October 25, 2024

In today’s note, we discuss a flurry of key news developments for several of our portfolio positions, including Baxter International (BAX), B2Gold (BTG), Intel (INTC), Polaris (PII), Solventum (SOLV), Viatris (VTRS) and Vodaphone (VOD).

We’re adding two new stocks to the portfolio, providing us with exposure to the white-hot silver mining sector as well as the seasonally strong food services industry.

We’ll also discuss some catalysts for the under-the-radar restaurant group, including three very attractive potential turnaround plays.

Comments on Portfolio Holdings

A few words about the precious metals outlook are in order. I began covering gold as an analyst back in 1998, and I’ve seldom seen a more sustained level of strength in the gold price over that time than I’ve seen in in the last year. Clearly, gold’s bull market is being driven by much more than the normal cyclical considerations, and I think it has approached a point where we can now describe it as a secular uptrend.

The catalysts are a likely mix of geopolitical concerns, with an expansion of the wars in the Middle East and Eastern Europe looking increasingly likely, while worries over the U.S. political and economic outlooks are also proliferating. Historically, gold outperforms in such a climate due to its established reputation as the ultimate safe-haven asset, and for this reason I expect the yellow metal to remain strong well into next year.

I think we have more than ample exposure to gold through our current portfolio holdings, but I’m proposing a change as of today. Specifically, I recommend that we buy a position in Pan American Silver (PAAS), a leading producer of silver and gold in the Americas, with operations in Canada, Mexico, Peru, Brazil, Bolivia, Chile and Argentina.

This decision is being made with an eye toward gaining some silver exposure in the portfolio, as the white metal looks to be in the early stages of playing “catch-up” with gold prices. And as discussed in a recent podcast, I’m seeing considerable strength and growing momentum in some of the blue-chip silver mining companies like Pan American. For PAAS, I’m assigning an initial upside target of 30-to-31 a share. I’ll have more to say about Pan American in next week’s monthly issue of the newsletter.

Multinational healthcare firm Baxter International (BAX) announced Thursday that it plans to restart its North Cove manufacturing facility in North Carolina, which was knocked offline by Hurricane Helene. Resumption of production is expected by the end of next week, but Baxter is still unsure when pre-hurricane production levels will be restored. However, the company said that staffing at the plant, which was damaged by flooding during the storm, would return to pre-hurricane levels by the end of this week. The plant is America’s biggest producer of intravenous and peritoneal dialysis solutions. Separately, Baxter announced that the FDA has temporarily authorized the importation of certain IV solution products made at its plants in Thailand and Singapore with a goal of returning to 90% to 100% allocation of this product category by the end of this year.

Financial services firm Canaccord Genuity just released its top mining sector picks, which happened to include our holding of senior precious metals producer B2Gold (BTG). The firm initially placed a buy rating on B2Gold last year after the company announced its acquisition of the Canadian miners Sabina Gold & Silver Corp. The analysts believe B2Gold’s experience with arctic mining will provide it with an edge over competitors in its developments of those resources. Shares of BTG are up 18% since being recommended in August, and are just under a 12-month high.

Chipmaker Intel (INTC) this week won an antitrust case in the European Union after the EU’s main court confirmed a lower court’s decision to overturn a billion-euro antitrust penalty. The case dates back to 2009, when the European Commission levied a $1 billion fine on Intel for allegedly using illegal sales tactics to keep smaller competitors out of the market. It accused Intel of abusing its dominant position in the global market for x86 microprocessors with a strategy to exclude rivals by using rebates. Shares were basically unaffected by the ruling.

Shares of Polaris (PII) were sold off this week after the company reported a 23% revenue decline for Q3. Sales were negatively impacted by lower volume, a negative mix and net pricing driven by higher promotional activity, with the firm’s North American segment seeing a pronounced 26% sales decline. The results were also due to Polaris taking actions to lower production and shipments to protect our dealer network during what it called a “challenging macroeconomic backdrop.” After the stock sell-off, I’m moving Polaris to a sell as the stock hasn’t lived up to its billing since first being recommended by one of my predecessors back in 2022. So as of today, PII is a Sell.

On Thursday, shares of medical device maker Solventum (SOLV) gained 4% after a report that it has hired bankers to explore a sale of its purification and filtration business. According to a Wall Street Journal report, the company is in the early stages of the sales process for the unit, which did $1 billion in sales last year and accounted for 12% of the company’s total sales. However, management cautioned there’s also a possibility the sale will not occur. That said, the unit is expected to draw interest from strategic and private-equity buyers, according to Solventum, which would likely use proceeds from a sale to pay down debt or for research and development. The story remains ongoing and will be updated as soon as more details emerge.

Pharmaceutical firm Viatris (VTRS) has just announced it has obtained an exclusive license to market Lexicon Pharmaceuticals’ (LXRX) drug sotagliflozin outside of the U.S. and Europe for all indications, including cardiovascular health. Under the agreement, Lexicon will receive an upfront payment of $25 million, with the potential for milestone payments plus tiered royalties ranging from low double-digits to the upper-teens on annual net sales.

While we’re in housecleaning mode, let’s go ahead and take this opportunity to cut another legacy name from the portfolio, namely Vodaphone (VOD). The British multinational telecom company has gone nowhere since our last update and appears to be establishing the early stages of a potential new downward trend in the share price. While Vodaphone has made some progress on its turnaround strategic objectives, including the recent sale of Vodaphone Spain, growth in the company’s top market Germany has been described as “sluggish” by analysts, while its merger with Three UK could require expensive remedies in the form of a significant investment commitment by the combined company to improve network infrastructure. Consequently, I’m using the lackadaisical performance of the stock as an opportunity to remove this laggard position from the portfolio and placing VOD on a Sell as of today.

By way of replacing some of the shares cut from the portfolio, I’m recommending the purchase of Super Hi International Holding (HDL), discussed previously in the podcast, as of Friday. I’ll have more to say about HDL in next week’s issue. To reiterate, I’m assigning a Buy rating on HDL with an initial upside target of 27.

RATING CHANGES: Polaris (PII) has been moved from a Hold to a Sell.

Vodaphone (VOD) has been moved from Buy to a Sell.

NEW POSITIONS: Pan American Silver (PAAS) is being added to the portfolio as a Buy with an initial upside target of 30-to-31.

Super Hi International Holding (HDL) is being added to the portfolio as a Buy with an initial upside target of 27.

Friday, October 25, 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 19 minutes and covers:

• Key leading indicators continue to support an overall favorable outlook for the near-term broad market trend in the face of an historically volatile election season.
  
• The NASDAQ, however, is showing internal weakness, mainly attributable to increased healthcare sector selling.
  
• Restaurant stocks look to outperform as we enter one of the most seasonally favorable periods of the year for the group.
  
• Comments on portfolio holdings.
  
• Final note
  
  • The latest divestments in the portfolio have made way for two new additions, with more new holdings expected in the weeks ahead.

Turnaround Watch List

In my constant scan for sectors showing significant turnaround potential, I’ve lately had my eye on the restaurant group. On that subject, America’s favorite fast food chain, McDonald’s, made news headlines this week—but for all the wrong reasons. An E. coli outbreak in the western U.S. resulted in a highly publicized removal of McDonald’s quarter pounder burgers from the menu in one out of every five of its restaurants.

But while McDonald’s stock took a big hit after the news broke, other restaurant stocks were basically unaffected. In fact, there are signs that many actively traded restaurant stocks are under accumulation by informed investors as the food services sector has been largely under the radar for most of this year. As a result, a growing number of restaurant stocks are what I view as prime turnaround candidates.

It’s also worth mentioning that we’re heading into what could be considered prime “restaurant season” here in the northern hemisphere, as the approaching holiday season typically sees the most foot traffic of any other time of the year with December regarded as the highest-selling month for U.S. restaurants.

With that in mind, let’s look at some of the more attractive restaurant stocks that are showing turnaround potential. We’ll begin with another high-profile fast food chain, Wendy’s (WEN).

The purveyor of the iconic square-shaped burgers and frosty desserts fell out of favor with customers and investors alike when it was announced the firm was considering so-called “dynamic pricing” that would see prices fluctuate at different times during the day depending on peak demand. Wendy’s later denied the claim, instead insisting it never intended to raise prices at times of peak demand, but rather to lower prices when store traffic was slow. Regardless, the initial news was a PR nightmare and sent the stock skidding.

In recent months, however, there are signs that a turnaround is afoot. In the second quarter, Wendy’s posted a small year-on-year increase in revenue, driven mainly by breakfast sales, but adjusted EBITDA and free cash flow were lower. However, these decreased numbers were mainly the result of Wendy’s incremental investment in its breakfast advertising and associated costs, as the company is focusing on increasing its breakfast sales, which it calls an “incredibly important” part of its daily sales. It further believes its investments will result in breakfast sales growth outpacing the rest of the sales day at Wendy’s in the foreseeable future.

Wendy’s currently has around a 10% share of total restaurant-level breakfast sales, at about $4,000 per store per week. Management says it wants to grow that dollar amount by 50% over the coming years which, if realized, would be significantly higher than the breakfast business percentages of competitors like McDonald’s. And it could make Wendy’s one of America’s premier drive-through breakfast restaurants.

On the estate growth front, Wendy’s is growing modestly with total global units up to 7,261 restaurants as of Q2, up 1.5% from a year ago. When the company reports Q3 earnings next Thursday, analysts expect sales to grow 2% from a year ago, with consistent low-single-digit revenue growth expected to follow over the next several quarters. A 5.1% dividend yield is an added attraction for turnaround investors with a longer timeframe.

Next is Dutch Bros (BROS), a drive-through coffee chain that serves a variety of hot and cold beverages with restaurants around the U.S. The company has an avid and growing following of patrons who, in some locations, are known to wait in line for up to 40 minutes for a cup of the company’s coffee—even at night!

The stock came public in 2021 at 32 a share, quickly shot up to 80, then fell out of favor the following year and crashed all the way to 20 where it found support. Over the last couple of years, the stock has been rounding out a bottom and it looks like the early stages of a turnaround are underway.

Recent introductions include the successful rollout of a mobile order option that will be available at all its stores by the end of this year. It also continued to grow its footprint with new shop openings nationwide. Although its locations (at just over 900 nationwide) aren’t nearly as ubiquitous as its rival Starbucks, it’s gaining traction as a competitor with lower pricing and a wider variety of drink options. And as it continues to expand its stores, management sees a total market opportunity in the tens of billions of dollars in the years ahead.

Revenue growth is also impressive, with Wall Street forecasting many years ahead of 20%-ish growth starting with 2025. When Dutch Bros releases Q3 earnings on November 6, the consensus is for the top line to increase 23%.

And finally, Super Hi International Holding (HDL) caught my attention when reviewing the restaurant industry. It’s a Singapore-based company that operates branded Chinese cuisine restaurants in Asia, North America and internationally. The company is also involved in the food delivery business, and it’s especially known for its hot pot condiment products and food ingredients.

The company has only been around since 2012, but it’s in rapid growth mode with plans to open new restaurants in select cities around the U.S. (which currently accounts for 16% of its total storefronts). North America is seen as a key market for the company to expand in, with metrics such as higher spending per guest and daily revenue per restaurant significantly above the firm’s restaurants in Asia. Thus, the potential for earnings growth due to U.S. expansion could provide a catalyst for the stock’s turnaround.

Super Hi sees the potential to increase restaurant-level operating margins to the low-to-mid-teens percentage range, with revenue expected to grow by similar levels over the next couple of years. Earnings potential, meanwhile, is rapidly increasing and analysts see the bottom line exploding 155% higher in 2025 to 87 cents a share.

In Q2, revenue expanded 13%, with the key metric of total table turnover rate and same-store table turnover rate both increasing 21% from a year ago to four times a day. Total guests of seven million increased 14% from six million in the year-ago quarter, while same-store sales growth was 7%.

As for the stock, it came public in the U.S. in May at 27 a share, then declined to 14 by August, where it has spent the last couple of months establishing a solid-looking base.

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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