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Value Investor
Wealth Building Opportunites for the Active Value Investor

Cabot Value Investor Issue: November 7, 2023

Thank you for subscribing to the Cabot Value Investor. We hope you enjoy reading the November 2023 issue.

We discuss recent earnings from our companies and move shares of Sensata Technologies (ST) from Buy to Hold given the company’s lower overall quality compared to our initial understanding.

We also include some thoughts on the current stock market and how rising interest rates and other factors have led investors to unload shares of most companies and riskier companies in particular.

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Oh, to Be a Mega-Cap Growth Investor

If you’re not a mega-cap growth investor or focused on a trading style unaffected by the market’s direction, you’ve probably had a mediocre year at best. The media focuses on the impressive 15% return for the S&P 500 index this year. But the distortion caused by mega-cap growth stocks, up 33% this year as measured by the Russell Top 200 Growth Index, has hidden the uninspiring results everywhere else.

These results elsewhere are truly “uninspiring.” The average S&P 500 stock is up only 2%, as are value stocks across the board. Small-cap stocks have gained only 1%. Without the sharp rally this month, all of these measures would be negative for the year.

What’s going on? We all know that the Magnificent 7 stocks have been major drivers. While much of their gains were posted in the first half of the year, they continue to hold their prices even with wobbly fundamentals. The artificial intelligence (AI) boost helps, but something else must be going on.

We see two drivers. First, rising interest rates are weighing on the value of all stocks. If cash can earn a risk-free 5% sitting in T-bills, stocks are inherently less appealing than when cash could earn only 3%. For investors on the geekier side of the world, this might be illustrated in a parallel shift down in the quality-valuation curve. Valuations become lower across the board.

The second driver is growing risk aversion by investors, given the elevated macro risks. So, the riskier the stock, the less appeal it has. (This is a complete reversal from two years ago). These risks might include lower-quality management, weaker profits or cash flows, and shallower moats. For geeks, this might be seen as a steepening of the quality-valuation curve. Valuations become lower the further out on the risk spectrum.

The combined result is that riskier stocks are being dumped – and their valuations show it.

On the other hand, stocks like the Magnificent 7, which historically have had top-quality management teams, wide moats, very low cyclicality, strong profits and cash-laden balance sheets, are seen as nearly risk-free. So, it is not surprising that their valuations haven’t compressed much at all.

Curiously, this bifurcation of mega-cap quality vs everything else went into overdrive right after the start of the banking crisis in the spring.

Most of our Cabot Value Investor stocks have held up reasonably well as they have some measure of quality. On the other hand, Sensata Technologies (ST) has been a stand-out loser, falling nearly 30% since mid-year and 40% since February.

Weaker earnings haven’t had much direct effect on Sensata’s share price. Estimates for 2024 EBITDA have ticked down only 7% over the past year.

The primary reason for the company’s share price collapse has been the valuation: the EV/EBITDA multiple has slid from 12x to 8x. Why? The company’s management has shown itself to be mediocre, it has over-bet on the transition to electric vehicles, its moat is narrower than previously believed, its revenues are cyclical and it carries a tad too much debt. It’s no wonder investors have bailed.

We discuss their issues and disappointing third-quarter results more in our note (below).

For the market as a whole, until there is more improvement in earnings and economic growth, a clear end to the interest rate hikes, and some relenting on the macro risk picture, valuation multiples probably aren’t going to increase much from here. That means the average stock is unlikely to move higher. Even the mega-cap tech stocks may eventually lose their luster. Holding excess cash makes sense while looking for fresh ideas among the growing pile of detritus.

Share prices in the table reflect Monday, November 6 closing prices. Please note that prices in the discussion below are based on mid-day November 6 prices.

Note to new subscribers: You can find additional color 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.

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Today’s Portfolio Changes
Sensata Technologies (ST) – Moving shares from Buy to Hold.

Portfolio Changes Since Last Month
Comcast (CMCSA) – Moving shares from Hold to Buy
Allison Transmission (ALSN) – Moving shares from Hold to Buy

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.

Stock (Symbol)Date AddedPrice Added11/06/23Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Cisco Systems (CSCO)11/18/2041.3253.2428.80%2.90%66Buy
Comcast Corp (CMCSA)10/26/2231.542.534.90%2.70%46Buy
Philip Morris International (PM)9/18/2396.7991.13-5.80%5.70%120Buy
Current Price2023 EPS Estimate2024 EPS EstimateChange in 2023 EstimateChange in 2024 EstimateP/E 2023P/E 2024
CSCO 53.01 4.06 4.230.0%-0.2% 13.1 12.5
CMCSA 42.51 3.93 4.290.8%0.9% 10.8 9.9
PM 91.19 6.13 6.520.6%0.4% 14.9 14.0

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.

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 (which it returns to shareholders through dividends and buybacks). Its announced deal for Splunk will drain most of its cash hoard but we see this as being replenished relatively quickly.

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

CSCO shares rose 3% in the week and have 25% upside to our 66 price target. Based on fiscal 2024 estimates, unadjusted for the Splunk acquisition, the valuation is attractive at 9.6x EV/EBITDA and 12.5x earnings per share. BUY


Comcast Corporation (CMCSA) With $120 billion in revenues, 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.

On October 26, Comcast reported a strong quarter with earnings of $1.08/share increasing 13% and beating the consensus estimate by about 14%. Revenues increased 1% and were 1% above estimates. Adjusted EBITDA of $10 billion was 7% above estimates. The company generated $4 billion of free cash flow – an immense sum – which was used to repurchase $3.5 billion of shares in the quarter. Comcast’s share count is down 5% from a year ago. The balance sheet remains robust. Video subscriber totals continue to fall, and advertising was weak, but Comcast has ticked up its prices to offset these. Costs remain under control.

Despite the strong numbers, Comcast shares fell. Declines in its domestic broadband customer count (down 18,000) and domestic video customer count (down 561,000), as well as declines in its advertising revenue (down 13%) were roughly comparable to their trends, but management wasn’t encouraging as they said these losses would likely continue. These metrics are seen as indicators of the core demand for Comcast’s products, so the lack of any meaningful improvement is seen as an enduring problem.

Management strongly implied that it will be selling its stake in Hulu. An outlier risk is that Comcast ends up buying Disney’s stake, which would scuttle our Comcast thesis.

The Peacock streaming service continues to grow at a hefty pace, but losses aren’t falling (8% smaller at $565 million) as quickly as we would like.

Also, Disney essentially agreed to buy Comcast’s one-third stake in Hulu. Media comments say the price will be $8.6 billion, but that is only the minimum allowed price. Negotiations for the price are underway and there is no way to accurately estimate what the final price will be.

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

Given Comcast’s financial strength and enduring business model that has many strong operations, we raised our rating back to Buy last week. However, the sharp 11% increase in the share price off the post-earnings bottom, which erased essentially all of the sell-off, has removed most of the incremental appeal.

Comcast shares rose 5% in the past week and have 8% upside to our 46 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 13.5x EBITDA and 15.6x per-share earnings 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 re-uniting the global Marlboro franchise.

On October 19, Philip Morris reported a reasonably decent quarter, incrementally raised its full-year 2023 volume and profit guidance and expressed confidence in its 2024-2026 outlook. However, IQOS volumes were incrementally disappointing, and management indicated that full-year IQOS volumes would be in the lower half of the guidance range. No change to our Buy rating.

In the quarter, revenues rose 14% but were fractionally below the consensus estimates. Adjusted earnings of $1.67/share rose 20% from a year ago and were 4% above estimates.

Revenue growth was +9% after factoring in currency changes and acquisitions. Total volumes rose 2%, led by heated tobacco units (non-combustibles, which is IQOS), up 18% and oral tobacco products, up 19% after scrubbing out the effect of acquisitions. Total volumes were weighed down by the -0.5% decline in cigarette volumes. The company’s cigarette and heated tobacco unit market shares increased in the quarter.

The cigarette business remains solid, with 9% higher prices more than offsetting the weak volumes, leading to a 6% lift in cigarette revenues. Philip Morris’ brands continue to improve their market shares after some fall-off in 2020-2021.

Management’s full-year guidance range for heated tobacco unit volumes is 125-130 billion units but are now guided toward the lower half of this range due to a number of temporary issues. Investors worried about this incremental disappointment but seem to have missed the strong growth these products are generating. At the low end, 2023 volumes would be 16% above year-ago volumes, an acceleration from the 2022 pace. Nevertheless, HTU volumes are a key component of the Philip Morris story. We anticipate renewed strength next year. The revenue and margin accretion from the Swedish Match deal is indicating that this acquisition is on track to be impressively successful.

The gross margin expanded to 65.4% while the adjusted operating margin narrowed on higher marketing and other costs. Adjusted operating income rose 11% after removing the effect of acquisitions and currency.

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

PM shares rose 2% in the past week and have 32% upside to our 120 price target. The shares offer an attractive 5.7% dividend yield. 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.

Stock (Symbol)Date AddedPrice Added11/06/23Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Allison Transmission Hldgs (ALSN)2/22/2239.9952.0430.10%1.80%59Buy
Aviva (AVVIY)3/3/2110.7510.22-4.90%7.80%14Buy
Barrick Gold (GOLD)3/17/2121.1316.42-22.30%2.40%27Buy
Citigroup (C)11/23/2168.142.04-38.30%5.00%85Buy
Gates Industrial Corp (GTES)8/31/2210.7111.345.90%0.00%16Buy
NOV, Inc (NOV)4/25/2318.820.016.40%1.00%25Buy
Sensata Technologies (ST)2/17/2158.5731.79-45.70%1.50%57Hold

Current Price2023 EPS Estimate2024 EPS EstimateChange in 2023 EstimateChange in 2024 EstimateP/E 2023P/E 2024
ALSN 52.02 6.97 7.27-0.1%0.6% 7.5 7.2
AVVIY 10.25 0.37 0.44-3.4%-3.1% 27.9 23.2
GOLD 16.25 0.81 1.08-0.3%-2.4% 20.0 15.0
C 41.95 6.01 5.93-0.2%-0.2% 7.0 7.1
GTES 11.56 1.23 1.372.3%1.2% 9.4 8.5
NOV 20.19 1.42 1.73-3.3%-1.6% 14.2 11.7
ST 31.79 3.68 4.07-1.6%-2.6% 8.7 7.8

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.

Allison Transmission Holdings, Inc. (ALSN) Allison Transmission is a midcap manufacturer of vehicle transmissions. While 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, Allison actually produces no car or light truck transmissions. Rather, it focuses on the school bus and Class 6-8 heavy-duty truck categories, where it holds an 80% market share. Its 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. 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 October 25, Allison reported another strong quarter, with adjusted earnings of $1.76/share increasing 21% and coming in 4% above estimates. Revenues rose 4% but were 4% below estimates. Adjusted EBITDA of $267 million rose 9% but was 2% below estimates. Management reiterated their full-year 2023 guidance that showed sales and profit resilience (sales up 8%, Adjusted EBITDA up 12%) but didn’t raise their guidance. The balance sheet remains impressively strong.

Allison shares fell, likely due to the revenue “miss” and perhaps due to a perception that the current business cycle has peaked and is likely to roll over. Year-over-year sales growth rates have decelerated in all but the Defense end market and have turned negative in the small-ish Off-Highway market, lending credence to investor worries.

We continue to see Allison as a rare gem of a well-managed, healthy-moat and shareholder-friendly company. Given the sell-down in the shares, we returned the shares to a Buy last week.

ALSN shares rose 2% in the past week and have 13% upside to our $59 price target. The shares offer a reasonable 1.8% dividend yield. 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. We expect that activist investor Cevian Capital, which holds a 5.2% stake, will keep pressuring the company to maintain shareholder-friendly actions.

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

Aviva shares increased 4% this past week and have 37% upside to our 14 price target. Based on management’s guidance for the 2023 dividend, which we believe is a sustainable base level, the shares offer a generous 7.9% yield. On a combined basis, the dividend and buybacks offer more than a 10% “shareholder yield” to investors. 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 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.

Barrick reported a reasonable quarter. Revenues increased 13% on 3% higher volume of gold sold and 12% higher gold prices, which were partly offset by weaker copper revenues (-2%). Costs rose only 2% so adjusted EBITDA increased 27%. Free cash flow of $359 million was encouraging as it was meaningfully above year-ago and prior quarter results. Net debt fell about $100 million to $514 million.

Gold production rose 5% from a year ago (favorable) but management said that full-year production will be just below the low end of its guidance range. This is disappointing. Management reiterated its confidence that production would increase by 30% by 2029 – which is six years away. We don’t share management’s confidence unless they back-door the growth by an acquisition (unfavorable).

Barrick continues to struggle to boost production while restraining costs. While costs on a per-ounce basis fell 1% in the quarter, this is due to more ounces produced rather than fewer dollars spent. And, in its efforts to boost production, Barrick is plowing about 80% of its operating cash flow back into capital spending, leaving only enough for the base dividend to shareholders and basic payouts to its joint venture partners.

We want to see better production, restrained dollar costs and lower capital spending, which should allow the company to be inherently more valuable as well as provide larger cash payouts to shareholders.

In the quarter, revenues rose 13% but were 3% below estimates. Adjusted earnings of $0.24/share rose 85% from a year ago and were 20% above estimates.

Over the past week, commodity gold ticked down 1% to $1,992/ounce. Gold prices seem stuck between about $1,800 and $2,000. Until the price shifts meaningfully outside of this range, in one direction or another, we consider most of the movements to be noise. The 10-year Treasury yield slid sharply to 4.62%.

The structural forces behind inflation may be permanent – war, government spending, crime, oil prices and past-the-peak fading of the benefits of global free trade, in addition to tight labor market – which could keep inflation at the 3-5% pace indefinitely. Permanent inflation would imply permanent 4-6% interest rates. We see this as a reasonably acceptable normal, which is more in line with history than the 0-3% rates of the past decade. The market has yet to fully digest this new normal.

The U.S. Dollar Index (the dollar and gold usually move in opposite directions) declined 1% to 105.05. Rising yields and relative safety are maintaining demand for the dollar. The US Dollar Index reached a peak of 119 in early 2001, a price that is around 10% above the current level. The world is a very different place than it was in the pre-9/11 era, so we have no way to effectively compare conditions across this time span. However, today, we see global capital moving to the safety of U.S. dollar assets relative to most other developed nation currencies. Gold may be seen as a lesser source of safety, partly due to its illiquidity.

Investors and commentators offer a wide range of outlooks for the economy, interest rates and inflation. We have our views but hold these as more of a general framework than a high-conviction posture. Investing in gold-related equities is a long-term decision – investors shouldn’t allow near-term weakness to deter their resolve.

Barrick shares rose 1% this past week and have 66% upside to our 27 price target. 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 October 3, Citi reported a reasonably decent quarter. In its two core businesses (Institutional Client Group and Personal Banking/Wealth Mgt), revenues rose 11% and profits rose 10%. Overall credit costs are rising but remain low and are backed by strong reserves. Deposits ticked lower but remain a minor issue. Non-core results were mixed. Capital is strong with CET1 at 13.5%. Citi remains burdened by excessive regulatory and other costs as well as unproductive capital. The return on equity of 7.7% is about half what it should be, implying that the bank either needs to double its earnings or cut its capital base in half. We believe that a combination of both efforts, driven by new and aggressive efficiency improvements and the eventual divestiture of non-core assets will move Citi close enough to a 15% ROE, but this will take yet more time, likely measured in years. Citi’s full-year guidance was uninspiring but not disappointing. The shares trade at less than half of tangible book value of $86.90/share. No change to our Buy rating.

Citi is rumored to be shutting its municipal bond business. Recently ranked #2 in the industry, the bank’s muni business is now a laggard at #8. If the bank exits this business, the move would support CEO Fraser’s new no-holds-barred approach to fixing Citi’s weak profitability.

Investors have lost hope in Citigroup. Despite the sharp recent price bounce, the shares trade essentially unchanged from 2010 prices and are at or near lows not seen since 2012, only a few years after the worst of the global financial crisis. Valued at roughly 50% of tangible book value, Citi shares are pricing in what amounts to a ceiling on its earnings power of about $4.50-$5.00/share, based on the assumption that a roughly 8x multiple is “about right.” This perhaps is based on the 4Q23 estimate of $1.18/share being the permanent run-rate ($1.18 x 4 quarters = $4.72).

We find it hard to believe that Citi’s earnings won’t improve over the fourth-quarter run rate. Not only are consensus annual estimates at $6/share, but the company is taking a more aggressive cost-cutting stance and its stronger segments continue to show growth.

Another way to look at the valuation: using the general rule of thumb that banks trade at a P/TBV that is 10x its return on tangible common equity, Citi shares are pricing in roughly $4.35/share of earnings. The rough math is that by valuing the shares at 50% of tangible book value, investors are assuming a 5.0% return on tangible common equity [5.0% x $87 TBV = $4.35 EPS]. While anything is possible, it would seem exceptionally unlikely that Citi would be stuck at $4.35/share of earnings.

The recently raised $0.53/share quarterly dividend looks sustainable outside of a devastating market calamity.

Citi shares rose 8% in the past week and have over 100% upside to our 85 price target. The shares remain attractive as they trade at less than 50% of tangible book value of $86.90. The dividend offers investors a 5.1% yield.

When comparing Citi shares with a U.S. 10-year Treasury bond, Citi offers a higher yield and considerably more upside price potential. Clearly, the Citi share price and dividend payout carry considerably more risk than the Treasury bond, but at the current valuation Citi shares would seem to have a remarkably better risk/return trade-off. 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 43% stake today.

Gates reported a good quarter, with adjusted earnings of $0.35/share rising 13%. Earnings beat the $0.31/share estimate by 13% which had called for flat earnings. Adjusted net income in dollars rose 6% and the share count fell by 6%, fueling the per-share increase. Adjusted EBITDA rose 7%. Revenues rose 1%, although organic growth was down (1%). Gates fractionally raised its full-year profit guidance, although this implies a 4% decline in fourth-quarter revenues compared to a year ago, while the implied 4Q EBITDA will be 85 basis points wider.

Sales growth is tapering. In the quarter, first-fit sales (sales to new vehicle and equipment makers) were flattish while replacement sales to end customers were healthier. Also weighing on growth: sales in China (9% of total sales) fell 9%. However, Gates’ ability to expand its margins was impressive: EBITDA margin increased to 21.7% from 20.6% as the company raised prices above its higher costs. The company said that further operating efficiency improvements are underway.

Year to date, cash flow has surged to about $245 million from $(47) million a year ago. Higher profits and tighter working capital management have driven this increase. Gates has plowed the excess cash into buybacks and debt paydown, as shares have declined 6% from a year ago. Net debt of $1.9 billion is a healthy 2.6x EBITDA.

All-in, Gates is a well-managed company that is showing its ability to boost profits and cash flow. While the industrial cycle is likely flattening out, Gates is attractively valued and not likely to suffer much of a downturn in profits when the economy weakens (whenever that happens).

Gates shares rose 6% this past week and have 38% upside to our 16 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.

On October 26, NOV reported adjusted earnings of $0.29/share, up 38% from a year ago but 14% below estimates. Revenues rose 16% and were 3% above estimates. Adjusted EBITDA of $267 million increased 37% and was 6% above estimates. Pricing improvements from stronger demand and from product innovations are boosting results. Order growth outpaced revenue growth. Free cash flow improved but remained sub-par: more revenues are coming from outside of the U.S. where receivables collection timing is slower, and inventories lifted due to catch-up shipments from suppliers. These working capital drains are expected to reverse in coming quarters.

Management sounded confident that its end markets are turning upward. Stronger international and offshore markets are more than offsetting weak North American land drilling activity. NOV said its margins lag where they should be, so the company is moving to two segments from three. This change could save $75 million a year, or about 1% of revenues. We’re fine with the cost savings but will miss the incremental visibility into the company’s performance.

All in, an encouraging quarter for our NOV recommendation.

The price of West Texas Intermediate (WTI) crude oil slipped 3% to $81.81/barrel. Oil prices appear to be quiet and largely unmoved by the Israel-Gaza conflict, but the potential for sharp volatility seems higher with the increasingly complicated game of shifting geopolitical and economic alignments. A major new catalyst, in addition to all of the others, would be export or production cuts from the Middle East should Iran become directly or even explicitly indirectly involved (including if the U.S. restores its sanctions).

The price of Henry Hub natural gas was unchanged at $3.58/mmBtu (million BTU). Investors are pricing in a possibly cold winter. Also, some traders worry about low storage volumes headed into the winter, as well as the possibility of a closure of Israeli offshore gas fields.

NOV shares rose 2% in the past week and have 24% upside to our 25 price target. The dividend produces a reasonable 1.0% 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 safety 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. Our Sensata investment remains an underperforming (from a business fundamentals perspective) work in progress.

Sensata reported a reasonable quarter, with adjusted earnings of $0.91/share, rising 7% from a year ago and were 1% above estimates. Revenues fell 1% ex-currency and were in line with estimates. Adjusted EBITDA of $228 million rose 2% and was 2% above estimates.

However, the company’s fourth-quarter revenue guidance was 4% below estimates and profits guidance was 12% below estimates. Sensata’s fundamentals at best are stable and appear to be weakening. Segment-only operating profits, already adjusted for recurring, non-recurring expenses and including profits from a merger, slipped 3% from a year ago.

Overall, Sensata is a lower-quality company than we initially estimated. This has created a permanent down-shift in its target valuation multiple.

We have lost most of our faith in management. The company is doubling down on electrification and electric vehicles. But this “transition” is likely to go a lot slower given the growing headwinds to electric vehicle adoption, leaving the company over-exposed to an industry that isn’t quite here yet. And, its franchise in the value chain seems less robust than we previously understood, limiting its already-slim margin improvement potential.

Part of Sensata’s problem is that its investor relations team seems to be inept. If management can’t identify this problem, then management is similarly inept. One issue is that the company misses consensus estimates too often. If the IR people can’t guide the street to a “beat” then they aren’t doing their jobs. And, there was at least one simple math mistake in the slide deck. One frustrating problem is that the company ignores long-term debt in its net cash calculation. Last time we checked, long-term debt is actually debt.

The incoming CFO will hopefully find and fix these IR problems, but we see the change-out as motivated by little more than the CEO looking to deflect blame.

We would pull the plug on Sensata but for a few incremental items. First, the shares have declined so sharply that at $32 they are clearly out of favor. This augers for some rebound. Second, the company is now generating reasonable free cash flow. But, potentially offsetting these is that the company is trimming its capital spending and relying on working capital improvements to boost its free cash flow. And, its share buybacks seem to only replace shares issued to employees as compensation, making these repurchases an expense rather than a “return of cash to shareholders” positive.

The shares will likely remain weak and stagnant for the near term. We will wait for a favorable change in investor sentiment but are poised to pull the plug. Given this, we are moving the shares to a Hold.

ST shares fell 7% in the past week, reflecting the weak results, and have 79% upside to our recently reduced 57 price target. HOLD


Disclosure: The chief analyst of the Cabot Value Investor 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.

The next Cabot Value Investor issue will be published on December 5, 2023.

Bruce Kaser has more than 25 years of value investing experience in managing institutional portfolios, mutual funds and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company.