December 12, 2023

Who Are Your influences?

When a band interviews a possible new hire, a common question is, “Who are your influences?” No musician was raised in a vacuum – everyone gets their musical foundations and inspirations from someone else. The Rolling Stones, for example, were heavily influenced by the Chicago blues and R&B scene including Muddy Waters and Bo Diddley. Learning someone’s influences helps the interviewer understand how a musician got to where they are and perhaps where they are headed in terms of their musical style, and provides some insight into what motivates the musician’s passion.

Another good reason to ask this question is to see if the musician is staying current with the industry. Are they continuing to evolve, develop, question and explore their own work and that of others? The only thing worse than a bad musician is a stale musician.

The investing business is much the same. Like musicians, investors don’t grow up in a vacuum. Their foundations and style have roots in someone else’s work. New influences along the way have helped foster the investor’s development and improve their results. Warren Buffett followed this path, getting early inspiration from his father, then Ben Graham, and eventually Charlie Munger. No doubt countless others have provided him with incremental ideas along the way. Without these, Buffett would not be the legend he is today.

So, it’s fair to ask, “Mr. Kaser, chief analyst of the Cabot Value Investor, who are your influences?”

Like nearly all value investors, I’ve been heavily influenced by Warren Buffett. While I have never met him personally, his writings (his annual Shareholder Letters going back to 1977 are available on the Berkshire Hathaway website), interviews on CNBC and other media outlets, various biographies and related works by respected authors (notably “Snowball: Warren Buffett and the Business of Life”), as well as when I attended the Berkshire Hathaway annual shareholder meeting this past year, have all provided worthy exposure to his philosophy and methods. Charlie Munger, for his part, has been a nearly equal influence.

Another influence is Seth Klarman, founder and head of The Baupost Group. His obscure book, “Margin of Safety,” available at the not-bargain price of over $2,000, is widely considered a bible of value investing. I’ve found immense inspiration from reading his book, watching some of his rare interviews, and seeing what his fund owns through 13F filings.

I’ve had other influences along the way. A former boss from years ago, David Chalupnik, who is still going strong as the head of equities at a major investment shop, provided critical foundational guidance in both value investing and personal demeanor that have helped keep me grounded in a common sense, honest and straightforward approach to investing and life. I am lucky to have had a mentor like David.

I’m finishing Edgar Wachenheim’s book, “Common Stocks & Common Sense.” Wachenheim is not widely known but has produced one of the best value investor track records in the business. His book provides insights into his philosophy, mindset and day-to-day approach to investing using investment examples from his past.

Howard Marks, Marty Whitman and countless others have provided past and ongoing inspiration. Several outstanding podcast series provide exposure to newer managers that might point to the future of value investing.

Columbia Business School is home to the Heilbrunn Center for Graham & Dodd Investing. This program publishes the Graham & Doddsville Newsletter (available for free, which fits with its value investing philosophy). This semi-annual publication includes in-depth interviews with notable value investors including veterans and up-n-comers. The most recent edition, Fall 2023, was just released.

So, now you know a bit more about your chief analyst. But, that is only half of the story. Please share with me your influences, both past and current. Value investing will never go away, but it will continue to evolve. The best way to stay on top of the field is to share what we each find useful and new.

Share prices in the table reflect Monday, December 11 closing prices. Please note that prices in the discussion below are based on mid-day December 11 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.

Send questions and comments to Bruce@CabotWealth.com.

This Week’s Portfolio Changes
Allison Transmission (ALSN) – Moving shares from BUY to HOLD.

Last Week’s Portfolio Changes
CNH Industrial (CNHI) – New BUY on November 30 via Alert.
Comcast Corp (CMCSA) – Moved shares from BUY to HOLD.

Growth/Income Portfolio

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 past the week and have 34% upside to our 66 price target. Based on fiscal 2024 estimates, unadjusted for the Splunk acquisition, the valuation is attractive at 8.9x EV/EBITDA and 12.7x (on July 2024) earnings per share. 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.

Disney has started to integrate Hulu into the Disney+ streaming service, providing another data point that Disney will be buying Comcast’s stake in Hulu.

Comcast shares fell 1% in the past week and have 8% upside to our 46 price target. As the shares are approaching our price target, last week we moved the shares to HOLD.

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 reuniting the global Marlboro franchise.

Philip Morris International (PM) shares dipped on news that competitor British American Tobacco is taking a $31 billion write-off to reflect impairment of its United States cigarette brands. These brands were acquired by BAT in its $49 billion acquisition of Reynolds American, which it made to get access to the United States cigarette market. However, today, U.S. industry cigarette volumes are slipping by 5-8% a year as smokers quit or shift to alternative tobacco products like pouches, heated tobacco and vaping.

These trends have little effect on Philip Morris (PMI) and to the extent they do, they are favorable. Almost none of its revenues are produced in the United States, and PMI’s acquisition of Swedish Match and expansion of its IQOS and other non-cigarette products focus on categories that are gaining share. BAT lags PMI severely in these categories, which squeezes BAT’s revenues, profits and cash flows as it chases PMI. While PMI has its own challenges, they are different from BAT’s.

PM shares were unchanged in the past week and have 29% upside to our 120 price target. The shares offer an attractive 5.6% dividend yield. BUY

Buy Low Opportunities Portfolio

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.

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

ALSN shares rose 1% in the past week and have 6% upside to our 59 price target. The shares offer a reasonable 1.7% dividend yield. Given the minimal upside, we are moving shares of Allison Transmission to HOLD.

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 significant company-specific news in the past week.

Aviva shares rose 1% this past week and have 29% 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 7.7% yield. We anticipate a dividend increase for 2024. 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.

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

Over the past week, commodity gold fell 4% to $1,995/ounce. Despite the recent spike, gold prices seem stuck between about $1,800 and $2,000. The 10-year Treasury yield ticked up to 4.28%, up 3 basis points in the week.

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 a 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 U.S. Dollar Index (the dollar and gold usually move in opposite directions) was fractionally higher at 104.22.

The U.S. 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 fell 6% this past week and remain depressed despite gold prices at the top end of the $1,800 - $2,000 range, indicating that investors have no confidence in gold prices and little confidence in the company’s ability to generate higher cash flow. Barrick shares have 63% 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. Investors have lost hope in Citigroup, creating an impressive bargain.

Citi said it would take $1 billion in charges related to its current restructuring program and that the program will be completed by the end of the first quarter.

Citi shares rose 2% in the past week and have 75% upside to our 85 price target. The shares remain attractive as they trade at about 56% of tangible book value of $86.90. The dividend offers investors a 4.4% 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

CNH Industrial (CNHI) – This company is a major producer 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 color on our thesis.

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

CNH’s shares rose 1% in the past week and have 36% upside to our 15 price target. 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 37% stake today.

Major shareholder Blackstone completed another bulk sale of Gates shares last week, offloading 15 million shares and reducing its stake to about 37%. Blackstone will likely continue to exit Gates, and the overhang is a constant weight on the stock. However, Gates’ fundamentals remain unchanged and this is a good opportunity for other investors to add to their positions.

Gates shares fell 7% this past week and have 37% 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.

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

The price of West Texas Intermediate (WTI) crude oil continues to weaken and traded down another 2% to $70.68/barrel. The recent extension of the OPEC+ production cuts aren’t providing much if any support for oil prices, as investors worry that the U.S. economy is slowing, North American oil production has returned to its previous peak and economic growth in China remains slow. The Israel-Hamas conflict has so far had little to no effect on oil prices but recent attacks on a U.S. Navy ship by Houthi rebels may lead to an escalation.

Outcomes in wars are unpredictable. It would seem that the potential for sharp oil price volatility is 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 if Iran became directly or even explicitly indirectly involved (including if the U.S. restores its sanctions). Also, American sanctions on Venezuelan oil may return, which would provide at least modest support for oil prices.

The price of Henry Hub natural gas slid another 11% to $2.37/mmBtu (million BTU). The near-term weather outlook points to warmer-than-expected temperatures while gas storage levels are high.

NOV shares fell 2% in the past week and have 34% upside to our 25 price target. The dividend produces a reasonable 1.1% 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.

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

The shares will likely remain weak or stagnant for the near term. We will wait for a favorable change in investor sentiment but are poised to pull the plug. ST shares rose 2% in the past week and have 68% upside to our recently reduced 57 price target. HOLD

Current price is yesterday’s mid-day price.

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.
CSCO: Estimates are for fiscal years ending in July of 2023 and 2024