October 11, 2024

In today’s note, we discuss the acceleration—and potential for overcrowding—of the China stock momentum trend, specifically how it relates to our position in Alibaba Group Holding (BABA).

The latest additions to this week’s portfolio updates, we’ll also discuss some catalysts for four transportation stocks to begin what could be intermediate-term turnarounds.

We also discuss the latest global economic events that should boost the market for aluminum, while improving the outlook for a couple of major U.S.-based aluminum producers.

Comments on Portfolio Holdings

The latest issue of Barron’s drew attention to the growing momentum trade in China stocks, which have rapidly become effervescent. No, I’m not calling this a China bubble, but the market does look to be getting a bit too crowded for comfort. From a contrarian’s perspective, as smaller traders pile into China stocks, the bigger institutions that have already built up considerable positions in major China ADRs will undoubtedly look to unload some of their holdings to take advantage of the easy profits.

Our position in Alibaba Group Holding (BABA) continues to perform well despite a well-earned pullback earlier this week. The stock is up 32% since first being recommended back in August, and we still own a 50% position in BABA. I’m OK with how the stock has acted lately and plan on retaining that position for now, but I’ll be watching closely for signs of overheating as the China trade gains more attention in the financial news media. Meanwhile, a major institution just upgraded Alibaba from Neutral to Outperform, which provided some additional near-term momentum for the shares. The stock retains a Hold rating in our portfolio.

We still have a 4% gain in our position in medical device maker Solventum (SOLV) despite the recent dip in the share price. A major Wall Street institution initiated coverage on the company with a Buy recommendation, citing a faster-than-expected turnaround, stating the turnaround story “is likely to unfold over a multi-year timeframe.” However, it added that “fundamental change is underway and will transpire at a faster, ever-more-visible pace and magnitude than investors currently contemplate.” The analysts placed a conservative 82 price target on Solventum, which isn’t too far below our 90 upside objective. The stock remains on a Buy for now in the portfolio.

On the housing market front, the Fed’s recent easing policy has resulted in a rush among previously hesitant homebuyers to lock in new mortgages. According to Redfin, there was a 70% spike in mortgage lock-in activity in September compared to the previous month, with mortgage purchase applications increasing more than 10% month-over-month, potentially leading to higher home sales over the next few weeks, according to the online real estate broker.

This should theoretically bode well for fellow real estate brokerage, Zillow Holdings (Z). However, the stock has lately come under selling pressure due to rising Treasury bond yields and currently sits at what I regard as a “line in the sand” at the 60 a share level. I’ve decided that if Zillow decisively falls under this level, I’m going to recommend that we sell our long position in the stock at what should be an 8% profit.

Granted, the turnaround potential in Zillow should be more of an intermediate-term affair, but I’m extremely leery where mortgage-related equities are concerned and for that reason I’m not willing to give Zillow a longer turnaround leash. So, if 60 is broken decisively at any time in the next few days, we’ll be exiting our position. It remains a Hold for now, and we’ve already taken a one-quarter profit in the position.

Novo Nordisk and Viatris (VTRS) have reportedly reached an agreement in their dispute over U.S. patents protecting Novo’s popular weight-loss drugs Wegovy and Ozempic. The suit involved Novo’s attempt at blocking Viatris from launching generic versions of the products. Viatris did not immediately respond to a Reuters request for comment. I’ve downgraded the stock to a Hold rating in the portfolio.

Finally, I’m making a new addition to the portfolio this week in the form of Alcoa (AA), which was discussed in this week’s podcast. The company releases earnings next Wednesday, so there’s an earnings-related volatility risk in the coming days. But I think the stock’s risk/reward profile merits a nibble around current levels, with an upside target of 50. For Q3, Wall Street expects 14% year-on-year revenue growth, with additional 14-to-16% growth in each of the next two quarters. BUY

RATING CHANGES: Viatris (VTRS) has been moved from Buy to Hold.

NEW POSITIONS: Alcoa (AA) is being added to the portfolio as a Buy with an initial upside target of 50 a share.

Friday, October 11, 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 14 minutes and includes:

• Discussion of the impact China’s recent stimulus measures have had—and are likely to continue having—on base metals prices and companies (especially aluminum).
  
• Transportation stocks across all segments of the industry are showing improving strength, with airlines taking the lead after a record-breaking summer.
  
• A look at two aluminum stocks with intriguing turnaround potential thanks to China’s ongoing fiscal stimulus measures and improving industry fundamentals.
  
• Comments on portfolio holdings.
  
• Final note
  
  • We’re watching closely our three-quarters position in Zillow (Z) despite an improving housing market outlook.

Turnaround Watch List

As discussed in this week’s podcast, certain areas of transportation are starting to show up on my relative strength radar, including members of the airline, trucking and railroad groups. Meanwhile, certain base metal companies are also strengthening along with farm-related commodity stocks. All told, there’s a nice mix of strength across a variety of sectors and industry groups, which supports an overall healthy broad market environment.

In the transport group, airlines are coming off one of the strongest summers ever, as travel demand broke several records in the U.S. during the latest travel season. Among the records set was the highest six-month total ever for ticket sales, record full-year revenue (which is forecast to be nearly $1 trillion!) and record anticipated passenger revenue. In addition, the full-time U.S. airline workforce is the highest it has been in over two decades.

Economy airline JetBlue (JBLU) hasn’t kept pace with some of its industry peers since bottoming out last year. Unfavorable revenue trends, worker shortages and other problems arising from the wake of the 2020 shutdown all combined to put the stock in a tailspin for several years. But the company has made some meaningful changes in its turnaround attempt over the last year, including better on-time performance and short-term bookings, lower fuel prices and the overall falling rate environment—all of which bode well for the airliner’s continued recovery going forward.

Falling rates in particular should help JetBlue’s attempt at transitioning to offering its customers more premiums and a better experience, moves recently implemented by other low-cost carriers. Going forward, management also plans to decrease capital spending, defer aircraft deliveries and improve the balance sheet in its ongoing attempt at strengthening its image and bolstering its overall position in the competitive air travel space. For investors with a long-term timeframe, I think the stock looks reasonable for nibbling around current levels or on minor weakness.

On the trucking industry front, the American Trucking Association’s advanced seasonally adjusted For-Hire Truck Tonnage Index grew nearly 2% in August after rising half a percent in July and continues its recovery after last year’s declining shipping trend. The latest levels are the highest in nearly three years, and according to an industry spokesman, the latest data shows a “robust gain” and suggests that freight levels are coming off the bottom and continuing to turn around.

On that score, a couple of trucking stocks that I believe have intermediate-term turnaround potential are J.B. Hunt (JBHT) and Saia Inc. (SAIA). I can’t currently recommend either stock for short-term purchases, however, as the bottoming patterns in both haven’t yet been fully established. But both are worth keeping on the watchlist for potential inclusion in our turnaround portfolio in the coming months.

And finally, while it’s not exactly a transportation company, Georgia-based AGCO (AGCO) does have a transportation management system that helps manage supply chains by sea, land or air. The company’s main claim to fame is as the world’s largest manufacturer of machinery and equipment focused solely on the ag industry. Its tractors and combine harvesters are used by farmers globally (including the Challenger, Fendt and Massey Ferguson brands), but after the last major farm machine upgrade cycle in 2022 and 2023, tractor sales have softened in the past year.

However, management believes lower farm input costs—including fertilizer and fuel—lower interest rates and growing demand for ag production in several emerging countries it serves will be the catalyst that ignites a renewed upcycle for tractor and farm equipment sales in 2025.

Moreover, AGCO is facing a request from its biggest shareholder for a drastic change of its board of directors, which could serve as a further catalyst for a turnaround. As with the aforementioned stocks, I’m not yet ready to recommend AGCO shares for purchase, but I believe the time is getting closer when we’ll have an entry point (assuming the board shakeup pans out).

But even more than transportation, the industry where I’m seeing the most strength is the overlooked base metals group, particularly aluminum. On this front, a couple of standouts are worth mentioning, namely Alcoa (AA) and Century Aluminum (CENX).

Aluminum demand is on the rise thanks to an ongoing recovery in packaging, electrical and automotive applications. According to a major industry group, global demand for the metal will increase by almost 40% by 2030, which means the sector will need to produce an additional 33 metric tons to meet demand growth in all industrial sectors, including transportation, construction, packaging and electronics.

At a recent industry conference, the top brass at Alcoa said that it’s seeing considerable growth in India and emerging Asian countries, which amounts to around 10% year-over-year growth overall. The company emphasized the growth is across all sectors, including building and construction, but particularly in packaging. In recognition of the improving industry fundamentals, a major Wall Street bank just increased its rating on Alcoa from Neutral to Buy and raised its share price guidance, citing a bullish aluminum price outlook for 2025-26 due to strong global demand and supply constraints.

Meanwhile, the ongoing fiscal stimulus measures in China are expected to boost base metals demand next year, with the country considering an additional $142 billion capital injection into the biggest state banks.

Among the base metal miners expected to benefit from the stimulus is Chicago-based Century Aluminum. It’s the largest producer of primary aluminum in the U.S., with plants in Kentucky, South Carolina and Iceland. The company has exposure to the lucrative Chinese market for the base metal, but its key markets are the U.S. and Europe, where it sees robust demand as it relates to the so-called “green economy,” especially in solar energy and other energy transmission applications.

The company is making progress on its growth projects, is making significant strides in reducing debt and improving liquidity and sees continued strength in aluminum prices in the coming quarters, while analysts see several quarters of improving bottom-line growth heading into next year.

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

Copyright © 2024. All rights reserved. Copying or electronic transmission of this information without permission is a violation of copyright law. For the protection of our subscribers, copyright violations will result in immediate termination of all subscriptions without refund. Disclosures: Cabot Wealth Network exists to serve you, our readers. We derive 100% of our revenue, or close to it, from selling subscriptions to our publications. Neither Cabot Wealth Network nor our employees are compensated in any way by the companies whose stocks we recommend or providers of associated financial services. Employees of Cabot Wealth Network may own some of the stocks recommended by our advisory services. Disclaimer: Sources of information are believed to be reliable but they are not guaranteed to be complete or error-free. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Buy/Sell Recommendations: are made in regular issues, updates, or alerts by email and on the private subscriber website. Subscribers agree to adhere to all terms and conditions which can be found on CabotWealth.com and are subject to change. Violations will result in termination of all subscriptions without refund in addition to any civil and criminal penalties available under the law.