September 20, 2024

In today’s note, we discuss the recent developments concerning Duluth Holdings (DLTH), Gannett (GCI) and Zillow (Z), with a particular emphasis on the latter due to recent interest rate-related strength.

Despite our focus on primarily mid-stage turnarounds with exceptional momentum potential in recent weeks, I’m looking for potential opportunities in early-stage candidates due to the additional improvement in the market’s intermediate-term outlook, thanks to the Fed’s latest rate cut.

We further continue our focus on rate-sensitive stocks for a falling interest rate environment, with a focus on under-appreciated real estate equities.

Several stocks in the portfolio have benefited from recent company developments or news headlines, and we examine them here. Four ratings changes are also included.

Comments on Portfolio Holdings

It was brought to my attention by a subscriber that Duluth Holdings (DLTH) was accidentally deleted from the portfolio spreadsheet recently. I apologize for this oversight and wish to reiterate that Duluth hasn’t been dropped from the portfolio and is still rated a Buy.

Duluth is one of the few remaining “lovable laggards,” as I call them, i.e., a remnant from years ago when it was first recommended by one of the previous editors of the Cabot Turnaround Letter. Specifically, it was first recommended in February 2020 at 8.70 a share, and it more than doubled over the next year or so. But for whatever reason, the stock was allowed to remain in the portfolio over the succeeding years despite steadily melting down to its current 4.00 level.

Rather than cut Duluth with some of the other stocks I cleaned out in recent weeks, I decided to let it remain since I think it has some early-stage turnaround potential once again. But I’m going to keep it on a fairly tight leash until I see some additional follow-through after its late-August earnings rally.

On a fundamental note, a very positive aspect of Duluth’s Q2 report which supports the turnaround thesis was the 7.5% EBITDA margin for the quarter, which was a significant increase from the year-ago 6.2% margin—and an even greater improvement from the 1.6% margin posted in this year’s Q1. What’s more, Duluth expects to reduce overhead expenses by around $1.2 million during Q4. For full-year 2024, the company expects adjusted EBITDA of $39 million compared to last year’s $33 million, an 18% increase if realized.

Gannett (GCI) this week entered a multi-year strategic partnership with BetMGM, a sports betting and iGaming operator. According to a press release, as part of the agreement, BetMGM will serve as the preferred online sportsbook and casino partner for USA TODAY Sports providing sports betting odds and betting information across the USA TODAY Network in more than 200 local U.S. markets across 43 states with more than 300 digital news and media brands in the portfolio. The announcement served as the catalyst for a big rally in Gannett shares, which rose by as much as 30% on an intraweek basis.

I’ve got to be honest: I’m not a fan of Gannett’s move into the sports betting industry as I believe there are better way of initiating content monetization. And while the company’s digital revenue is on the rise, serving to offset print-related losses, the company has yet to turn the corner to profitability. What’s more, Wall Street doesn’t foresee profitability this year or next while revenue is expected to continue trending lower.

And as one analyst recently put it, “Artificial intelligence is upending many areas of the news industry, and may affect both [Gannett’s] print and digital operations.” All told, in the wake of a 30% rally, I’m going to go ahead and recommend that we cut Gannett from the portfolio as I’m skeptical the momentum can continue without further prolonged consolidation.

And finally, our position in Zillow (Z) was one of this week’s biggest movers, and the stock is up 24% from last week. This occurred despite U.S. existing home sales recently hitting a 30-year low, according to Fannie Mae, as home sales are expected to average only around four million annualized units for the rest of 2024, slightly below last year’s sales pace.

Home inventories remain tight, however, and there’s still plenty of pent-up demand as prospective buyers are likely waiting for mortgage rates to fall further before pouncing. Moreover, Zillow is doing a fine job of improving the monetization of its online traffic, boosting revenue growth even in the face of a weak housing market.

Zillow has the most customers of any real estate site, with a roughly 70% market share. The company is also three times the size of any of its competitors and has a sizable opportunity to further expand the reach of its apps. I recently recommended selling a quarter of our long position in the stock, but I’m maintaining a Hold rating for the remaining three-quarters of the position we have left.

RATING CHANGES: Our position in Alibaba Group Holdings (BABA) finally broke out on good volume this week and is closely approaching our conservative 90 a share target. Accordingly, the stock is being changed from a Buy to a Hold. HOLD

I’m moving Gannett (GCI) to a sell after the stock rallied by as much as 30% this week. Profitability issues remain a concern, as mentioned above. SELL

Solventum (SOLV) continues to perform well, but due to its recent rally, I’m downgrading the shares from Buy to Hold. HOLD

This week, we took a one-quarter profit in Zillow (Z) after its sizable rally. We’ll remain long the remaining three-quarters position, but I’m changing the rating from Buy to Hold. HOLD

Friday, September 20, 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 15 minutes and covers:

• Discussion of the Fed’s decision to lower interest rates by 50 basis points and what it likely means for stocks—and the housing market—going forward.
• Why recent activity in the energy sector should continue to be a key reason for broad market strength, including many of our turnaround portfolio holdings.
• Comments on potential early-stage turnarounds in some big-name semiconductor, e-commerce and software stocks.
• Comments on portfolio holdings.
• Elsewhere in the markets
  
  • A brief commentary on the recent rally catalysts for apparel retailer Duluth Holdings (DLTH) and online real estate platform Zillow (Z).
• Final note
  
  • We’re cutting our position in Gannett (GCI) after this week’s 30% rally.

Turnaround Watch List

Despite an admittedly favorable technical and liquidity backdrop, I’m not seeing much in the way of favorable setups for new long positions in our turnaround portfolio. For that reason, I recommend that we stand pat in terms of our current positions and wait for a more favorable entry opportunity before doing any new buying.

Providing additional context for this assessment, Thursday’s investor sentiment reading from the American Association of Individual Investors (AAII) shows a remarkable jump in the percentage of bulls. From last week’s reading of 38% bullish, the latest reading of 51% bulls is high by historical standards and suggests too much enthusiasm among small participants (from a contrarian perspective). And while this doesn’t necessarily imply a short-term market top, it does mean the market is likely to be more sensitive to any potentially disappointing news headlines in the coming days. This is another reason why I’m embracing a “wait-and-see” approach for now.

Before we turn our attention to the weekly watch list, a brief note on strategy is in order. For the last several weeks in the run-up into the Fed’s rate cut, my focus has been mainly on mid-cycle turnaround stocks due to the fact that they were almost certain to receive an additional momentum boost from falling rates, as proved to be the case.

But now that the lower rate environment has been made official by the Fed’s decision, I suspect the coming weeks will likely reveal some increasingly attractive entry points for early-stage turnarounds. And in the more comprehensively bullish environment which falling rates should create, getting into early-cycle turnaround stocks should be a lower-risk proposition.

With that in mind, let’s take a look at a few of the longer-term-oriented, early-stage candidates I’ve had on my watch list for a while. We’ll start with the one that has garnered the most attention in recent weeks since its high-profile sell-off in August, Intel (INTC).

The CPU and semiconductor giant’s stock fell hard in early August after its second-quarter earnings disappointed on both the top and bottom lines. The company ended up losing a quarter of its market cap after weak guidance, and a slew of analyst rating downgrades followed as sentiment dramatically weakened. On top of it all, Intel announced it would lay off around 15% of its staff, plus it suspended the dividend.

However, the earnings-induced crash was accompanied by the highest single-day trading volume seen since the crash in early 2020 which, as I mentioned at that time, suggested a capitulation moment on the part of the sellers. And as our resident options expert here at Cabot, Jacob Mintz, also pointed out around that time, there was some very concentrated purchasing of long-dated call options on Intel in the wake of its crash, suggesting the “smart money” crowd was beginning to accumulate a new long position in the stock.

I noted then that I wasn’t quite ready to pull the trigger on an Intel purchase recommendation for the portfolio, but that I was monitoring the stock very closely. What I wanted to see were signs of constructive bottoming activity before I placed Intel in the portfolio since I’m not a believer in catching the proverbial “falling dagger.” Since that time, however, there has been a notable dissipation of downward momentum, followed by more than six weeks of base-building activity.

Indeed, Intel continues to make progress toward an eventual turnaround, but more work remains before the stock is completely out of the danger zone, and a few more weeks of basing activity would be ideal before we pull the trigger on a new purchase. For now, the stock is still high on my list of monitored stocks under the category of potential early-stage turnarounds.

It’s not exactly an early-stage turnaround, and it’s not exactly a mid-cycle turnaround, either. But MongoDB (MDB) is another stock I’m paying particularly close attention to after recent basing activity has spurred some initial buying interest on the part of bottom fishers. From strictly a technical standpoint, the stock has established a three-month basis, which is the ideal minimum for a sustainable turnaround to begin. And late last month, there was a sizable earnings-related upside move on strong volume as big institutions started moving back into Mongo.

As a reminder, the company provides very robust and flexible document database systems that have become the industry standard for software developers. Among other things, its products allow advertisers to efficiently gather data and glean insights from social media posts and other online sources, which is a major draw right now.

And with artificial intelligence still all the rage on Wall Street, management gave investors a reason to salivate a few days ago when it said the company would benefit as large language models (LLMs) become more accurate. Specifically, the top brass said that the so-called “inference market” (where LLMs will have to be “married” with business needs) should boost revenue for Mongo as more companies spend increasing sums of money to train LLMs, which power AI chatbots.

Analysts see several consecutive quarters of 15%-ish revenue growth ahead for Mongo, which could prove too conservative if accelerating AI-related momentum is any indication.

And finally, another stock that fell out of bed in late August and has what I regard as early-stage turnaround potential is PDD Holdings (PDD). The Chinese e-commerce leader, which combines online shopping with social media to offer deep discounts to group shoppers for household, food and apparel items, fell below 100 for the first time this year in late August after missing consensus revenue estimates with its Q2 earnings report and warned that revenue growth will face pressure in the coming quarters.

One major Wall Street bank said that while it doesn’t view the consensus revenue miss as thesis changing, it “struggles to reconcile if management’s cautious tone on outlook citing intensified competition, shift of consumption patterns and uncertain external environment reflects actual challenges amid diminishing return on its value-for-money moat and regulatory risk or trying to manage competition and investor expectation through low profile approach.”

Basically, that’s a long-winded way of acknowledging that the weakening global economic backdrop of the last several months is a key reason for PDD’s underperformance. But with the Fed just cutting rates and several major central banks worldwide expected to follow suit—and with China widely expected to trim its main policy and benchmark lending rates—a rebound in consumer demand for e-commerce retail goods is a reasonable expectation heading into 2025.

The stock has only just begun to etch out a bottom, and we’re nowhere near recommending PDD for purchase, but it’s definitely on my list of potential early-stage turnarounds. Suffice it to say, I’ll be watching it closely in the coming weeks.

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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