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Value Investor
Wealth Building Opportunites for the Active Value Investor

May 11, 2022

The stock market’s enduring slide must be driven by something – the S&P500 rarely (but occasionally) falls 16% in four months for “no reason.” No doubt the long list of issues led by inflation, war in Europe, the end of cheap and easy money, the cut-off of generous stimulus checks and a possible recession feature large.

When Will the Market Stop Going Down?
The stock market’s enduring slide must be driven by something – the S&P500 rarely (but occasionally) falls 16% in four months for “no reason.” No doubt the long list of issues led by inflation, war in Europe, the end of cheap and easy money, the cut-off of generous stimulus checks and a possible recession feature large. But it is our view, as investors anchored in the basics of valuation, that the sell-down is primarily an adjustment to rising interest rates.

We acknowledge that some of the market’s burndown is being led by an inevitable unraveling of prior meteoric run-ups in tech stocks that probably never would have occurred without the pandemic or a decade of zero interest rates. But many (most?) of these companies, like Okta (OKTA), Peloton (PTON) and many of Cathie Wood’s ARKK names, generate huge operating losses yet had stratospheric valuations. This was unsustainable. As long as the sharp decline in these stocks doesn’t metastasize into a financial accident or broad panic (whether by naive meme-speculators or supposedly sophisticated hedge funds like Tiger Global which is down 40% year to date – appalling but that is another story), the market decline should remain orderly.

But, we believe that most of the decline is ultimately being driven by rising interest rates. Earnings that are years away are worth less than earnings today in any market environment – but at near-zero interest rates the difference was relatively small. But when interest rates move toward 4%, the difference is huge. The cost of betting on the future is now higher. And, the more speculative the name, the higher the cost. Since valuation is really just the inverse of the cost of betting, valuations need to come down for all companies as rates rise – those with only far-away earnings much more so than those with near-in earnings.

If rising interest rates are the primary driver, then the end of rising interest rates should end the sell-off. Markets will anticipate this, so when there is some reasonable certainty that rates have peaked (we use the 10-year Treasury as our interest rate benchmark), markets could start an upward climb, all else being equal.

Yet, with the 10-year Treasury yielding 3.0% in an economy generating over 8% inflation, yields have a lot further to rise. Former Fed Vice Chairman Richard Clarida commented recently that he sees the 10-year Treasury reaching as high as 4% if the Fed wants to get inflation back down to its 2% target.

Any continued increase in wages, home prices and other core components could push inflation deeper into consumer expectations. It could take rates as high as 5% or more to dampen these expectations. Pulling inflation down to 2% seems like a monumental task – one that the Fed will either fight to achieve (ugly for the market and economy) or will relent on (ugly for the U.S. dollar).

Until we can confidently call “peak bond yield,” it seems the market isn’t going anywhere.

Share prices in the table reflect Tuesday (May 10) closing prices. Please note that prices in the discussion below are based on mid-day May 10 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.

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Today’s Portfolio Changes

Last Week’s Portfolio Changes

Upcoming Earnings Reports
Wednesday, May 18: Cisco Systems (CSCO)

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.

On April 29, Bristol-Myers reported encouraging first-quarter earnings, which rose 13% from a year ago and were about 4% above the consensus estimate. Sales rose 5% from a year ago (up 7% on a local market basis which excludes currency changes) and was about 3% above estimates. The company continues to put up respectable and positive numbers even as sales of patent-expired Revlimid fell 5% and sales of new products was a bit lower than we’d like to see. Bristol trimmed its revenue guidance from +2% to flat and profit guidance by about 3% due to modestly faster-than-expected decay of Revlimid and Abraxane sales. All-in, a reasonable quarter that continues to support our thesis. The company continues to generate immense free cash flow and is repurchasing sizeable amounts (2.5%) of its shares.

There was no significant company-specific news in the past week.

BMY shares rose 1% in the past week and trade just below our 78 price target. Valuation remains reasonable compared to its peers and the company seems to be executing on its strategy while also maintaining a solid financial posture, so we are inclined to let the stock at least reach 78 before deciding on what changes to make to the rating and/or price target. 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 slipped 1% in the past week and have 34% upside to our 66 price target. The dividend yield is an attractive 3.1%. 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 oversized 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 April 25, Coca-Cola reported strong earnings, up 16% from a year ago and about 10% above the consensus estimate. Despite suspending its Russia operations, the company reiterated its full-year volume, revenue, profit and free cash flow guidance. Overall, the outlook for Coke remains strong, with no changes to our price target or rating.

There was no significant company-specific news in the past week.

KO shares rose 2% in the past week and have 7% upside to our recently and tepidly raised 69 price target. The stock now trades noticeably above its prior record high (in February 2020) and has reasonable upward momentum even as valuation is no longer “cheap” – traits that are a tad unfamiliar and uncomfortable for a value/contrarian investor. However, we also rarely have the chance to own a high-quality and enduring franchise like Coca-Cola, so we will be a bit more patient with the shares.

Coca-Cola’s fundamentals remain sturdy with respectable revenue, profit and free cash flow growth. Management continues to focus on execution in its core business while generally avoiding any major non-core commitments. 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 will likely be strong for a while. Dow 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 4.3% dividend yield while waiting for more share buybacks, more balance sheet improvement, more profits and a higher valuation.

On April 21, Dow reported strong first-quarter adjusted operating earnings that rose 72% from a year ago and were about 14% higher than the consensus estimate. Revenues rose 28% and were about 5% above the consensus estimate. The impressive growth was driven nearly entirely by price increases, which more than offset its higher costs. Overall, the report indicates that fundamentals at Dow remain strong and that earnings estimates will likely continue to increase. Free cash flow was $1.3 billion, of which Dow used $600 million to repurchase shares as part of its new $3 billion share repurchase program. The balance sheet remains sturdy.

Dow has several headwinds, including potential pricing pressure from new supply in a year or so, rapidly rising natural gas input prices, a complicated demand situation in China, and to some degree reliance on high oil prices for its pricing power. The shares have been strong this year, in a difficult market, and continue to have strong dividend support, but the upside from our perspective is probably capped around our price target. No change to our price target or rating.

There was no significant company-specific news in the past week. Dow shares slipped 4% in the past week and have 19% 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.

On April 28, Merck reported first-quarter adjusted earnings of $2.14/share, up 84% from a year ago and about 17% above the $1.84/share consensus estimate. Sales rose 50% from a year ago and was about 9% above estimates. Sales excluding Covid treatment mulnupiravir (branded as Lagevrio) rose 19%. Keytruda (+23%) and Gardasil (+59%) generated impressive growth, quieting skeptics. The company raised and narrowed its full-year revenue and earnings guidance by about 1%, to a pace of about 18% year-over-year growth. As Merck doesn’t release a balance sheet or cash flow statement until it files its 10Q, we will have to wait on reviewing the company’s financial condition, but we anticipate few issues. All-in, an encouraging quarter.

There was no significant company-specific news in the past week.

Merck shares were flat in the past week and have about 13% upside to our 99 price target. The company has a strong commitment to its dividend (3.2% 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. Many investors view this company as a low-margin producer of car and light truck transmissions that is destined for obscurity in an electric vehicle world. However, 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 is 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 and has a low-debt balance sheet. Its capable leadership team keeps its shareholders in mind, as the company has reduced its share count by 38% in the past five years.

On April 27, Allison reported healthy first-quarter earnings which rose 21% from a year ago and were about 2% above the consensus estimate. Revenue rose 15% and was about 5% above estimates. The company maintained its full-year revenue, profit and cash flow outlook, which calls for 12% sales growth, 9% EBITDA growth and flat free cash flow. Profit growth lagged revenue growth due to sharp increases in input prices as well as tight labor, transportation and procurement conditions. These supply issues will likely continue, and Allison’s price increases are clearly helping offset the effects. Overhead expenses increased modestly, helping dampen the drag on earnings. The company’s shareholder-friendly reputation was bolstered as it raised its dividend by 11%, repurchased 2% of its shares and raised its buyback authorization by $1 billion to a total of $4 billion. Allison’s balance sheet was essentially unchanged during the quarter, so the debt burden remains reasonable.

The company announced that D. Scott Barbour joined the company’s board following the shareholder meeting. Barbour is CEO of Advanced Drainage Systems and led a turnaround at that company.

Allison shares fell 3% in the past week on the encouraging earnings report (the higher consensus estimate reflects this) and have 27% upside to our 48 price target.

The stock pays an attractive and sustainable 2.2% dividend yield to help compensate for the wait. 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 reopen. 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 issues in Brazil related to its economic conditions (in particular, inflation, running at a 11.3% rate), currency and the chances that a socialist might win this 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.

There was no significant company-specific news in the past week.

ARCO shares fell 10% in the past week and have 28% upside to our recently increased 8.50 price target. The stock has fallen 20% since approaching our price target only a few weeks ago. More than half the decline is directly attributable to the fall-off in the Brazilian currency relative to the U.S. dollar – the correlation has moved closer to 1:1. While the shares surged earlier in the year, in sync with the Brazilian currency, we had attributed much/most of the gains to Arco’s sharply improving fundamentals. We may have been wrong in this thinking. We will stay with our Buy on ARCO shares, however, due to the still-low valuation and improving fundamentals but are watching this stock price/currency relationship with new clarity. 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 (U.K., 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.

There was no significant company-specific news in the past week.

Aviva shares fell 9% in the past week and have about 41% upside to our 14 price target. Much of the decline is likely due to falling bond prices in its investment portfolio, which weakens its capital position and thus its likely share buyback. The projected dividend, which would produce a generous 8.3% 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.

On May 4, Barrick reported adjusted earnings of $0.26/share, about 10% lower than a year ago but 8% above the consensus estimate. Profits fell even though the realized price of gold rose 6%, as gold production fell 10% and overall costs rose 2%. Copper results were relatively stable from a year ago. Despite the weak gold production, management said that they remain confident in reaching their full-year production guidance. One of our eternal frustrations with gold mining companies is that their costs seem to rise and fall with the price of gold. While we look at the detailed data underlying the costs, we’ve yet to find a compelling and consistent rationale for this in what should be essentially a fixed cost operation. Despite this annoying conundrum, and the generally OK but not great results, we are retaining our Buy rating and price target.

Barrick’s cash balance net of debt surged to $743 million, as cash flow from operations was augmented by receipt of accumulated dividends from the Kibali mine in the Democratic Republic of Congo after a new agreement was reached last year, as well as from the sale of non-core assets.

In keeping with its new dividend policy, the company is paying a $0.10/share bonus quarterly dividend on top of its $0.10/share base quarterly dividend.

Over the past week, commodity gold dipped 1% to $1,843/ounce. The 10-year Treasury yield ticked down to 2.94%. The spread between this yield and inflation of 8.5% remains exceptionally wide compared to a long-term average spread of perhaps one to two percentage points, strongly suggesting many more interest rate hikes ahead. The April CPI data will be released after this letter’s publication deadline. Chatter about the “real” yield turning positive is based on other yields and inflation rates and we consider them to be less useful. The U.S. Dollar Index, another driver of gold prices (the dollar and gold usually move in opposite directions), rose fractionally to 103.87, staying at its 20-year high.

Barrick shares slipped 5% in the past week and have about 27% 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

Big Lots (BIG) – Big Lots is a discount general merchandise retailer based in Columbus, Ohio, with 1,431 stores across 47 states. Its stores offer an assortment of furniture, hard and soft home goods, apparel, electronics, food and consumables as well as seasonal merchandise. The company has a large and loyal customer base of 22 million Rewards program members, which has growth steadily over the past decade. Big Lots should benefit if consumers trade down due to a slowing and inflationary economy. While low, the 5.5% cash operating profit margin appears stable. Management guided for weak first-quarter results and investors expect the full-year guidance may be too high, as well. The company generates free cash flow, its balance sheet is essentially debt-free and the management and board quality is “good enough.”

We are intrigued enough by the shares’ remarkably low valuation to make this stock a Buy. On conservative fiscal 2022 (ending in January 2023) estimates, the shares currently trade at 3.1x EV/EBITDA and 7.3x per-share earnings. These multiples imply a dour recessionary future for the company. The EV/EBITDA multiple is sharply below an average of perhaps 5x-9x for its peers. Even adjusting for scale and quality, a discount of this size for BIG is unwarranted. Big Lots’ shares trade unchanged from their 2007 price level and are down 50% from their stimulus-boosted peak at over 70 last year. Activist investor Mill Road Capital (5.1% stake) recently highlighted the shares’ deeply discounted valuation. All-in, while BIG shares carry higher risk, the risk/return trade-off appears compelling.

There was no significant company-specific news in the past week.

Big Lots shares fell 2% in the past week and have 41% upside to our 45 price target. Despite their sharp daily volatility, the stock is down only about 8% from our cost. While a disappointing start, this decline right out of the gate is not rare for new value positions. We attribute much of the decline to concerns over upcoming first quarter results. The dividend produces an attractive 3.8% yield. 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.

On Thursday, April 14, Citigroup reported earnings of $2.02/share that fell 44% from a year ago but were 45% above the consensus estimate. The report was positive in the sense that it largely contained no new negatives. Net interest income rose 3%, fee income fell 9% and expenses rose 15% as Citi is finding that business transformation is expensive. Credit and capital remain healthy.

Citi shares fell 5% over the past week and have about 68% upside to our 85 price target. Bank stocks have not been spared in this downturn, as concerns over higher credit losses in a possible recession are offsetting the potentially higher profits from a steepening yield curve. Citi’s shares have fallen 30% since our recommendation – a painful start requiring both patience and fortitude.

The bank trades at only 60% of its tangible book value of $79.03/share, perhaps half or less its peers’ multiples. This valuation, which approximates liquidation value, implies some remarkable further decay in the bank’s fundamentals even as it looks well-positioned to generate at least reasonable profits over the next several years. As the bank makes more progress with its strategic overhaul – a grinding process for sure – the share valuation should converge with its peers, providing exceptional upside with what appears to be limited downside.

We note that the spread between the 90-day T-bill and the 10-year Treasury note, which approximates the drivers behind Citi’s net interest margin, is now 2.13%, is about the widest it has been in five years

Citigroup investors enjoy a 4.3% 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 straightforward – 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.

On May 3, Molson Coors reported first-quarter adjusted earnings of $0.29/share, which compared to $0.01/share a year ago and the consensus estimate of $0.19. Year-ago results were depressed from pandemic pub closures, which made for easy comparisons. Nevertheless, results were solid. Sales grew 17% and were about 3% higher than estimates. Driving the strong results were healthy volumes (+5%) and pricing (+10%). Strategically, Molson continues to make good progress with its cost and product rationalization and new product initiatives. While the results were impressively strong, the company’s second-quarter earnings guidance was surprisingly weak (even though management reaffirmed their full-year guidance), leading to a 3% dip in the stock price.

Second-quarter earnings were guided to a decline of 20-30% compared to a year ago. The company is aggressively stepping up its marketing spending as it launches new products. While this spending is critical to strong launches, it is higher than we expected and than implied by the company’s prior commentary. Also, an ongoing strike at its Canadian facilities will weigh on second-quarter volumes and profits. Another drag is higher inventory at wholesalers compared to a year ago, so shipments to the wholesale channel will be weaker.

As the company maintained its full-year guidance, the weak second quarter implies a strong third and fourth quarter – achievable for sure but now not quite as likely. The company’s ability to maintain its pricing spread relative to inflation and its ability to maintain volume growth even as Americas volumes are underwhelming will be critical to achieving its guidance – we are not entirely convinced but the shares’ discount provides a margin for safety.

All-in, the Molson story remains on track but the full recovery to the assumptions in our price target may take a bit longer.

TAP shares rose 2% in the past week and have about 28% 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 9.1x estimated 2022 results, still among the lowest valuations in the consumer staples group and below other brewing companies. The 2.8% 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.

On May 5, Organon reported adjusted earnings of $1.65/share, down 7% compared to the pre-spin, year-ago period and about 27% above the consensus estimate. Revenues rose 4% and were about 3% above estimates. Adjusted EBITDA rose 14% and was 26% above estimates. We take the earnings comparisons vs a year ago with a grain of salt as the company was still part of Merck and as such its true costs can only be estimated. Still, the report was encouraging, the company maintained its full-year revenue and profit guidance, and the shares rose 5% on a day when the stock market slid over 3%.

The solid results were driven by relatively steady sales of the Nexplanon contraceptive (-7%), as well as growth in the Biosimilars (+22%) and Established Brands (+10%) segment. There was no effect from China’s volume-based procurement program which had previously been a drag on sales. All-in, Organon’s revenue stability helps establish a floor to profits, which if sustained would lead to a higher valuation for the company’s shares. Organon’s balance sheet has improved from the spin-off date but was essentially unchanged in the quarter.

OGN shares rose 5% in the past week and have about 35% 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 3.3% 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.

On April 26, Sensata reported earnings that fell 9% from a year ago but about 3% above the consensus estimate. Revenues rose 4% from a year ago and was about 2% above the consensus estimate. The company initiated a dividend, at $0.11/share per quarter, which produces an attractive 1.0% yield (last week’s note stated an incorrect yield). Despite the respectable results and new dividend, the shares fell through midday trading due mostly to the weak stock market. Sensata’s organic revenues grew noticeably faster than its end markets, which fell more than 6%, but this is a bit uninspiring as a target. Its profit margin slipped as price increases only partly offset rising costs. Sensata’s heavy investments are starting to weigh on our view of its shares, but we will remain patient as the valuation remains attractive and the company is making both strategic and earnings progress.

ST shares fell 7% in the past week and have about 72% upside to our 75 price target. The shares’ decline is partly attributable to the broad tech market sell-off, and partly due to the company not meeting or beating reasonable expectations as its end-markets remain somewhat below potential. Our 75 price target now looks optimistic in light of the broad market sell-off, but we will keep it for now, even as it may take longer for the shares to reach it. 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 AddedPrice Added5/10/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Bristol-Myers Squibb (BMY)04-01-2054.8276.2939.2%2.8%78.00Buy
Cisco Systems (CSCO)11-18-2041.3249.5519.9%3.1%66.00Buy
Coca-Cola (KO)11-11-2053.5864.0119.5%2.6%69.00Buy
Dow Inc (DOW) *04-01-1953.5065.8123.0%4.3%78.00Buy
Merck (MRK)12-9-2083.4787.815.2%3.1%99.00Buy
Buy Low Opportunities Portfolio
Stock (Symbol)Date AddedPrice Added5/10/22Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Allison Transmission Hldgs (ALSN)02-22-2239.9938.32-4.2%2.2%48.00Buy
Arcos Dorados (ARCO)04-28-215.416.8226.1%2.2%8.50Buy
Aviva (AVVIY)03-03-2110.7510.07-6.3%8.2%14.00Buy
Barrick Gold (GOLD)03-17-2121.1321.290.8%1.9%27.00Buy
BigLots (BIG)04-12-2235.2432.43-8.0%3.7%45.00Buy
Citigroup (C)11-23-2168.1048.75-28.4%4.2%85.00Buy
Molson Coors (TAP)08-05-2036.5354.8450.1%2.5%69.00Buy
Organon (OGN)06-07-2131.4234.7610.6%3.2%46.00Buy
Sensata Technologies (ST)02-17-2158.5744.29-24.4%1.0%75.00Buy

*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 2022
EPS Estimate
Current 2023
EPS Estimate
Change in
2022 Estimate
Change in
2023 Estimate
P/E 2022P/E 2023
BMY 76.09 7.64 8.190.0%0.0% 10.0 9.3
CSCO 49.34 3.44 3.730.0%0.0% 14.3 13.2
KO 64.33 2.47 2.650.0%0.0% 26.0 24.3
DOW 65.41 8.28 7.36-0.1%0.7% 7.9 8.9
MRK 87.47 7.37 7.401.0%1.0% 11.9 11.8
Buy Low Opportunities Portfolio
Current 2022
EPS Estimate
Current 2023
EPS Estimate
Change in
2022 Estimate
Change in
2023 Estimate
P/E 2022P/E 2023
ALSN 37.82 6.24 7.210.0%0.0% 6.1 5.2
ARCO 6.65 0.39 0.450.0%0.0% 17.1 14.8
AVVIY 9.95 1.08 1.30-1.6%-1.6% 9.2 7.6
BIG 31.91 4.76 5.54-1.9%-1.1% 6.7 5.8
GOLD 21.18 1.16 1.22-0.6%-1.3% 18.3 17.4
C 47.76 6.76 7.370.0%0.0% 7.1 6.5
TAP 53.77 3.91 4.29-2.5%0.0% 13.8 12.5
OGN 34.04 5.33 5.84-2.6%0.0% 6.4 5.8
ST 43.59 3.89 4.540.0%-0.2% 11.2 9.6

CSCO: Estimates are for fiscal years ending in July.

Current price is yesterday’s mid-day price.