4 Turnarounds for the Falling Rate Thesis
After the tumultuous sell-off in the broad equity market last month, the S&P 500 Index is back to within a few points of its all-time high as of this writing in what has been one of the fastest comebacks in recent memory.
Not long ago, we discussed in these pages the fact that a big reason for the market’s incredible rebound is the very favorable liquidity backdrop which equities currently enjoy. This can be easily demonstrated by the presently low credit spreads, along with rising prices (and falling yields) for both high-yield “junk” debt and high-quality corporate bonds.
A related factor behind the stock market’s resurgence is the falling interest rate environment we’re entering. This can be seen in the dramatic drop in U.S. government bond yields, with the widely-watched 10-year Treasury Yield Index (TNX) dropping from its October peak around 5% to the current level around 3.8%, which amounts to the largest bond yield decline since the interest rate up-cycle began in 2020.
Driving this decline in yields is the growing expectation for the Fed to cut interest rates starting in mid-September. If it happens as expected, it would mark the first such rate cut in four years and would provide further impetus for strength in the rate-sensitive areas of the equity market.
At its annual conference in Jackson Hole, Wyoming, Fed Chairman Jerome Powell provided support for these hopes when he said, “The time has come for policy to adjust,” adding that “the direction of travel is clear,” although he added that the timing and pace of rate cuts “will depend on incoming data, the evolving outlook and the balance of risks.”
Along with the downward trend in Treasury and corporate bond yields, mortgage rates are coming down which, aside from making homebuying more attractive, provides an incentive for current homeowners to refinance while increasing their purchasing power.
Indeed, the falling rate environment is potentially bullish for a number of sectors—many of which have early-to-mid-stage turnaround potential. Not least among them is anything related to real estate, including construction and building material stocks, home furnishing retailers, REITs and real estate service providers.
Another sector well positioned for a falling rate environment is retail, which also stands to benefit from consumers having more confidence and higher purchasing power. We’ve talked about this segment in recent weeks, and our holding in Foot Locker (FL) has been a particularly strong beneficiary of the retail sector comeback of late.
Then there’s the medical sector, which should also enjoy clear benefits from lower rates—specifically in the form of lowered borrowing costs and potentially increased consumer spending. As mentioned previously, there are a number of attractive turnaround candidates among biopharma stocks and medical tool and device makers (about which I’ll have more to say later).
All of this is by way of preface to underscore what I think should be our continued focus going forward, namely a concentration on areas of the market that will not only benefit from falling rates, but also from the growing demand for safety-related investments. With that in mind, here are a few stocks that just missed the cut for this month’s stock-in-focus, but which are nonetheless compelling additions to our watchlist (at least one of which will likely become a formal Cabot Turnaround Letter portfolio addition in September).
At the very top of that list is Incyte Corp. (INCY), a global biopharmaceutical company focused on finding solutions for cancer and skin disease patients. Its drug portfolio includes the blood cancer treatments, Pemazyre and Jakafi (its best seller, used to treat bone marrow disorders), the autoimmune disease drug, Olumiant, the lymphoma drug, Monjuvi and the dermatitis drug, Opzelura.
While Monjuvi is already approved for elapsed or refractory diffuse large B-cell lymphoma, in August the drug met its primary endpoint in a pivotal trial in patients with relapsed or refractory follicular lymphoma. Consequently, Incyte plans to file a supplemental license application for Monjuvi as second-line treatment for follicular lymphoma by the end of 2024.
Around the same time, the company announced the FDA approval of its biologic therapy, Niktimvo, for the treatment of chronic graft-versus-host disease, or cGVHD. (Incyte will jointly commercialize this drug in the U.S. with its partner, Syndax Pharmaceuticals.)
Sales of this Monjuvi in particular are rapidly expanding, with over $31 million of the drug sold during the quarter ended June 30, which amounts to a stunning 136% year-on-year sales increase. The sales contributed to a 9% total revenue increase in Q2, to just over $1 billion. Analysts are looking for 10%-ish top-line growth for Incyte in each of the next three years, which could prove conservative given the combined strength of its hematology, oncology and dermatology pipeline.
The Monjuvi and Niktimvo news injected some much-needed new life into the stock, which has already established a multi-month series of new highs and lows since bottoming in late April at 55 (recent price 65), yet it’s still a long way from the all-time high of 150, last seen over seven years ago. That said, I like the overall price structure of the bottom and early turnaround effort, and I see the 85-90 area as a conservative (and achievable) intermediate-term price target.
Another potential turnaround in the pharmaceutical category is Bristol-Myers Squibb (BMY), which we talked about in a recent Cabot Turnaround Letter podcast. The company is well known for its treatments across several indications, including hematology, oncology, cardiovascular and neuroscience diseases.
Although the company has expressed concern over the recent changes under which Medicare has revised prices for its blockbuster drug, the anticoagulant Eliquis, the new prices won’t take effect until 2026. Moreover, the firm’s cardiovascular portfolio has the potential to lead sales growth going forward, with sales of its oral cardiac-specific myosin inhibitor estimated to reach $4 billion by 2030.
In the latest news, the FDA agreed to review the company’s marketing application submitted to expand the product labeling of its liver cancer drug, Opdivo plus Yervoy. Bristol-Myers said that the FDA accepted a supplemental biologics license application filed to seek the regulatory nod for its use as a first-line therapy for adults with the liver cancer, unresectable hepatocellular carcinoma.
On the financial front, the company posted Q2 revenue of over $12 billion that increased 9% from a year ago, with earnings of $2.07 a share beating estimates by 44 cents. A 5% dividend yield is an added attraction.
In the financial sector, Global Payments (GPN) falls neatly under the category of stocks primed to benefit from falling rates. The firm provides payment technology and software solutions for card, check and digital-based payments in the Americas, Europe and the Asia-Pacific, operating through two segments (Merchant Solutions and Issuer Solutions).
GPN peaked in early 2021 at around 220 a share, then commenced a precipitous decline over the next two years before coming to rest around 100. One of the catalysts to the company’s turnaround was the transition of Cameron Bready from chief operating officer to chief executive in June 2023. This served as a pivotal point for the company, which has since embarked on its rebound under Bready’s capable leadership (which includes a 10-year tenure with the firm under various executive roles).
Although the stock fell out of favor more than three years ago, it’s starting to attract attention again from value-oriented investors after hitting a multi-year low near the century mark. In the last 10 years, the company has witnessed head-turning revenue and balance sheet growth (during which time the company’s total cash holdings more than tripled!), while free cash flow growth has been particularly impressive in the last three years. The strong financial performance is thanks to Global Payments’ aggressive investments in new product and technology development.
The steady revenue growth, along with margin improvements, are expected to continue going forward, with analysts further projecting 12% earnings growth for 2024 and in each of the next two years.
On a technical note, GPN is in the very early stages of what is likely a developing turnaround, having just established its first significant series of higher price highs of this year. While some investors may regard this as merely a cyclical influence (i.e. short covering), if the falling rate environment accelerates as expected, the stock should see meaningful acceleration.
Elsewhere on the real estate front, Centerspace (CSR) has already firmly established a rebound and is likely entering the middle stages of its turnaround. The North Dakota-based residential REIT owns, manages, acquires, redevelops and develops apartment communities mainly in the Midwestern U.S. (It currently owns 72 apartment communities and over 13,000 homes in Colorado, Minnesota, Montana, Nebraska and the Dakotas.)
Centerspace was in long-term decline before the current CEO, Anne M. Olson, first entered the picture in 2018 as the firm’s chief operating officer. Olson was instrumental in helping to orchestrate the company’s turnaround, which began the same year she took over as COO. Her real estate law background has helped the firm navigate how to execute on a long-term strategic turnaround plan since then. Since joining the firm, she has overseen more than $800 million of dispositions and the expansion of Centerspace’s market presence in Denver alone.
The company is expected to generate net operating income of around $160 million this year, compared to a $2.1 enterprise value, which in turn reflects a favorable market cap rate of 7.5%. Earnings, meanwhile, are forecast to grow by around 4% in each of the next couple of years (likely conservative if rates continue falling). A 5% dividend yield also helps the case.
With that, we now turn our attention to this month’s stock in focus, which happens to be a well-known name in the real estate sector. And as I suggested earlier, real estate should be the strongest beneficiary of the falling rate environment—in turn providing a very favorable tailwind for this particular company.
Recommendations
Purchase Recommendation: Zillow (Z)
1301 Second Avenue
Floor 36
Seattle, WA 98101
Web Site: www.zillow.com
Symbol: Z
Market Cap: $13.2 billion
Category: Large Cap
Business: Real Estate Rentals
Revenues (2024e): $2.2 Billion
Earnings (2024e): $310 Million
7/27/24 Price: $57.50
52-Week Range: $33.80-$61.10
Dividend Yield: N/A
Price target: $90
Background:
Seattle-based Zillow is America’s premier online real estate portal, allowing prospective homebuyers and renters to save time and money by using search filters (for views, amenities such as air conditioning, upcoming open houses and square footage), and by taking virtual 3D tours and inspections of the properties they’re interested in.
Moreover, Zillow enjoys a big advantage over its competitors since 80% of its online traffic is organic in nature, meaning it doesn’t have to spend much on advertising to bring customers to its various sites.
Analysis:
One part of the turnaround story for Zillow involves a new set of real estate industry rules that will take effect in August. The rules show favor to prospective buyers who decide against using agents and conduct their own independent research on the homes they’re interested in, which definitely favors digital platforms like Zillow.
Although Zillow hasn’t been profitable on a GAAP basis since 2012 (mainly because of the firm’s sizable share-based compensation), the company enjoys a strong profile in other metrics, including overall sales and adjusted EBITDA.
In the latest reporting period, Zillow reported Q2 earnings that featured broad-based home sales and rental growth. Total revenue of $572 million rose 13% from the year-ago Q2, with non-GAAP earnings of 39 cents a share beating estimates by 30% and adjusted EBITDA of $134 million increasing 21%.
The revenue growth was broad-based with residential home sales improving 8% to $409 million (the main driver for EBITDA growth), rentals revenue jumping 29% to $117 million and mortgage revenue soaring 42% to $34 million. (Rentals revenue has been particularly strong of late and is expected to support continued growth going forward irrespective of the rate environment.)
Zillow further outperformed the broad residential real estate industry (which grew 3%) for the eighth consecutive quarter in Q2, which management said puts the firm on a solid path to deliver “strong GAAP profitability” over time, plus double-digit revenue growth in 2024 while expanding EBITDA margins.
Loan origination volume, meanwhile, increased 125% to $756 million, which the company expects to lead growth for Zillow Home Loans as it launches more Enhanced Markets (which offer a variety of tools, products and services for buyers, sellers and agents) and improves its go-to-market integration with its Premier Agent partners.
Going forward, Wall Street expect the top line to grow 13% both this year and next, while the company said it expects continued growth across every part of the business heading into 2025, particularly as mortgage rates are expected to decline in the coming months.
As an aside, a notable recent spike in insider buying of Zillow shares is another reason for near-term optimism. The increase in shares bought by insiders in April-June amounted to a 300% increase from levels earlier this year and was the highest amount of insider buying in over a year.
Key to the Zillow story is the latest change on the management front: CEO Rich Barton was instrumental in kicking off the company’s major growth phase during the pandemic years. Although he was originally the chief executive from Zillow’s founding until 2010, he returned to the CEO position in 2019 before recently transitioning to co-executive chairman in August.
The incoming CEO is Jeremy Wacksman, the company’s long-time chief operating officer. Wacksman joined Zillow from Microsoft in 2009 and has earned multiple promotions throughout his 15 years at Zillow. He has been an innovation driver during his tenure with the company, helping to pioneer mobile real estate shopping, with Zillow Group apps having three times more daily active users than any other company in the category thanks to his contributions.
Moreover, in his prior role as chief marketing officer, Wacksman guided the pivotal strategy that helped Zillow grow into the household brand it is today, with 231 million average monthly unique users and the word “Zillow” searched more than the term “real estate.” His entrée as CEO should serve as a catalyst for additional growth at Zillow going forward. BUY
Other Ratings Changes:
Gannett Co. (GCI) has been changed from BUY to HOLD. The stock had an impressive 18% rally on August 26 and is up an even more impressive 44% in the last few weeks since Q2 earnings were released. The latest move was catalyzed by a $900 million refinancing deal with Apollo managed funds, aimed at extending debt maturities and reducing the dilutive effect of convertible notes.
Performance
The following tables show the performance of all our currently active recommendations, plus recently closed out recommendations. You can find more details by visiting our website at cabotwealth.com.
The chief analyst of the Cabot Turnaround Letter does not yet personally hold shares of every company on the Current Recommendations List, but that will change over time subject to the following guidelines. The chief analyst may purchase securities discussed in the “Purchase Recommendation” section or sell securities discussed in the “Sell Recommendation” section but not before the fourth day after the recommendation has been emailed to subscribers. However, the chief analyst may currently hold and may purchase or sell securities mentioned in other parts of the Cabot Turnaround Letter at any time.
The following tables show the performance of all our currently active recommendations, plus recently closed out recommendations.
Large Cap1 (over $10 billion) Current Recommendations
| RECOMMENDATION | SYMBOL | REC. ISSUE | PRICE AT REC. | 8/27/24 PRICE | TOTAL % RETURN (2) | CURRENT YIELD | RATING AND PRICE TARGET |
| General Electric | GE | Jul-07 | 195 | 171 | -13*** | 0.70% | Hold (210) |
| Nokia Corporation | NOK | Mar-15 | 8.02 | 4.2 | -40 | 2.20% | Hold (5) |
| Newell Brands | NWL | Jun-18 | 24.78 | 7.3 | -52 | 3.40% | Buy (16) |
| Vodafone Group plc | VOD | Dec-18 | 21.24 | 9.7 | -31 | 9.80% | Buy (13) |
| Berkshire Hathaway | BRK/B | Apr-20 | 183.18 | 455 | 150 | 0% | Hold |
| Walgreens Boots Alliance | WBA | Aug-21 | 46.53 | 10.4 | -74 | 9.60% | Buy (27) |
| Warner Brothers Discovery | WBD | Sep-22 | 13.16 | 8.25 | -36 | 0% | Hold |
| Bayer AG | BAYRY | Feb-23 | 15.41 | 7.72 | -52 | 0.30% | Hold |
| Tyson Foods | TSN | Jun-23 | 52.01 | 64.1 | 23 | 0% | 3.10% |
| Agnico Eagle Mines Ltd | AEM | Nov-23 | 49.8 | 82.3 | 65 | 3.10% | Hold |
| Fidelity National Info Svces | FIS | Dec-23 | 55.5 | 80.4 | 45 | 1.80% | Hold (85) |
| Baxter International | BAX | Feb-24 | 38.79 | 38 | -2 | 3.60% | Buy (44) |
| B2Gold | BTG | Aug-24 | 2.89 | 2.9 | 0 | 5.6 | Buy (3.5) |
| Alibaba Group Holdings | BABA | Aug-24 | 82.5 | 81.8 | -1 | 1.2 | Buy (95) |
Mid Cap1 ($1 billion - $10 billion) Current Recommendations
| RECOMMENDATION | SYMBOL | REC. ISSUE | PRICE AT REC. | 8/27/24 PRICE | TOTAL % RETURN (2) | CURRENT YIELD | RATING AND PRICE TARGET |
| Mattel | MAT | May-15 | 28.43 | 19.55 | -30 | 0% | Buy (26) |
| Adient plc | ADNT | Oct-18 | 39.77 | 22.15 | -44 | 0% | Buy (45) |
| Xerox Holdings | XRX | Dec-20 | 21.91 | 11 | -40 | 9.10% | Buy (20) |
| Viatris | VTRS | Feb-21 | 17.43 | 11.75 | -25 | 4.10% | Buy (19) |
| TreeHouse Foods | THS | Oct-21 | 39.43 | 41.4 | 5 | 0% | Buy (55) |
| Brookfield Reinsurance | BNRE | Jan-22 | 61.32 | 49.3 | -8** | 0% | Hold |
| Polaris, Inc. | PII | Feb-22 | 105.78 | 86.9 | -15 | 3.10% | Buy (100) |
| Janus Henderson Group | JHG | Jun-22 | 27.17 | 37.15 | 37 | 4.20% | Buy (42) |
| Six Flags Entertainment | FUN | Dec-22 | 38.62 | 43.6 | 14 | 2.70% | Buy (35) |
| Mohawk Industries | MHK | Jan-24 | 103.11 | 155 | 50 | 0% | Hold (165) |
| VF Corporation | VFC | Mar-24 | 16.24 | 17.7 | 9 | 2% | Hold (21) |
| Foot Locker | FL | Jul-24 | 26.56 | 32.8 | 24 | 0% | Sell Half |
| YETI Holdings | YETI | Aug-24 | 41.95 | 41 | -2 | 0 | Buy (54) |
| Alibaba Group Holdings | BABA | Aug-24 | 82.5 | 81.8 | -1 | 1.2 | Buy (95) |
Small Cap1 (under $1 billion) Current Recommendations
| RECOMMENDATION | SYMBOL | REC. ISSUE | PRICE AT REC. | 8/27/24 PRICE | TOTAL % RETURN (2) | CURRENT YIELD | RATING AND PRICE TARGET |
| Gannett Company | GCI | Aug-17 | 16.99 | 5.75 | 14 | 0% | Hold (9) |
| Duluth Holdings | DLTH | Feb-20 | 8.68 | 3.4 | -60 | 0% | Buy (5.5) |
| Dril-Quip | DRQ | May-21 | 28.28 | 16.1 | -43 | 0% | Buy (30) |
| Kopin Corporation | KOPN | Aug-23 | 2.03 | 1.04 | -49 | 0% | Buy (2.75) |
| Ammo, Inc. | POWW | Oct-23 | 1.99 | 1.55 | -22 | 0% | Hold |
Most Recent Closed-Out Recommendations
| Recommendation | Symbol | Category | Buy Issue | Price At Buy | Sell Issue | Price At Sell | Total Return(3) |
| Kaman Corp | KAMN | Mid | Nov-21 | 37.41 | *Feb 2024 | 45.05 | 25 |
| L.B. Foster Company | FSTR | Small | Nov-21 | 13.6 | *April 2024 | 26.17 | 92 |
| Capital One Financial | COF | Large | Nov-22 | 96.25 | *June 2024 | 138.75 | 48 |
| Wells Fargo | WFC | Large | Jun-20 | 27.22 | *June 2024 | 108 | 108 |
| Barnes Group | B | Mid | Apr-24 | 36.55 | *Aug 2024 | 37.9 | 4 |
| United States Steel | X | Mid | Jun-24 | 37.12 | *Aug 2024 | 38.15 | 3 |
| Western Digital | WDC | Large | Oct-20 | 38.47 | *Aug 2024 | 64.05 | 67 |
| Western Union | WU | Mid | Dec-21 | 16.4 | *Aug 2024 | 11.7 | -28 |
| Foot Locker | FL | Mid | Jul-24 | 26.56 | ****Aug 2024 | 33 | 24 |
Notes to ratings:
1. Based on market capitalization on the Recommendation date.
2. Total return includes price changes and dividends, with adjustments as necessary for stock splits and mergers.
* Indicates mid-month change in Recommendation rating. For Sells, price and returns are as-of the Sell date.
** BNRE return includes spin-off value of BAM shares.
*** GE total return includes spin-off value of GEHC shares at January 6, 2023 closing price to reflect our sale.
**** Indicates a partial sell.
The next Cabot Turnaround Letter will be published on September 25, 2024.
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