January 17, 2025

In today’s note, we discuss pertinent developments and ratings changes for some of the stocks in the portfolio, including Alcoa (AA), Atlassian (TEAM), GE Aerospace (GE), SLB Ltd. (SLB), Starbucks (SBUX), Super Hi International Holding (HDL) and Teladoc Health (TDOC).

The latest core inflation report for December served as a catalyst for a broad market rebound, but rising inflation expectations and high Treasury yields remain a concern going forward.

Beyond the intermediate-term outlook, the near-term looks positive according to several of our leading indicators.

A strong potential turnaround candidate in the process automation software space is UiPath (PATH), which should benefit from the ongoing AI buildout trend.

Comments on Portfolio Holdings

The European Commission (EC) intends to propose a gradual ban on imports of Russian primary aluminum in its latest sanctions against Russia’s invasion of Ukraine. Until now, the EC has banned aluminum products including wire, tubes and foil, but these amount to less than 15% of imports of the metal used in the transport, packaging and construction industries in the European Union.

According to Seeking Alpha, “Between January and October 2024, the EU imported more than 130,000 metric tons of primary aluminum from Russia, or ~6% of the 2.2 million-ton total, compared with 11% and 19% in the corresponding periods of 2023 and 2022, respectively.”

Russia is a significant global aluminum producer, accounting for around 6% of the world’s primary aluminum production. If the major aluminum consuming member states of the EU ban Russian aluminum, it would reduce the available supply in the global market, likely lifting global aluminum prices and in turn having a potentially positive impact on our holding of Alcoa (AA). After taking profits on a quarter of our position in November, the stock remains a Hold in the portfolio.

One of the more positive aspects of the CPI report for December mentioned earlier, travel demand was reported as “strong” during the recent holiday season despite an 8% year-on-year increase in airfares in the U.S. Airfares have increased in six of the last seven months, according to the Bureau of Transportation Statistics.

Wall Street analysts see this trend contributing to a projected doubling of earnings-per-share of 65 cents, with revenue expected to modestly increase by 3%, when American Airlines (AAL) reports Q4 financial results next Thursday, January 23 before the market opens. After taking a quarter profit in our holding of AAL in early December, I now recommend taking another quarter profit ahead of next week’s earnings release. The remainder of our position maintains a Hold rating in the portfolio.

Investment bank Barclays just upgraded the shares of collaboration software specialist Atlassian (TEAM), citing an increased confidence in sustainable growth. According to an analyst note by the bank, “While we are not raising our estimates, our confidence has increased that Atlassian can sustain ~20% year-over-year growth through a combination of factors, after passing the very difficult March comparison.” The firm upped its rating on Atlassian to Outperform from Market Perform and raised the price target from 255 to 292 a share. After taking profits on half our position in November, the stock maintains a Hold rating in the portfolio.

GE Aerospace (GE) is expected to report earnings next Tuesday. It’s further anticipated that the company’s earnings release will have an outsized impact on a number of exchange-traded funds, including the Industrial Select Sector SPDR Fund (XLI), of which the largest holding is GE. To that end, the earnings bar for GE was set fairly low by Wall Street, with the consensus expecting the firm to report revenue of $9.5 billion next week which, if realized, would amount to a 50% decline from a year ago, while forecasted earnings of $1.04 a share would be essentially unchanged if realized.

On a related note, Bank of America released an analyst note this week which placed GE among its top defense industry stock picks heading into 2025. The analysts said that “budget constraints will continue to be an issue even as Republicans control the White House, Senate and House of Representatives, but defense spending will expand.”

Despite uncertainties, moreover, the analysts said “we keep our contrarian view and expect defense spending to continue to grow.” The bank expects GE to benefit from the ongoing strength in the commercial aftermarket and widebody recovery, and it expects the firm’s “investment in next-generation platforms to position the company well for future growth and allow it to take market share in the near term.” GE maintains a Hold rating in our portfolio.

Oilfield services provider SLB Ltd. (SLB) will release Q4 earnings results today before the market opens. Analysts expect the company to post a quarterly EPS of 90 cents (up 5% year-on-year if realized) and revenue of $9.2 billion (up 2%). The company recently reiterated its expectation of delivering full-year adjusted EBITDA margin at or above 25%, thanks in part to cost-cutting, and it sees its international market spending rising at a low-to-mid-single digit percentage rate, while North American spending is forecast to be flat or slightly lower.

Over the last two years, SLB has beaten per-share earnings estimates 100% of the time and has beaten revenue estimates 50% of the time, according to Seeking Alpha. We’ll see if the record stands today after the latest release, but for now, the stock remains a Buy in the portfolio.

Starbucks (SBUX) made headlines this week with the scrapping of its famous open-door policy which allowed even non-paying customers to hang out at its stores or use the restrooms without making a purchase. Under its new rules, customers will be required to make a purchase in order to remain in its cafes or use its facilities.

The efforts are part of CEO Brian Niccol’s efforts to improve the Starbucks experience and deter homeless people and other non-paying customers who enter Starbucks solely for shelter and bathroom access. The rule applies to all locations in North America and will be displayed on store doors, according to CNN.

Other changes include a ban on panhandling, discrimination, consuming outside alcohol and vaping. The company believes the rules changes will serve to attract customers who may have been deterred by the store’s formerly permissive policies.

Additionally, Starbucks plans to incentivize customers to stay in its cafes instead of ordering to-go by providing exclusive perks for in-store orders. Beginning January 27, all customers can get one free hot or iced coffee refill served in its ceramic mugs or reusable glasses, a perk that previously only applied to members of the company’s loyalty program. SBUX maintains a Buy rating in the portfolio.

Shares of Super Hi International Holding (HDL) have lately been sagging on no news in particular. The stock has had a great run since we first recommended it back in October, and we already took a quarter profit in our position. However, given that our upside target has already been realized and the stock is showing classic signs of being offloaded by investors, I recommend that we sell the remainder of our position in HDL. I’m therefore moving it to a Sell in the portfolio.

Also this week, healthcare tech provider Teladoc Health (TDOC) announced a collaboration with Amazon to expand access to its chronic condition programs. Eligible customers can now enroll in Teladoc’s diabetes, hypertension, pre-diabetes, and weight management programs through Amazon’s Health Benefits Connector.

Teladoc’s participation in the program comes as the companies look to collaborate on opportunities focused on putting the consumer at the center of the healthcare experience. The stock maintains a Buy rating in the portfolio.

RATING CHANGES: Super Hi International Holding (HDL) has been changed from Hold to Sell.

Friday, January 17, 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 18 minutes and covers:

• After expanding to dangerously high levels, new 52-week lows on both major exchanges contracted significantly in a sign that buyers have re-entered the market.
• However, despite a much-needed pullback in Treasury yields, the threat of rising inflation remains and necessitates a cautious approach going forward.
• Several of our portfolio holdings are about to announce Q4 earnings, including SLB Ltd. (SLB) on Friday.
• Final note
  
  • Super Hi International Holding (HDL) has been downgraded from Hold to Sell.

Market Outlook

Heading into this week, the market showed a decidedly sullen aspect as stocks across a growing number of industry groups made new 52-week lows. On Monday, for instance, the number of new lows approached 300—the highest number seen in over a year—while new highs were a mere 24. This was an undeniable sign of internal weakness, and further, a sign that that the growing selling pressure was becoming untenable.

But instead of serving as a harbinger of even more selling, this instead proved to be a contrarian bottom signal, with stocks taking flight in the next couple of days on some very timely and well-received economic news.

The main catalyst for this week’s rally was the positive spin that many economists put on the latest inflation numbers for December, which showed that while overall inflation continued to rise, “core” CPI rose less than forecast, which was taken as a sign that upward pressure on shelter costs is diminishing.

In the words of Raymond James’ chief economist, this was a “good reason” for the rally since it assumes the Federal Reserve has no problem watching the headline CPI rate increase “temporarily if that increase does not spill over into the core CPI.”

Put another way, like many economists, he’s suggesting the Fed is OK with food and energy costs rising as long as housing and rent prices aren’t increasing “too much.” And if that’s the case, investors believe this implies the central bank may not have to tighten policy going forward.

The bond market also reacted to the inflation news, with the 10-year Treasury yield pulling back after coming perilously close to reaching the benchmark 5% level (which many analysts believe marks the proverbial “danger zone” in the stock/bond market relationship).

However, I maintain that the relentless rise of the 10-year Treasury yield prior to the latest CPI report was a definite cause for concern since it suggested the market foresaw inflation as a serious problem going forward. And while the latest bond yield pullback is certainly a relief, the uptrend in bond yields is still intact with no reason to assume the inflationary threat has completely diminished.

A case in point is worth mentioning: Although it tends to be underestimated by official sources, by some accounts, gasoline costs alone can amount to nearly 20% of the budgets for many working-class American households (as referenced in a 2021 study by Aceee.org). That doesn’t even account for electricity costs, which are apparently harder to quantify. Then there’s the official assessment that food costs account for around 11% of the typical middle-class budget and which, frankly, also seems understated.

So, between energy and food costs—both of which are still increasing with no signs of abatement—inflation is obviously a much greater concern for most Americans than the financial media would have us believe. And for that reason, I suspect the problem of rising yields hasn’t yet fully diminished. This means a measure of caution is still in order since equities are still potentially at risk if bond yields resume their upward march.

With that said, by way of caveat, let’s briefly recount some of the market’s favorable aspects and how it should impact our stock holdings in the near term. Encouragingly, aside from the immediate abatement of stocks making new 52-week lows, the past week saw the first rally in the NYSE advance-decline (A-D) line in recent weeks. This in turn suggests liquidity hasn’t diminished enough to allow sellers to take over and may well serve to deter any further incursions by the bears for a while.

Moreover, the ultra-speculative crypto market saw an immediate rebound, with many crypto assets making their way back toward previous highs in a sign that the speculative juices are still flowing on Wall Street. And as I’ve noted many times previously, bear raids on stocks are typically preceded by abnormal bitcoin market weakness. Therefore, I view the crypto rally as a favorable sign.

Finally, one of my favorite leading indicators for stocks in the aggregate—namely the broker/dealers—rallied back to previous highs this week, which suggests to me that the bulls are serious about regaining control of the immediate trend. Collectively, the evidence I’m looking at tells me the market remains on a bullish footing for now, although we must avoid becoming complacent as long as bond yields remain strong.

Catalyst Watch

An equity that falls into the category of attractively priced potential turnarounds coming off a relatively low base is UiPath (PATH). It’s a New York-based provider of robotic process automation software to clients worldwide across multiple industries, which basically eliminates inefficiencies, reduces manual tasks and improves productivity—all through leveraging AI.

A key feature of the firm’s Agent Builder platform (which allows users to build AI-powered agents by combining classical automation with more advanced, agentic automation capabilities), is that its agents can perform complex tasks by interacting with corporate databases, which analysts believe represents a major leap forward in automation.

One recent example of how UiPath uses generative AI to solve problems is provided by some of its high-profile banking clients, including Wells Fargo and JPMorgan Chase. UiPath’s platform has allowed these banks to automate their lending process by handling mortgage originations and processes, as well as managing default risk, all thanks to the platform’s ability to solve tasks such as onboarding, due diligence and customer support.

Key to the firm’s future growth is an application owned by UiPath called AI Fabric, which allows developers to deploy, manage and continuously improve machine learning models into the automation process, in turn leading to synergies as developers add to its functionalities.

Moreover, the outfit’s strategic partnerships with several leading tech companies is another potential growth catalyst. And finally, analysts eagerly await UiPath’s fiscal Q4 results (due out on March 14), where progress on its Agent Builder deployment could serve as a catalyst for near-term growth.

In its fiscal third quarter, the company’s revenue increased 9% year-over-year to $355 million, while earnings of 11 cents a share beat estimates by seven cents. Annual recurring revenue (ARR, a key metric) of $1.6 billion grew 19%.

At this week’s Needham Growth Conference, UiPath’s management laid out some of its expansion plans going forward. The company noted that among its nearly 11,000 total customer base, its core customers (2,235 as of Q3) continue to expand “very nicely,” with clients spending between $100,000 and $1 million a year expanding at a 119% growth rate.

UiPath’s share price cratered from a high of 90 a share shortly after its debut in mid-2021 and fell to 10 by late 2022 in a punishing post-IPO selling event, yet it has no debt and plenty of cash (about $1.5 billion), has been improving its free cash profile and even recently announced a $500 million share repurchase program. The company has been streamlining its operations in the last couple of years, while revenues are stable and are projected by analysts to continue improving in the next two to three years.

All told, UiPath possesses most of the characteristics of what I look for in an ideal turnaround story, and while I’m not quite ready to pull the trigger on a buy, it remains very high on my watchlist.

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.

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