November 22, 2024

In today’s note, we discuss a number of earnings results and new developments for several of our portfolio positions, including Alcoa (AA), Brookfield Wealth Solutions (BNT), Intel (INTC) and Starbucks (SBUX).

The broad market outlook remains bullish for the rest of this year and early next year, but with the possibility for weakness to emerge heading further into 2025.

We’re adding SLB Ltd. (SLB) to our portfolio on the basis of a big improvement in the outlook for oil and, particularly, for natural gas.

We’ll also discuss some catalysts for two attractive companies in the percolating energy sector.

Comments on Portfolio Holdings

Alcoa (AA) shares jumped after China canceled a tax rebate on exports of aluminum and other commodities. Aluminum futures on the London Metal Exchange have rallied by more than 10% following the announcement from China’s Ministry of Finance.

China announced it will end tax rebates on exports of semi-manufactured aluminum products in December, removing around five million tons of supply from the international market, according to industry estimates. Alcoa remains a Hold after our recent decision to book a one-quarter profit.

Brookfield Wealth Solutions (BNT) last week released Q3 results that featured a head-turning 94% year-on-year revenue increase, to $3 billion, plus earnings of eight cents that increased 14%.

Across the full portfolio, Brookfield originated approximately $4 billion in proprietary investment strategies during the quarter at returns in excess of 8% and generated $4 billion of annuity sales, bringing the year-to-date total to $12 billion.

The company noted that it’s in a strong liquidity position across the portfolio, with approximately $31 billion of cash and short-term liquid investments across its investment portfolios, plus another $21 billion of long-term liquid investments. Management said these liquid assets will support the ongoing rotation among investment portfolios into higher-yielding investment strategies, while ensuring it has “sufficient liquidity coverage for liabilities in the case of any stress events impacting the broader market.” The stock remains a Hold in the portfolio.

Meanwhile this week, the White House has finalized up to $1.5 billion in direct funding for semiconductor contractor GlobalFoundries (GFS) as part of the CHIPS and Science Act. The award enables the company to expand essential chip production and technology development in the U.S.

The CHIPS Act provides for $39 billion in grants, billions more in loans and 25% tax credits to boost domestic chip manufacturing and reduce reliance on Asia. The GlobalFoundries announcement marked the first major CHIPS Act deal to be completed, while Intel (INTC) and other semiconductor companies are still discussing details of agreements. Intel remains a Buy in the portfolio.

Starbucks (SBUX) is said to be considering a sale of a stake in its Chinese operations. Bloomberg News reported on Thursday that the company has been consulting with advisers on ways to expand its operations in China, including the potential introduction of a local partner. The company has informally evaluated interest from prospective investors, including domestic private equity firms, according to Bloomberg.

China represents the second-biggest market globally for Starbucks, but domestic competitors like Luckin Coffee are undermining the firm’s market share. In its latest earnings call, turnaround CEO Brian Niccol said that all indications show that China’s competitive environment is “extreme,” with additional headwinds from the macroeconomic environment.

The firm’s contemplation of selling China assets is also being prompted by activist investor Elliott Management, which “wants it to commit to reviewing its Chinese business,” according to a recent Seeking Alpha news report. No decision on how Starbucks plans to proceed has been made yet. The stock remains a Buy in the portfolio.

RATING CHANGES: None this week.

NEW POSITIONS: SLB Ltd. (SLB) is being added to the portfolio this week as a Buy with an initial upside target of 55. I recommend using an initial stop-loss slightly under 39.50 for this position.

Friday, November 22, 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:

• Liquidity and investor sentiment backdrop remain favorable for the rest of Q4.
• We explore the bearish case for next year.
• The energy sector should yield an increasing number of turnaround candidates heading into 2025.
• Comments on portfolio holdings.
• Final note
  
  • SLB (SLB) and other energy players with a presence in both traditional and renewable energy are poised to benefit from a looser domestic energy policy under the incoming White House administration.

Turnaround Watchlist

A backdrop of plentiful liquidity as measured by my favorite indicators also continues to support stocks. In particular, bitcoin ETF prices are reaching new records on almost a daily basis in a sign that money is strongly flowing into speculative assets.

Meanwhile, the latest AAII investor sentiment poll revealed that 41% of investors are bullish versus 33% bearish, which is a significant improvement from last week and suggests that sentiment remains cautiously optimistic in support of the near-term outlook.

It’s also worth pointing out that some of the market’s strongest performers of late have been in the rate-sensitive financial sector, with bank and broker/dealer stocks cranking out new highs in the days since the election.

And speaking of the presidential election, according to Bloomberg data (see chart below), during the last eight elections, the S&P 500 increased an average of 7% in the six months after election day, compared with a gain of 1.5% in the six months prior.

All told, the weight of evidence sends a message that favors the continuation of the broad market uptrend, which in turn should prove supportive for our turnaround positions in the portfolio. My best guess is that the strength will continue through year end, especially as the historically bullish month of December is expected to see buoyant holiday retail sales backed by lower inflation expectations in the coming months.

Now with all of that said, not everything beyond the short-term outlook is entirely rosy. You may have noticed that the defensive-oriented assets that were jettisoned immediately prior to the election, and in its immediate wake, have been making a comeback in just the last few days. Utilities, consumer staples and even the beleaguered healthcare sector stocks have been showing strength this week.

And just when it looked like the precious metals were falling out of favor, gold is clawing its way back toward last month’s peak price. This could certainly be taken as a sign that informed investors have reassessed the possibility for a market setback in the coming months and are buying protection for it while still maintaining a mostly bullish posture.

Then there’s the contrarian case to consider, namely that a growing number of observers now see the equity market as being “priced to perfection.” In fact, those exact words were used in the headline of a November 13 CNBC article by Jeff Cox, which warned that “there is concern that the market is pulling forward gains now and could pay the price later.”

However, that same article concluded with a quote from investment strategist Jim Paulsen, who observed that market uncertainty (the so-called “Wall of Worry”) has often led to higher stock prices. Thus, what started as an ominous warning about a potential post-election downturn turned into an assurance, as the article ended with Paulsen’s quote: “I don’t think we’re falling apart and I don’t think the market’s all that far ahead of itself so much as people think.”

Yet another contrarian consideration is that investors are heavily positioned for a market melt-up. As a recent Wall Street Journal article put it, participants have lately “stampeded into funds tracking U.S. stocks” with index ETFs bringing in nearly $56 billion in the week of November 13—the second-largest weekly inflow since 2008, while one of the largest ETFs tied to the Russell 2000 Index attracted almost $4 billion in a single trading session earlier this month—the highest rate since 2007. The latter year, of course, immediately preceded the financial crisis that lay ahead.

Meanwhile, the Financial Times reported that the trading accounts of U.S. banks exceeded $1 trillion in this year’s Q3, which is the highest level since 2008 (again, immediately prior to the worst part of the credit crisis). FT further noted that the growth of trading funds had left the banks, “particularly the largest ones, more exposed to market moves than at any time since the financial crisis as they hold ever-greater inventories of price-sensitive securities.”

Additionally, WSJ noted: “Three of the top five days for trading in call options…have occurred [in November], according to options records going back to 1973.” This serves as a further warning from a contrarian perspective that perhaps the stock market really is “priced to perfection” and therefore vulnerable to a setback.

In view of the contrarian case for the bear to possibly emerge in the coming months, the temptation to view the ProShares UltraShort S&P 500 ETF (SDS) as a potential turnaround play for 2025 might just be too great to resist for some participants. Indeed, after declining 60% from its October 2022 high price (when broad market selling pressure reached a peak), SDS could almost be regarded as something of a “value” play for next year.

All things considered, however, I’m not in the business of assuming the worst-case scenario will happen, nor do I consider it prudent to predict bear markets (which tend to be elusive whenever they are sought by analysts). Instead, I look for signs of early strength in overlooked areas of the market that will likely surprise investors with a strong performance in the months ahead.

Right now, I’m seeing preliminary indications that the largely ignored energy sector could turn the corner in 2025. Specifically, I’m seeing value in coal, oil and natural gas stocks, and especially in companies in those areas that are also transitioning into renewable energy while maintaining a footprint in traditional fuel exploration and production.

Last week I drew attention to Comstock Resources (CRK), an independent energy company that explores and produces natural gas and oil properties in Louisiana and Texas. I noted that Comstock is something of a contrarian play, mainly because natural gas has been in a well-publicized bear market for the last couple of years. But with natural gas prices having likely turned a corner and starting to perk up, the company—along with other domestic energy sector players—is poised to benefit from the favorable energy price outlook going forward. (Indeed, natural gas prices rallied nearly 30% in just the last week!)

With that said, let’s take a look at some other players in the percolating energy space to see if we can find some more turnaround candidates.

SLB Ltd. (SLB), formerly Schlumberger, is the world’s largest oilfield service company, offering technology and project management solutions for petroleum producers with operations in over 100 countries. While decarbonization has become a bigger focus for SLB going forward, traditional fossil fuels are where most of the action is right now.

In its latest financial quarter, SLB posted revenue of over $9 billion that increased 10% from a year ago, plus adjusted EBITDA of $2.3 billion that jumped 13%. A key highlight of the third-quarter report was the firm’s Digital Technology business, which grew 25% as its “customers are increasingly embracing digital technology to shorten planning cycle times, boost automation, and extract efficiency,” in the company’s words. SLB sees this segment as a key growth driver going forward.

SLB further reported that some of its customers have adopted a cautious approach to their near-term capital expenditures and discretionary spending amid lower commodity prices, but that most projects are “progressing as planned.” What’s more, management said that recent geopolitical events have further highlighted the importance of long-term energy security and reducing potential supply disruptions.

Against a backdrop of improving natural gas prices—plus the potential for an oil price rebound if geopolitical tensions escalate as many expect—the company expects to see earnings growth momentum to increase going forward. In its Q3 earnings call, management had this to say:

“Although the rate of upstream spending growth has moderated in the last few months due to the macroenvironment, we continue to expect a sustained level of upstream investment in the years to come. In this context, we anticipate delivering strong cash flows and a full-year adjusted EBITDA margin at or above 25%, supported by our international leadership, robust digital sales, and ongoing cost optimization initiatives.”

All told, SLB sees itself remaining well positioned to deliver further margin expansion and increased returns to shareholders in the coming quarters. Wall Street analysts, meanwhile, have set a very low bar for 2025, but I believe their estimates are far too conservative.

Halliburton (HAL) is one of the largest and broadest oil service outfits out there, with various products and technologies that help clients with reservoir evaluation, well construction and completions, production and more.

The company is forecasting improving natural gas prices for next year and is well positioned to benefit from this development through a combination of M&A and internal product development. As highlighted in a recent research report by analyst Richard Durant, artificial lift is one area of strength for Halliburton right now, with the firm’s artificial lift product line growing at double the industry average in international markets. Drilling services is another growth prospect for Halliburton going forward, with its drilling services revenue in the Middle East growing by a remarkable 30% year-on-year.

In its recently reported Q3 results, Halliburton’s sales and earnings were mostly flat from lost or delayed revenue due to the August cybersecurity event and storms in the Gulf of Mexico. However, the top brass expects free cash flow and cash return to shareholders to accelerate in the fourth quarter as operations return to normal. Rising energy prices should further lift the bullish case for the company.

Going forward, Halliburton sees “solid opportunities” across business lines and geographies, particularly overseas. It’s further prioritizing capital allocation “to the highest return opportunities” as well as free cash flow generation and shareholder returns. Accordingly, I’m placing Halliburton high atop our turnaround watchlist with a buy confirmation likely forthcoming.

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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