March 7, 2025

In today’s note, we discuss pertinent developments for some of the stocks in the portfolio, including Alcoa (AA), Janus Henderson Group (JHG), Paramount Global (PARA) and Starbucks (SBUX).

This week’s watch list includes a focus on the suddenly interesting toy market outlook, with two major industry members poised to benefit from it.

Trump’s tariffs continue to exert mixed results for our holdings, with Alcoa (AA) potentially benefiting going forward, while Starbucks (SBUX) may be immune.

Comments on Portfolio Holdings

It has been a quiet week for earnings, so there isn’t much new to report on that front. There were, however, some company-related developments worth mentioning.

After a tough past month for Alcoa (AA), the stock finally got some good news this week. Price premiums for aluminum soared to a record high in response to the imposition of a 25% tariff on imports of the metal starting March 12, according to Reuters.

Per the report, “Buyers on the physical market usually pay the London Metal Exchange benchmark aluminum price, plus a premium which typically covers taxes, transport and handling costs.”

In response to the report, Bank of America analyst Michael Widmer said, “Ultimately, the U.S. is a net importer of aluminum...Producers will not want to pay the tariff, they will try to pass on as much as they can to consumers. This leaves you with a market where aluminum units will potentially be diverted away from the United States.”

Putting it into even greater perspective, industry member Eivind Kallevik, the CEO of aluminum producer Norsk Hydro, commented: “If the U.S. is going to keep manufacturing cars and other products, they will need to attract the metal. That means higher premiums and costs.”

After taking a one-quarter profit in AA, the stock remains a Hold in the portfolio.

On Thursday, it was announced that a U.S. judge may block the deal between Paramount Global (PARA) and Skydance in the wake of shareholder allegations of a fiduciary breach. The potential blockage is based on a lawsuit that alleges that Paramount’s $8 billion sale to David Ellison’s Skydance Media should be blocked from closing because it “short-changes public shareholders,” according to a Reuters report.

The report said an investor group called Project Rise Partners submitted a proposal in January valued at over $13 billion to buy Paramount, but that bid was rejected by Paramount. Consequently, pension funds for New York City employees that own Paramount stock filed a lawsuit alleging the company breached its fiduciary duties to its shareholders by not considering the bid.

On Thursday, a Delaware judge agreed to expedite the pension funds’ lawsuit, but declined to issue a temporary restraining order to block the deal because “it did not appear the deal was about to close,” in the report’s words.

The Skydance deal’s closing is subject to the FCC’s approval and the earliest the deal can close is March 20. The merger has an April 7 termination date, although it can be extended twice by 90 days if the FCC does not give clearance for the merger to close, according to the report.

Paramount, meanwhile, says it expects the deal to close sometime in the first half of this year. What’s more, the stock continues to be unfazed by the ongoing drama surrounding the Skydance deal. PARA retains a Buy rating in the portfolio.

Will an unfolding global coffee supply chain crunch eventually hit Starbucks (SBUX)? That’s the question investors are apparently beginning to ask, as evidenced by this week’s sell-off in several big-name coffee stocks.

According to Bloomberg, “Prices for premium arabica beans and the robusta type used in instant drinks have surged over the past year—as much as doubling—as unfavorable weather hit crops in key growers Brazil and Vietnam.”

The article went on to state that, “That’s squeezing roasters and hitting consumers. Firms like Folgers maker J.M. Smucker Co. have hiked prices, Nestle SA is making packs smaller to limit the cost impact, and Pret-A-Manger scrapped its subscription that gave customers ‘free’ drinks.”

The supply chain disruptions are mainly being felt in Europe, but as retailers push back against roasters’ efforts to raise prices in new negotiations, it’s causing a “temporary lack of some products in certain stores,” according to Bloomberg.

Moreover, President Trump’s proposed 30% tariffs on imported Colombian goods, including coffee, has sent shockwaves through the coffee market, exacerbating already high bean prices.

As industry publication, Coffee Intelligence, recently observed, “If (or possibly when) implemented, U.S. consumers would ultimately foot the bill.” The publication further quoted an industry source, who said, “Supply chain disruptions and rising freight costs continue to strain the market, as they do in many other sectors.”

To date, however, Trump hasn’t carried out the tariffs against Colombia, the world’s third-largest coffee producer.

Moreover, according to a March 6 article in the industry publication, Global Coffee Report, “Consumers in this segment are considered to be more price-sensitive, and even modest price hikes could push them to switch to cheaper alternatives.”

With cheaper tea now being more popular than coffee in 30 U.S. states, it’s not inconceivable that continued coffee price hikes could further push coffee drinkers into this beverage category. However, Starbucks is somewhat insulated from this trend as the company has been expanding its tea offerings and believes it can gain a bigger share of the $80 billion global tea market.

After taking a 50% profit in SBUX earlier this week, the shares remain a Hold in the portfolio.

RATINGS CHANGES: I recommend that we exit our position in Janus Henderson Group (JHG). The stock has come under heavy selling pressure of late and has decisively closed under its 200-day moving average in a sign that the stock’s formerly strong momentum has been lost. Getting out now gives us a 40% profit in a position that was first initiated in June 2022. Sell

Earlier this week, we took a 50% profit in Starbucks (SBUX) while downgrading the shares from Buy to Hold. Sell a Half

We also exited our remaining 50% stake in American Airlines (AAL) earlier this week. Sell

NEW POSITIONS: None this week.

Friday, March 7, 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 20 minutes and covers:

• My answer to the question, “What constitutes a bear market…and are we in one yet?”
• How the Tooth Fairy Index can signal an upcoming bear market/recession.
• Toy stocks offer attractive hedging potential in a challenging market environment.
• Final note
  
  • Starbucks (SBUX) could still benefit from tea if recent supply-chain problems for coffee persist.

Market Outlook

A question that demands an answer in view of recent market events is, “At what point does a bear market begin?”

The traditional answer is that a decline of at least 20% in the S&P 500 index constitutes a bear. But the problem with that definition is obvious: By the time the bear is officially declared, it’s typically over, since (with some notable exceptions) selling events more often than not end after 20% to 30% declines. Clearly, the classical bear market definition is more descriptive than prescriptive.

While a more utilitarian method for identifying the bear when he first makes his appearance will admittedly involve a great deal of subjectivity, I propose a simple rule for it: When a majority of the major indexes—small-, mid- and large-cap—violate their respective 200-day moving averages on a closing basis, it’s a bear market.

Admittedly, there are potential pitfalls involved with this simplified (some would say overly simplistic) definition, including the possibility for the market to reverse its downward trend immediately after closing under the 200-day trend line. But given the ubiquity of interest that individual traders and institutional investors alike have in watching this particular trend line, it has taken on its own psychological significance as a barometer of broad market health. For that reason alone, I don’t think it’s a stretch to view it as a “line in the sand” bull/bear identifier.

Moreover, by the time the 200-day trend line is broken there has usually already been a significant amount of internal damage in the market, as identified by deteriorating breadth readings, as well as major declines if not outright crashes in leading stocks. And that manifestly is the case right now, with several leading large-cap companies and growth stocks having crashed in recent days.

As it now stands on early Friday morning, March 7, three of the six major indexes that comprise my trend indicator have already broken under the 200-day line. These include the Nasdaq 100, the Russell 2000 Small-Cap and the S&P 400 Mid-Cap indexes. The large-cap indexes that include the S&P 500, the Dow Industrials and the NYSE Composite are still above the trend line, which I would argue signals a neutral market (as I stated last week).

However, the S&P 500 is right at the 200-day line as of now, and if it closes under this trend line on Friday, I’d be inclined to call that a bear signal since a majority of the six major indexes would have violated the “line in the sand.”

Arguably the biggest concern from a technical standpoint has been the continued erosion within the market as evidenced by the NYSE new highs and lows. For the last month, stocks making new 52-week lows have been abnormally large on most days. Historically, anything above 40 new lows a day is considered to be above normal and a sign that internal selling pressure is building.

In recent days, we’ve seen the new lows in triple digits, and while this can sometimes signal that capitulation is imminent, the fact that the lows have been trending higher for most of this year is troubling. What’s more, the types of stocks making new lows are spread out across many different industries, which is more typical of an overall bearish environment (as opposed to the concentrated selling within one or two major industries that typifies a market correction).

For investors who are more fundamentally inclined, you might embrace Wall Street economist Ed Yardeni’s view of a bear market, namely that they are caused by recessions. I don’t entirely agree with that assessment, but here’s some food for thought on that score: According to the latest Federal Reserve data, consumer spending adjusted for inflation sank 0.5% in January, which marks the biggest monthly decline in four years. The last time this happened, it served as a harbinger for a so-called “technical recession.”

And while this is strictly anecdotal—and admittedly humorous—another consideration is the Tooth Fairy Index. It’s an annual poll released by Delta Dental on the average amount of money parents put under their children’s pillows in “tooth fairy payments” for lost teeth. The poll is then compared with the S&P 500 and, over time, has proven to be a remarkably accurate leading indicator for the equity market, with declines in lost tooth payouts often preceding big market dips.

As the latest poll shows, there has been a substantial decline in the Tooth Fairy Index over the last two years (down almost 20%), as inflation has presumably taken a toll on how much money the “tooth fairy” can afford to pay out. And while correlation shouldn’t be confused with cause, it does beg the question of whether continually rising consumer prices will eventually tilt the economy into recession, thus feeding the bear.

Bottom line, I’m still not quite ready to call this a bear market, but in my estimation, we’re on the brink of what could be considered the beginning of one. Granted, this could be reversed in fairly short order since the technical damage to date hasn’t been severe enough to keep the market stuck in the mud for months on end. For now, though, I think caution is still in order. And that means trimming our sails a bit while also being ultra-selective when initiating new individual stock positions, unless they are defensive in nature.

Watch List

With all the talk swirling around about recessions and bear markets, it behooves us to look at some areas of the market that tend to be immune to such negative environments. Perhaps surprisingly, that would include the toy market.

While parents might be pulling in spending on lost teeth, they’re arguably less inclined to deprive their children of their favorite toys—even when times are tough. Indeed, toy spending in the U.S. tends to be stable even during recessions and is more resilient than other sectors of the economy during the most turbulent of times. As one commentator put it, “While they may cut back on luxury items for themselves, parents still purchase toys, especially for birthdays and holidays.”

A couple of considerations on this subject include the psychology of toy spending; during economic downturns, it’s common for families to spend more time at home and less time traveling, which often translates into more time playing board games, puzzles and other toys geared toward both children and adults.

For instance, during the 2008 credit crisis, the domestic toy industry declined by 5% overall, but not nearly as much as other industries, and some segments of the toy industries saw year-over-year gains (including puzzles and board games). More recently, during the 2020 recession, toy sales actually increased due to the Covid shutdown and government stimulus checks.

However, it’s important to remember that in a deep recession, while toy spending might not decline, consumers will likely shift their purchases to lower-cost toy options while shopping at big-name retailers rather than higher-end stores. This trend is more likely to benefit mass-market brands and discount stores. With this in mind, let’s examine a couple of interesting toy stocks that I think could benefit in the current climate.

Hasbro (HAS) is one of America’s, and the world’s, biggest toy makers with a portfolio consisting of over 1,800 brands. Among them are iconic toy lines like Nerf, G.I. Joe, Transformers and Play-Doh. Its board game offerings include Monopoly, Yahtzee and Clue.

The company performed extremely well during the pandemic years, but then fell out of favor in early 2022 with the stock dropping 70% into 2023. The weakness continued well into that year, as Hasbro struggled with excess inventory and closeouts, as well as problems related to its turnaround plan to discard less profitable toys and business segments.

However, there are signs emerging that the firm is on the right track to right-size the business. A couple of weeks ago, management unveiled a new strategy called “Play to Win,” which seeks to expand the company’s reach from over 500 million kids, families, and fans today to over 750 million by 2027.

As the plan is executed through 2027, Hasbro expects an average of mid-single-digit revenue growth and 50-100 basis points of annual operating profit margin improvement. And by 2026, Hasbro’s gross debt to adjusted EBITDA ratio is projected to stand at 2.5x.

Further, by 2027, Hasbro’s operational excellence program is expected to deliver $1 billion of gross cost savings, with approximately half dropping to the bottom line.

Commenting on the plan, the company’s CEO said, “Our new strategy is grounded in the key insights which will drive Hasbro’s evolution into a modern play company: serving fans of all ages around the world at every price point, and meeting fans where they are playing, which is increasingly online.”

Significantly, Hasbro sees the plan as pivotal to its return to growth. Wall Street tends to agree, with the consensus forecasting the company’s top line to increase by a modest 5% this year, but then growing by low teens percentages in each of the next several years as the plan presumably sees a successful execution. A 4.4% dividend yield is an added bonus.

Mattel (MAT) was a multi-year holding of the Turnaround Letter that was, alas, discarded by yours truly during last year’s portfolio cleanup. But in recent weeks, the stock has finally shown signs of life and may in fact be poised to deliver on its long-awaited turnaround potential.

Mattel is of course known for several world-famous toy lines including Barbie, Hot Wheels, Fisher-Price and Uno. While the company is expected to do well with the Barbie segment this year, doll sales have been struggling categorically in recent years. And although Barbie sales received a big boost from the Barbie movie in 2023, sales of the doll declined 8% year-on-year in 2024.

Meanwhile, Hot Wheels sales are expected to remain strong, with Mattel predicting positive revenue growth of 2-3% driven by continued demand from both children and adult collectors. It’s an overall positive, but not exactly earth-shattering, sales outlook.

However, Mattel is planning to leverage both brands to maximize returns by investing in another category that is experiencing rapid growth—and which could pay off very handsomely in the years ahead.

I’m referring to the comic book craze known as Manga, the Japanese-inspired trend that has swept the U.S. market in the last few years. To get an idea of just how vast this market is, visit any Barnes & Noble bookstore and you’ll see a sizable section of the store dedicated to Manga comics alone.

Mattel just announced it has partnered with anime and manga distributor Tokyopop to develop manga-style graphic novels (i.e. comics that are read from left to right) based on Barbie and Hot Wheels. The graphic novels will be published by Penguin Random House for consumption in the U.S. market.

Along with the foray into manga, Mattel is targeting growth this year and next from its other entertainment initiatives that include theatrical releases for Disney’s Snow White and Wicked 2, as well as digital expansion with the launch of self-published games targeted for 2026. Analysts, meanwhile, expect growth for 2025 to be driven by the firm’s strong position in games, action figures and toy vehicles. It’s a very compelling stock, and I’m seriously considering placing it back into the portfolio.

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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