June 27, 2024

Editor’s Note: Due to the Fourth of July holiday next Thursday, your July issue of Cabot Value Investor will come out next Friday, July 5. Happy 4^th!

Leveraging cyclicality is a good way to squeeze more profits out of value stocks.

That was an idea put forth by Matt Warder, the newest addition to the Cabot analyst team and the successor to Bruce Kaser in Cabot Value Investor’s “sister” value investing advisory, Cabot Turnaround Letter, on the latest edition of the Street Check podcast I host with my colleague Brad Simmerman.

What did Matt mean by that? (Actually, I think it was Brad who framed the question that way). Matt specializes in cyclical stocks, which are a breeding ground for turnaround stories. And while, as I’ve written several times in this space the last couple months, value stocks have underperformed for more than a decade, there have been periods of great strength along the way.

Take consumer staples, which have made no headway the last two years and have significantly underperformed the S&P the last five years. But from the September 2011 bottom until the July 2016 top, the XLP ETF narrowly edged out the S&P 500, 89% to 88%.

Or take renewable energy stocks, which we discussed earlier this month when we added Canadian Solar (CSIQ) to the portfolio. They’ve literally gone nowhere for the last 12 years. But, from late 2012 to early 2014, they were all the rage, and the WilderHill Clean Energy ETF (PBW) more than doubled. They were even hotter during the post-Covid crash rally in 2020, advancing 454% in 11 months, from the March 2020 bottom to the following February.

Both groups are way undervalued these days. The PBW is at a seven-year low; consumer staples, as measured by XLP, haven’t budged since the start of 2022. Most sectors have been overlooked, if not totally ignored, the last couple years as artificial intelligence and the Magnificent Seven have attracted virtually all of Wall Street’s attention in this high-interest-rate, high-inflation environment. Eventually – perhaps once the Fed starts to finally cut rates from two-decade highs – the AI narrative will run out of steam (even if it’s temporary), and the record $6.4 trillion sitting on the sidelines (or at least in money market funds) will be deployed elsewhere.

Renewable energy and cyclicals like consumer staples may be near the top of the deployment list, given that both are still growing at a healthy clip (solar companies, as I wrote earlier this month, have gotten a major boost since the Inflation Reduction Act was signed in August 2022). While Canadian Solar isn’t exactly off to a rollicking start, we can afford to be patient with it. Meanwhile, certain consumer staples are teeming with growth-at-value-prices opportunities today, and I plan on adding a big name from the group in next week’s issue.

Stay tuned!

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
Worthington Enterprises (WOR) Moves from Buy to Sell

Last Week’s Portfolio Changes
None

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, 40% of book value, and a paltry 0.15x sales. The latter two numbers are the cheapest the stock has ever been.

There was no major news for Canadian Solar this week, though the stock was down another 5% anyway. Clearly, our timing wasn’t perfect on this stock or solar stocks as a group, which are down a whopping 15% in June alone. As mentioned above, the PBW is at a seven-year low, and solar stocks, as measured by the TAN, are bumping up against 52-week lows. With no real reason for the pullback, at some point the tide will turn and solar stocks – CSIQ included – will bounce back. For now, patience is key.

CSIQ shares have a whopping 83% 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.

Things have been quiet on the news front for Honda of late. Mercifully, the stock has stopped falling and was even up slightly since our last issue; hopefully, the 31.30 level it touched about a week ago was a short-term bottom. Year to date, it’s still up 4% and rose as high as 37 in March. I don’t think shares will stay down long. They have 41% upside to our 45 price target. The 4.1% dividend yield helps matters. 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 news for Philip Morris this week. That’s a good thing, following a week in which it got dinged for selling flavored versions of its popular Zyn nicotine pouches in Washington, D.C., where flavored nicotine pouches are banned. The company did the right thing by quickly acknowledging the error and saying it was “predominantly related to certain online sales platforms and some independent retailers.” Online sales were briefly halted. While this could be an ongoing issue in other cities down the road, investors have thus far shrugged off the violation, and PM shares were actually up slightly this week.

Zyn has been the driving force behind Philip Morris’ growth of late. Zyn sales were up 80% in the first quarter and account for 74% of the nicotine pouch market.

PM shares have 18% upside to our 120 price target. The 5.1% dividend yield adds to the appeal. 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 1.74. 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’s been no major news for United lately, though the stock was down 3% to reach a two-month low of 48. A busy summer travel season could help move the needle, however. UAL shares were up 15% in June and July last year, as air travelers returned in droves in a post-Covid world.

The stock has 44% upside to our 70 price target. 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.

Agnico has increased its stake in Maple Gold Mines, acquiring another 33.82 million shares at C$0.085 each, for nearly C$2.87m ($2.1m). That ups Agnico’s stake in Maple Gold Mines to nearly 19.9% on a non-diluted basis, up from a stake of around 11.97%. Agnico Eagle now holds a total of 74,674,257 common shares in Maple Gold Mines.

The increased stake in Maple gives Agnico additional rights, including participating in equity financings to retain its pro rata ownership, the option to acquire up to a 19.9% ownership interest in the company, and to nominate up to one new board member.

The deal didn’t move the needle much on AEM shares, though the stock is up about 1.5% since we last wrote despite a slight drop off in gold prices – a good sign. AEM shares have 15% 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 for Aviva this past week.

AVVIY shares were up slightly this week but have remained in the low to mid-12s since flirting with new highs above 12.7 last month. 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 0.41 and a price-to-book of 1.44. Shares have 15% upside to our 14 price target. The 6.8% 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.

Last month, 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 $27.78 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% since 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 couple weeks. Trading at less than 7x earnings (and just 0.54x sales), CNHI shares have 39% upside to our 14 price target. The 4.7% 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 from last month. 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 down 3% this week and have fallen below 16 support. I’d wait to start new buys until it finds a clear level of support. The stock has 28% upside to our 20 price target. GTES trades at less than 12x earnings, 1.20x sales and 1.29x 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 $81 a barrel after dipping as low as $73 earlier this month. NOV shares have followed suit, advancing nearly 8.5% in the last three weeks. Crude prices being back above $80 for the first time since April could serve as a tailwind for NOV shares going forward.

The stock still has 28% upside to our 24 price target. It trades at just 12.2x forward earnings estimates and 0.85x sales. BUY

Worthington Enterprises (WOR) reported fiscal fourth-quarter 2024 earnings yesterday and they stunk. Net sales were $318.8 million, down from $368.8 million in the fourth quarter a year ago, while continuing operations came in at a net loss of $31.5 million, or -$0.64 per share, well off a net gain of $50.1 million ($1.01 per share) last year.

These results are bad enough, and the performance has been lacking enough since this was added to the portfolio in February, that I don’t see sufficient upside to warrant keeping Worthington in the portfolio any longer. This will open up a spot for our new addition in next week’s issue, as our preferred portfolio size is 10 stocks. SELL

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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