October 18, 2024

In today’s note, we discuss the reasons why it’s a good time to exit our (mostly) profitable holdings in Alibaba Group Holding (BABA), Nokia (NOK), Tyson Foods (TSN) and Zillow (Z).

We’re adding two new stocks to the portfolio, providing us with exposure to the booming software and utilities sectors.

We’ll also discuss some catalysts for three stocks across three different sectors in what look to be powerful intermediate-term turnarounds.

Comments on Portfolio Holdings

Telecom giant Nokia (NOK) came under some fairly intense selling pressure on Thursday after the company posted an 8% year-over-year revenue decline for Q3 and a weak performance in its Mobile Networks segment. The stock was down by as much as 7% intraday before recovering and closing just 2.5% lower in the latest session. But trading volume on the decline was exceptionally high, and I didn’t like the fact that the stock broke its widely-watched 50-day moving average. Given that the stock, which was first recommended by my predecessor back in 2015, is down substantially from its originally recommended price, I’m going to use this show of conspicuous technical weakness as an excuse to close out what has been a drag on the portfolio. Accordingly, I’m downgrading Nokia to a Sell as of Friday.

Not long ago I said that I would wait for a rally before pulling the trigger on a sell for Tyson Foods (TSN), and here we are, so I’m also placing Tyson on a Sell as of Friday. The poultry processor is still up 15% from last year’s original purchase price, but given the headwinds the company is currently facing in beef, chicken and pork prices, I think this is as good a time as any to take profits and exit the position.

I also think it’s an ideal time to sell our remaining half position in Chinese online retail company Alibaba Group Holding (BABA). It has been an excellent run since we first recommended the stock back in August, but I think the sizzle has clearly worn off the China stock rally after last month’s economic stimulus announcement for the country. As we’ll be discussing in upcoming issues, there seems to be a rotation out of online retail platforms with exposure to China and into businesses with more of a utilitarian focus, particularly those that serve the infrastructure sector. So as of Friday, I’m recommending that we sell the remainder of our open position in BABA giving us a final profit of 21%.

Given the recent weakness in the Treasury market, which heavily influences mortgage rates, I’m also recommending that we sell our remaining three-quarters position in online homebuying platform Zillow (Z). The stock has struggled of late after peaking last month, and my suspicion is that the trade in real estate equities is falling out of favor while other sectors gain the lead. Therefore, we’ll take our remaining profit here, which is 13% at current levels.

The latest portfolio divestments have made room for some new additions, so we’ll start with the aforementioned Centuri Holdings (CTRI). As discussed previously in the podcast, the latest presence of a well-known activist investor with a powerful reach should bode well for the turnaround, so I’m placing the stock on a Buy as of Friday with an initial upside target of 24.

And finally, I’m putting Atlassian (TEAM) on a Buy, as mentioned earlier in the podcast. This will provide us with some exposure to the outperforming software sector. My conservative upside target for this position is the 225 level, but with the potential to move higher beyond the intermediate-term outlook.

RATING CHANGES: Alibaba Group Holding (BABA) has been moved from a Hold to a Sell.

Nokia (NOK) has been moved from Hold to a Sell.

Tyson Foods (TSN) has been moved from a Hold to a Sell.

Zillow (Z) has been moved from a Hold to a Sell.

NEW POSITIONS: Atlassian (TEAM) is being added to the portfolio as a Buy with an initial upside target of 225.

Centuri Holdings (CTRI) is being added to the portfolio as a Buy with an initial upside target of 24 a share.

Friday, October 18, 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 covers:

• Financial market liquidity continues to expand, creating a lively market opportunity for buying turnaround stocks.
• Volatility also remains supportive for buying stocks, even with the upcoming U.S. presidential election.
• The utility sector boom is as much a result of the energy transformation and AI buildout, which favors stocks with utility infrastructure exposure.
• The AI buildout further supports the software sector.
• Comments on portfolio holdings.
• Final note
  
  • The latest divestments in the portfolio have made way for two new additions, with additional new holdings expected in the weeks ahead.

Turnaround Watch List

Just when you thought the supportive liquidity backdrop for equities couldn’t get even better, that’s exactly what it did. In just the last couple of weeks, liquidity has increased to what could be described as spectacular levels.

My favorite liquidity indicator, the NYSE advance-decline line, continues to hit record highs even as certain major indexes have struggled to do so. Additionally, the Bank of America High Yield Index has fallen to multi-year lows, which is considered as a bullish liquidity indication, while high-quality corporate bonds are also reflecting the strength.

All in all, the exceptionally liquid nature of the financial sector has made it very easy for stocks to rally—particularly those that were already in a relative strength position. And for our purposes, it has made finding potential turnaround stock candidates far less difficult than would normally be the case.

A strong liquidity profile also tends to reduce broad market volatility, a fact that can be seen in current readings for the CBOE Volatility Index (VIX). Recent VIX readings have been far below the 25 level, which traditionally separates a bullish from a bearish market environment. In fact, VIX readings of late have tended to be below the 20 level, which makes for an even more favorable buyer’s market.

What’s perhaps most surprising about this dynamic is the fact that the weeks which immediately precede a U.S. presidential election have historically been high-volatility affairs. But far from seeing elevated turbulence, we’re seeing quite the opposite as a surprisingly calm state of mind prevails over the broad market. Granted, this could quickly change as election day draws closer, but given that investors likely regard neither candidate as a major threat to corporate profits, my guess is that the strong liquidity backdrop will continue to support a lower volatility environment well into the fourth quarter.

That said, the naysayers point out that if the market is truly in the bulls’ hands, safe haven assets like gold, utilities and consumer staple stocks shouldn’t be outperforming right now. This is a fair enough point, but by the same token, it’s not unusual for a bull market to be characterized by categorical strength across all major sectors—including the defensive ones. What’s more, it can be argued that the strength in gold, utilities and staples is due to investors hedging their bullish bets by some having exposure to the traditional safe havens.

And while we’re on the subject of the utilities, another likely reason for the strength in this defensive sector is the enormous investment that will be required for the alternative energy and emerging technology buildout. Consider just one aspect of this trend, namely the artificial intelligence boom. The amount of electricity required to run generative AI applications, while difficult to fully quantify, is expected to constitute a significant portion of the world’s energy generation in the coming years. By one estimate, the energy consumption of AI and cloud computing alone could account for up to 8% of global electricity use if current trends continue.

To give just one example of how much electricity is required to support generative AI, a recent Carnegie Mellon study found that generating a single image using a powerful AI model takes as much energy as fully charging your smartphone. This certainly provides greater perspective on the relentless strength in utility, nuclear and alternate energy stocks.

While utilities fall more under the category of momentum stocks than turnarounds, that’s not to say there aren’t turnaround opportunities within this group. One very conspicuous instance of this, I think, can be found in a relative newcomer to the utilities space, namely Centuri Holdings (CTRI).

More specifically, Centuri is a strategic infrastructure services company that partners with regulated utilities to help build and maintain the energy network that powers millions of homes and businesses across the U.S. and Canada. The company was established 10 years ago but came public in April at around 23 a share. It quickly rallied to a high of 28, then came under selling pressure and dropped all the way down to around 14 in August before finding support above that level.

Aside from the usual post-IPO buyer’s remorse, a big reason for the decline was investors’ perception that Centuri’s revenues weren’t living up to expectations. Despite having some of the lowest reliance on fixed price contracts within the industry, Centuri saw revenue drop 17% year-on-year in Q2 while earnings missed estimates by 10%. But aside from this setback, there are signs that the company’s future prospects are decidedly more sanguine. Wall Street sees a massive 63% leap in earnings next year, with additional strong double-digit growth in each of the next few years as the massive-scale utilities buildout boom presumably gathers steam in support of electric grid modernization, EV and alternative energy structure, and of course, AI.

Of particular interest, hedge fund manager Carl Icahn has recently initiated a nearly 3 million-share stake in Centuri which, given Icahn’s history of picking winners, should bode well for the stock’s turnaround prospects.

Next up for consideration is a stock that pertains to the continuation of last week’s discussion of the bullish potential in the transportation group, namely the airlines. Despite exiting the S&P 500 Index in September, American Airlines (AAL) continues to strengthen after turning a corner this summer. Broadly speaking, airlines are showing improved revenue trends after a horrendous showing during the Covid years, with both domestic and international flight trends drastically improving this year.

According to the International Air Transport Association (IATA), net profits for the global airline industry are expected to improve in 2024 by 11% from a year ago, with net margins also expected to increase. Total travelers, meanwhile, are expected to reach a record high of 5 billion in 2024.

Domestically, 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 and record anticipated passenger revenue. In addition, the full-time U.S. airline workforce is the highest it has been in over two decades.

As for American Airlines, it’s worth noting that stocks that are delisted from major indexes often rally in the months following the delisting. What’s more, the company has the added potential impetus of a strong earnings backdrop: Analysts see the bottom line growing by around 40% in each of the next two years starting with 2025, with profits accelerating even more in the years to follow, driven by improvements in air travel costs and efficiencies along with the continued growth of expeditious online booking platforms. All told, I like what I’m seeing in AAL.

And finally, on the still-bullish software front, Atlassian (TEAM) has lately caught my attention. The company is a project management and collaboration specialist that has positioned itself to dramatically boost revenue from its customers now that the next software spending cycle is underway.

For 2024, global software spending is projected to grow 14% from last year, reaching approximately $1 trillion. The growth is being driven mainly by increased investments in AI, cloud services, cybersecurity and automation technologies, but Atlassian’s offerings are also poised to benefit from the higher spending.

The fact that Atlassian also weaves AI throughout its various offerings is another potential growth catalyst, with the continuation of the digital transformation and cloud migration, plus the hybrid work trend, all combining to make the firm’s software attractive to new potential customers. To that end, Atlassian’s total addressable market (TAM) is a whopping $67 billion, a figure that’s expected to grow 13% annually.

Atlassian also just landed on a major Wall Street investment bank’s “highest conviction” list, thanks in part to high-level federal software spending and rising earnings expectations for software-as-a-service (SaaS) companies. When the company releases earnings on October 31, analysts expect 18% year-on-year revenue growth, which could prove conservative given the strength of the ongoing software spending cycle.

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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