Today’s recommendation is a steel stock! It’s a sector that nobody is excited about, but the value proposition is great, and the stock has just blasted off following an excellent earnings report.
Cabot Stock of the Week 153
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The bull market remains intact, though likely closer to the end than the beginning. But don’t let that worry you much. There’s still plenty of opportunity out there, and if you continue to follow proven rules of investing, you can still do well. In fact, there’s even a possibility that as we get closer to the end of this bull market, there will emerge an industry that everyone is dying to get into—because it seems like a sure winner. If this happens, the profits will be impressive for early buyers—while the losses will come quickly for those who buy at the top. It will be interesting!
Turning to today’s stock, it’s a little-known undervalued stock in the steel industry, where a turnaround is taking place. It’s in Crista Huff’s Cabot Undervalued Stocks Advisor Buy Low Opportunities portfolio. Here are Crista’s latest thoughts.
Schnitzer Steel Industries (SCHN)
Schnitzer Steel Industries (SCHN – yield 3.2%) is one of the largest U.S. scrap metal recycling companies, and a manufacturer of steel products that are used in nonresidential construction. The company also owns over 50 stores that sell used auto parts. Schnitzer is based in Oregon, and exports 60% of its steel products to international destinations, primarily India, Bangladesh and Turkey. (A strengthening U.S. dollar could negatively impact the export business.)
The company has been reporting two business segments: Auto and Metals Recycling (AMR) and Steel Manufacturing (SMB). Beginning in the current fourth quarter (August year-end), Schnitzer will combine SMB with AMR’s Oregon metals recycling operations to form a new business segment, Cascade Steel and Scrap (CSS).
Back in April, as I read an analyst report on Schnitzer, it became apparent that consensus earnings estimates could be extremely inaccurate for SCHN, and that profit growth might be even higher than previously believed. Then on June 15, Schnitzer issued preliminary third-quarter results, putting earnings per share (EPS) in a range of $0.52-$0.56, far above the previous consensus estimate of $0.42. Curiously, the share price did not respond to that bullish news, which is likely attributed to the limited analyst coverage on the stock.
Then this week, Schnitzer reported its best third-quarter and nine-month results in five years, reflecting increases in both revenue and profits. Adjusted EPS of $0.56 came in at the top of the company’s projected EPS range. Revenue was $477 million, far above the $393 million consensus estimate. You can access the webcast of the earnings conference call on the company’s website.
Investors who follow my stock recommendations know that I almost always quote consensus earnings estimates, rather than just one analyst’s estimates. However, there are so few analysts on Wall Street covering SCHN, and their estimates have been so incredibly wrong, that today I’m quoting the numbers from a heavy-hitter on Wall Street. This analyst has been projecting earnings growth that’s far above consensus. (I’m not at liberty to publicize the name of the firm because I do not have legal permission to cite their private research. I don’t want them to close my account!)
The steel industry analyst at this prominent Wall Street investment bank has been increasing his earnings estimates to reflect this year’s surge in profits. Reflecting third-quarter results, he’s now expecting 2017 and 2018 earnings per share (EPS) of $1.29 and $1.54, representing aggressive year-over-year EPS growth of 169% and 19.4%.
My general rule of thumb is that I want to see the price/earnings ratios (P/Es) well below the earnings growth rates. Schnitzer’s corresponding P/Es are 18.3 and 15.3, making the stock quite undervalued.
The company has not increased its dividend since May 2012. Shareholders receive $0.1875 per quarter, currently yielding 3.2%.
The long-term debt-to-capitalization ratio is attractive at 27%, indicating that the company’s cash flow will not be strangled by debt service. Schnitzer reduced its net debt during the quarter from $200 million to $169 million.
Basic industry stocks surged upward after the November 2016 U.S. election, followed by big price corrections in early 2017. I originally added SCHN to the Cabot Undervalued Stocks Advisor’s Buy Low Opportunities Portfolio on January 31, 2017 with a price target of 30, where it last traded in December 2016. The stocks in the Buy Low Opportunities Portfolio meet all my fundamental criteria but have fallen far from their recent highs when I recommend them.
At this point, most steel stocks have begun their rebounds. Now is an optimal time to buy low. Even if SCHN climbs to just 27 and stops there, where it traded in February, that would deliver a 15% capital gain to new investors; and a rebound to 30 would deliver a 27% capital gain, plus dividends.
SCHN is a small-cap stock in a volatile market sector with relatively little analyst coverage. Risk-tolerant investors have an opportunity to earn outsized capital gains with SCHN in the coming months.
That was Crista; this is Tim. The stock’s strength in recent days has been truly encouraging—a real blastoff. It’s possible that the stock might retrace half of this blastoff in recent days—especially if we get a broad market selloff—but I don’t expect it. I think these buyers, like Crista, are looking for a longer run. Keeping it simple, as usual, we’ll record our buy tomorrow.
Schnitzer Steel Industries (SCHN 23)
299 SW Clay Street, Suite 350
Portland, Oregon 97201
503-224-9900
www.schnitzersteel.com
CURRENT RECOMMENDATIONS
One of the challenges of keeping the number of stocks in this portfolio under 20, given that I recommend a new one every week, is that I often sell stocks before I might otherwise do so, especially in the case of stocks with great long-term growth potential. If you’ve read my recent series on forever stocks, you understand the wisdom of holding growth stocks like China Lodging or Tesla (both of which I have accorded Heritage Stock status in this portfolio) or Square in pursuit of compound capital appreciation.
On the other hand, the longer a bull lasts, the more investors begin to feel that holding long-term is a good strategy—perhaps you can recognize that feeling in yourself today—and it’s often good to resist your feelings in investing. In fact, long experience has taught me that a rigorous and disciplined approach to portfolio management, particularly selling growth stocks that aren’t living up to expectations, is the best way to avoid losses and maximize profits, and thus I work hard every month to identify stocks that deserve to be sold. This week, recent recommendation Ulta Beauty (ULTA) gets the axe.
Alliance Data Systems (ADS), originally recommended by Roy Ward in Cabot Benjamin Graham Value Investor, is a data-driven marketing company that works with credit-card issuers and airline loyalty programs. We bought well (near the stock’s May low), and the stock is now well above Roy’s official Maximum Buy Price of 243.55, so our course is clear. We’ll hold until the stock reaches Roy’s Minimum Sell Price of 376.41. HOLD.
Biogen (BIIB), originally recommended by Roy Ward in Cabot Benjamin Graham Value Investor, and added to the portfolio a year ago, went through a painful slump in late May, but has rebounded strongly in recent weeks, thanks in part to the resurgence of biotech stocks. Roy’s Maximum Buy Price is 258.14, so you shouldn’t buy here. We’re holding for his Minimum Sell Price of 351.13. HOLD.
Carnival (CCL), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her Dividend Growth Tier, released its quarterly report last week, posting an earnings decline for the quarter but raising full-year projections—and the stock barely budged. Which means Carnival still has a beautiful chart, trending steadily higher with minor pullbacks along the way. Major forces behind the stock’s advance (aside from the firm’s industry-leading position) are the economic growth of the world—China in particular—and the low price of fuel. If you don’t own it yet, look for a pullback toward the stock’s 50-day moving average (now at 63) to get on board. BUY.
Celgene (CELG), recommended by Roy Ward in Cabot Benjamin Graham Value Investor, is now sitting tight under 134, consolidating the gains of the past few weeks. Roy’s Maximum Buy Price is down at 119.48, so you definitely can’t buy here, but you can hold tight, waiting for his Minimum Sell Price of 177.34. HOLD.
China Lodging Group (HTHT), originally recommended by Paul Goodwin of Cabot Emerging Markets Investor, has rebounded strongly from its pullback to 75, and the volume on the bounce has been excellent! If you don’t own it yet, you can nibble here. As I mentioned above, I’m committed to the long term with HTHT, but such an attitude is not appropriate until you’ve amassed a healthy profit cushion; I like to wait for a profit of at least 100%. BUY.
Facebook (FB), originally recommended by Mike Cintolo in Cabot Growth Investor, hit a record high yesterday and has pulled back slightly since. According to our value guru, Roy Ward, the stock is still a good value, with a Maximum Buy Price of 156.97 and a Minimum Sell Price of 239.18. When I first recommended buying FB, it was because I perceived it to have the potential to be one of the last stocks still climbing as this bull market ends (someday) and I haven’t changed my opinion. Try to buy on pullbacks. BUY.
GameStop (GME), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her High Yield Tier (and also recommended by Crista Huff and Roy Ward), remains a challenge—a non-participant in this bull market. But the promise of the turnaround is still there. In her update this morning, Crista wrote, “The Dallas Business Journal reported that GameStop will sell its game publisher Kongregate for $55 million. GameStop commented, “It allows us to use the proceeds from the acquisition in shareholder friendly ways.” That most likely means that the money will be used for share repurchases.” Also, as the stock has been building a bottom at 20 since November, it appears—unlike today’s hottest stocks—to have minimal downside potential. HOLD.
IntercontinentalExchange (ICE), originally recommended by Roy Ward of Cabot Benjamin Graham Value Investor, is on fire! After a tiny three-day correction following its surge from 58 to 65, it’s off and running again! It’s too high to buy here, so I’m just sitting tight, waiting for the stock to hit Roy’s minimum sell price of 73.63. HOLD.
JD.com (JD), originally recommended by Paul Goodwin of Cabot Emerging Markets Investor, bounced off its 50-day moving average two weeks ago and yesterday hit a new high—which is good. However, the volume clues were mixed; volume was high but not as high as the volume on the breakout in early May. Thus I remain concerned. As I explained last week, JD’s big advance this year means that risk is a bit elevated here—and with both technology stocks and Chinese stocks at risk of major corrections, I’m happy to keep the stock on Hold. HOLD.
Legg Mason (LM), originally recommended by Crista Huff of Cabot Undervalued Stocks Advisor, is now consolidating its recent gains. In her latest update, Crista wrote, “Legg Mason is a very undervalued asset management and financial services company with aggressive earnings growth. The stock is approaching long-term price resistance at 44, where I plan to sell, rather than hold LM through a prolonged period of sideways trading. There is nothing wrong with the stock’s fundamentals, and I will consider buying LM again, either during a market correction, or when it appears ready to begin a new run-up.” HOLD.
Pembina Pipeline (PBA), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her High Yield Tier, has a shallow long-term uptrend that’s interspersed with moderate corrections, often because of energy industry factors. In her latest update, Chloe wrote, “Short-term, energy prices are a headwind, but long-term, growth expectations for Pembina are excellent, and there’s relatively little selling pressure evident (compared to other energy stocks). Risk tolerant high yield investors could buy a little here, or try to wait for a pullback toward 30.” BUY.
Sherwin-Williams (SHW), originally recommended by Mike Cintolo in Cabot Top Ten Trader and featured here last week, looks fine. You can still buy here, though waiting for a pullback could get you in at a lower-risk level—not that risk is high to begin with. BUY.
Square (SQ), originally recommended by Mike Cintolo in Cabot Growth Investor, is changing the world by providing the financial software and hardware that enable increasing numbers of people to run their own businesses—and most investors know that, which is why the stock is up big this year. But what comes next? The stock is now in its third week of base-building at the 24 level, while its 50-day moving average, now above 21, works to catch up. I’ll happily upgrade it to Buy when I see risk reduced. HOLD.
Tesla (TSLA), a recommendation of Cabot Top Ten Trader, closed at a record high last Friday, but volume was lower than at the previous peak and the stock is pulling back normally now. Long-term, I continue to be bullish on both the company and the stock, but I’m going to downgrade it to Hold now because I see more short-term potential on the downside than the upside. Reason one is the chart; the stock is up 74% this year. And reason two is the fundamental picture; expectations are huge for the first deliveries of the Model 3, and I’m guessing that (even though the car will be very good) the stock will sell off when reality arrives. TSLA’s 50-day moving average is at 334, while its 200-day moving average is at 255. HOLD.
Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Growth Investor and featured here last week, did not bounce off its 50-day moving average at 293 as it appeared it would last week. Instead, the stock turned around and sank right through it, hitting a low of 281 yesterday—and now we have a small loss. The stock is almost certain to rebound to at least its 50-day moving average from here, and I recommend that you sell there—or use a tight trailing stop and ask the stock to keep climbing. The momentum is clearly fading here, and I fear that investors are now lumping Ulta in the same basket as other brick and mortar retailers. SELL.
Vertex Pharmaceuticals (VRTX), originally recommended by Crista Huff of Cabot Undervalued Stocks Advisor in her Buy Low Opportunities Portfolio, topped 135 last week and has pulled back minimally this week. In her latest update, Crista wrote, “Vertex is an undervalued, aggressive growth biotech company that corners the market in treatments for cystic fibrosis (CF). The stock is up about 54% since joining the Buy Low Opportunities Portfolio a year ago. I plan to sell VRTX when it approaches two-year price resistance near 140.” HOLD.
VMware (VMW), originally recommended by Roy Ward in Cabot Benjamin Graham Value Investor, bottomed at 86 two weeks ago and is now working its way back toward its June 1 high of 98. Roy’s Maximum Buy Price is 87.79, while his Minimum Sell Price is 113.61. HOLD.
Weibo (WB), originally recommended by Paul Goodwin of Cabot Emerging Markets Investor, sold off sharply last Thursday after the Chinese State Administration of Press, Publication, Radio, Film and Television said the company (and other online media companies) has been operating without the correct license, publishing content that violated government policies and “promoting negative comments.” As Paul told his readers, “this sort of thing has happened to Weibo before along with Baidu, which has been sanctioned for not verifying the claims of medical advertisers. The usual outcome of this kind of government enforcement action is for content providers like Weibo to pledge to purge objectionable content and increase vigilance. This might actually be a buying opportunity, but we will shift … to a Hold rating until we can confirm that investors are sticking with the stock.” Here in Cabot Stock of the Week, I have a quick double-digit loss after three weeks, which was not my goal. However, the stock’s 50-day moving average is right here, offering support at 68. Plus, the bad news is already out, so it’s unlikely to hurt the stock more. I’ll hold tight for now. HOLD.
Wynn Resorts (WYNN), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her Dividend Growth Tier, hit another new high yesterday! In her latest update, Chloe wrote, “WYNN continues to demonstrate great momentum. Visitors, including VIPs, are returning to Macau more quickly than expected, and the company’s new resort there is receiving very favorable reviews. Analysts expect Wynn to achieve 30% sales growth this year, the first full year of operation for the Wynn Palace. The stock is up 58% year-to-date, but still well below its 2014 peak (when the stock topped out just below 250). If you own it, hold on tight, but if you don’t, I still think you can buy here. The company’s dividend can rise very quickly when cash flow is growing.” BUY.
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All Cabot Stock of the Week buy and sell recommendations are made in issues or updates and posted on the Cabot subscribers’ website. Sell recommendations may also be sent to subscribers as special alerts via email. To calculate the performance of the hypothetical portfolio, Cabot “buys” and “sells” at the midpoint of the high and low prices of the stock on the day following the recommendation. Cabot’s growth stock policy is to sell any stock that shows a loss of 20% in a bull market (15% in a bear market) from our original buy price, calculated using the current closing (not intra-day) price. Subscribers should apply loss limits based on their own personal purchase prices.
THE NEXT CABOT STOCK OF THE WEEK WILL BE PUBLISHED JULY 3, 2017
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