Cabot Value Investor Issue: July 5, 2024

An All-Weather Retailer Trading at a Rare Discount

Consumer cyclical stocks haven’t been the worst-performing sector of 2024. They’re up 5.1%, better than three other sectors – real estate (-5.5%), basic materials (3.9%) and utilities (4.9%).

They’re not the most undervalued either. As a group, consumer cyclicals trade at a forward price-to-earnings ratio just north of 18, more expensive than four other sectors (energy, financials, basic materials and utilities). On a price-to-book basis, it’s the third-cheapest sector. That said, it boasts the third-highest projected earnings per share growth over the next five years (18.4%), trailing only the two dominant, artificial intelligence-enhanced technology and communication services sectors.

Add it all up, and consumer cyclicals are at the sweet spot of where one might find growth at value prices.

The sector’s valuation – and stock performance – has been held in check of late by declining retail sales. After expanding month over month in eight of the last nine months of 2023, U.S. retail sales have declined in two of the first five reported months in 2024 (June sales won’t be reported until later this month). On a year-over-year basis, sales growth has declined from 3.6% in March to a mere 2.3% in May.

The trend is clear, and it’s a big reason many economists expect the Fed to (finally) start slashing interest rates in the coming months – the CME Group’s FedWatch Tool puts the odds at 66% that the Fed will cut rates at least once by September. Meanwhile, inflation is cooling, as the Consumer Price Index (CPI) – while still stubbornly above 3% – hasn’t been above 4% in a year; more importantly the Personal Consumption Expenditures (PCE) index, the Fed’s preferred inflation gauge, just dipped to its lowest reading in three years.

Declining inflation and lower interest rates in an economy that’s still growing, a.k.a. the Fed’s long strived-for “soft landing” scenario, seems perilously close. When it happens, U.S. consumers are likely to feel emboldened to start spending again after months of hoarding cash. No, the ensuing spending spree isn’t likely to match the stimulus check-fueled economic boom we saw in the pre-inflationary days of 2021 (which feels more like it was 2011, doesn’t it?). But barring a sudden spike in inflation or some other unforeseen disaster event (always possible these days), a loosening of the purse strings seems imminent.

One retail area in which spending has remained robust, however, is sporting goods stores. In May, sales at sporting goods stores improved 2.8% from April – tops by far of any retail subsector. So today, we keep things simple by adding the biggest brand name in U.S. sporting goods stores to the Cabot Value Investor portfolio …

New Buy

Dick’s Sporting Goods, Inc. (DKS)

Sometimes, anecdotal evidence can be useful.

For example, the Walgreens that’s about seven minutes from my house is usually a ghost town. I use it quite a bit because it’s the closest drug store to me, and with two young kids, the need for cough medicine, toothpaste, and Easter/Halloween/Christmas/birthday candy never ends. But it’s typically just me and maybe one or two other people in there; the woman at the cash register is always fiddling around on her phone to fend off boredom, and seems startled to have an actual living customer to ring up when I sidle up next to the counter.

So it came as no surprise to me when Walgreens Boots Alliance (WBA) announced last week that it would be shuttering hundreds of underperforming stores and the stock dropped more than 20% overnight. All told, WBA shares plummeted more than 55% through the first half of 2024, and have lost more than 80% of their value since 2019. It’s a dying company, and pretty soon I may have to start driving the extra seven minutes to Kinney Drugs to do all my drugstore shopping.

Then there’s my local Dick’s Sporting Goods outlet, which is the anti-Walgreens.

It’s packed every time I walk in there, which is often, especially during the just-completed spring sports season. It doesn’t matter if it’s 10 a.m. on a Tuesday in February or 1 p.m. on a Saturday in May, the line to check out at Dick’s is always 10-12 people deep, minimum. Granted, it’s the only Dick’s Sporting Goods for 100 miles (Vermont isn’t exactly known for its big box stores), and that scarcity is no doubt good for business. But it’s also not that abnormal.

Nationally, Dick’s Sporting Goods has been growing steadily for years. From 2016 to 2023, the sporting goods chain’s revenues have improved 64%, from just under $8 billion to just under $13 billion. This year, the top line is on track to top $13 billion for the first time. It should top $13.5 billion next year.

Dick’s, in fact, has grown sales in each of the last seven years – including in 2020 and 2021, when most other retailers saw sales nosedive due to Covid restrictions. But Dick’s all-weather ability to keep growing no matter what’s happening in the world or the economy speaks to its versatility. It has something for everyone. It sells basketball equipment, baseball equipment, football equipment, lacrosse equipment, soccer equipment, ice hockey equipment, field hockey equipment, etc., for all ages. It sells running shoes, tennis shoes, basketball shoes, soccer, baseball and football cleats. It has an entire golf section, a hunting and fishing section, it sells exercise equipment, clothing for all sports, Ping-Pong tables and yard games like Cornhole. You name it, they have it. Thus, even when team sports shut down for a year, Dick’s kept on growing due to a spike in demand from people trying to stay in shape during Covid by doing solo activities like running, bicycling, or improving their at-home gyms.

Since Covid ended, however, Dick’s sales have entered another stratosphere. As youth sports returned in 2021, Dick’s revenues jumped from $9.58 billion to $12.29 billion. They’ve been rising steadily each year since, and are expected to do so again this year.

In its fiscal first-quarter 2025 earnings report in late May, the company raised full-year earnings guidance after comparable-store sales (5.3%) more than doubled estimates (2.4%). Transactions improved by 2.7% while spending per person increased 2.6%. Meanwhile, the company was more profitable than expected at $3.30 per share, well above the $2.95 analysts anticipated. For the year, EPS is expected to improve by 6.4%, on 2% revenue growth; next year (fiscal 2026), both numbers are projected to accelerate, to 7.3% EPS growth and 4.5% revenue growth.

Accelerating earnings and revenue are perhaps the number one characteristic we at Cabot look for most when identifying strong growth stocks. But Dick’s isn’t purely a growth stock—it’s also undervalued, thanks to the recent selling in retail stocks on the heels of the underwhelming May retail sales report.

Since peaking at a closing high around 230 just 10 days ago, DKS shares have retreated more than 13%. They currently trade at less than 15x forward earnings estimates and at 1.27x sales. To be sure, it’s not the cheapest stock in our portfolio. But given the growth and the recent sharp downturn on no company-specific news, I think this is the perfect time to pounce on a very good stock that has been outperforming the market for the past three years, since the post-Covid sales spike. DKS shares are up 53% in the last year, 163% in the last two years, and 451% in the last five years. Again – not a true value stock. But I do think it has value in light of the recent mini-selloff, and Wall Street agrees with me.

The average price target among the 22 analysts that cover the stock is 241.64, 20% higher than the current share price. I’m a tad more optimistic. I think the combination of accelerating sales and earnings (not to mention a history of earnings beats), the potential extra boost to the consumer from the Fed if/when it starts to cut interest rates and Dick’s proven knack for growing revenues every year, regardless of economic conditions, that DKS shares can rise as high as 250.

That would be a fairly modest 25% gain from current levels. But I think the stock could get there more quickly than some of our other holdings. The 2.2% dividend yield adds to the appeal and makes DKS a perfect fit for our Growth/Income Portfolio. BUY

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.

Also, please join me and my colleague Brad Simmerman on our weekly investment podcast, Cabot Street Check. You can find it wherever you get your podcasts, or you can watch us on the Cabot Wealth Network YouTube channel.

This Week’s Portfolio Changes
Dick’s Sporting Goods (DKS) – New Buy with a 250 Price Target

Last Week’s Portfolio Changes
Worthington Enterprises (WOR) Moved from Buy to Sell

Upcoming Earnings Reports
None

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.

Canadian Solar Inc. (CSIQ) is not only Canada’s largest solar energy company; it’s a global leader in the solar space. And it’s gotten much larger in the last two years, since the Canadian government announced a 50% income tax cut for zero-emission technology manufacturers (which the new 2023 legislation extended by three years). Canadian Solar’s revenues were up 41.5% in 2022, another 2% in 2023 (both record highs), and are on track to tack on another 1.2% this year and a whopping 20.2% in 2025. If it meets those estimates, the company will have gone from $3.5 billion in annual revenues to $8.25 billion in just five years. Earnings per share have more than doubled since 2021, and while they’re expected to take a step back this year, they’re projected to reach new highs of $4.75 per share next year.

And the company is right in the sweet spot for the North American solar boom. It manufactures solar photovoltaic modules and runs large-scale solar projects across Canada, and in 29 other countries, even spinning off a subsidiary – CSI Solar Ltd. – last year that trades on the Shanghai Stock Exchange. The company boasts 61 gigawatt (GW) module capacity, is up to 125GW solar module shipments, and has a project pipeline of 26.3GW. That doesn’t include its battery storage shipments (4.5 GW hours, or GWh) or capacity (20GWh expected by year’s end).

It’s a big company that operates on a global scale, and it’s growing fast. And yet … the stock is a small cap, with a market capitalization of a mere $1 billion. It used to be four times as big, trading as high as 63 a share in January 2021. Today, it trades at 15 a share, and at less than 7x forward earnings, 38% of book value, and a paltry 0.14x sales. The latter two numbers are the cheapest the stock has ever been.

There was no company-specific news for Canadian Solar this week, but the stock was up 1.5% after many gyrations. Wednesday’s 6% spike was a welcome bounce-back after a rough start since we added CSIQ shares to the portfolio a month ago. Solar stocks (+3% for the Invesco Solar (TAN) ETF) had a good day Wednesday, so CSIQ was likely riding its sector’s coattails. I’ve maintained that the selling in renewable energy stocks is way overdone, with the WilderHill Clean Energy ETF (PBW) dipping to seven-year lows, and 85% below its early-2021 peak. While renewable energy stocks have a checkered history, they’ve rarely been this cheap, and Canadian Solar is one of the fastest growing of the bunch.

I don’t expect the stock to stay down long, and perhaps Wednesday’s spike was the start of a long-overdue rebound. CSIQ shares have a whopping 81% upside to our 28 price target. BUY

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.

There was no company-specific news for Honda this week, though rival General Motors (GM) reported a slight improvement in second-quarter sales, fueled by a 40% jump in electric vehicle sales. It might not mean much for Honda, but it adds further evidence that consumers are ready to pivot to electric, which bodes well for Honda’s ongoing surge in hybrid car sales.

HMC shares were up 1.5% this week, and appear to have bottomed at 31.3 two weeks ago. The stock has 38% upside to our 45 price target. The 4.1% dividend yield adds to the appeal. 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 14.9x EBITDA and 16.4x 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 for Philip Morris this week, and the stock was unchanged.

PM shares have 18% upside to our 120 price target. The 5.1% dividend yield essentially doubles our total return since the stock was added to the portfolio last September. BUY

United Airlines (UAL) – People are flying in planes again in Covid’s aftermath, and no major airline is taking advantage of it quite like United.

United Airlines is the fastest-growing major U.S. airline. The third-largest airline carrier in the world by revenues behind Delta (DAL) and American (AAL), United is expected to grow sales by 7.4% in 2024 – more than its two larger competitors – and that’s with revenues already topping a record $50 billion in 2023 – 19.6% higher than in 2022, which was also a record year. For United, business has not only returned to pre-pandemic levels; it’s better.

Meanwhile, the stock is super cheap. It trades at less than 5x forward earnings estimates, with a price-to-sales ratio of just 0.29 and a price-to-book value of 1.72. The stock peaked at 96 a share in November 2018; it’s currently in the upper 40s.

A company that’s making more money than ever before (gross profits reached a record $15.2 billion last year, though earnings were still second to 2019 levels on a per-share basis), and yet its stock trades at barely more than half its peak from five and a half years ago. A true growth-at-value-prices opportunity.

There was no company-specific news for United Airlines this week. But the stock, while flat this past week, has been gaining support on Wall Street, as three big-name firms have upgraded UAL in the last six weeks. In May, Wolfe Research upgraded the stock from “Peer Perform” to “Outperform,” while Jefferies upgraded UAL from “Hold” to “Buy.” In June, Redburn Atlantic bumped the stock from “Neutral” to “Buy.” The average price target among the 18 analysts that cover the stock is now 71.3, 47% above the current price and even slightly above our 70 price target.

Momentum is building for UAL, and the summer travel season is in full swing. The stage is set for a bounce-back after two weeks of base-building in the 48 range. Perhaps the July 17 earnings report could trigger the next rally. Analysts still see earnings north of $10 per share this year and more growth in 2025. 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 AISC) 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.

There was no company-specific news for Agnico Mines this week, though gold prices surged to their highest price in more than a month, a rising tide that lifted all gold miners. AEM shares were up 5% in the last week and are starting to close in on our 75 price target. Still, shares are below their May highs near 71, so we’ll see how AEM behaves as it nears that resistance level.

The 2.4% dividend yield adds to our solid return thus far. 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 for Aviva this past week.

AVVIY shares were down 1.5% this week but remain in the low 12s, where they’ve been for the past month since flirting with new highs above 12.7 in late May. Any break above that level would be bullish. The stock remains cheap, trading at less than 12x earnings estimates, with a price-to-sales ratio of 0.40 and a price-to-book of 1.44. Shares have 16% upside to our 14 price target. The 6.9% dividend yield adds to our strong total return thus far. BUY

CNH Industrial (CNH) – 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.

There was no company-specific news for CNH Industrial this week.

In May, the company reported earnings that were a bit mixed.

Both sales (-9.8%) and earnings per share (-5.7%) declined from the same quarter a year ago. However, both figures beat modest estimates, with EPS (33 cents) coming in well ahead of the 26 cents that were estimated.

Broken down by segment, CNH’s Agriculture wing (its largest at $3.37 billion, or 70% of total revenues) saw a 14.1% decline in sales year over year. Construction revenues dipped 10.7% year over year. Financial Services were the lone bright spot, with revenues increasing 24.8% over last year.

Overall, CNH’s cash/cash equivalents dipped to $3.24 billion from $4.32 billion at the end of 2023. Total debt was up a tick, to $27.8 billion. But cash from operating activities improved to $894 million from $701 million.

CNH shares are down sharply since the report, getting an initial bump but giving back about 13% afterward as Wall Street seems to have decided there was more bad than good in the results. The stock does seem to have stabilized, however, finding support just below 10 in the last few weeks. Trading at less than 7x earnings (and just 0.54x sales), CNH shares have 40% upside to our 14 price target. The 4.8% dividend yield is at least providing a life raft as the stock has taken on water in recent weeks. 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 company-specific news for Gates this week.

Like CNH, Gates is coming off some mixed earnings results in May. The 31-cent EPS results outpaced analyst estimates of 30 cents and was up 20% from the 25 cents it earned in the first quarter a year ago. However, sales of $862.6 million even more narrowly missed analyst estimates and, more importantly, represented a 3.9% decline from the $897.7 million in revenue from Q1 a year ago. The underwhelming results sent GTES tumbling about 8.7% in the immediate aftermath; it has continued to trickle downward, dipping to the mid-15s, a three-and-a-half-month low.

GTES shares were flat this week and seem to have found new support around 15.5. The stock has 28% upside to our 20 price target. GTES trades at 11x earnings, 1.19x sales and 1.27x book value, so they remain undervalued by traditional measures. GTES remains our best-performing stock, with a return of 46% in less than two years. 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 for NOV this week, but the energy sector is starting to gather momentum as oil prices have risen to nearly $83 a barrel after dipping as low as $73 last month. NOV shares have followed suit, advancing nearly 7% in the last month, despite a modest pullback this past week. Crude prices being back above $80 for the first time since April could serve as a tailwind for NOV shares going forward.

The stock has 30% upside to our 24 price target. It trades at just 11.9x forward earnings estimates and 0.84x sales, with a modest 1.2% dividend yield helping the cause a bit. BUY

The next Cabot Value Investor issue will be published on August 1, 2024.

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