averaged a six-month return of 10% and has been in positive territory nearly two-thirds of the time.” This is only one example of the widespread use of statistical history to guide investors. An investor can hardly go through a day without reading similar justifications for market timing.
As an ardent student of history, I’m intrigued yet also wary of these stats. They’re intriguing, because they provide some sense of perspective on how markets have historically behaved. A tweak to the above statistic from Barron’s, that, instead, markets went down 25%, rather than up 10%, might change how I think about the current market.
Yet, one of my favorite phrases about statistics, “if you torture the numbers hard enough, they’ll confess to anything,” suggests that any such historical parallels may not be very useful. Consider that the Barron’s statistic goes back only to 1972. Nearly the entire data set occurred during a period of secularly declining interest rates and inflation rates, as well as an easing of global tensions. We clearly are not in such a period today.
One period it does include that has perhaps many similarities to today, is the early 1970s. Stock valuations were high while inflation and interest rates were low but rising. Here, the data is less comforting: In the six months after entering a bear market in May 1973, the Nasdaq rebounded 7% – impressive enough, but then collapsed nearly 50% in an almost straight line over the next year.
So, when reading someone’s statistics that are intended as a comforting guide to the future, remember that the future is impossible to predict. And, keep in mind a quote from baseball great Yogi Berra about how things might turn out, who said, “it has a 50-50 chance of going one way or the other.”
With the first quarter of 2022 ending in about two weeks, companies are starting to enter the so-called quiet period, when they are reluctant to provide much color to analysts on their earnings prospects. As such, there were almost no earnings estimate changes or company-specific news this week.
Share prices in the table reflect Tuesday (March 15) closing prices. Please note that prices in the discussion below are based on mid-day March 15 prices.
Note to new subscribers: You can find additional color on our thesis, recent earnings reports and other news on recommended companies in prior editions of the Cabot Undervalued Stocks Advisor, particularly the monthly edition, on the Cabot website.
Send questions and comments to Bruce@CabotWealth.com.
Today’s Portfolio Changes
None.
Last Week’s Portfolio Changes
The Coca-Cola Company (KO) – From Buy/Under review (approaching price target) to Buy with no price target change.
Upcoming Earnings Reports
Wednesday, March 16: Arcos Dorados (ARCO)
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, has a solid, investment-grade balance sheet, and trades at a sizeable discount to its peers.
There was no significant company-specific news in the past week.
BMY shares rose 3% in the past week and have about 12% upside to our 78 price target. Valuation remains low at 8.9x estimated 2022 earnings, compared to 11x or better for its major peer companies. The stock’s 8.3x EV/EBITDA multiple is similarly cheap, compared to 9-10x or better for peers.
Assuming an average of $15 billion/year in free cash flow, the shares trade at a 10% free cash flow yield.
Either we are completely wrong about the company’s fundamental strength, or the market will 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. 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 rose 1% in the past week and have 21% upside to our 66 price target. The dividend yield is an attractive 2.8%. BUY.
The Coca-Cola Company (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.
There was no significant company-specific news in the past week.
KO shares rose 1% in the past week and have about 8% upside remaining to our 64 price target. 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, its cyclicality and concern that management will squander its resources. 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). 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.
Industry conditions for Dow will likely be strong for a while. The firm remains well-positioned to generate immense free cash flows over the next few years, even as the stock market cares little about cash but rather is focused on the incremental news flow related to economic growth, energy prices and any industry capacity changes. In the meantime, Dow shareholders can collect a highly-sustainable 4.8% dividend yield while waiting for more share buybacks, more balance sheet improvement, more profits and a higher valuation.
Dow will participate in the JPMorgan 2022 Industrials Conference on Thursday, March 17 at 11:20 am EDT. The discussion will be viewable through the Dow investor relations website.
Dow shares were unchanged in the past week and have 35% upside to our 78 price target. BUY.
Merck (MRK) shares are undervalued as investors worry about Keytruda, a blockbuster oncology treatment (about 30% of revenues) which faces 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, is accelerating Merck’s acquisition program, which adds return potential and risks to the story. The company is highly profitable and has a solid balance sheet. It spun-off its Organon business last June and we think it will divest its animal health segment sometime in the next five years.
There was no significant company-specific news in the past week.
Merck shares rose 2% in the past week and have about 26% upside to our 99 price target. The company has a strong commitment to its dividend (3.5% yield) which it backs up with generous free cash flow, although its shift to a more acquisition-driven strategy will slow the pace of dividend increases. BUY.
Buy Low Opportunities Portfolio
Allison Transmission Holdings, Inc. (ALSN) – Allison Transmission is a midcap ($6.4 billion market cap) manufacturer of vehicle transmissions with about $2.7 billion in revenues. About 76% of sales come from North America. Many investors reflexively dismiss this company, viewing it as a low-margin producer of car and light truck transmissions that is destined for obscurity in an electric vehicle world. But we disagree. Allison produces no car and light truck transmissions, instead it focuses on the school bus and Class 6-8 heavy-duty truck categories, where it holds an 80% market share. Its 35% EBITDA margin is sharply higher than its competitors and on-par with many specialty manufacturers. And it’s a leading producer and innovator in electric axles which all electric trucks will require. Another indicator of its advanced capabilities: Allison was selected to help design the U.S. Army’s next-generation electric-powered vehicle.
The company generates considerable free cash flow, which has helped it maintain a low-debt balance sheet. Its capable leadership team keeps its shareholders in mind, as the company has reduced its share count by a huge 38% in the past five years. The shares were highlighted in our latest Cabot Turnaround Letter as a “like watching paint dry” stock, and as it fit our 13F criteria, as noted value investment firm Polaris Capital Management recently took a sizeable position (1.5% stake) in the company.
There was no significant company-specific news in the past week.
Valuation at 6.5x estimated 2022 EBITDA is below the company’s historical average and undervalues its franchise and financial strength. From a tactical perspective, investors may want to establish a starter position here, then add if the shares exhibit significant weakness.
Allison shares were flat over the past week and have 22% upside to our 48 price target. The shares offer an appealing 2.1% dividend yield. BUY.
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. The shares are depressed as investors worry about the pandemic, as well as political/social unrest, inflation and currency devaluations. However, the company has a solid brand and high recurring demand and is well-positioned to benefit as local economies re-open. The leadership looks highly capable, led by the founder/chairman who owns a 38% stake, and 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.
Macro issues, including iffy economic conditions in Brazil (inflation is running at a 10.4% rate), currency issues and the chances that a socialist might win next year’s Brazilian presidential elections will continue to move ARCO shares. Brazil is one of the most Covid-vaccinated countries in the world, which reduces pandemic-related demand risks.
Arco reports earnings on Wednesday, March 16, with the consensus estimate at $0.16/share.
ARCO shares rose 2% in the past week and have 15% upside to our recently-increased 8.50 price target. BUY.
Aviva, plc (AVVIY), based in London, is a major European company specializing in life insurance, savings and investment management products. Amanda Blanc was hired as the new CEO in July 2020 to revitalize Aviva’s laggard prospects. She divested operations around the world to 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 and share repurchases.
Much of our interest in Aviva is based on its plans for returning its excess capital to shareholders, including share repurchases and dividends. These distributions could be substantial. We also look for incremental shareholder-friendly pressure from highly-regarded European activist investor Cevian Capital, which holds a 5.2% stake.
On March 2, Aviva reported second half and full-year 2021 results that were in-line with consensus estimates. For the year, adjusted operating profit of £1.6 billion rose 16% from a year ago and was in-line with estimates. The company’s core operations are producing significantly improved results – both better revenue growth and cost control – and management is now able to fully focus on growth now that the divestiture program has been completed.
Management announced a new ‘own funds generated’ target of £1.5 billion – this is as much as 20% above current analyst estimates. It raised its cash remittances target by around 8%. These metrics are proxies for free cash flow, and indicate that the business is being run much more efficiently and that surplus capital is accumulating. This is allowing more cash to be returned to shareholders. Aviva also announced new cost-savings and growth initiative plans.
The company raised its share buyback program to £4.75 billion from £1.0 billion, more in-line with what activist Cevian Capital is pushing for. The buyback will be in the form of a “B Share Scheme,” a round-about way of repurchasing shares, which will be explained by Aviva in more detail in April. The incremental buyback will be completed by May 2022.
Also, Aviva raised its final (second half) dividend to £0.147/share, up from £0.14 a year ago. For the year, the total dividend will be £0.2205. Importantly, the company guided its 2022 full-year dividend to £0.315/share, up more than 40%. This would produce a 7.7% dividend yield. The company said this new dividend is likely to be a new base, with annual dividends for future years rising from this level. Combined with the buybacks, this produces a remarkably high shareholder yield on the current £15.5 billion market value for Aviva shares.
All-in, Aviva continues to look like an attractive and undervalued stock. As an insurance company, it carries considerable exposure to financial markets – and rising interest rates – as its assets are primarily fixed-rate investment grade bonds. These risks, particularly in the currently volatile capital markets, restrain its valuation. Additionally, the company is exposed to potentially elevated insurance losses, higher cyber-attack risks, and elevated compliance costs and risks, among other risks.
Aviva shares rose 6% in the past week and have about 29% upside to our 14 price target. The dividend, which produces a generous 7.7% yield, looks fully sustainable. 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%). 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 nearly zero debt net of cash. 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.
Over the past week, gold bullion fell 6% to $1,913/ounce, slipping back near its $1,700 to $1,900 trading range. The 10-year Treasury yield jumped to 2.11% in advance of the Fed’s likely move to raise short-term interest rates by a quarter-percent at its meeting this week. The U.S. Dollar Index, another driver of gold prices (the dollar and gold usually move in opposite directions), was unchanged at 98.81.
Barrick shares fell 6% over the past week and have about 14% 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. BUY.
Citigroup (C) – Citi is one of the world’s largest banks, with over $2.4 trillion in assets. The bank’s weak compliance and risk-management culture led to Citi’s disastrous and humiliating experience in the 2009 global financial crisis, which required an enormous government bailout. The successor CEO, Michael Corbat, navigated the bank through the post-crisis period to a position of reasonable stability. Unfinished, though, is the project to restore Citi to a highly-profitable banking company, which is the task of new CEO Jane Fraser.
There was no significant company-specific news in the past week.
Citi shares rose 1% over the past week and have about 54% upside to our 85 price target. The valuation remains attractive at 70% of tangible book value and 7.6x estimated 2022 earnings. We note the dip in earnings estimates following the Investor Day presentations. Our set of peer banks currently trade at an average of 1.8x tangible book value and 12.0x estimated 2022 earnings. Citi shares are among the cheapest in the banking sector – a major attraction as expectations are low. As the bank grinds along with its turnaround, the valuation should continue to lift.
Citigroup investors enjoy a 3.7% dividend yield and perhaps another 3% or more in annual accretion from the bank’s share repurchase program. BUY.
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.
There was no significant company-specific news in the past week.
TAP shares fell 3% in the past week and have about 36% upside to our 69 price target. The stock remains cheap, particularly on an EV/EBITDA basis, or enterprise value/cash operating profits, where it trades at 8.4x estimated 2022 results, still among the lowest valuations in the consumer staples group and below other brewing companies. The 2.7% dividend only adds to the appeal. 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.
There was no significant company-specific news in the past week.
OGN shares fell 12% in the past week, mostly due to a sharp one-day 10% drop this past Monday. We have found no company-specific news, changes in analyst ratings or any other direct justification for the drop. Our best guess is that it occurred on a day when Chinese stocks fell sharply due to possible regulatory crack-downs. Organon has significant business in China and thus might experience similar regulatory pressure.
The shares have about 42% upside to our 46 price target (using the same target as the Cabot Turnaround Letter). The shares continue to trade at a remarkably low valuation while offering an attractive 3.5% 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. 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. Electric vehicles are an opportunity as they expand Sensata’s reachable market.
There was no significant company-specific news in the past week.
ST shares fell 6% in the past week and have about 44% upside to our 75 price target. 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 | 3/15/22 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Bristol-Myers Squibb (BMY) | 04-01-20 | 54.82 | 69.75 | 27.2% | 3.1% | 78.00 | Buy |
| Cisco Systems (CSCO) | 11-18-20 | 41.32 | 55.60 | 34.6% | 2.7% | 66.00 | Buy |
| Coca-Cola (KO) | 11-11-20 | 53.58 | 59.62 | 11.3% | 2.8% | 64.00 | Buy |
| Dow Inc (DOW) * | 04-01-19 | 53.50 | 58.87 | 10.0% | 4.8% | 78.00 | Buy |
| Merck (MRK) | 12-9-20 | 83.47 | 78.64 | -5.8% | 3.5% | 99.00 | Buy |
| Buy Low Opportunities Portfolio | |||||||
| Stock (Symbol) | Date Added | Price Added | 3/15/22 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Allison Transmission Hldgs (ALSN) | 02-22-22 | 39.99 | 38.59 | -3.5% | 2.2% | 48.00 | Buy |
| Arcos Dorados (ARCO) | 04-28-21 | 5.41 | 7.34 | 35.7% | — | 8.50 | Buy |
| Aviva (AVVIY) | 03-03-21 | 10.75 | 10.80 | 0.5% | 7.7% | 14.00 | Buy |
| Barrick Gold (GOLD) | 03-17-21 | 21.13 | 23.77 | 12.5% | 1.7% | 27.00 | Buy |
| Citigroup (C) | 11-23-21 | 68.10 | 55.11 | -19.1% | 3.7% | 85.00 | Buy |
| Molson Coors (TAP) | 08-05-20 | 36.53 | 50.85 | 39.2% | 2.7% | 69.00 | Buy |
| Organon (OGN) | 06-07-21 | 31.42 | 32.29 | 2.8% | 3.5% | 46.00 | Buy |
| Sensata Technologies (ST) | 02-17-21 | 58.57 | 52.24 | -10.8% | — | 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.
| CUSA Valuation and Earnings | |||||||
| Growth/Income Portfolio | |||||||
| Current price | Current 2022 EPS Estimate | Current 2023 EPS Estimate | Change in 2022 Estimate | Change in 2023 Estimate | P/E 2022 | P/E 2023 | |
| BMY | 69.58 | 7.80 | 8.34 | 0.0% | 0.0% | 8.9 | 8.3 |
| CSCO | 54.76 | 3.45 | 3.73 | 0.0% | 0.0% | 15.9 | 14.7 |
| KO | 59.45 | 2.46 | 2.64 | 0.0% | 0.0% | 24.2 | 22.5 |
| DOW | 57.98 | 6.72 | 6.54 | 0.4% | 0.9% | 8.6 | 8.9 |
| MRK | 78.48 | 7.31 | 7.24 | -0.1% | -0.3% | 10.7 | 10.8 |
| Buy Low Opportunities Portfolio | |||||||
| Current price | Current 2022 EPS Estimate | Current 2023 EPS Estimate | Change in 2022 Estimate | Change in 2023 Estimate | P/E 2022 | P/E 2023 | |
| ALSN | 39.22 | 5.88 | 7.02 | na | na | 6.7 | 5.6 |
| ARCO | 7.36 | 0.35 | 0.43 | 0.0% | 0.0% | 21.0 | 17.1 |
| AVVIY | 10.83 | 1.18 | 1.39 | 0.0% | 0.0% | 9.2 | 7.8 |
| GOLD | 23.74 | 1.10 | 1.16 | -0.7% | -0.7% | 21.5 | 20.5 |
| C | 55.26 | 7.24 | 8.01 | -1.2% | -0.5% | 7.6 | 6.9 |
| TAP | 50.64 | 3.96 | 4.29 | -0.3% | -0.5% | 12.8 | 11.8 |
| OGN | 32.33 | 5.48 | 5.68 | 0.0% | 0.0% | 5.9 | 5.7 |
| ST | 51.91 | 3.99 | 4.60 | 0.0% | -0.2% | 13.0 | 11.3 |
CSCO: Estimates are for fiscal years ending in July.
Current price is yesterday’s mid-day price.