December 20, 2024

In today’s note, we discuss developments and institutional ratings upgrades for some of the stocks in the portfolio, including Agnico-Eagle Mines (AEM), Atlassian (TEAM), GE Aerospace (GE), SPDR S&P Retail ETF (XRT) and Starbucks (SBUX).

An “oversold” condition is rapidly approaching in the broad market, which should benefit the overall portfolio heading into the New Year.

We take a closer look at the latest developments (positive and negative) for coffee chain giant Starbucks (SBUX).

We’ll also discuss some potentially positive catalysts for two attractive companies in the media and entertainment and e-commerce sectors.

Comments on Portfolio Holdings

Gold miner Agnico-Eagle Mines (AEM) announced this week that it’s making a friendly takeover bid to acquire all remaining shares of O3 Mining for 1.67 per share in cash through a wholly-owned subsidiary. The offer is supported by O3 Mining’s board, which recommended that O3 Mining shareholders deposit their common shares under the offer.

O3 Mining is a gold explorer and mine developer in based in Québec, Canada, adjacent to Agnico’s Canadian Malartic mine. O3 Mining owns a 100% interest in all its properties (128,680 hectares) in Québec. Its principal asset is the Marban Alliance project in Québec, which O3 Mining has advanced over the last five years to the cusp of its next stage of development, with the expectation that the project will deliver long-term benefits to stakeholders.

AEM shares maintain a Hold rating in the portfolio.

Collaboration software specialist Atlassian (TEAM), along with some of its cohorts, is poised to benefit from increased cloud migrations in the quarters ahead, according to an in-depth research report from a major multinational investment banking firm. The report expressed a decidedly sanguine outlook on the durability of cloud adoption in the next couple of years from existing on-premise customers and new customers.

The bank further believes Atlassian’s two-pronged approach, which consists of next-gen tech (AI and analytics) and an improving group of products only available in cloud, “should increasingly drive Data Center to Cloud migrations over the next 2-3 years,” it said.

Our remaining half position in TEAM remains a Hold.

GE Aerospace (GE) recently declared a 28 cent-per-share quarterly dividend at a yield of 0.7%. The dividend is payable January 27 for shareholders of record as of December 27. The stock maintains a Hold rating in the portfolio, but will likely soon be returned to a Buy in light of an improving fundamental backdrop (which will be discussed at length in an upcoming issue).

On the retail front, U.S. retail sales beat analysts’ expectations in November, increasing by 0.7% compared to October. Core retail sales were up 0.2% and were flat from the prior month.

The non-store retailers category was particularly strong, showing 2% month-over-month and 10% year-over-year growth for the latest month. (The data didn’t include the Sunday after Thanksgiving and Cyber Monday, which this year occurred in December.)

In other categories, grocery stores were up almost 2% year-over-year, clothing and accessories increasing by just over 2%, the closely-watched electronics store category rose just over 1%, while the auto dealers category soared 7%.

Given the positive holiday sales climate, the current backdrop should help boost our holding in the SPDR S&P Retail ETF (XRT) going forward, and it remains a Buy in the portfolio.

The latest headlines have been fairly mixed for coffee chain giant Starbucks (SBUX), which perhaps accounts for some of the near-term share price volatility. It was announced last week that incoming CEO Brian Niccol plans to triple the amount of paid leave it will give parents in an effort at boosting employee morale and retention at the company. Birth parents will now receive 18 weeks of full paid leave, compared with the previous six weeks of full paid leave and 12 weeks of unpaid leave. The news weighed heavily on the shares due to bottom-line concerns.

Meanwhile on Wednesday, the workers’ union representing Starbucks said that 98% of its union partners have voted to authorize a potential strike, which provides a potential headwind ahead of the final scheduled bargaining session for 2024. Starbucks has so far declined to comment on this situation.

On the positive side of the ledger, a major Wall Street bank just included Starbucks on its list of top restaurant picks for 2025. The bank embraced a contrarian outlook, noting that investors’ expectations for Starbucks next year are “too low,” while recent data has inflected positive. It further believes the company can navigate through wholesale coffee and cocoa price disruptions.

The shares remain a Buy in the portfolio.

RATING CHANGES: None this week.

Friday, December 20, 2024 Subscribers-Only Podcast:

Covering recent news and analysis for our portfolio companies and other topics relevant to value/contrarian investors.

Today’s podcast is about 19 minutes and covers:

• A discussion of the recent post-FOMC market sell-off and the prospects for a late-month rebound.
• Stocks are becoming exceptionally “oversold” by a couple of key indications.
• Two potential turnaround candidates have lately come into focus with the involvement of well-known activist investors and stakeholders in Paramount Global (PARA) and Etsy (ETSY).
• Comments on portfolio holdings.
• Final note
  
  • Starbucks (SBUX) faces headwinds on multiple fronts, but the overall retail outlook remains supportive.

Please know that while I don’t yet personally own shares of all Cabot Turnaround Letter recommended stocks, this will materially change in the coming weeks as I become fully integrated as your new Chief Analyst.

Please feel free to share your ideas and suggestions for the podcast and the letter with an email to either me at cdroke@cabotwealth.com or to our friendly customer support team at support@cabotwealth.com. Due to the time and space limits we may not be able to cover every topic, but we will work to cover as much as possible or respond by email.

The Catalyst Report

After what has seemed like a relentless rally in the major indexes for months on end, the S&P 500 Index had its deepest pullback since early August, giving back 4% this week in an across-the-board selling event.

The Dow Jones Industrial Average in particular made headlines for its longest losing streak (10 days) since 1978 as of December 19. Granted, the Dow was just 6% under its record high at the time—hardly a devastating decline—but the unusual weakness for this time of year understandably raises concerns for some investors.

The bulk of this week’s sell-off was catalyzed by a disappointed reaction on the part of traders after the Federal Reserve cut its benchmark interest rate by a quarter point on Wednesday, bringing the target range to 4.25% to 4.5%.

The reason for the pessimistic reaction was the Fed’s revision of the rate cut outlook for 2025, as the central bank said there would be just two reductions, which is down from the previous four reductions that were forecast back in September. Chairman Jerome Powell noted the Fed would be monitoring the inflation situation closely, stating that, “We have been moving sideways on 12-month inflation.”

In response to the Fed’s more subdued inflation outlook, stocks sold off heavily at mid-week, although there was some stabilization on Thursday. The market isn’t completely out of the woods yet, and further selling is certainly possible in the very near term.

However, the fact that the sell-off had a clearly defined catalyst (the Fed) is encouraging, as that is always preferable versus the market selling off for no reason in particular. The reason for this is that news-driven selling is usually reversed in fairly short order, while a steep decline without a definite catalyst is often how bear markets begin.

While I don’t normally like to go too much into technical analysis in this space, at times when the market is unusually weak it’s sometimes insightful to see what the market’s leading technical indicators are saying. With that said, let’s take a look at a couple of the more reliable indications to see what they’re saying.

One of my favorite market analysts is Tom McClellan, whose father invented the famous McClellan Oscillator for divining major turning points in the stock market trend. In his latest blog entry, Tom points out that his Advance-Decline (A-D) indicator is flashing an exceptionally “oversold” reading that suggests a bottom should be near. In fact, the indicator just hit its lowest level since late April, which as it turned out, marked a major low for the S&P.

And in a post on Twitter/X this week, Tom further noted that the market’s post-FOMC reaction sent the CBOE Volatility Index (VIX) considerably above its futures level, which resulted in a deeply negative reading. He observed, “It did get lower than this during the 2020 Covid Crash, and that one took a few days to end the carnage. Otherwise it is a great bottoming indication.”

And while it’s anyone’s guess what the next few days will bring, at least we can say things are looking a lot more encouraging than they were just a few days ago.

Turning our attention to this month’s Catalyst Report, in view of the market’s currently unsettled state, I don’t want to overload the potential buy list with new candidates until the near-term outlook improves. But there are a couple of early-stage turnaround stocks that I think are too promising to ignore—even in the context of a weak market environment.

The first one is Paramount Global (PARA), the legendary producer and global distributor of mass media and filmed entertainment. After a sizzling performance during the Covid era of 2020, the stock peaked at around the century market in early 2021 and collapsed in spectacular fashion, then spent the next few years grinding out a tortuous bottom.

As with many of its compatriots in the business, there were multiple reasons for the weakness behind Paramount’s stock: losses for its streaming services in the pandemic’s wake, declining viewership across cable networks and substantial debt management issues were among the high-profile contributing factors.

Another reason for Paramount’s woes were headwinds related to the linear TV advertising market, since high levels of inflation and lower consumer spending levels post-2020 resulted in reduced ad spend budgets on the part of advertisers. The company’s TV Media segment subsequently witnessed a conspicuous decrease in ad sales in the following years and has continued to experience struggles.

Serving as a counterpoise to this negative trend, however, has been Paramount’s direct-to-consumer sales which have helped drive growth more recently. The company’s Paramount+ streaming service has also lately teamed up with Showtime’s streaming app, with the premium streaming bundle offering consumers content on both platforms, as well as Paramount+ originals and other shows and movies.

The deal is expected to increase subscription revenue and profit margins, as the combined service allows people to spend more time on the unified app, which in turn increases the company’s average revenue per user (ARPU). Paramount expects ARPU to increase by 20% for full-year 2024. The deal should also allow Paramount to further improve its direct-to-consumer advertising sales.

One of the catalysts for the company’s early-stage turnaround falls under the M&A heading. This summer, Paramount Global and Skydance Media announced a definitive agreement to merge in a deal valued at $8 billion, forming a new entity known as “New Paramount.” The newly formed entity is valued at approximately $28 billion, and the transaction is expected to close sometime in the first half of next year.

More pertinently for investors, the company stands to benefit from the transfer of control of the company to Oracle co-founder Larry Ellison, his son David Ellison and their private equity partners who control Skydance Media. David Ellison, the founder of Skydance, will have full control of the combined Paramount-Skydance company after the deal closes, with David serving as the chairman and CEO of Paramount.

The deal between Paramount and Ellison’s Skydance has been the subject of great controversy, as it values Skydance at what many investors consider to be a very high price multiple, while significantly undervaluing Paramount’s assets, resulting in the dilution of existing shareholders.

But as analysts have pointed out, Paramount shareholders also have the option to receive $15 a share for up to half of all shares outstanding, which effectively allows half of the firm’s shareholders to cash out at a 40%+ premium to the current share price of 10.60. As Seeking Alpha recently noted, “This transaction is effectively an accelerated share repurchase of half the shares of the company by one of the richest families in America.”

In its Q3 report, Paramount reported revenue of $6.7 billion that was 6% lower on a year-on-year basis, but revenues continue to stabilize on a quarterly basis, and the bottom line of 49 cents beat estimates by an encouraging 25 cents.

Moreover, Paramount+ added 3.5 million subscribers in the quarter, reinforcing its position as the number four global streaming service, while continuing its momentum with year-over-year revenue growth of 25%. Digital ad growth also remained strong, showing a “notable increase” in demand year-over-year.

Management further noted that Q3 also marked the second quarter in a row where its direct-to-consumer business achieved profitability, with adjusted operating income before depreciation and amortization improving more than $1 billion over the past four quarters. Consequently, the company says it remains on track to reach Paramount+ domestic profitability in 2025. To that end, a major investment bank just added Paramount to its top media and entertainment ideas for 2025 based on the domestic streaming profitability outlook.

Going forward, revenues are expected to be choppy-but-stable in the coming quarters, with 6% growth projected when it releases Q4 results on Valentine’s Day. All told, I like what I’m seeing with Paramount and will likely soon add the stock to the portfolio.

Our next Catalyst Report addition is the online marketplace provider Etsy (ETSY), which offers shoppers a platform for buying and selling handmade or vintage items and craft supplies. These items fall under a wide range of categories, including jewelry, clothing, home decor, furniture, toys, art, as well as craft supplies and tools.

Much like Paramount, Etsy’s halcyon days were during the Covid era, when shutdowns forced millions of people to stay home and in turn led to a revival of interest in arts and crafts. Etsy allowed suddenly unemployed individuals turn their hobbies into supplemental income by selling them online through its e-commerce platform.

After rising 500% between early 2020 and late 2021, Etsy’s stock cratered in 2022 and ended up back where it started pre-pandemic by this fall. However, there are preliminary indications that Etsy will once again be able to turn things around in the coming year.

To begin with, the company’s CEO is Josh Silverman, an expert turnaround manager who formerly held a top executive position with eBay and Skype. During his tenure with the latter company, his initiatives resulted in a doubling of sales and a tripling of profits. His arrival at Etsy has already resulted in success on the turnaround front, and the company’s improved financial profile suggests the turnaround will be successfully completed in the foreseeable future.

A part of this improvement is a strong free cash flow profile that gives Etsy plenty of latitude for its strategic objectives, which includes core investments in organic growth, selective acquisitions and share repurchases.

But what really attracted me to the Etsy turnaround story was the entry of the venerable investor activist, Elliott Management, and the increase of its stake in Etsy to five million shares, as per a recent 13F filing. This serves as a huge vote of confidence on Etsy’s future outlook that simply cannot be ignored, especially given Elliott’s success in its previous investments in distressed companies and special situations.

For the consumer side of the business, Etsy’s turnaround plan is focused on improving its app in order to encourage new visitors to shop the online site. According to management, the total spending of a buyer increases by 40% when they download the Etsy app, and the firm has been working to prompt more shoppers to download the app halfway through their navigation of the site. If successful, the end result should lead to higher spend per customer based on company statistics.

The company is also working to increase engagement within the site’s search feature in order to increase exposure to its offerings by revamping search algorithms. And finally, it has just launched an Etsy Insider Loyalty program that offers free domestic shipping and discounts on selected items, along with other benefits. Collectively, the firm believes these efforts will increase overall search traffic and spending on the site, while creating long-term returning customers on both the buy and the sell side of transactions.

While the turnaround will likely take a few years to complete (Wall Street doesn’t expect growth to accelerate until later this decade), I like what I’m seeing with Etsy and am looking to add it to the portfolio at the first available opportunity.

Portfolio

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