May 9, 2024

What Warren Buffett’s Cash Hoard Means

Warren Buffett doesn’t see any great values in this market. At least that was the gist of the message he delivered in Berkshire Hathaway’s annual shareholder meeting in Omaha last weekend.

When asked why Berkshire’s cash hoard had swelled to $189 billion in the first quarter – up from $167.6 billion at the end of the fourth quarter of 2023 – the Oracle of Omaha replied, “We only swing at pitches we like.” In other words: the world’s foremost value investor doesn’t see many great value stocks right now. Instead, he’s been putting his cash in Treasury bills – investing more every Monday in 3- and 6-month T-bills, which yield roughly 5.4% – and biding his time until he sees an attractive stock investment.

That, in a nutshell, is what’s happening in the stock market these days. Value stocks have been underperforming growth stocks for years, as the Magnificent Seven and, increasingly, artificial intelligence-related plays have driven the S&P 500 to its highest valuation in three years. And yet, as I wrote last week, there’s a record amount of cash ($6.4 trillion worth!) sitting on the sidelines in money market funds … waiting for a good pitch to hit.

High interest rates, and the attractive bond yields that accompany them, are the biggest reason why this rally has been so historically concentrated – the S&P Equal Weight index peaked at the end of 2021; it’s down 9.3% since then – but they aren’t the only reason. As Buffett himself said of his cash hoard last weekend, “We don’t use it now at 5.4%, but we wouldn’t use it if it was at 1%. Don’t tell the Federal Reserve.”

Until valuations come under control, great values are going to be difficult to find. It’s why I’ve tweaked the parameters of what we’re looking for since taking over Cabot Value Investor last month: Instead of pure value stocks, we’re seeking growth at value prices (hence, the Honda Motor (HMC) and United Airlines (UAL) additions thus far). In a growth investor’s market, that’s how value investors can keep pace.

By combining growth and value, we should be able to find a few more fat pitches to swing at.

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.

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This Week’s Portfolio Changes
None

Last Week’s Portfolio Changes
United Airlines (UAL) – New Buy with a 70 price target

Upcoming Earnings Reports
Friday, May 10: Honda Motor Co. (HMC)

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.

Investors are coming around to the bright spots in Comcast’s decidedly mixed earnings from two weeks ago.

Adjusted earnings per share of $1.04 surpassed analyst projections of $0.99, while revenue ($30.06 billion) eked past expectations of $29.81 billion. Year-over-year growth was fairly modest at 0.6% for EPS and 1.2% for revenue.

Broadband internet and cable subscriber numbers continue to bleed, although Comcast’s broadband segment got a boost after raising rates despite losing 65,000 customers during the quarter. It lost 487,000 cable customers. Theme park earnings were also down, at least on an EBITDA basis, with a 3.9% year-over-year decline, mostly due to higher marketing and promotion costs.

The bright spots were Comcast’s wireless segment (21% gain in customers, to 6.9 million total lines); its Peacock streaming service, which was the exclusive home of Oppenheimer, last year’s Best Picture winner at the Oscars and a box office hit. That, combined with the airing of an NFL Wild Card playoff game in January, helped bring in 3 million new Peacock subscribers, raising the total number to 34 million. But at $1.1 billion, it’s roughly 1/30^th of total revenue.

After initial pessimism from investors following the report, it seems Wall Street found some things to like this week, helping CMCSA shares recover about half their post-earnings losses, jumping from 38 to 39 (shares were at 40 prior to earnings). The stock still has 16% upside to our 46 price target. And trading at 9x forward earnings estimates and just 1.3x sales, it’s still a bargain. 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.

There was no company-specific news for Honda ahead of fiscal 2024 fourth-quarter earnings tomorrow (May 10). Analysts are looking for 21% sales growth, but a 13.7% decline in earnings per share. The company, however, has beaten earnings estimates in three of the last four quarters, by an average of 31%. So it’s possible those estimates are overly pessimistic.

As for the stock, HMC shares were almost exactly flat in the last week ahead of the report. They have 33% upside to our 45 price target. BUY

Philip Morris International (PM) – Based in Connecticut, Philip Morris owns the global non-U.S. rights to sell Marlboro cigarettes, the world’s best-selling cigarette brand. Cigarettes comprise about 65% of PMI’s revenues. The balance of its revenues is produced by smoke-free tobacco products. The cigarette franchise produces steady revenues and profits while its smoke-free products are profitable and growing quickly. The upcoming full launch of IQOS products in the United States, a wider launch of the IQOS ILUMA product and the recent $14 billion acquisition of Swedish Match should help drive new growth.

The company is highly profitable, generates strong free cash flow and carries only modestly elevated debt (at about 3.2x EBITDA) which it will whittle lower over the next few years. The share valuation at about 14x EBITDA and 14.3x 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 about 1% in the last week and have advanced nearly 9% in the last month, at a time when the market’s been down, thanks in large part to that promising earnings report, especially the news about Zyn. The stock has 23% upside to our 120 price target. The 5.3% 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 1.89. 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.

There was no company-specific news for United this past week. Nevertheless, UAL shares had a very good debut in the stock’s first week in our portfolio, advancing more than 6%. The stock still has 32% upside to our 70 price target. It’s now up 29% year to date, though it has yet to eclipse its late-April high above 54 following a stellar earnings report. A break above 54 could lead to another extended rally. 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. Gold prices remain elevated at well above $2,300 an ounce, which is acting as a tailwind for all gold miners. Sure enough, AEM shares were up more than 3% this past week and are up 21% year to date.

Agnico also reported strong first-quarter results two weeks ago, 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 13% 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 4% and have recovered a majority 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 0.41 and a price-to-book of 1.45. Shares have 14% upside to our 14 price target. The 6.8% 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.

There was no major company-specific news for Citigroup this week, though the bank reported strong quarterly earnings 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 9.5% since a mid-April bottom at 57, including about 2% this past week. C shares trade at less than 11x earnings and at 1.5x sales. 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.

CNH reported first-quarter earnings last Thursday that beat estimates but were a bit underwhelming. 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.

That decidedly mixed bag resulted in a modest uptick in the share price, which is about 4% higher since the earnings report. Trading at less than 8x earnings (and just 0.65x sales), CNHI shares have 19% upside to our 14 price target. And the 4% 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 past week on the heels of reporting mixed earnings results the previous week.

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 bounced back slightly this past week. It’s important to note that prior to the report, GTES was trading near 52-week highs.

GTES shares have 20% upside to our 20 price target. They trade at less than 12x earnings estimates and at 1.26x sales, so they remain undervalued by traditional measures. 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 up 4% this past week but still have 26% upside to our 24 price target. 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 were up 1.7% but have been bouncing around in the 57 to 60 range for the past month. They remain cheap at less than 12x forward earnings and just 0.61x sales. WOR has 25% upside to our 73 price target. BUY

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.

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