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Value Investor
Wealth Building Opportunites for the Active Value Investor

Cabot Undervalued Stocks Advisor Weekly Update

The S&P 500 index traded up near all-time highs in early June, then had an orderly pullback, partly encouraged by investor worries over the Brexit vote. The index seems to have completed its correction, and could easily retrace recent highs. Many of our portfolio stocks mirrored that pullback and are also rebounding.

The Federal Reserve Open Market Committee (FOMC) might now postpone a rate increase until September, as mixed economic signals hamper decisive action. A weak May employment report spurred that decision. Then on June 14, a May retail sales report came in +0.5%, when economists were expecting +0.03%. The surge came from online merchants, sporting goods stores and clothing stores. Our economy remains one of slow growth. 2016 marks two consecutive years of conflicting statements and actions from the FOMC. They could have just as easily stated, “There’s no strong trend of economic growth. We’re taking a wait-and-see attitude until the case to raise interest rates becomes compelling.” Caution makes the FOMC look thoughtful and prudent, while wishy-washiness reeks of rudderless leadership.

This week brings more volatility in global financial markets, as Great Britain votes on June 23 whether to remain in or leave the European Union. As it becomes clearer that the “remain” vote will win, we’re seeing rebounds in currencies and stock markets, while gold falls.

The S&P 500 index traded up near all-time highs in early June, then had an orderly pullback, partly encouraged by investor worries over the Brexit vote. The index seems to have completed its correction, and could easily retrace recent highs. Many of our portfolio stocks mirrored that pullback and are also rebounding.

More importantly, we have several portfolio stocks that are breaking out from trading ranges, and beginning new run-ups: Boise Cascade (BCC), Dollar Tree (DLTR), Kraft Heinz (KHC) and WellCare Health Plans (WCG).

Portfolio Notes

Here are some portfolio highlights from today’s update:

• I issued a Special Bulletin on June 15 to sell Universal Electronics (UEIC) from the Growth Portfolio.
• I’m changing the rating on Delta Air Lines (DAL) to Hold.
• Adobe Systems (ADBE)
and FedEx (FDX) will report quarterly results on June 21 after the market close. Expect share price volatility in both stocks on June 22. If the stocks jump or fall on the open, it could easily have more to do with traders than whether the earnings reports were good or bad. (I’m not hearing any buzz about either company having a poor quarter or poor outlook.) I’ll report to you on the earnings results and revised outlooks.

Updates on Growth Portfolio Stocks

Adobe Systems (ADBE) is a software company. Adobe will report second-quarter results today, June 21, when the stock markets close. The earnings report will trigger share price volatility on June 22. Consensus estimates project $1.4 billion revenue and EPS of 68 cents. ADBE is an undervalued aggressive growth stock with a strong balance sheet. The stock rose to an all-time high on June 2, then pulled back a little, completing a shake-out chart pattern (bullish) yesterday. Strong Buy.

Chemtura (CHMT) is a specialty chemical manufacturer. CHMT is an undervalued, small-cap growth stock. CHMT is having a small pullback within an uptrend. The stock could easily surpass 29.50 on its next run-up. There’s additional upside resistance around 32. Strong Buy.

D.R. Horton (DHI) is a homebuilder. DHI is an undervalued growth stock with a 1% dividend yield. The share price rose to minor upside resistance in June, had a small pullback, and is climbing again toward upside resistance at 33. Buy.

Delta Air Lines (DAL) is a global passenger and cargo air transportation company. Delta is the third-largest passenger airline in the world, serving 58 countries. The company also owns an oil refinery. The stock was featured in the June issue of Cabot Undervalued Stocks Advisor.

It was recently reported that Delta and several other airlines were contemplating buying Avianca Holdings SA (AVH). On June 16, Avianca’s Chairman said, “Avianca is not for sale,” but is open to investment partnerships with other airlines. Avianca is having balance sheet problems. An alliance with Delta could enable Avianca to renovate its fleet of planes and enable Delta to expand its presence in South America.

Delta’s EPS are expected to grow 37.5% and 6.3% in 2016 and 2017 (December year-end). (The 2016 estimate has been consistently inching downward since February.) The corresponding P/Es are 6.0 and 5.6. The current dividend yield is 1.4%, and based on the preannounced third-quarter dividend increase, the new yield will be 2.1%. Despite the much-slower 2017 earnings growth, DAL remains undervalued.

Airline share prices weakened in June. I’m changing my opinion on DAL to Hold until the share price appears ready to recover. Hold.

Dollar Tree (DLTR) is the nation’s leading operator of discount variety stores. DLTR is an undervalued, large-cap aggressive growth stock, with a low degree of volatility. (Caveat: Dollar Tree’s long-term debt-to-capitalization ratio is higher than I would prefer, at 62%.) After a huge run-up in May, the stock rested for four weeks, and now appears ready to climb again. Buy DLTR now. Strong Buy.

E*Trade (ETFC) offers financial brokerage and banking products and services. E*Trade launched a new robo-advisor service in June, called Adaptive Portfolio. The service will help investors assess their investment goals and risk tolerance, and assemble a portfolio of ETFs and mutual funds.

ETFC is overvalued based on 2017 earnings expectations. When ETFC reaches upside resistance at 31, I will consider selling the stock, unless 2017 EPS estimates increase. There’s strong price support between 24.75 and 25. Hold.

Royal Caribbean Cruises (RCL) is a global cruise vacation company. RCL offers investors strong earnings growth, a low P/E, a 2% dividend yield, big dividend increases and share repurchases. The stock is significantly undervalued.

The share price has repeatedly bounced in the low 70s since February, within a trading range that has delivered 10%-20% upswings. We seem to be past the recent low on the share price. Traders and longer-term investors could buy now. Buy.

Vulcan Materials (VMC) produces construction aggregates. VMC is a very undervalued aggressive growth stock, with a small 0.7% dividend yield. The chart remains bullish. VMC rose as high as 120 in late May. Strong Buy

WellCare Health Plans (WCG) is an undervalued aggressive growth stock in the managed healthcare sector. An interesting article in TheStreet discussed the possibility that Cigna (CI) might be interested in purchasing WellCare, if Cigna’s troubled merger with Anthem (ANTM) falls through.

Wall Street expects 2016 and 2017 EPS to grow aggressively at 35.2% and 22.2% (December year-end). The corresponding P/Es are 22.8 and 18.7—much lower than the EPS growth rates, indicating that the stock is undervalued. The stock would be relatively fairly valued at 126, based on its expected 2017 EPS growth rate. WCG rested briefly after its big run-up in late May, and is now climbing again. Strong Buy.

Updates on Growth & Income Portfolio Stocks

Big Lots (BIG) is an American discount retailer. BIG is a slightly undervalued growth & income stock with a strong balance sheet and a 1.6% dividend yield. The stock had a big run-up in late May. Try to buy on dips near 50. Strong Buy.

Cardinal Health (CAH) is one of the largest U.S. distributors of healthcare products and services. Cardinal hosted an Investor Day on Friday June 17. They’ll be wrapping up their 2016 fiscal year this month, with market expectations of 19.6% full-year EPS growth. We’ll probably see changes in the consensus 2017 earnings estimates in the coming weeks, followed by more definitive numbers when full-year results are reported on July 28.

Cardinal and its two biggest competitors, AmerisourceBergen (ABC, September year-end) and McKesson (MCK, March year-end), each guided their fiscal 2017 earnings projections downward, in recent months. The industry is being impacted by fewer new generic drug launches and price deflation. In addition, Cardinal is incurring increased IT expenses.

Pluses include Cardinal management’s expectation of long-term double-digit EPS growth, and a possible June pharmaceutical contract win from Kaiser. The contract could add 1%-2% to earnings growth, in addition to leading to future profitable joint ventures.

CAH has a dividend yield of 2.4%. Hold.

Carnival (CCL) is a cruise vacation company, and the largest leisure travel company in the world. CCL is extremely undervalued, with a current dividend yield of 3.0%. The price charts of cruise company stocks have been weak, but their earnings growth is strong. Investors’ patience will likely be well rewarded with CCL. There’s short-term upside resistance at 50.50, and again at 53. Buy.

Federated Investors (FII) is a global investment management company. New rules governing money market funds, which take effect in October, will work in Federated Investors’ favor. Institutional investors are expected to move approximately $400 billion from prime funds to government money funds. That’s because prime funds, which invest in corporate debt securities, will be potentially less liquid, and their net asset values (NAV) will be more likely to fluctuate from the common one dollar per share.
FII has a 3.3% dividend yield. The stock’s been trading sideways between 30 and 34. Traders could make 10% on the rebound. Hold.

GameStop (GME) is a video game and consumer electronics retailer. GameStop’s earnings growth is slow, but Wall Street’s consensus estimates show the company achieving record profits in 2017 and 2018 (January year-end). The share price seems to have just completed a bottom, and could rise to 29.50 before resting. The current dividend yield is 5.6%. Buy.

General Motors (GM) is an American auto manufacturer. Last week, credit rating agency Fitch revised General Motor’s outlook from “stable” to “positive,” reflecting a strengthening credit profile.

Industry-wide new car deliveries in Europe were up 9.7% year-to-date through May.

The market is expecting GM’s EPS to grow 13.1% this year. While earnings growth slows dramatically in 2017, the stock remains incredibly undervalued, especially in light of the big 5.3% dividend yield. The share price is in a trading range between 29 and 32.50. Buy.

Goldman Sachs Group (GS) is a global investment banker, serving consumer, institutional and government clients. Goldman was featured in the June issue of Cabot Undervalued Stocks Advisor. GS offers investors aggressive earnings growth, a very low P/E, and a 1.8% dividend yield. Investors who buy now will be getting quite a bargain. There’s short-term upside price resistance at 160. Strong Buy.

H&R Block (HRB) is a leader in tax preparation services. In an analyst meeting last week, H&R Block’s management said that they are rethinking their pricing strategy, and that the pricing changes would be very visible and marketable. Earlier in June, the company reported fourth-quarter results that met analysts’ downward-revised expectations, and increased its quarterly dividend by 10%, from 20 cents to 22 cents per share.

HRB is an undervalued growth & income stock with a 3.7% dividend yield. The share price has barely receded since its huge jump in early June—a bullish sign. The best-case scenario for the share price, through the summer, is for HRB to rise to 28. Buy.

Kraft Heinz (KHC) is a global food and beverage producer. KHC is an undervalued aggressive growth & income stock with a 2.7% dividend yield. The share price is trading sideways after a big run-up in early May, and appears capable of beginning another run-up in the coming days. Strong Buy.

Updates on Buy Low Opportunities Portfolio Stocks

Boise Cascade Company (BCC) is a leading U.S. wholesaler of wood products and building materials. Revenue is benefiting from a strong home-building market, but profits are suffering due to weak plywood pricing, which resulted from increased foreign and domestic competition, and a strong dollar. The company is currently slated for 4.5% and 41.7% EPS growth in 2016 and 2017 (December year-end). The stock is quite undervalued based on 2017 earnings estimates. The share price appears poised for a run-up to upside resistance at 25. Buy.

BorgWarner (BWA) is a maker of engineered automotive systems and components for power train applications. BWA is fairly valued based on moderate 2016 earnings, and quite undervalued based on stronger 2017 earnings. The dividend yield is 1.6%. BWA has a wide trading range, with upside resistance at 40. The stock is low within its range. This is a great time for both traders and longer-term investors to buy BWA. Buy.

FedEx (FDX) is an international package delivery company. A $1.6 billion criminal case against FedEx was dismissed last week, when a U.S. District Court judge found FedEx factually innocent of charges that it shipped packages from illegal online pharmacies.

FedEx will report-fourth quarter 2016 results on June 21 upon the close of the market (May year-end). Analysts are expecting approximately $3.26 to $3.28 EPS.

The company closed on its purchase of TNT Express in late May. Therefore, expect FedEx’ 2017 fiscal year to be characterized by frequent changes in earnings estimates, as analysts begin to get a handle on the company’s post-merger revenues, margins, and net income.

In June, FedEx increased its quarterly dividend by 60%, from 25 cents to 40 cents per share. The current yield is 1.0%. FDX is slightly undervalued, based on the fiscal 2017 consensus EPS estimate (May year-end), and distinctly undervalued vs. competitor United Parcel Service’s (UPS) stock valuation. The stock has traded sideways since its big run-up in mid-March. FDX has upside resistance at 168, and again at 180. The June 21 earnings report will trigger share price volatility on June 22. Buy.

Harman International Industries (HAR) is the premiere connected technologies company for automotive, consumer and enterprise markets, best known for its JBL and Harman Kardon audio systems. The company is about to begin its 2017 fiscal year (June year-end). Analysts expect 13.2% EPS growth, with a P/E of 10.9. HAR is an undervalued growth & income stock with a 1.8% dividend yield. The stock is climbing to 81, with additional upside price resistance at 89. Buy.

Johnson Controls (JCI) operates in the areas of energy management and auto batteries. JCI is a large-cap growth & income stock with a 2.6% dividend yield. (The dividend is expected to remain fully intact through the spin-off and merger processes.)

Here’s a recap of upcoming Johnson Controls M&A activity:

• The company plans to spin off Adient (ADNT), its automotive seating & interiors business, on October 3, 2016. Adient’s margins are expected to rise from 5.8% to about 6.9%, post-spin-off. JCI shareholders will receive one share of ADNT—valued somewhere near $8 per share—for every ten shares of JCI that they own. The ADNT spin-off is expected to be a taxable event.

• In June, Johnson Controls bought a 56% stake in security systems company Tyco International PLC (TYC). The combined company will offer electrical systems and security systems to the building industry. Tyco brings strength in Europe to the new venture, while Johnson Controls is strong in the Americas and Asia. The combined company will domicile in Ireland, to take advantage of lower income tax rates.

JCI has been trading sideways in recent weeks. A close above 45 would be a bullish sign for a near-term run-up. Hold.

Robert Half International (RHI) is a staffing and consulting company. RHI is a growth & income stock with a strong balance sheet and a 2.2% dividend yield. The stock has pulled back to support levels, and presents a good buying opportunity. Buy.

Toll Brothers (TOL) is the leading U.S. luxury homebuilder. TOL is a greatly undervalued, mid-cap growth stock. I expect TOL to deliver lots more capital gains to shareholders this year. Any price below $30 is a bargain. Buy.

Whirlpool (WHR) is the world’s largest appliance manufacturer. Whirlpool was featured in the June issue of Cabot Undervalued Stocks Advisor. WHR is a very undervalued growth stock with a 2.3% dividend yield. The share price peaked in April, pulled back, and is now heading back toward 190. When WHR reaches its all-time closing high of 213 from February 2015, today’s investors will have an 18% capital gain, plus dividends, and the stock will still be vastly undervalued. Buy WHR now! Strong Buy.

Prices as of June 20 market close.