May 23, 2024

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Be a Delta, Not a Wormer

“Markets are never wrong, only opinions are.” – Jesse Livermore

Few quotes related to investing have stuck with me more than that one.

Jesse Livermore, of course, is an investment legend who, in the early 20^th century, pioneered day trading and who was the basis of the best-selling Edwin Lefevre book, Reminiscences of a Stock Operator – considered by many to be the investing Bible. Many of his words are relevant to today’s market, nearly 85 years after his death. And I think the above quote is as evergreen as any and is important to remember in bull markets like this one.

No one knows where stocks are headed next. Not today, not in a week, not in a month, not in a year. We often make educated guesses about where stocks might head next – though as we often say here at Cabot, our “crystal ball is in the shop” – but in the end, they’re just guesses – opinions. And opinions, as Livermore aptly noted, are often wrong. The market never is.

At times, I feel many of my fellow investment gurus/pundits/experts would do well to remember that. And that especially goes for the value investing experts.

It seems every time there’s a bull market, and share prices are “overextended” according to certain valuation metrics (several of which I outlined in this space a week ago), every dyed-in-the-wool value stock expert turns into Dean Wormer railing against those rule-breaking rapscallions from Delta house in the movie Animal House.

“They can’t do that!” these fun-killing party poopers often rant. “Stocks are WAY too overvalued at these prices. They’re due for a major comeuppance!”

I’ve heard some version of that opinion dozens of times in my 13 years in the investment business. And those opinions are almost always wrong, at least in the short term.

Sure, the market never goes up in a straight line, so eventually the Wormers are right, the same way a broken clock is still right twice a day. But think of all the profits people miss out on – again, value investors in particular – from sitting on the sidelines, shaking in their boots out of fear of a market pullback that could happen.

I prefer to strike while the iron is hot and invest where the market winds are blowing. And right now, the market is at all-time highs, and traditional growth stocks – i.e., the tech stocks and other upstarts that populate the Nasdaq, up nearly 12% year to date – are thriving. In fact, growth stocks have been outpacing value stocks for the last decade, 13.2% to 7.8%, on an annualized basis, as detailed by my colleague Brad Simmerman in a column on our website yesterday. Along the way, certain value investors have scolded growth stocks for having the audacity to keep rising well beyond what their valuations suggest they should – like Dean Wormer tut-tutting a Delta pledge for being “fat, drunk and stupid.”

Sometimes, stocks act like fat, drunk and stupid frat boys, behaving unreasonably and debaucherously, and partying longer than they “should.” But investors don’t make money on woulds and shoulds; they profit from what actually happens. Thus, no amount of scolding is worth a fig if the market just keeps rising, callously ignoring all the opinions that it “should” pull back.

To quote another investing legend, my old boss Tim Lutts, Cabot’s version of Jesse Livermore: “Trends on Wall Street last longer than anyone expects.” Yes, the trend toward growth stocks has lasted longer than anyone expected, more than a decade now. If you’ve been holding out for better values, you’ve mostly missed out.

Let’s not make the mistake of holding out for better values. We will continue to go with the market’s tide, searching for growth at value prices. The market may be fat and drunk, but let’s not be stupid.

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
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Last Week’s Portfolio Changes
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Upcoming Earnings Reports
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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.

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.

Comcast is fast-tracking its new streaming bundle. The just-announced package of Netflix, Apple TV+ and its own Peacock streaming service will launch next week at a price point of $15 a month, saving people about 35% from subscribing to all three individually. The new bundle, called StreamSaver, will be available only to Comcast internet and/or TV subscribers and could make those services more attractive and perhaps help reverse the bleeding at a time of rampant cord-cutting – or at least put a tourniquet on it. Wall Street seems skeptical thus far, however, as shares have scarcely budged since the announcement. In fact, they’re only a dollar above 2024 lows.

Overall, CMCSA shares have been a solid performer for us, advancing more than 23% in two and a half years, plus a 3.2% dividend yield. But it hasn’t made any progress in the last two years. So, it’s the only Hold in our portfolio and will remain there until we see real progress in the share price. The valuation is good – it trades at a mere 9x forward earnings and 1.3x sales – but a perennially low valuation doesn’t mean much if the stock isn’t performing, sort of the inverse of what I wrote in the opening.

If we don’t see progress soon with Comcast, especially after its StreamSaver bundle launches next week, we may cut bait and pocket the respectable profits. For now, we’ll Hold. But a dip below the April lows in the high 37s would surely be the last straw. HOLD

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.

Honda reported another strong, hybrid-growth-fueled quarter two weeks ago, but so far the stock doesn’t have much to show for it – a common theme this earnings season. Thanks in part to a weak yen, the Japanese automaker saw a 77% increase in its operating profits in the most recent quarter, on a 21% improvement in sales. Hybrid sales were the real star, helping Honda sell 3 million cars globally, up from 2.3 million in the same quarter a year ago.

“Hybrids are our weapon,” CEO Toshihiro Mibe said.

So the company is leaning into deploying its new “weapon,” with plans to produce 2 million hybrids by 2030; an $11 billion investment in a new EV and EV battery plant in Canada should help both with hybrids and electric vehicles – an area in which Honda continues to lag behind other major automakers (the Honda Prologue is the only fully electric vehicle it sells in the U.S.). Meanwhile, the company is using its excess profits to ramp up stock buybacks. Add it all up, and there’s a lot to be encouraged about, and I believe investors will soon catch on, even if they haven’t done so since the report.

HMC shares are down 2% since our last update and have 35% upside to our 45 price target. They remain dirt-cheap, trading at less than 8x earnings and just 0.42x sales. 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 14.6x EBITDA and 16.1x per-share earnings estimates is too low in our view. Primary risks include an acceleration of volume declines and/or deteriorating pricing, higher excise taxes, new regulatory or legal issues, slowing adoption of its new products, and higher marketing costs. A strong U.S. dollar will weigh on reported results. While unlikely, Philip Morris could acquire Altria, thus reuniting the global Marlboro franchise.

There was no company-specific news for Philip Morris this week.

The company is coming off an encouraging earnings report in late April. Adjusted EPS of $1.50 outpaced analyst estimates of $1.41 per share, while revenues improved 11% year over year. There was a clear driver behind the sales growth: Zyn. That’s the company’s nicotine pouch; it sold 131.6 million cans of Zyn in Q1, a whopping 80% improvement from the first quarter a year ago. Zyn’s share of the nicotine pouch market is now up to 74%. Another contributor to Philip Morris’ strong quarter was its heated tobacco device IQOS, which is expected to launch in the U.S. in the second quarter. Global shipments of IQOS units grew by 21% to 33.1 billion in the quarter.

PM shares are up marginally in the last week and have advanced nearly 8% in the last month, outperforming the market thanks in large part to that promising earnings report, especially the news about Zyn. The stock has 19% upside to our 120 price target. The 5.2% dividend yield adds to the appeal. BUY

United Airlines (UAL) – People are flying 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 cheap. It trades at a mere 5x forward earnings estimates, with a price-to-sales ratio of just 0.32 and a price-to-book value of 1.90. The stock peaked at 96 a share in November 2018; it’s currently in the low 50s.

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.

As a company, United had a very good week. The airline can start adding new routes and planes to its fleet after it says the FAA has completed a review of safety measures taken by the company after several incidents earlier this year, including a wheel detaching from one aircraft, another aircraft veering off the runway, and another having a loose fuselage in mid-flight. Passing the FAA’s safety review helps in two ways: it puts potential passengers at ease about flying United and allows the airline to continue its expansion coming off a record year for sales.

The news prompted one Wall Street analyst, Wolfe Research, to upgrade its rating on UAL shares from “Peer Perform” to “Outperform.”

Despite all that, UAL shares were down 4% since we last wrote, likely because the stock was trading at 2024 highs entering the week. The stock has 33% 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.

We see in Agnico a well-managed company that meets/exceeds its production and cost guidance yet has shares that are noticeably undervalued.

There was no company-specific news for Agnico Eagle Mines this week, though gold prices briefly touched new all-time highs above $2,400 an ounce. That’s been acting as a tailwind for all gold miners, though AEM shares were mostly unchanged this week. Year to date, however, AEM is up 16%.

Agnico reported strong first-quarter results in late April, with revenues up 21% and EPS up 33% year over year with gold prices spiking to all-time highs in the quarter. Both figures handily beat analyst estimates. Also, the gold miner ended the quarter with cash and cash equivalents of $524.6 million, up 55%, while total cash from operating activities reached $783.2 million, up from $649.6 million a year ago.

AEM shares have 9% 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 this past week.

AVVIY shares were up marginally and have now recovered all of their April losses after the stock dipped from 52-week highs around 12.7 to as low as 11.44. But the stock remains cheap, trading at less than 12x earnings estimates, with a price-to-sales ratio of 0.36 and a price-to-book of 1.48. Shares have 10% upside to our 14 price target. The 6.6% dividend yield adds to our strong total return thus far. 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.

The bill has come due for Citigroup to pay for its 2022 “fat-finger” accidental trade of $444 billion that led to a flash crash in European markets. A failure in its trading system led to one of its London traders accidentally creating a basket of $444 billion instead of the $58 million basket he’d intended to sell. U.K. regulators have handed down a $78.4 million fine, which Citigroup is not disputing.

The announcement of the hefty fine weighed on C shares a bit on Wednesday, but they’re still up about 1% since our last issue, extending their recent run. The bank is coming off a strong quarter last month. Revenue came in at $21.1 billion, ahead of $20.4 billion expected. Earnings per share of $1.86 blew away analyst estimates of $1.23. However, EPS was down 27% from last year’s first-quarter tally due to higher expenses and credit costs. Revenue was also down, about 2% year over year, but it was only down compared to a first quarter last year in which the bank sold an overseas business.

The highlight was Citi’s investment banking unit, which saw a 35% revenue bump on the strength of a solid Q1 for the market.

Investors initially sold out of C after the report but have since come around, and the stock is up 13% since a mid-April bottom at 57. C shares trade at less than 11x earnings and at 1.6x sales. They have 32% upside to our 85 price target. 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 commentary on our thesis.

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

Earlier this 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 a bit since the report, getting an initial bump but giving back about 6% this past week as Wall Street struggles to make up its mind about the mixed results. Trading at 7x earnings (and just 0.6x sales), CNHI shares have 26% upside to our 14 price target. And the 4.2% dividend yield helps. 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 earlier this month. The 31-cent EPS 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, though it has bounced back since and was up another 3% this past week. It’s important to note that prior to the report, GTES was trading near 52-week highs.

GTES shares have 14% upside to our 20 price target. They trade at 1.37x sales and 1.47x book value, so they remain undervalued by traditional measures. GTES remains our best-performing stock, with a return of 64% 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 past week.

NOV reported earnings in late April that were fairly mixed. Revenues improved 10% year over year (better than the 7.7% top-line growth that was expected), but EPS declined 5.6%, far less than the 15% shortfall that was estimated. However, with operating profits and adjusted EBITDA improved, the company plans to return more cash to shareholders: $1 billion in share repurchases over the next three years, and a 50% hike in the dividend payout starting this June. The driller currently pays a 30-cent (1.6% yield) annual dividend.

NOV shares were down 2% for the week, as crude oil prices have been stuck at $78 a barrel for virtually the entire month of May. They have 30% upside to our 24 price target. The stock trades at just 12x forward earnings estimates and 0.87x sales. 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.

There was no company-specific news this past week.

WOR shares gave back all of their 3.5% gain from the previous week and have been bouncing around in the 57 to 60 range for the past month-plus. They remain relatively cheap at less than 17x forward earnings and just 0.61x sales. WOR has 27% upside to our 73 price target. BUY

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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