December 27, 2024

In today’s note, we discuss developments and institutional ratings upgrades for some of the stocks in the portfolio, including Fidelity National Information (FIS), Paramount Global (PARA) and Starbucks (SBUX).

The famed “Santa Claus Rally” is underway and, assuming a successful conclusion, portends a bullish early part of the coming New Year.

We take another look at the latest developments for coffee chain giant Starbucks (SBUX) and why an increasing investment in automation will likely resolve one of its biggest headwinds.

We’ll also discuss some potentially positive catalysts for two attractive companies in the automobile sector with a focus on the electric vehicle outlook.

Comments on Portfolio Holdings

Turning to the portfolio, it was a typically light holiday week, which means there’s not much to report on that front. Fidelity National Information (FIS) got a favorable rating from a major Wall Street bank last week when analysts at Citi said they expect fintech to enter a “dynamic new phase” in 2025 as the global fintech revolution accelerates.

Among the predictions Citi made in its report is for an increase in M&A within the sector next year, which the report said would become palatable as stock prices and multiples increase. Further, Citi sees fresh capital from rising capital markets activity leading to new ways to play fintech for investors who are focused on profitable and sustainable growth.

More specifically, Citi said that among companies undergoing transformations, Fidelity is making notable progress, although it still has a way to go before reaching its long-term goals. It further believes Fidelity is in a good position to “prove itself” in 2025 in terms of solidifying its turnaround. After selling half our position in Fidelity, the stock maintains a Hold rating in the portfolio.

Meanwhile, the labor dispute among baristas at Starbucks (SBUX) isn’t over yet, despite the favorable ending of a Christmas strike at the coffee chain. The union representing the workers organized a five-day strike to protest a lack of progress in contract negotiations with the company, stating: “These unfair labor practice strikes are an initial show of strength, and we’re just getting started. We’re going to keep fighting until Starbucks gives us a serious economic offer.”

According to Starbucks management, the union proposed an immediate hourly wage increase of 64% and an overall 77% pay raise over the duration of a three-year contract, which Starbucks said was “not sustainable.”

I think the eventual resolution to the problems that turnaround CEO Brian Niccol is aiming for ultimately involve more technological innovation, which is to say, automation. We’re already seen a big increase in automation in other areas of the fast food and beverage industry, which ultimately leads to fewer employees per store and this, I think, is the direction Starbucks is headed.

At a recent investor conference, the company outlined a plan to double its seven million global Starbucks Rewards members within five years and “expand digital and technology collaborations to elevate the partner and customer experience.” My admittedly loose reading of this is that Niccol wants to do more to increase sales by relying less on employees and more on technology. That, presumably, would go a long way toward resolving at least some of its labor issues.

Already the company has invested in automated equipment designed to streamline beverage preparation by installing new machines that can reduce the time to make a Frappuccino from nearly 90 seconds to just over 30 seconds, and by automating tasks like ice dispensing and whipped cream application.

Additionally, Starbucks is leveraging automation to optimize inventory management, with ordering systems that help ensure that stores are adequately stocked, while reducing waste and simplifying operations for employees.

But automated ordering is where the real cost efficiencies will be seen, and to that end, Starbucks is exploring and implementing automated ordering systems, including the introduction of self-service kiosks and mobile order-only stores. Starbucks has also introduced self-service coffee machines in several of its locations, which allow customers to order and customize beverages without a barista.

Wall Street still believes in the turnaround, as do I, and sees the top line inching higher by 3% in 2025, followed by several more years of accelerating revenue growth. More importantly, analysts see a big improvement in earnings growth starting in 2026 as the turnaround measures presumably gain traction. The stock remains a Buy in the portfolio.

RATING CHANGES: None this week.

NEW POSITION: Last week we discussed the turnaround potential for entertainment media giant Paramount Global (PARA), and this week I’ve decided to add it to the portfolio. To reiterate, a key catalyst for the company’s early-stage turnaround involves the merger deal with Skydance in a deal valued at approximately $28 billion. Paramount also 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. I’m placing a Buy rating on PARA with an upside target of 14. BUY

Friday, December 27, 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 16 minutes and covers:

• A discussion of the mostly bullish near-term indications that stocks remain in strong hands.
• Preliminary holiday retail sales data should also prove supportive for the near-term outlook.
• Two potential turnaround candidates are discussed within the auto industry, namely Rivian (RIVN) and Stellantis N.V. (STLA).
• Comments on portfolio holdings.
• Final note
  
  • Paramount Global (PARA) has been added to the portfolio this week based on its recent multi-billion dollar deal with Skydance Media and consequent management change.

Turnaround Watchlist

Wall Street’s famous “Santa Claus Rally” is officially underway after starting right on schedule. According to the Stock Trader’s Almanac, the seasonal rally comprises the last five trading days of the year, plus the first two of the New Year. This year it started at the opening bell on December 24 and ends the second trading day of 2025, which is January 3.

To reiterate our previous discussion, a failure for the market to rally during this window would potentially pave the way for a bearish first part of the New Year. But if the market achieves a net gain by the end of January 3, the odds favor a continuation of the strength. At least, that’s what the statistics show.

To be fair, most of my short-term indicators still support a bullish outlook, although there’s definitely some evidence of sub-surface selling pressure in the form of an elevated number of NYSE stocks making new 52-week lows. However, a good chunk of the recent new lows are rate-sensitive issues that normally don’t show up on the average investor’s radar, so I’m not reading too much into this right now.

Also supportive of the near-term bullish outlook is the latest retail sector strength, with preliminary reports indicating a strong Christmas sales season. Credit card issuer Visa (V) just announced that this year’s holiday spending showed strength in in-store purchases, marked by a jump in clothing and accessories purchases.

According to Visa, “This holiday shopping season, we’re seeing increasing consumer confidence as people sought out in-store experiences—and went online—to purchase gifts and celebrate the holidays with friends and family.”

The data showed that in-store spending rose 4% year-over-year, increasing from 1.6% in 2023, led by a 5% jump in clothing and accessories sales and a 4% increase in electronics purchases. The robust spending levels have been particularly buoyant for retail stocks, which is another positive near-term indicator for the overall market outlook.

Despite the bullish retail sector, it was a tough year for more than a few automakers in 2024, including manufacturers of both traditional and electric vehicles. There were continued headwinds relating to vehicle affordability, not to mention a difficult auto market outlook in top producer China.

For the EV market, the year was especially filled with serious challenges as leading producers experienced market pressure from the slower adoption of new battery electric vehicles, as well as an ongoing struggle to build EVs that appeal to consumers’ predilections.

But industry analysts are cautiously optimistic looking ahead to 2025. Despite the anticipated policy shifts in the wake of the U.S. presidential election, 2025 global automotive forecasts are for new vehicle sales to reach 90 million, which will be a 2% year-over-year improvement if realized—up from this year’s 88 million units.

However, in spite of uncertainty surrounding the outlook for gas-powered vehicles, EVs are expected to be a bright spot in the coming year. According to S&P Global Mobility predictions, global sales for battery electric passenger vehicles are expected to increase 30% in 2025 to 15 million units—led by strong demand in China and Europe—and which, if realized, would account for an estimated 17% of global light vehicle sales. By contrast, 2024 saw an estimated 12 million BEVs globally, for 13% market share.

Despite the strong overseas demand, domestic sales of EVs continues to struggle against traditional ICE vehicles. The past year witnessed several notable bankruptcies in the auto sector, especially among EV startups and related industries. Among the higher profile bankruptcies were Chinese luxury EV maker HiPhi and American EV maker Fisker, which filed for Chapter 11 bankruptcy protection in June due to higher production costs and lower EV demand in the U.S.

More recently, Northvolt AB, which makes EV batteries for major carmakers like BMW, Audi, Porsche and Volvo, along with eight affiliates, filed for bankruptcy in November owing to an “acute” liquidity crisis that it blames in part on supply chain disruptions. Needless to say, it has been a tough year for the industry as a whole.

Meanwhile, another major automaker is on the ropes and is reportedly in a precarious situation with a potential bankruptcy looming. The negative sentiment for Japanese car giant Nissan (NSANY) started this fall when the Financial Times reported the company could be in bankruptcy “within 12 to 14 months.”

The bad news came within the context of a massive sales slide in the U.S. and Japan, along with fierce competition in China, plus an anticipated 70% decline in profits for this year. Nissan further posted a $60 million loss last quarter and has cut 7,000 jobs while reducing production in an attempt to save $3 billion in costs. The company was also said by the Financial Times to be looking for a strategic partner to stabilize its operations.

One culprit behind the falling sales is the Leaf, Nissan’s all-electric vehicle that was a money loser for the firm for years. The car wasn’t a profitable model for Nissan because of its limited range, slow charging times and competition from more advanced EVs, which culminated with the company making the decision to phase out the Leaf.

However, Nissan isn’t giving up on EVs and has projected that 40% of its U.S. auto sales will be electric cars by 2030. To that end, the company just announced jointly with Honda Motor on Monday that they’ve officially entered into merger discussions which, if finalized, would create the world’s third-largest auto company by sales behind Toyota and Volkswagen. The merger talks are scheduled to take place over the next six months with a successful outcome expected to create a combined company with about $190 billion in annual revenue with a strong focus on EVs and related software development.

Another big EV player worth discussion is Stellantis (STLA). The stock experienced a 60% drop between late March and early December due partly to a wider auto industry slowdown as well as internal headwinds. But the latest bottoming attempt came earlier this month after the company’s chief executive, Carlos Tavares, abruptly resigned his position following a strained relationship with the United Auto Workers (UAW) union and the firm’s board.

Wall Street seems to be mostly sanguine on the resignation of Tavares and is optimistic that new management can fix the company’s fractured relationship with the union, dealers and employees. A new CEO is expected in the first half of 2025, and this will likely be a major catalyst for a turnaround for Stellantis, the shares of which are currently undervalued and attractive based on several key metrics. Although the dividend is in danger of being cut, I think the stock is buyable around the current level of 13 a share for investors with a 12-month window.

Finally, EV maker Rivian (RIVN) is another stock worth keeping an eye on heading into the New Year. While some investors initially feared that the upcoming change in White House administrations might upend the EV market, those fears were at least partially allayed when a Trump transition team member recently said, “When he takes office, President Trump will support the auto industry, allowing space for both gas-powered cars and electric vehicles.”

Worries that Trump’s incoming administration might create an obstacle for EVs were further allayed when a major venture capital firm initiated coverage of Rivian in a report earlier this month, citing the outfit’s “significant share of a massive market opportunity in the coming decade.”

The report went on to state, “After a pause this year, domestic EV production is expected to improve in 2025 and further accelerate in 2026-27 as [application service providers] decline and the charging infrastructure is built out.”

Rivian was further said to be well-positioned thanks to its contracts with Amazon (AMZN) and Volkswagen (VLKAF), in conjunction with its popular models on the market. What’s more, a positive gross profit is anticipated in Q4 for Rivian. I’m also bullish on the year-ahead prospects for Rivian and have the stock high on my watch list.

Other factors in support of the EV industry having a better sales year in 2025 are China’s recent decision to adopt an “appropriately loose” monetary policy next year while implementing fiscal policies aimed at stimulating economic growth—a positive for the nation’s automobile sector and likely to have spillover implications for the U.S. market. All told, the weight of evidence suggests a brighter outlook ahead for automakers in general and for the EV industry in particular.

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.

Portfolio

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