January 10, 2025

In today’s note, we discuss pertinent developments and institutional ratings changes for some of the stocks in the portfolio, including Agnico Eagle Mines (AEM), Alcoa (AA), American Airlines (AAL), Atlassian (TEAM) and Toast Inc. (TOST).

Continued pressure on stocks from rising Treasury bond yields is a concern going forward, but a bear market isn’t anticipated.

Instead, rising yields reflect higher inflation expectations, which should prove supportive of some of the stocks in our portfolio, as well as industries supporting the electric vehicle industry we’ve lately discussed.

Among the possible beneficiaries of this trend include Sociedad Quimica y Minera De Chile (SQM) and ICL Group (ICL), as we’ll discuss here.

Comments on Portfolio Holdings

There isn’t much to report in the way of company news and developments in the typically sluggish early part of the new year. However, a number of Wall Street firms have lately issued ratings upgrades in support of some of our holdings.

Included among them is a major investment bank, Oppenheimer, which just published a list of its top picks for 2025 in the so-called “low-momentum” basic materials sector as a hedge against the January Effect. This effect often happens when prices for smaller-cap stocks tend to rise more significantly in January compared to other months of the year, and it’s attributed to tax-loss selling in December, which can lead to increased buying pressure in January.

Among stocks in the Russell 3000 universe that the bank scanned for, only eight made the cut, and at the very top of its list was our holding in Agnico Eagle Mines (AEM). According to the Oppenheimer analysts, “These stocks fit our bottom-up discipline, and from a top-down view, should be supported if the sector stages an oversold bounce counter to its long-term downtrend.” Agnico maintains a Hold rating in our portfolio.

Elsewhere, another leading investment bank, Jefferies, named aluminum producer Alcoa (AA) as one of its four top mining stock picks for 2025. The team of analysts at the bank wrote, “While we have recently become more cautious on the near-term outlook for the sector due to cyclical factors…our bias is to buy our preferred miners and steel producers following the recent significant weakness.”

Jefferies further noted that it sees “idiosyncratic factors” driving share price performance in 2025 and foresees an “eventful year in the world of metals and mining.” Alcoa maintains a Hold rating in the portfolio.

Further receiving an upgrade earlier this week was American Airlines (AAL), as both Jefferies and TD Cowen said the firm’s strategy to focus on its short-haul network is “ideally” served by its regional fleet that offers connectivity to its other domestic hubs while benefiting its international network, an advantage that compares favorably against its competitors.

According to Jefferies, “Ongoing corporate share recapture, lower capacity and [capital expenditures] and a new [credit card deal with Citigroup] means American could see significant surprise to the upside in 2025 against a rationalizing industry backdrop.”

Regarding American Airlines’ deal with Citigroup (which begins in 2026), Jefferies expects $1.5 billion in incremental pre-tax profit for the airline compared with 2024, along with a cumulative gain of $5 billion over the deal’s 10-year term.

Jefferies further estimates 30% in pre-tax profit on a compounded average growth rate to 2027, converting to $5.6 billion in free cash flow in 2025 to 2027 on an average capital expenditure of $4 billion per year, which is expected to reduce America’s debt by nearly 20% by the end of 2027. American Airlines maintains a Hold rating in our portfolio.

Atlassian (TEAM) also received a ratings upgrade this week. A group of analysts at Truist Securities highlighted the outlook for the software sector, with an upgrade of Atlassian from Hold to Buy while increasing the price target from 250 to 300 a share. Truist said its reason for the upgrade is based on three components, namely “a favorable model setup for the year; a unique AI opportunity for the company, and the potential for margin upside that the analysts believe is currently underappreciated by the Street.” After taking some profit in the stock in November, Atlassian is currently rated a Hold in our portfolio.

Further benefiting from recent institutional attention is the stock of payments firm Toast Inc. (TOST), which rallied earlier this week after BMO Capital Markets initiated coverage with a Buy rating, calling it a “long-term winner in the U.S. restaurant technology/payments market.”

BMO also said Toast should benefit from a “comprehensive product offering and highly efficient go-to-market strategy that underpins attractive/improving unit economics and [average revenue per unit] growth.” BMO expects the outfit to continue gaining market share in the restaurant sector and projects the compound annual growth rate in Toast locations through 2027 in the high teens. Toast maintains a Buy rating in our portfolio.

RATING CHANGES: No changes this week.

Friday, January 10, 2025 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:

• Investors are worried about rising bond yields, as evidenced by recent extreme weakness in rate-sensitive issues like REITs and homebuilders.
• Despite rising inflation expectations, speculative-type assets like bitcoin and tech stocks remain strong as investors maintain a “risk-on” posture.
• The rising yield trend should benefit the metals and mining sectors going forward.
• No new ratings changes to the portfolio.
• Final note
  
  • The heavily punished and unloved rare earth minerals sector looks well positioned for a turnaround in 2025.

Market Outlook

As we head further into the new year, certain areas of the broad market are showing signs of cracking under the pressure of rising Treasury bond yields. The biggest show of weakness is coming from the real estate sector, as the rate-sensitive REITs and homebuilders have folded under the pressure of rising yields since peaking in late November.

In fact, real estate-related stocks have increasingly shown up on the expanding list of NYSE stocks making new 52-week lows, along with other rate-sensitive issues. In the market’s latest session, new lows outnumbered new highs by a six-to-one margin in a sign that internal weakness is a lingering problem, as we talked about in last week update.

But not all of the securities making new lows are rate sensitive, with a growing number of defensive-oriented consumer staple and utility stocks also coming under extreme selling pressure. The consumer staples stock ETFs, for instance, are down 7% from their early December highs while utility stock ETFs are down 10%. The S&P 500 Index, by contrast, is down just 3% from its December high.

What this tells me is that investors aren’t ready to run for the exits and are still basically embracing a speculative posture. This is reflected in the continued embracement of crypto assets on the part of bitcoin enthusiasts, including the Grayscale Bitcoin Trust (GBTC), which is just a tad off its all-time high.

In the words of market analyst Tom McClellan, “Bitcoin is the modern era’s number-one speculative trading asset. But the public mood waxes and wanes concerning enthusiasm toward bitcoin, just like any other type of speculative vehicle.” As Tom has observed, crypto market strength has proven to be a reliable confirmation of investors embracing a “risk-on” posture, while bitcoin weakness is proof that “risk-off” is back in vogue.

But there’s no denying that the continuing strength in the 10-year Treasury Yield Index (TNX) is a concern among investors, and the response to this has so far been focused on selling rate-sensitive stocks as well as in some profit-taking in outperforming tech shares. And while the worry hasn’t yet metastasized to most areas of the market, it’s possible that higher bond yields could put increased pressure on the broader market.

However, while we could see some downward pressure on stock prices in the next few weeks, I’m not predicting a bear market will unfold anytime soon. In support of this view, credit spreads remain low, corporate profits are hovering near record highs while economic indicators—including the Leading Economic Index—aren’t signaling that recession is imminent.

Instead, what we could end up seeing is a repetition of a pattern that has played out in recent years in which high yields—which I define as the 10-year approaching 5%—prompt temporary selling of stocks, followed by a resumption of broad market strength as investors fully assess the need to hedge against persistent inflation pressures.

To that end, we’ve seen several instances in recent years where equities are treated as an inflation hedge by investors, including during runaway bouts of inflation in countries like Venezuela and Argentina and, to a lesser degree, here in the U.S. The most recent example of this is the massive upside run of Argentina’s stock market over the past year while that nation’s inflation rate was in the triple digits.

In the U.S., where the inflation rate is fractional by comparison, the similarities end. But given that rising government bond yields reflect rising inflation expectations, the admittedly loose comparison is at least somewhat apt. With that in mind, let’s take a look at some areas of the market that stand to benefit from rising inflation expectations.

A couple of major industry groups that stand out as being large potential beneficiaries of inflation hedging are mining and energy. On the energy front, companies with exposure to natural gas exploration and production are outperforming right now due to a combination of favorable supply and demand factors, plus the exceptionally cold weather in several parts of the country. And as the Trading Economics website recently observed, “These supply constraints have been compounded by rising gas flows to LNG export plants, driven by Europe’s shift away from Russian pipeline supplies.”

In the crude oil market, there are also signs of increasing demand as shown by a recent report indicating a continued declining trend in domestic crude stockpiles. Additionally, Russia’s seaborne oil exports have fallen to their lowest levels in over two years, which has resulted in further supply concerns and is putting some upward pressure on oil prices along with oil and gas stocks.

Meanwhile on the mining front, gold mining stocks in particular should benefit from rising inflation expectations as investors continue to embrace the shiny yellow metal as the preferred inflation hedge. In support of this outlook, the World Gold Council (WGC) has reported that physically-backed gold ETFs recently recorded their first inflows since 2020, driven in part by rising demand in Asia, while North American funds saw their first annual inflow in over four years. On a side note, gold outperformed all major asset classes in 2024, according to the WGC, and I expect gold to maintain its relative strength position in the coming months.

All told, the strength in both the energy and precious metals arenas should bode well for our holdings of Agnico Eagle Mines (AEM) and SLB Ltd. (SLB) going forward, and there exists an opening for further exposure to both sectors in the coming weeks and months.

On a closely related subject, the question some investors are asking is: Will this be the year that the beaten-down and unloved rare earth metals and equities make a comeback? Given recent developments surrounding the industries the rare metals support, it’s certainly a question that merits closer scrutiny.

One of my favorite benchmarks for this sector, the VanEck Rare Earth & Strategic Metals ETF (REMX) is down nearly 70% on a three-year basis and is basically exactly where it was five years ago, making it an ideal potential turnaround candidate. Retail investors have all but thrown in the towel on the rare earth minerals space, but in view of our bullish outlook for electric vehicle stocks in 2025, I think we should start to look more closely at the companies that mine lithium, rare earths and other battery metals that are heavily used in this industry.

Among prospective turnarounds serving these industries is Sociedad Quimica y Minera De Chile (SQM)—or Chemical and Mining Society of Chile—which is the world’s second-largest lithium producer behind Albemarle Corp. (ALB). SQM extracts lithium from a salt basin in northern Chile which contains nearly a quarter of the world’s lithium supply.

Despite the worldwide lithium glut of recent years, metals giant Rio Tinto (RIO) forecasts a 10% compound annual growth rate for lithium demand that’s expected to persist into 2040, leading to an eventual global supply deficit.

Industrial analysts see all the main variables in place for a lithium price turnaround, possibly beginning later this year, which would position SQM nicely for a rebound of its own. On that score, Toronto-based battery metal and EV consulting firm Adamas Intelligence is forecasting global lithium demand to increase 26% this year, to 1.5 million tons, on a lithium carbonate equivalent (LCE) basis. Moreover, analysts expect that mergers and acquisitions will continue to consolidate the industry, which could also put pressure on lithium supplies and boost prices.

On the earnings front, Wall Street sees the top and bottom lines for SQM launching a significant recovery starting in 2025 and accelerating over the next two years. The company also compares favorably to its industry peers on an EV/EBIT basis. It’s a stock that’s on my watchlist, and while I’m not quite ready to buy it, any signs of a lithium price recovery in the coming months will likely prompt a speculative purchase recommendation.

For Israel-based ICL Group (ICL), the early stages of a cyclical turnaround are already underway. The company is a specialty minerals and chemicals producer, mainly mining and selling potash and phosphate fertilizers and related products, but also having an industrial segment that is poised to benefit from growing worldwide EV demand. Among its products, ICL makes flame retardants, which are used in electronics, EVs and other applications pertaining to battery-powered devices and vehicles, and this is where a significant portion of the firm’s future growth is expected to come from.

Related to this, ICL recently announced it will invest more than half a billion dollars for a manufacturing facility for a key component in lithium batteries in St. Louis after also breaking ground for what is expected to be the first large-scale lithium iron phosphate facility in the U.S.

On the management front, ICL also just announced the appointment of a new president and CEO who has vast experience in the fertilizer and battery minerals business, and who is expected to help transition the company for sustained growth on both fronts.

The shares are attractively valued across multiple metrics compared to industry peers, and Wall Street expects steady revenue growth in each of the next three years. If you’re game, near-term pullbacks can be used to do some nibbling in the stock.

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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