April 11, 2024

Living in Vermont has its perks, and one of them was being in the “path of totality” for Monday’s eclipse. My family and I went to an eclipse-watching party, where for nearly three minutes the moon completely obscured the sun, forming a perfect ring-like orb in the sky that was reminiscent of the Eye of Sauron from Lord of the Rings. It was one of the more incredible sights I’ve ever seen. And the brief period of semi-ominous darkness that ensued reminded me a bit of what inflation is doing to the market these days.

No, this isn’t 2022 all over again, thank goodness. It’s a bull market, and the S&P 500 is coming off five straight up months for just the 30^th time since 1950. But stocks have also been a bit stuck in the mud for the last month or so, partly because investor confidence in the Fed’s interest rate-slashing timetable has waned as inflation has remained stickier than expected. Wednesday’s CPI print didn’t help; March inflation came in at 3.5% year over year, a tad hotter than the 3.4% expected and up from 3.2% in February. The month-over-month increase was 0.4%, higher than the 0.3% bump that was anticipated. Stocks promptly sold off, with all three major indexes down more than 1% in early Wednesday trading.

Eventually, however, inflation will dip below that stubborn 3% threshold, and the Fed will start to cut short-term interest rates. We just don’t know when. And it’s the not knowing that’s holding the market hostage at the moment. A few months ago, everyone was sure the Fed would cut interest rates at least three times this year, starting as early as March. Now, the majority of economists don’t think rate cuts will even start until September, at least according to the CME Group’s perennially in flux FedWatch tool.

So, while it’s not the anvil weighing the market down that it was 18 months ago, inflation – and the Fed’s response to it – is back to being something that blots everything else out and investors can’t take their eyes off of. Sort of like an … well, you know.

What to do as value investors? First, try and ignore all the inflation and Fed noise and pay attention to how the market, and the stocks you follow, are actually behaving. On the whole, the action has been sideways, as inflation angst typically knocks stocks back for a day or two before the buyers swoop in and push the market back up close to where it was just 48 to 72 hours prior.

Second, if stocks do finally begin to fall for more than just a day or two, it’s an opportunity to find better values after the five-month rally. I doubt the bull market will up and fizzle any time soon. The economy is still in good shape; corporate earnings growth has returned; consumer sentiment is improving; the unemployment rate remains healthy, etc. There are enough reasons to think share prices will be higher a year from now, or even six months from now, even if inflation remains in the 3-3.5% range and the Fed doesn’t start cutting rates until later than anyone expected.

Besides, a market pullback – or even an extended period of stagnation – could be a good thing, especially for bargain hunters. And we have a portfolio positioned to capitalize on the renewed interest in value.

Note to new subscribers: You can find additional commentary on past earnings reports and other news on recommended companies in prior editions and weekly updates of the Cabot Value Investor on the Cabot website.

Send questions and comments to chris@cabotwealth.com.

This Week’s Portfolio Changes
None

Last Week’s Portfolio Changes
Honda Motor Co. (HMC) – New Buy with a 45 price target

Upcoming Earnings Reports
Friday, April 12: Citigroup (C)

Growth/Income Portfolio

Growth & Income Portfolio stocks are generally higher-quality, larger-cap companies that have fallen out of favor. They usually have some combination of attractive earnings growth and an above-average dividend yield. Risk levels tend to be relatively moderate, with reasonable debt levels and modest share valuations.

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 and generates vast cash flow. Its recently completed deal for Splunk will drain most of its cash hoard ($28 billion of it) but we see this as being replenished relatively quickly.

Cisco is trading at quite a discount, according to Morgan Stanley analyst Meta Marshall. She resumed coverage of the stock with an “Overweight” rating and a 58 price target, an 18% premium to its current share price. Deutsche Bank’s Matthew Niknam followed suit, upping his price target from 51 to 52. Both analyst upgrades come on the heels of Cisco’s long-delayed $28 billion acquisition of cybersecurity giant Splunk finally closing last month after gaining European regulatory approval. The Splunk deal not only bolsters Cisco’s cybersecurity footprint but also adds to its all-important artificial intelligence appeal, as Splunk’s cybersecurity platforms are in demand among companies trying to protect their AI data.

CSCO shares got a nice bump, from 48 to 50, after the analyst upgrades, though the stock retreated back to 49 on Wednesday morning. All told, shares are slightly lower since our last issue and have 35% upside to our 66 price target. BUY

Comcast Corporation (CMCSA) – Comcast is one of the world’s largest media and entertainment companies. Its properties include Comcast cable television, NBCUniversal (movie studios, theme parks, NBC, Telemundo and Peacock), and Sky media. The Roberts family holds a near-controlling stake in Comcast. Comcast shares have tumbled due to worries about cyclical and secular declines in advertising revenues and a secular decline in cable subscriptions as consumers shift toward streaming services, as well as rising programming costs and incremental competitive pressure as phone companies upgrade their fiber networks.

However, Comcast is a well-run, solidly profitable and stable company that will likely continue to successfully fend off intense competition while increasing its revenues and profits, as it has for decades. The company generates immense free cash flow which is more than enough to support its reasonable debt level, generous dividend and sizeable share buybacks.

There was no company-specific news this past week, though the fallout from the hiring and immediate firing of controversial former Republican National Committee chairwoman Ronna McDaniel in the NBC News division appears to still be weighing on the share price. CMCSA shares were down 4% this past week and have tumbled 8.5% in April already, dipping to six-month lows below 40. Could this be a market overreaction to bad news? Certainly. A more important litmus test will come in two weeks, when the company releases first-quarter earnings on April 25.

For now, Comcast shares have 16% upside to our 46 price target. But let’s keep our rating at Hold until those earnings come out. HOLD

Honda Motor Co. (HMC) – After years of declining sales, Honda was rejuvenated in 2023 thanks to hybrids. The Japanese automaker sold 1.3 million cars last year, up 33% from 2022; a quarter of the cars it sold were hybrids, led by its popular CR-V sport utility vehicle (SUV) and Accord mid-size sedan. The CR-V was the best-selling hybrid in the U.S. last year, with 197,317 units sold. The Accord wasn’t far behind, with 96,323 sold. All told, Honda’s hybrid sales nearly tripled in 2023, to 294,000 units.

So, Honda is making the full pivot to hybrids, with the Civic soon to become the latest addition to its hybrid fleet. Investors have started gravitating more to the companies that sell them. Invariably, those are well-established, big-name car companies made famous by many decades of selling internal combustion engine vehicles; most aren’t ready to fully abandon their roots but want to tap into the surging national (and global) appetite for electric, so they instead are turning to hybrids as a compromise. As a result, these once-stodgy car companies are tapping into new revenue streams, and their share prices are surging accordingly.

Among the hybrid-rejuvenated, brand-name automakers, Honda offers the best value.

Honda reported 17% growth in U.S. vehicle sales in the first quarter, fueled by a continued surge in hybrid sales. We won’t know the full results for this global automaker until the company reports earnings in a month (May 9). But the spike in U.S. sales is a good sign.

As for the stock, it got off to a nice start in its first week in the Value Investor portfolio before pulling back on Wednesday after the inflation report. HMC shares trade at less than 10 times earnings and have a price-to-sales ratio of 0.48 and an EV/EBITDA of a microscopic 0.04. Shares have 23% upside to our 45 price target. BUY

Philip Morris International (PM) – Based in Connecticut, Philip Morris owns the global non-U.S. rights to sell Marlboro cigarettes, the world’s best-selling cigarette brand. Cigarettes comprise about 65% of PMI’s revenues. The balance of its revenues is produced by smoke-free tobacco products. The cigarette franchise produces steady revenues and profits while its smoke-free products are profitable and growing quickly. The upcoming full launch of IQOS products in the United States, a wider launch of the IQOS ILUMA product and the recent $14 billion acquisition of Swedish Match should help drive new growth.

The company is highly profitable, generates strong free cash flow and carries only modestly elevated debt (at about 3.2x EBITDA) which it will whittle lower over the next few years. The share valuation at about 14x EBITDA and 14.3x per-share earnings estimates is too low in our view. Primary risks include an acceleration of volume declines and/or deteriorating pricing, higher excise taxes, new regulatory or legal issues, slowing adoption of its new products, and higher marketing costs. A strong U.S. dollar will weigh on reported results. While unlikely, Philip Morris could acquire Altria, thus reuniting the global Marlboro franchise.

There was no company-specific news this past week.

Philip Morris’ shares were down about 2.5% and now have 34% upside to our 120 price target. The shares offer an attractive 5.6% dividend yield. Earnings are due out April 23. BUY

Buy Low Opportunities Portfolio

Buy Low Opportunities Portfolio stocks include a wide range of value opportunities. These stocks carry higher risk than our Growth & Income stocks yet also offer more potential upside. This group may include stocks across the quality and market cap spectrum, including those with relatively high levels of debt and a less clear earnings outlook. The stocks may not pay a dividend. In all cases, the shares will trade at meaningful discounts to our estimate of fair value.

Agnico Eagle Mines (AEM) is the world’s third-largest and likely the highest-quality and lowest-risk gold mining company. Its strategy of “proven geological potential in premier jurisdictions” appropriately describes its exclusive focus on quality mines in the legally safe countries of Canada, Mexico, Australia and Finland. In the past few years, Agnico has made several in-region acquisitions including Kirkland Lake in 2022 for $11 billion and Yamana Gold’s Canadian assets for $2.6 billion. The plan for the next five years is to fully integrate and improve these operations and grow production in its existing mines.

As the owner of some of the industry’s highest-quality mines, Agnico has production volumes that look steady for years to come. While some of its ten major mines will see tapering output, nearly all of the others will have steady increases, driven by continued investment and exploration. Agnico’s gold reserves are high quality and increased 11% last year, supporting its outlook for at least stable production volumes. In 2023, the company’s production came in at the high end of its guidance range.

Agnico continues to be an efficient operator, with all-in sustaining¹ (or ASIC) of about $1,200/ounce, which is roughly 12% below the industry average. Helping its economics are the quality of its mines, the close geographic proximity of its Ontario and Quebec mines and the surplus capacity in its Detour Lake facility that will allow for higher throughput with minimal incremental costs.

We see in Agnico a well-managed company that meets/exceeds its production and cost guidance yet has shares that are noticeably undervalued.

There was no company-specific news this past week, though the price of gold continued to soar, topping $2,300 an ounce for the first time ever. Despite that, AEM shares were flat for the week after advancing nearly 9% the previous week – the stock’s first in the Value Investor portfolio. Shares have 23% upside to our 75 price target, and the stock pays a nice 2.6% dividend yield. Earnings are due out April 25. BUY

Aviva, plc (AVVIY), based in London, is a major European company specializing in life insurance, savings and investment management products. Amanda Blanc, hired as CEO in July 2020, is revitalizing Aviva’s core U.K., Ireland and Canada operations following her divestiture of other global businesses. The company now has excess capital which it is returning to shareholders as likely hefty dividends following a sizeable share repurchase program. While activist investor Cevian Capital has closed out its previous 5.2% stake, highly regarded value investor Dodge & Cox now holds a 5.0% stake, providing a valuable imprimatur and as well as ongoing pressure on the company to maintain shareholder-friendly actions.

There was no company-specific news this past week.

Shares were flat since our last issue but are still hovering near 52-week highs after a big run-up in February and March. They still have 11% upside to our 14 price target, and Aviva shares pay a hefty 6.6% dividend 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. Investors have lost hope in Citigroup, creating an impressive bargain.

Citigroup is set to report first-quarter earnings tomorrow, April 12. Analysts are expecting a 45% decline in EPS on a modest 2% bump in revenue, though Citigroup has beaten earnings estimates in each of the last four quarters.

Citi shares were down 2% last week, ahead of the report. With a 10% loss on the stock after nearly two and a half years in the portfolio, I’m keeping this one on a short leash, despite the 17% run-up so far in 2024. A miss and subsequent tumble on earnings tomorrow could be enough to cut bait. But given the bank’s recent history of beating estimates, let’s see what happens. BUY

CNH Industrial (CNHI) – This company is a major producer of agriculture (80% of sales) and construction (20% of sales) equipment and is the #2 ag equipment producer in North America (behind Deere). Its shares have slid from their peak and now trade essentially unchanged over the past 20 years. While investors see an average cyclical company at the cusp of a downturn, with a complicated history and share structure, we see a high-quality and financially strong company that is improving its business prospects and is simplifying itself yet whose shares are trading at a highly discounted price. See our November 30 Alert and the December 5 Monthly letter for more commentary on our thesis.

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

CNH shares were up another 2% this week and are now trading at 2024 highs! They still have 15% upside to our 15 price target. The 3.6% dividend yield offers a reasonable interim cash return. BUY

Gates Industrial Corp, plc (GTES) – Gates is a specialized producer of industrial drive belts and tubing. While this niche might sound unimpressive, Gates has become a leading global manufacturer by producing premium and innovative products. Its customers depend on heavy-duty vehicles, robots, production and warehouse machines and other equipment to operate without fail, so the belts and hydraulic tubing that power these must be exceptionally reliable. Few buyers would balk at a reasonable price premium on a small-priced part from Gates if it means their million-dollar equipment keeps running. Even in automobiles, which comprise roughly 43% of its revenues, Gates’ belts are nearly industry-standard for their reliability and value. Helping provide revenue stability, over 60% of its sales are for replacements. Gates is well-positioned to prosper in an electric vehicle world, as its average content per EV, which require water pumps and other thermal management components for the battery and inverters, is likely to be considerably higher than its average content per gas-powered vehicle.

The company produces wide EBITDA margins, has a reasonable debt balance and generates considerable free cash flow. The management is high-quality. In 2014, private equity firm Blackstone acquired Gates and significantly improved its product line-up and quality, operating efficiency, culture and financial performance. Gates completed its IPO in 2018. Following several sell-downs, Blackstone has a 27% stake today.

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

Gates shares were down 1% this past week but are still roughly holding near 52-week highs after big February and March gains. Shares have 15% upside to our new 20 price target. BUY

NOV, Inc (NOV) – This high-quality, mid-cap company, formerly named National Oilwell Varco, builds drilling rigs and produces a wide range of gear, aftermarket parts and related services for efficiently drilling and completing wells, producing oil and natural gas, constructing wind towers and kitting drillships. About 64% of its revenues are generated outside of the United States. Its emphasis on proprietary technologies makes it a leader in both hardware, software and digital innovations, while strong economies of scale in manufacturing and distribution as well as research and development further boost its competitive edge. The company’s large installed base helps stabilize its revenues through recurring sales of replacement parts and related services.

We see the consensus view as overly pessimistic, given the company’s strong position in an industry with improving conditions, backed by capable company leadership and a conservative balance sheet.

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

The price of West Texas Intermediate (WTI) crude oil is up sharply this year, rising to $85.39 a barrel as of this writing – close to a six-month high. Demand remains robust while supplies continue to be reasonably plentiful. Several OPEC+ producers led by Saudi Arabia agreed to extend their production cuts through June.

Meanwhile, Henry Hub natural gas held mostly firm at $1.87/million BTUs, still below the usual floor of $2.00. Right now, the low natural gas prices are being offset by the surge in crude oil prices.

With both nat. gas and oil prices flat this week, NOV shares were also flat. They have 24% upside to our 25 price target. BUY

Worthington Enterprises (WOR) – Following the split-up of Worthington Industries late last year, “Enterprises” focuses on producing specialized building products (42% of sales) and consumer products (48%). The value of these operations was previously obscured by the market’s perception that the original Worthington Industries was primarily a steel processor. While the market sees an average company with a mix of only partly related products, we see a high-quality company with strong positions in valuable and profitable niches, backed by capable management and a solid balance sheet.

There was no company-specific news this past week.

WOR shares were flat and have been holding right near 59 support after getting knocked backward by earnings in late March. Revenues were down 9% in the company’s fiscal third quarter, while earnings per share declined 1%. Wall Street understandably didn’t love the results, though EPS did come in 16% ahead of consensus estimates, and both gross margins and adjusted EBITDA margins ticked up slightly.

The stock has 21% upside to our 73 price target. BUY

Strong Buy – This stock offers an unusually favorable risk/reward trade-off, often one that has been rated as a Buy yet the market has sold aggressively for temporary reasons. We recommend adding to existing positions.
Buy – This stock is worth buying.
Hold – The shares are worth keeping but the risk/return trade-off is not favorable enough for more buying nor unfavorable enough to warrant selling.
Sell – This stock is approaching or has reached our price target, its value has become permanently impaired or changes in its risk or other traits warrant a sale.

Note for stock table: For stocks rated Sell, the current price is the sell date price.

Current price is yesterday’s mid-day price.

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