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Value Investor
Wealth Building Opportunites for the Active Value Investor

October 24, 2023

The S&P 500 index, of course, is the most widely used benchmark for stock market returns. Individual investors, financial media and those overseeing complicated institutional portfolios use this metric as their core measure of absolute and relative performance.

Professional investment consultants may take umbrage with this statement. These highly trained analysts are well-versed in the intricacies of quantitative analysis and can parse portfolio returns, relative to potentially hundreds of alternative benchmarks, into dozens of marginally relevant categories down to the 8th decimal place.

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The S&P 500 – The Real Benchmark for Stocks

The S&P 500 index, of course, is the most widely used benchmark for stock market returns. Individual investors, financial media and those overseeing complicated institutional portfolios use this metric as their core measure of absolute and relative performance.

Professional investment consultants may take umbrage with this statement. These highly trained analysts are well-versed in the intricacies of quantitative analysis and can parse portfolio returns, relative to potentially hundreds of alternative benchmarks, into dozens of marginally relevant categories down to the 8th decimal place.

Nevertheless, these consultants report to pension boards which generally are comprised of people less interested in minutiae and are rather more focused on the big picture. Outperformance by fund managers against their respective benchmarks has appeal, for sure, but those benchmarks are invariably compared to the S&P 500. Chronically weak benchmarks get “allocated out” of pension and endowment funds. Many trendy and revered private equity managers will likely find that they succumb to this process.

Fiscal year returns for Ivy League endowment funds are making the rounds. So far, they are unimpressive. The top performer was Columbia University, with a 4.7% return during the year ended June 30, 2023. Harvard University’s endowment produced a 2.9% return. Watchers will see that this severely lags the 18.5% gain in the S&P 500 over that time. While Harvard points to its -1.8% return a year ago, when markets were noticeably weaker, the two-year return still lags the S&P 500 by about 2 percentage points. Like most Ivys, Harvard is loaded with private equity (39% weight) and other alternative assets. Public stocks comprise a small 11% of total assets.

We anticipate that this allocation to alternative assets will slip in coming years. Lackluster returns will push consultants to follow the trends set by better returning investment classes and a move to fixed-income investments. Perhaps we will finally see a stronger move back into publicly traded stocks, boosting the returns of the true benchmark, the S&P 500.

Share prices in the table reflect Monday, October 23 closing prices. Please note that prices in the discussion below are based on mid-day October 23 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

Last Week’s Portfolio Changes

Upcoming Earnings Reports
Wednesday, October 25: Allison Transmission (ALSN)
Thursday, October 26: Comcast (CMCSA)
Friday, October 27: NOV, Inc (NOV)
Tuesday, October 31: Sensata Technologies (ST)

Growth/Income Portfolio

Cisco Systems (CSCO) is facing revenue pressure as customers migrate to the cloud and thus need less of Cisco’s equipment and one-stop-shop services. Cisco’s prospects are starting to improve under a relatively new CEO, who is shifting Cisco toward a software and subscription model and is rolling out new products, helped by its strong reputation and entrenched position within its customers’ infrastructure. The company is highly profitable and generates vast cash flow (which it returns to shareholders through dividends and buybacks). Its announced deal for Splunk will drain most of its cash hoard but we see this as being replenished relatively quickly.

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

CSCO shares slipped 3% in the week and have 25% upside to our 66 price target. Based on fiscal 2024 estimates, unadjusted for the Splunk acquisition, the valuation is attractive at 9.4x EV/EBITDA and 12.4x earnings per share. BUY

Comcast Corporation (CMCSA) With $120 billion in revenues, 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 as worry 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 reports earnings on Thursday, with a consensus estimate of $0.95/share.

Comcast shares fell 3% in the past week and have 7% upside to our 46 price target. For now, we are keeping our Hold rating. The shares aren’t particularly cheap, but the fundamentals continue to remain sturdy. HOLD

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

The company is highly profitable, generates strong free cash flow and carries only modestly elevated debt (at about 3.2x EBITDA) which it will whittle lower over the next few years. The share valuation at about 13.5x EBITDA and 15.6x per-share earnings is too low in our view. Primary risks include an acceleration of volume declines and/or deteriorating pricing, higher excise taxes, new regulatory or legal issues, slowing adoption of its new products, and higher marketing costs. A strong U.S. dollar will weigh on reported results. While unlikely, Philip Morris could acquire Altria, thus reuniting the global Marlboro franchise.

Philip Morris reported a reasonably decent quarter, incrementally raised its full-year 2023 volume and profit guidance and expressed confidence in its 2024-2026 outlook. However, IQOS volumes were incrementally disappointing, and management indicated that full-year IQOS volumes would be in the lower half of the guidance range. No change to our Buy rating.

In the quarter, revenues rose 14% but were fractionally below the consensus estimates. Adjusted earnings of $1.67/share rose 20% from a year ago and were 4% above estimates.

Revenue growth was +9% after factoring in currency changes and acquisitions. Total volumes rose 2%, led by heated tobacco units (non-combustibles, which is IQOS), up 18% and oral tobacco products, up 19% after scrubbing out the effect of acquisitions. Total volumes were weighed down by the -0.5% decline in cigarette volumes. The company’s cigarette and heated tobacco unit market shares increased in the quarter.

The cigarette business remains solid, with 9% higher prices more than offsetting the weak volumes, leading to a 6% lift in cigarette revenues. Philip Morris’ brands continue to improve their market shares after some fall-off in 2020-2021.

Management’s full-year guidance range for heated tobacco unit volumes is 125-130 billion units but are now guided toward the lower half of this range due to a number of temporary issues. Investors worried about this incremental disappointment but seem to have missed the strong growth these products are generating. At the low end, 2023 volumes would be 16% above year-ago volumes, an acceleration from the 2022 pace. Nevertheless, HTU volumes are a key component of the Philip Morris story. We anticipate renewed strength next year. The revenue and margin accretion from the Swedish Match deal is indicating that this acquisition is on track to be impressively successful.

The gross margin expanded to 65.4% while the adjusted operating margin narrowed on higher marketing and other costs. Adjusted operating income rose 11% after removing the effect of acquisitions and currency.

PM shares ticked down 2% in the past week and have 32% upside to our 120 price target. The shares offer an attractive 5.7% dividend yield. BUY

Buy Low Opportunities Portfolio

Allison Transmission Holdings, Inc. (ALSN) Allison Transmission is a midcap manufacturer of vehicle transmissions. While many investors view this company as a low-margin producer of car and light truck transmissions that is destined for obscurity in an electric vehicle world, Allison actually produces no car or light truck transmissions. Rather, it focuses on the school bus and Class 6-8 heavy-duty truck categories, where it holds an 80% market share. Its EBITDA margin is sharply higher than its competitors and on par with many specialty manufacturers. And, it is a leading producer and innovator in electric axles which all electric trucks will require. The company generates considerable free cash flow and has a low-debt balance sheet. Its capable leadership team keeps its shareholders in mind, as the company has reduced its share count by 38% in the past five years.

Allison reports earnings on Wednesday, with the consensus estimate of $1.70/share.

ALSN shares slipped 3% in the past week and remain near our recently raised 59 price target. The shares offer a reasonable 1.6% dividend yield. We are keeping our Hold rating for now, given the acceptable valuation combined with the strong management and company fundamentals. HOLD

Aviva, plc (AVVIY), based in London, is a major European company specializing in life insurance, savings and investment management products. Amanda Blanc, hired as CEO in July 2020, is revitalizing Aviva’s core U.K., Ireland and Canada operations following her divestiture of other global businesses. The company now has excess capital which it is returning to shareholders as likely hefty dividends following a sizeable share repurchase program. We expect that activist investor Cevian Capital, which holds a 5.2% stake, will keep pressuring the company to maintain shareholder-friendly actions.

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

Aviva shares fell 3% this past week and have 42% upside to our 14 price target. Based on management’s guidance for the 2023 dividend, which we believe is a sustainable base level, the shares offer a generous 8.0% yield. On a combined basis, the dividend and buybacks offer more than a 10% “shareholder yield” to investors. BUY

Barrick Gold (GOLD), based in Toronto, is one of the world’s largest and highest-quality gold mining companies. About 50% of its production comes from North America, with the balance from Africa/Middle East (32%) and Latin America/Asia Pacific (18%). Barrick will continue to improve its operating performance (led by its highly capable CEO), generate strong free cash flow at current gold prices, and return much of that free cash flow to investors while making minor but sensible acquisitions. Also, Barrick shares offer optionality – if the unusual economic and fiscal conditions drive up the price of gold, Barrick’s shares will rise with it. Given their attractive valuation, the shares don’t need this second (optionality) point to work – it offers extra upside. Barrick’s balance sheet has nearly zero debt net of cash. Major risks include the possibility of a decline in gold prices, production problems at its mines, a major acquisition and/or an expropriation of one or more of its mines.

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

Over the past week, commodity gold ticked up 3% to $1,988/ounce. Gold prices seem stuck between about $1,800 and $2,000. Until the price shifts meaningfully outside of this range, in one direction or another, we consider most of the movements to be noise. The 10-year Treasury yield jumped to 4.88% after ticking above 5.00%.

The structural forces behind inflation may be permanent – war, government spending, crime, oil prices and past-the-peak fading of the benefits of global free trade, in addition to a tight labor market – which could keep inflation at the 3-5% pace indefinitely. Permanent inflation would imply permanent 4-6% interest rates. We see this as a reasonably acceptable normal, which is more in line with history than the 0-3% rates of the past decade. The market has yet to fully digest this new normal.

The U.S. Dollar Index (the dollar and gold usually move in opposite directions) slipped to 105.84. Rising yields and relative safety are maintaining demand for the dollar. The U.S. Dollar Index reached a peak of 119 in early 2001, a price that is around 10% above the current level. The world is a very different place than it was in the pre-9/11 era, so we have no way to effectively compare conditions across this time span. However, today, we see global capital moving to the safety of U.S. dollar assets relative to most other developed nation currencies. Gold may be seen as a lesser source of safety, partly due to its illiquidity.

Investors and commentators offer a wide range of outlooks for the economy, interest rates and inflation. We have our views but hold these as more of a general framework than a high-conviction posture. Investing in gold-related equities is a long-term decision – investors shouldn’t allow near-term weakness to deter their resolve.

Barrick shares rose 7% this past week and have 60% upside to our 27 price target. BUY

Citigroup (C) Citi is one of the world’s largest banks, with over $2.4 trillion in assets. The bank’s weak compliance and risk-management culture led to Citi’s disastrous and humiliating experience in the 2009 global financial crisis, which required an enormous government bailout. The successor CEO, Michael Corbat, navigated the bank through the post-crisis period to a position of reasonable stability. Unfinished, though, is the project to restore Citi to a highly profitable banking company, which is the task of new CEO Jane Fraser.

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

Citi reported a reasonably decent quarter. In its two core businesses (Institutional Client Group and Personal Banking/Wealth Mgt), revenues rose 11% and profits rose 10%. Overall credit costs are rising but remain low and are backed by strong reserves. Deposits ticked lower but remain a minor issue. Non-core results were mixed. Capital is strong with CET1 at 13.5%. Citi remains burdened by excessive regulatory and other costs as well as unproductive capital. The return on equity of 7.7% is about half what it should be, implying that the bank either needs to double its earnings or cut its capital base in half. We believe that a combination of both efforts, driven by new and aggressive efficiency improvements and the eventual divestiture of non-core assets will move Citi close enough to a 15% ROE, but this will take yet more time, likely measured in years. Citi’s full-year guidance was uninspiring but not disappointing. The shares trade at less than half of tangible book value of $86.90/share. No change to our Buy rating.

Citi shares fell 4% in the past week and have over 100% upside to our 85 price target. The shares remain attractive as they trade at 45% of tangible book value of $86.90. The recently raised $0.53 quarterly dividend looks sustainable and offers investors a 5.4% yield.

When comparing Citi shares with a U.S. 10-year Treasury bond, Citi offers a higher yield and considerably more upside price potential. Clearly, the Citi share price and dividend payout carry considerably more risk than the Treasury bond, but at the current valuation Citi shares would seem to have a remarkably better risk/return trade-off. BUY

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 43% stake today.

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

Gates shares were flat this past week and have 43% upside to our 16 price target. BUY

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

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

NOV reports earnings on Friday, with a consensus estimate of $0.34/share.

The price of West Texas Intermediate (WTI) crude oil ticked up to $87.27/barrel. Oil prices appear to be quiet and largely unmoved by the Israel-Gaza conflict, but the potential for sharp volatility seems higher with the increasingly complicated game of shifting geopolitical and economic alignments. A major new catalyst, in addition to all of the others, would be export or production cuts from the Middle East should Iran become directly or even explicitly indirectly involved (including if the U.S. restores its sanctions).

The price of Henry Hub natural gas slipped 7% to $2.95/mmBtu (million BTU). Prices had been strong on worries about low storage volumes headed into the winter, as well as the shutting of Israeli offshore gas fields.

NOV shares fell 4% in the past week and have 26% upside to our 25 price target. The dividend produces a reasonable 1.0% dividend yield. BUY

Sensata Technologies (ST) is a $3.8 billion (revenues) producer of nearly 47,000 highly engineered sensors used by automotive (60% of revenues), heavy vehicle, industrial and aerospace customers. About two-thirds of its revenues are generated outside of the United States, with China producing about 21%. Investors undervalue Sensata’s durable franchise. Its sensors are typically critical components that generally produce high profit margins. As the sensors’ reliability is vital to safety and performance, customers are reluctant to switch to another supplier that may have lower prices but also lower or unproven quality. Sensata has an arguably under-leveraged balance sheet and generates healthy free cash flow. The relatively new CEO will likely continue to expand the company’s growth potential through acquisitions. Electric vehicles are an opportunity as they expand Sensata’s reachable market. Our Sensata investment remains an underperforming (from a business fundamentals perspective) work in progress.

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

ST shares fell 6% in the past week and have 62% upside to our recently reduced 57 price target. BUY

Growth/Income Portfolio

Stock (Symbol)Date AddedPrice Added10/23/23Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Cisco Systems (CSCO)11/18/2041.3252.527.10%3.00%66Buy
Comcast Corp (CMCSA)10/26/2231.543.0836.80%2.70%46Hold
Philip Morris International (PM)9/18/2396.7991.29-5.70%5.70%120Buy

Buy Low Opportunities Portfolio

Stock (Symbol)Date AddedPrice Added10/23/23Capital Gain/LossCurrent Dividend YieldPrice TargetRating
Allison Transmission Hldgs (ALSN)2/22/2239.9957.243.00%1.60%59Hold
Aviva (AVVIY)3/3/2110.759.93-7.60%8.10%14Buy
Barrick Gold (GOLD)3/17/2121.1316.59-21.50%2.40%27Buy
Citigroup (C)11/23/2168.139.17-42.50%5.40%85Buy
Gates Industrial Corp (GTES)8/31/2210.7111.164.20%0.00%16Buy
NOV, Inc (NOV)4/25/2318.819.815.40%1.00%25Buy
Sensata Technologies (ST)2/17/2158.5735.12-40.00%1.40%57Buy

Current price is yesterday’s mid-day price.

CVI Valuation and Earnings

Growth/Income Portfolio

2023 EPS
2024 EPS
Change in 2023 EstimateChange in 2024 EstimateP/E 2023P/E 2024
CSCO 52.61 4.06 4.24-0.1%0.0% 13.0 12.4
CMCSA 43.11 3.79 4.200.0%0.0% 11.4 10.3
PM 91.02 6.13 6.590.2%-0.4% 14.9 13.8

Buy Low Opportunities Portfolio

Current price2023 EPS Estimate2024 EPS EstimateChange in 2023 EstimateChange in 2024 EstimateP/E 2023P/E 2024
ALSN 57.36 7.01 7.430.0%0.0% 8.2 7.7
AVVIY 9.89 0.38 0.46-1.6%0.2% 26.0 21.7
GOLD 16.85 0.85 1.12-0.4%-0.4% 19.9 15.0
C 39.27 5.94 5.880.0%0.0% 6.6 6.7
GTES 11.16 1.20 1.35-0.1%0.6% 9.3 8.3
NOV 19.78 1.48 1.770.4%0.1% 13.4 11.2
ST 35.28 3.74 4.180.2%0.0% 9.4 8.4

Strong Buy – This stock offers an unusually favorable risk/reward trade-off, often one that has been rated as a Buy yet the market has sold aggressively for temporary reasons. We recommend adding to existing positions.

Buy – This stock is worth buying.
Hold – The shares are worth keeping but the risk/return trade-off is not favorable enough for more buying nor unfavorable enough to warrant selling.
Sell – This stock is approaching or has reached our price target, its value has become permanently impaired or changes in its risk or other traits warrant a sale.

Note for stock table: For stocks rated Sell, the current price is the sell date price.

Current price is yesterday’s mid-day price.
CSCO: Estimates are for fiscal years ending in July of 2023 and 2024

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.