April 25, 2024

Tesla and the Lesson of Buying Good Stocks Cheap

Tesla (TSLA) has had a rough start to the year. Entering Wednesday, TSLA shares were down nearly 42% year to date thanks to a bitter cocktail of sagging revenues, narrowing margins, and increased competition, especially in China. At the start of this week, TSLA shares had dipped to 142, a 52-week low, and were trading at their cheapest valuation on a price-to-earnings basis since last May and on a price-to-book-value basis since 2019.

Value investors spotted a bargain in a great company.

And so, when Tesla reported disappointing first-quarter earnings results on Tuesday – both revenue and earnings fell well short of analyst estimates and the company warned of “notably lower” delivery volume in the coming quarters – TSLA shares were up more than 12% in early Wednesday trading. Why? Because Elon Musk said the company plans to accelerate the launch of more affordable models to as early as later this year, in an effort to better compete with lower-cost producers like China’s hard-charging BYD (BYDDY).

Normally, a steep earnings shortfall from a company that has now posted three consecutive underwhelming quarters would be easy fodder for short sellers. Instead, investors focused on the positive, despite it being a far less tangible “goal” of bumping up the release date on a new product. But after months of declines – TSLA shares had been sliced almost exactly in half from their July 2023 highs above 290 – the bad news of declining sales, earnings and deliveries was already baked into the share price. And bargain hunters stepped in at the first sign of encouraging news.

Their rationale is similar to the approach I’d like to employ as new Chief Analyst of this advisory: buying good companies at value prices. For all the warts it’s shown of late – declining sales and earnings in the face of increased competition from lower-priced competitors; price cuts on some of its signature models eroding the company’s long-revered profit margins; Musk’s ever-increasing propensity for putting his foot in his mouth – Tesla remains the clear leader in electric vehicles. And while EV appetites have quelled, at least in the U.S., as more Americans are turning to hybrids as a compromise between their wallets and their environmental guilt, EV sales were still up 46% last year.

And despite a down quarter, Tesla still sold more electric vehicles in Q1 (386,810 of them) than any other EV maker in the world, BYD included (it sold 300,114). It’s still the Coca-Cola, McDonald’s or Nike of the EV-making world. More than any other company, Tesla is synonymous with electric vehicles. And historically speaking, the electric vehicle industry is still in its infancy – EVs accounted for just 7.6% of total U.S. sales last year, up from 5.9% in 2022.

While I don’t plan on adding Tesla (TSLA) to the Cabot Value Investor portfolio today – we just added Honda (HMC) earlier this month, and for now, that’s enough exposure to EVs/hybrids in a 10-stock portfolio – TSLA is the type of stock I’m looking for. My goal is to “buy wonderful companies at fair prices,” to paraphrase Warren Buffett. Every great company gets knocked on its keister from time to time, either due to a rough quarter or two or a, um, eccentric CEO acting out (check and check). And their share prices get sold off accordingly. But it doesn’t change the fact that they are great companies. All the bad news has done is make Tesla a great company trading at a far more attractive share price.

Those types of stocks are a value investor’s dream. I will endeavor to add as many of them as possible to the Cabot Value Investor portfolio.

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
Cisco Systems (CSCO) Moved from Buy to Sell

Upcoming Earnings Reports
Thursday, April 25: Agnico Eagle Mines (AEM)
Thursday, April 25: Comcast (CMCSA)
Thursday, April 25: NOV, Inc. (NOV)

Wednesday, May 1: Gates Industrial Corp. (GTES)

Thursday, May 2: CNH Industrial (CNHI)

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.

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 for Comcast ahead of today’s (April 25) earnings report. Analysts are expecting modest improvement: 1.7% revenue growth and 7.6% earnings per share growth. The company has handily beaten estimates in each of the last four quarters, so it’s quite possible those estimates are too modest. You may already know by the time you read this, as the results were due out pre-market open (but after press time).

CMCSA shares were up 3% this week ahead of the report, bouncing back from a down week in the five trading days prior. Shares have 15% upside to our 46 price target. Meanwhile, the stock trades at a mere 9x forward earnings estimates and at just 1.4 times sales. Keeping at Hold, but a good report tomorrow could convince us to restore our Buy rating. 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.

One week after announcing plans to launch six next-generation electric vehicles in China by 2027, Honda set its sights on Brazil, saying it will pour $808 million into its Brazilian Itirapina plant by 2030. The main focus will be to develop a hybrid car for the Brazilian market, which would run 100% on ethanol. The announcement didn’t move the needle much for the share price – Honda’s stock is exactly flat in the last week – but it was the latest evidence of the company’s global pivot to expanding its hybrid offerings.

Honda shares remain dirt-cheap at 7x earnings and with a price-to-sales ratio of 0.46. The EV/EBITDA is a microscopic 0.04.

The stock has 29% 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.

Philip Morris reported first-quarter earnings on Tuesday and the results were encouraging. Adjusted EPS of $1.50 outpaced analyst estimates of $1.41 per share, while revenues improved 11% year over year. There was a clear driver behind the sales growth: Zyn. That’s the company’s nicotine pouch; it sold 131.6 million cans of Zyn in Q1, a whopping 80% improvement from the first quarter a year ago. Zyn’s share of the nicotine pouch market is now up to 74%. Another contributor to Philip Morris’ strong quarter was its heated tobacco device IQOS, which is expected to launch in the U.S. in the second quarter. Global shipments of IQOS units grew by 21% to 33.1 billion in the quarter.

PM shares were up 7% since our last issue, with the gains coming both before and after the earnings report. They now trade at new 2024 highs around 97, but still have 24% upside to our 120 price target. The 5.3% dividend yield has been an added bonus for patient investors, and now that patience is also paying off in the form of the share price. 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 sustaining costs (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.

Gold prices finally cooled off, pulling back about 3% after touching new all-time highs above $2,400 an ounce a week ago. But AEM shares weren’t punished; in fact, they were up another 1% ahead of today’s (April 25) earnings report. Analysts are expecting big things: 14.8% revenue growth and 3.5% EPS growth. We’ll see if Agnico can match those expectations.

Up more than 40% since mid-February, Agnico shares still have 19% upside to our 75 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, 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.

Aviva shares bounced back slightly after a down week, recouping about 2%. AVVIY shares have 18% upside to our 14 price target. The 7% dividend yield helps make up for the 7% retreat this month. 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 coming off a strong quarter. Revenue came in at $21.1 billion, ahead of $20.4 billion expected. Earnings per share of $1.86 blew away analyst estimates of $1.23. However, EPS was down 27% from last year’s first-quarter tally due to higher expenses and credit costs. Revenue was also down, about 2% year over year, but it was only down compared to a first quarter last year in which the bank sold an overseas business.

The highlight was Citi’s investment banking unit, which saw a 35% revenue bump on the strength of a solid Q1 for the market. While the results were mostly good, because the headline numbers showed year-over-year declines in revenue and earnings, investors initially sold out of C shares. But they thought better of things this week (as I anticipated!) – C shares were up 7%, rising back to pre-earnings levels.

Still trading at a mere 11x forward earnings and at just 1.56x sales, with double-digit revenue growth expected, Citi shares look like a bargain – and now they have momentum again. 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.

Shares were down 8% this week after falling 6% the previous week and are now trading at their lowest point since January. Perhaps next week’s (May 2) earnings can stop the inexplicable bleeding. Shares now have 31% upside to our 14 price target. The 4.1% dividend yield helps ease the recent slide. 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. The company reports earnings next Wednesday, May 1. Analysts are anticipating a 3.1% decline in revenue, but a 28% EPS improvement. And the company has beaten earnings estimates in each of the last three quarters.

Gates shares were up 2% this past week and are still holding close to 52-week highs after big February and March gains. That’s a good sign given the market turmoil in April. Shares have 13% 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 company-specific news ahead of today’s (April 25) earnings report, after the market close. For the quarter, analysts are expecting 7.7% revenue growth ($2.1 billion) but a 15.6% decline in earnings per share. Ahead of such mixed earnings expectations, shares were flat this past week. Where they go next will likely come down to what happens today. The company reports earnings after the close. Shares have 29% upside to our 24 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 up marginally and are still shaking off the cobwebs from a disappointing earnings report 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 25% 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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