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Value Investor
Wealth Building Opportunites for the Active Value Investor

March 19, 2024

The financial media over the past weekend and in the early days of this week has been full of stories about the upcoming Fed meeting on Wednesday. It’s remarkable how much ink (or electrons) is being spilled in efforts to predict what the Fed will do, and why, along with all of the implications of this or that outcome.

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Yogi Berra on the Fed’s Decision on Wednesday

The financial media over the past weekend and in the early days of this week has been full of stories about the upcoming Fed meeting on Wednesday. It’s remarkable how much ink (or electrons) is being spilled in efforts to predict what the Fed will do, and why, along with all of the implications of this or that outcome.

We’re forever amazed at how badly the economists and prognosticators get macro wrong. Late last year, the consensus was certain that the Fed would cut interest rates seven or eight times in 2024. Today, the consensus is certain that there will be three cuts. We wouldn’t be surprised if the Fed cuts rates zero times this year… or maybe one cut after the election. Perhaps the only certainty is that economic forecasters will get things wrong.

One recurring source of error is that forecasters seem to assume that the economy changes quickly. That, in effect, if a recession is anywhere in the foreseeable future, and if the Fed is likely to eventually cut rates at some point any time in that future, then the Fed will start making those cuts immediately. This assumption about the speed of change is wrong.

Economic conditions usually change slowly, measured in multiple quarters or perhaps years, not months. Our economy is resilient – especially when the federal government infuses vast amounts of cash directly into the pockets of consumers and businesses. This makes the arrival of a typical recession a slow and grinding process. As such, recession predicting has been an outstanding tarnish-producer for the reputation of impatient economists.

Extra-strength tarnish has come from economists’ completely missing the only two recessions our country has had in the past 20 years: during the 2008-2009 global financial crisis and then in the midst of the 2020 pandemic. These forecasting omissions have come despite the rapid-onset nature of these downturns that economists seem to always anticipate.

Another error is the assumption that the Fed will respond immediately to any perceived changes in the economic outlook. This error is a misunderstanding of the nature of the Fed. The Fed is a political organization – not in the Democrat or Republican sense, but in the sense that it is run by humans who want to maintain their personal reputations and the reputation of their organization. So, the folks who run the Fed want to be seen as prudent, which means no rash moves or moves that could be perceived as partisan.

The Fed isn’t always right – sometimes it makes huge blunders. But it always wants to be seen as making defensible moves. So, slower is better, unless there is a catalyst-driven emergency like a crisis.

Our view on the Fed’s decision on Wednesday? We’ll quote baseball legend Yogi Berra, who said, “It has a 50-50 chance of going one way or the other.”

Share prices in the table and discussion below reflect Monday, March 18 closing prices. Please note that prices in the discussion below are based on mid-day March 18 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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This Week’s Portfolio Changes
Gates Industrial (GTES) – Raising price target from 16 to 20.

Last Week’s Portfolio Changes

Upcoming Earnings Reports
Thursday, March 21: Worthington Enterprises (WOR)

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. Its announced deal for Splunk will drain most of its cash hoard but we see this as being replenished relatively quickly.

Cisco completed its $28 billion all-cash acquisition of Splunk, effective pre-market open this past Monday. Splunk shares no longer trade. Our initial view on this deal is mixed, but with the closing, we anticipate more information about the combined company’s prospects in the coming weeks and months, notably from Cisco’s third-quarter earnings report on May 15. For now, we will rely on our model which shows reasonable enough upside to keep the shares.

CSCO shares ticked down 1% in the past week and have 33% upside to our 66 price target. Based on 2024 estimates, unadjusted for the Splunk acquisition, the valuation is reasonably attractive at 9.5x EV/EBITDA and 13.2x 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.

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

Comcast shares slipped 1% in the past week and have 6% upside to our 46 price target. 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 re-uniting the global Marlboro franchise.

The company announced the launch of its IQOS ILUMA products in Japan, which opens a potentially sizeable opportunity for smoke-free tobacco products.

PMI’s shares were flat in the past week and have 27% upside to our 120 price target. The shares offer an attractive 5.5% dividend yield. BUY

Buy Low Opportunities Portfolio

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.

On Thursday, March 7, Aviva reported full-year results, with adjusted operating profits of £1.5 billion rising 9%. Operating earnings of £0.40/share rose 1% and were 11% above estimates. Net insurance revenues rose 8.5%. Claims costs rose 7% but were smaller as a percent of revenues. Corporate costs fell 1%. The return on equity was 14.7%. Aviva’s full-year dividend was set at £0.334/share, in line with our estimate. Cash flow and capital look healthy. All in, Aviva continues to produce solid results.

The company set a 2026 operating profit target of £2 billion, about 36% above the 2023 results. For 2024, the company said it would raise the dividend by about 5%. Also, share buybacks will continue with a new £300 million program now underway. Aviva’s share count fell 2% last year – this new buyback program would reduce it by another 2%.

Aviva’s strategic and operational turnaround is largely complete, and we are waiting for a higher valuation multiple. From here, the leadership is working to produce steady and repeatable if dull revenue, profit, capital and dividend growth, along with repurchasing a steady 2% or so of its shares each year. Over time, this consistency should help the shares grind higher to our $14 price target, currently only about 16% away.

This past week, Aviva announced that it has completed the sale of its 26% stake in Singapore Life Holdings for $1.2 billion. Part of the proceeds will help fund Aviva’s share buyback program.

Aviva shares rose 2% in the past week and have 14% upside to our 14 price target. Based on management’s guidance for the 2024 full-year dividend, the shares offer a generous and sustainable 7.3% yield. On a combined basis, the dividends and buybacks offer 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.

Over the past week, commodity gold slipped 1% to $2,163/ounce. Gold is holding its $2,000+ pricing despite what is increasingly becoming a higher-for-longer U.S. interest rate environment.

Gold’s new, higher range may be driven by enduring domestic and international government fiscal deficits as well as from enduring inflation. Also, reasonably reliable official data indicates that central banks, particularly China’s, are stepping up their gold purchases.

There may be a correlation trade among hedge funds that links gold and Bitcoin. Bitcoin is surging as demand has been remarkably strong for newly approved Bitcoin ETFs. Most previous institutional holdouts, including BlackRock, have become supporters of Bitcoin. The correlation trade would carry gold upward with Bitcoin prices.

Our view on gold prices is based on what we believe is a structural upshift in inflation. These changes include 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. There is a reasonably good chance that inflation will remain above a 3% pace indefinitely. This would imply permanent 4-6% interest rates.

The 10-year Treasury yield jumped to 4.33%, following a wild round-trip ride which took the yield from 4.30% in late February to 4.08% in early March to the current 4.33% level. The U.S. Dollar Index (the dollar and gold usually move in opposite directions) ticked fractionally higher to 103.50.

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.

For investors concerned about Barrick’s production and cost issues, as well as its expropriation risk from cash-hungry governments in Africa and elsewhere, we would offer Agnico Eagle Mines Ltd (AEM) as an alternative. Agnico is a large-cap, top-quality mining company based in Toronto, led by highly reputable executives with a track record of delivering on their guidance. The company’s mines are located only in the law-respecting countries of Canada, Finland, Australia and Mexico. Agnico has a fortress balance sheet and generates excess free cash flow. Our only quibble with the shares is that their valuation, at 8.4x EBITDA, requires investors to pay a 25% premium relative to Barrick’s 6.7x multiple. However, Agnico’s shares may earn this premium given Barrick’s inconsistent financial and operating results.

Barrick shares ticked down 1% in the past week and have 72% upside to our 27 price target. The shares remain depressed despite gold prices trading near $2,200, indicating that investors have no confidence in gold prices and little confidence in the company’s ability to generate higher cash flow. 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.

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

Citi shares rose 1% in the past week and have 46% upside to our 85 price target. The stock remains attractive as it trades at about 67% of tangible book value of $86.19. The dividend offers investors a 3.6% yield. BUY

CNH Industrial (CNHI) This company is a major producer of agriculture (80% of sales) and construction (20% of sales) equipment and is the #2 ag equipment producer in North America (behind Deere). Its shares have slid from their peak and now trade essentially unchanged over the past 20 years. While investors see an average cyclical company at the cusp of a downturn, with a complicated history and share structure, we see a high-quality and financially strong company that is improving its business prospects and is simplifying itself yet whose shares are trading at a highly discounted price. See our November 30 Alert and the December 5 Monthly letter for more 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 23% upside to our 15 price target. The 3.2% dividend yield offers a reasonable interim cash return. 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.

At Gates’ Capital Markets Day presentation, the company raised its near-term guidance, reaffirmed full-year 2024 guidance and provided a generally upbeat longer-term outlook that included reaching an EBITDA margin of 23.5% to 25.5% by 2026 (compared to 20.9% in 2023). Management also highlighted their capital allocation plan to use free cash flow to trim its debt, repurchase shares and pursue worthwhile acquisitions. The company’s healthy guidance and outlook raise our confidence enough to lift our price target to 20.

Gates shares rose 4% in the past week and have 17% upside to our new 20 price target. BUY

NOV, Inc (NOV)This high-quality, mid-cap company, formerly named National Oilwell Varco, builds drilling rigs and produces a wide range of gear, aftermarket parts and related services for efficiently drilling and completing wells, producing oil and natural gas, constructing wind towers and kitting drillships. About 64% of its revenues are generated outside of the United States. Its emphasis on proprietary technologies makes it a leader in both hardware, software and digital innovations, while strong economies of scale in manufacturing and distribution as well as research and development further boost its competitive edge. The company’s large installed base helps stabilize its revenues through recurring sales of replacement parts and related services.

We see the consensus view as overly pessimistic, given the company’s strong position in an industry with improving conditions, backed by capable company leadership and a conservative balance sheet.

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

The price of West Texas Intermediate (WTI) crude oil rose 4% to $81.66/barrel. Demand remains robust while supplies continue to be reasonably plentiful. Several OPEC+ producers led by Saudi Arabia agreed to extend their production cuts through June.

For the moment, the two major hot wars – in Ukraine and in the Middle East – appear to have stopped getting worse. This has eased pressure on oil prices. However, outcomes in wars are unpredictable. Another major step-up in aggression, particularly in the Middle East, could push oil prices higher. If Iran becomes directly involved, oil prices could surge to at least $150/barrel.

The price of Henry Hub natural gas slipped 6% this past week to $1.69/mmBtu (million BTU), below its rough floor at around $2. As the traders’ saying goes, “The cure for low commodity prices is low commodity prices.” As such, producers will likely curtail production, but this is a slow and unsteady process that is unlikely to raise natural gas prices significantly until at least the end of summer. For NOV, the commodity price weakness will incrementally reduce demand for its equipment.

NOV shares rose 4% in the past week and have 34% upside to our 25 price target. The dividend produces a reasonable 1.1% dividend yield. BUY

Worthington Enterprises (WOR)Following the split-up of Worthington Industries late last year, “Enterprises” focuses on producing specialized building products (42% of sales) and consumer products (48%). The value of these operations was previously obscured by the market’s perception that the original Worthington Industries was primarily a steel processor. While the market sees an average company with a mix of only partly related products, we see a high-quality company with strong positions in valuable and profitable niches, backed by capable management and a solid balance sheet.

The company reports third-quarter earnings on Thursday, March 21, pre-market, with a consensus earnings estimate of $0.69/share.

WOR shares rose 2% in the past week and have 15% upside to our 73 price target. The dividend produces a reasonable 1.0% dividend yield. BUY

Growth/Income Portfolio

Stock (Symbol)Date AddedPrice Added3/18/24Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Cisco Systems (CSCO)11/18/2041.3249.3519.40%3.20%66Buy
Comcast Corp (CMCSA)10/26/2231.543.0936.80%2.90%46Hold
Philip Morris International (PM)9/18/2396.9695.36-1.70%5.50%120Buy

Buy Low Opportunities Portfolio

Stock (Symbol)Date AddedPrice Added3/18/24Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Aviva (AVVIY)3/3/2110.7512.2814.20%6.80%14Buy
Barrick Gold (GOLD)3/17/2121.1315.68-25.80%2.60%27Buy
Citigroup (C)11/24/2167.2858.45-13.10%3.60%85Buy
CNH Industrial (CNHI)11/30/2310.7412.415.50%3.20%15Buy
Gates Industrial Corp (GTES)8/31/2210.7217.2861.20%0.00%20Buy
NOV, Inc (NOV)4/25/2318.1918.652.50%1.10%25Buy
Worthington Enterprises (WOR)2/6/2457.1363.9111.90%1.00%73Buy

Current price is yesterday’s mid-day price

CVI Valuation and Earnings

Growth/Income Portfolio

2024 EPS Estimate2025 EPS EstimateChange in 2024 EstimateChange in 2025 EstimateP/E 2024P/E 2025
CSCO 49.49 3.76 3.880.0%0.0% 13.2 12.7
CMCSA 43.29 4.24 4.62-0.3%-0.2% 10.2 9.4
PM 94.66 6.40 7.030.0%0.0% 14.8 13.5

Buy Low Opportunities Portfolio

2024 EPS Estimate2025 EPS EstimateChange in 2024 EstimateChange in 2025 EstimateP/E 2024P/E 2025
AVVIY 12.29 0.44 0.50-1.1%1.0% 27.8 24.4
GOLD 15.69 0.95 1.110.3%-0.5% 16.6 14.2
C 58.12 5.93 7.120.0%0.1% 9.8 8.2
CNHI 12.24 1.55 1.60-0.1%0.8% 7.9 7.7
GTES 17.07 1.41 1.641.5%2.2% 12.1 10.4
NOV 18.65 1.51 1.84-0.1%-0.1% 12.3 10.1
WOR 63.30 3.47 3.560.0%0.0% 18.2 17.8

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.

Current price is yesterday’s mid-day price.
CSCO: Earnings estimates are for calendar years.

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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.