A Wile E. Coyote Situation? Nobody Knows.
It’s not news that the stock market has been sloppy lately. After the steady march upward to a doubling of the S&P 500 from the early 2020 low, and a 33% increase from year-end 2019 before the pandemic, one can hardly be disappointed in the market’s performance.
Strategists have been calling for a correction of 5-10%. The S&P 500 has had a brief 3.5% pullback, perhaps justifying the fears. It’s easy to see a Wile E. Coyote (of the Road Runner cartoon fame) situation, where the market surges over a cliff, hangs suspended in mid-air, then plummets.
The well-telegraphed and slow-moving collapse of Evergrande, the hyper-leveraged Chinese real estate firm, seems to provide the “excuse that the market has been looking for” as one commentator suggested. At least two major media services have pointed to the 50-day moving average as a catalyst for a selloff. Their worry was that when this technical indicator was crossed on the downside, short-term investors would aggressively sell their positions. For investors using a momentum-driven strategy, this might make perfect sense. But nobody can see the future, so nobody really knows what the market has in store.
We’re no better than the next analyst at guessing the market’s direction. What we are reasonably good at is assessing the value of individual companies. When individual stocks are expensive, we are inclined to sell. When they are cheap, we’re included to buy. This is the opposite of a momentum-driven approach to investing.
One of the most difficult things to do as an investor is nothing. Sitting still seems uncomfortable and perhaps unacceptable, when stocks are moving sharply. But, just as the best batters in baseball wait for their pitch, it’s OK for investors to wait for theirs.
Much of this year, we’ve found little to buy, as valuations have been elevated across the board. We don’t quite share the doom and gloom of Jeremy Grantham, legendary co-founder of the Boston-based investment firm GMO. Grantham may be described as a perma-bear but he has a point with his “everything bubble” thesis – prices are really expensive and vulnerable to a mark-down if/when interest rates increase.
Several Cabot Undervalued Stock Advisor names have slipped from their recent highs much more than the market, including BMY (-13%), DOW (-21%), ARCO (-22%), GOLD (-25%), GM (-21%) and TAP (-26%). Fundamentals for all of these companies remain sturdy, although each one has its own, unique narrative that has pushed down its shares. We’re buyers of all of these names and are changing some ratings accordingly.
The market may continue to sell off. Or, it may rebound. We are much more comfortable and confident in our individual holdings, and their valuations, than we are in the market’s sentiment, and we move our money around accordingly.
Let’s hope Grantham is wrong. But, if he is right, it will be a target-rich environment ripe for value investors as everyone else will be aggressively selling.
Share prices in the table reflect Tuesday (September 21) closing prices. Please note that prices in the discussion below are based on mid-day September 21 prices.
Note to new subscribers: You can find additional color on our thesis, recent earnings reports and other news on recommended companies in prior editions of the Cabot Undervalued Stocks Advisor, particularly the monthly edition, on the Cabot website.
Send questions and comments to Bruce@CabotWealth.com.
Today’s Portfolio Changes
Dow (DOW) – Moving from HOLD to BUY.
General Motors (GM) – Moving from HOLD to BUY.
Last Week’s Portfolio Changes
None.
GROWTH/INCOME PORTFOLIO
Bristol Myers Squibb Company (BMY) shares sell at a low valuation due to worries over patent expirations for Revlimid (starting in 2022) and Opdivo and Eliquis (starting in 2026). However, the company is working to replace the eventual revenue losses by developing its robust product pipeline while also acquiring new treatments (notably with its acquisitions of Celgene and MyoKardia), and by signing agreements with generics competitors to forestall their competitive entry. The likely worst-case scenario is flat revenues over the next 3-5 years. Bristol should continue to generate vast free cash flow, helped by a $2.5 billion cost-cutting program, and has a relatively modest debt level.
There was no significant company-specific news in the past week.
BMY shares fell 3% in the past week and have slipped about 13% from their recent high, with about 29% upside to our 78 price target. We continue to believe that most of the downward pressure is due to worries over new drug price controls in the $3.5 trillion infrastructure bill, although progress on this piece of the bill appears to have stalled recently. However, the exact scope and depth of the proposals won’t be known until at least after the bill is passed (if it is passed). Many investors simply avoid pharma stocks during such a period. We are a bit more optimistic that Congress won’t gut the industry, in part due to the impressive strength of the pharma lobby, and remain patient with BMY shares with strong conviction in the company’s underlying fundamentals.
The stock trades at a low 7.5x estimated 2022 earnings of $8.03 (down 3 cents in the past week) and 7.1x estimates of $8.45 (down 2%) for 2023. Either we are completely wrong about the company’s fundamental strength, or the market must eventually recognize Bristol’s earnings stability and power. We believe the earning power, low valuation and 3.2% dividend yield that is well-covered by enormous free cash flow make a compelling story. BUY
Cisco Systems (CSCO) is facing revenue pressure as customers migrate to the cloud and thus need less of Cisco’s equipment and one-stop-shop services. Cisco’s prospects are starting to improve under a relatively new CEO, who is shifting Cisco toward a software and subscription model and is rolling out new products, helped by its strong reputation and entrenched position within its customers’ infrastructure. The company is highly profitable, generates vast cash flow (which it returns to shareholders through dividends and buybacks) and has a very strong balance sheet.
On August 18, Cisco reported encouraging fiscal fourth-quarter results and provided favorable and longer-term guidance. The company’s fundamentals are improving, and management is helping boost investor confidence by providing more visibility. Cisco shares are somewhat driven by revenues, with little need for expanding margins although this would help the shares’ valuation multiple. Cash flow – another key aspect of the story, was robust. We are wary of Cisco’s practice of substituting acquisitions for internal R&D, as this in effect removes R&D costs from the income statement while also artificially boosting revenue growth. This strategy will likely push us to sell the stock sooner than if its earnings were of higher quality.
Last week, at Cisco’s first Investor Day in four years, the company provided color on its strategy and financial targets. Cisco is targeting 5-7% revenue growth and non-GAAP EPS growth through FY2025, and reiterated its policy of returning at least 50% of free cash flow to shareholders through dividends and share repurchases.
While the revenue and EPS targets imply no margin expansion (a tad disappointing), we believe that this is intentionally conservative, as Cisco’s management is highly skilled in managing investor expectations. In terms of revenue growth, there appear to be enough opportunities from organic and inorganic sources to meet their target. As Cisco shares rely on revenue growth, the size of the target (respectably strong but not an overreach) is somewhat of a confidence-builder, although we consider revenue growth to be acquirable and thus the target is of lower quality than if it had said “organic” revenue growth of 5-7%.
The company is emphasizing recurring subscription software growth and is changing its salesforce compensation structure to help drive this growth. Cisco said its current markets are about $150 billion in size and growing 5%, with “expansion” markets being $140 billion in size and growing 18%. Adjacent markets are about $500 billion in size. We see Cisco continuing its acquisitions, perhaps at a stepped-up pace, in the expansion and adjacent markets.
Overall, following the Investor Day, the story continues to look worthwhile enough on the fundamentals and current share valuation to stay involved.
CSCO shares fell 4% in the past week and have about 8% upside to our 60 price target.
The shares trade at 16.2x estimated FY2022 earnings of $3.43 (unchanged in the past week). On FY2023 earnings (which ends in July 2023) of $3.68, the shares trade at 15.1x (unchanged). On an EV/EBITDA basis on FY2022 estimates, the shares trade at a 11.5x multiple. CSCO shares offer a 2.7% dividend yield. We continue to like Cisco. BUY
Coca-Cola (KO) is best-known for its iconic soft drinks yet nearly 40% of its revenues come from non-soda beverages across the non-alcoholic spectrum. Its global distribution system reaches nearly every human on the planet. Coca-Cola’s longer-term picture looks bright but the shares remain undervalued due to concerns over the pandemic, the secular trend away from sugary sodas, and a tax dispute which could cost as much as $12 billion (likely worst-case scenario). The relatively new CEO James Quincey (2017) is reinvigorating the company by narrowing its oversized brand portfolio, boosting its innovation and improving its efficiency, as well as improving its health and environmental image. Coca-Cola’s balance sheet is sturdy, and its growth investing, debt service and dividend are well-covered by free cash flow.
There was no significant company-specific news in the past week.
KO shares slipped 3% in the past week and have about 18% upside to our 64 price target.
While the valuation is not statistically cheap, at 22.3x estimated 2022 earnings of $2.43 (unchanged this past week) and 20.7x estimated 2023 earnings of $2.61 (unchanged), the shares remain undervalued given the company’s future earning power and valuable franchise. Also, the value of Coke’s partial ownership of a number of publicly traded companies (including Monster Beverage) is somewhat hidden on the balance sheet, yet is worth about $23 billion, or 9% of Coke’s market value. This $5/share value provides additional cushion supporting our 64 price target. KO shares offer an attractive 3.1% dividend yield. BUY
Dow Inc. (DOW) merged with DuPont to create DowDuPont, then split into three companies in 2019 based on product type. The new Dow is the world’s largest producer of ethylene/polyethylene, the most widely used plastics. Investors undervalue Dow’s hefty cash flows and sturdy balance sheet largely due to its uninspiring secular growth traits and its cyclicality. The shares are driven by: 1) commodity plastics prices, which are often correlated with oil prices and global growth, along with competitors’ production volumes; 2) volume sold, largely driven by global economic conditions, and 3) ongoing efficiency improvements (a never-ending quest of all commodity companies). Investors worry about a cyclical peak and whether Dow will squander its vast free cash flow. We see Dow as having more years of strong profits before capacity increases signal a cyclical peak, and expect the company to continue its strong dividend, reduce its pension and debt obligations, repurchase shares slowly and restrain its capital spending.
On July 22, Dow reported a strong second quarter, with adjusted earnings that were sharply higher than the loss a year ago in the depths of the pandemic and also that were 16% above the consensus estimate. Management provided an encouraging outlook. While profits may be peaking, they will likely remain elevated rather than fall off sharply. Industry capacity increases are coming next year, but we do not see large price cuts from our current vantage point. We would like to see Dow generate more free cash flow, trim its debt and issue fewer stock options.
Dow will host an investor day on October 6, starting at 10am ET, which will be accessible via the Dow investor relations website.
There was no significant company-specific news in the past week.
Dow shares slipped 7% this past week and have 41% upside to our 78 price target. On estimated 2022 earnings of $6.03 (unchanged in the past week), the shares trade at a 9.2x multiple. On estimated 2023 earnings of $5.63 (unchanged and slightly higher than 2021 estimated earnings), the shares trade at about 9.8x. That analysts believe that 2023 earnings will remain steady compared to 2021 is probably a binary compromise – as in reality the earnings will likely be either a lot stronger or a lot weaker.
Analysts are somewhat pessimistic about 2022 earnings (they assume a 30% decline from 2021). If the 2022 estimate continues to tick up, the shares will likely follow, although Dow’s cyclical earnings and investor fears of an eventual downcycle will ultimately limit Dow’s upside. The high 5.1% dividend yield adds to the shares’ appeal – especially in a low-interest-rate environment. In a prolonged downcycle, the dividend could be cut, but that could be years away and even then a cut isn’t a certainty if Dow can manage its balance sheet and down-cycle profits reasonably well.
We are moving Dow back to a BUY.
Merck (MRK) shares are undervalued as investors worry about Keytruda, a blockbuster oncology treatment (about 30% of revenues), facing generic competition in late 2028. Also, its Januvia diabetes treatment may see generic competition next year, and like all pharmaceuticals it is at-risk from possible government price controls. Yet, Keytruda is an impressive franchise that is growing at a 20% rate and will produce solid cash flow for nearly seven more years, providing the company with considerable time to replace the potential revenue loss. Merck’s new CEO, previously the CFO, will likely accelerate Merck’s acquisition program, which adds both return potential and risks to the story. The company is highly profitable and has a solid balance sheet. It spun off its Organon business in June and we think it will divest its animal health sometime in the next five years.
Merck appears to be getting closer to receiving FDA approval for its molnupiravir Covid-19 treatment. The treatment would help alleviate symptoms in those that have already contracted Covid.
Merck shares were flat this past week (a calm port in the storm) and have about 38% upside to our 99 price target. Valuation is an attractive 11.2x estimated 2022 earnings of $6.44 (down a cent this past week) and 10.4x estimated 2023 earnings of $6.91 (down 2 cents). We note that Keytruda’s patent expiration doesn’t happen until late 2028. If the company produces earnings close to these estimates and continues to provide evidence of solid post-Keytruda prospects, as we expect, the shares are considerably undervalued.
Merck produces generous free cash flow to fund its current dividend (now yielding 3.6%) as well as likely future dividend increases, although its shift to a more acquisition-driven strategy will slow the pace of increases. BUY
Otter Tail Corporation (OTTR) is a rare utility/industrial hybrid company, with a $2 billion market cap. The electric utility has a solid and high-quality franchise, with a balanced mix of generation, transmission and distribution assets that produce about 75% of the parent company’s earnings, supported by an accommodative regulatory environment. The industrial side includes the Manufacturing and Plastics segments. Otter Tail has an investment grade balance sheet, produces solid earnings and prides itself on steady dividend growth. The unusual utility/manufacturing structure is creating a discounted valuation, which might make the company a target for activists, as the two parts may be worth more separately, perhaps in the hands of larger, specialized companies.
The company presented at various conferences. Its September 21st presentation to T. Rowe Price showed that its slow/steady 5-7% profit growth plan looks credible. Otter Tail provided color on its capital spending, rate base and other metrics through 2025. The electricity segment capital spending will accelerate this year and next year, then fall off considerably, while the utility rate base will expand. This segment continues to reduce its reliance on coal-fired power production, now at about 35% (was 68% in 2005) and on track to decline to 27% over the next two years. Its renewable sources will increase from about 19% today to about 30% over the next two years. This transition should help boost the company’s appeal to investors.
OTTR shares slipped 2% this past week and have about 4% upside to our 57 price target. The stock trades at about 15.3x estimated 2021 earnings of $3.59 (unchanged). On estimated 2022 earnings of $3.13, the shares trade at about 17.5x. Analysts are assuming that the plastics upcycle will fade in 2022, weighing on earnings by about 13%. OTTR shares offer a 2.8% dividend yield. BUY
BUY LOW OPPORTUNITIES PORTFOLIO
Arcos Dorados (ARCO), which is Spanish for “golden arches,” is the world’s largest independent McDonald’s franchisee. Based in stable Uruguay and listed on the NYSE, the company produces about 72% of its revenues in Brazil, Mexico, Argentina and Chile. Arcos’ leadership looks highly capable, led by the founder/chairman who owns a 38% stake. The shares are undervalued as investors worry about the pandemic, as well as political/social unrest, inflation and currency devaluations. However, the company is well-managed and positioned to benefit as local economies reopen, and it has the experience to successfully navigate the complex local conditions. Debt is reasonable relative to post-recovery earnings, and the company is currently producing positive free cash flow.
Macro issues will continue to move ARCO shares. We would like to see stability/strength in the Brazilian currency after its weakness since the pandemic. The pace of vaccinations in Brazil appears to be accelerating, which should boost economic results later this year, likely helping Arcos’ business. The political situation is edgier, as slow job growth increases the pressure on the president, Jair Bolsonaro, in advance of the October 2022 election. See additional comments in our September 1 letter.
In recent presentations, the company highlighted its top-quality McDonalds franchise, revenue growth initiatives, and progress in boosting sales post-Covid.
ARCO shares fell 4% this past week and have about 42% upside to our 7.50 price target. Investors appear to be playing the macro newsflow about Brazil’s political and economic issues and not the company’s underlying fundamentals. We remain steady in our conviction in the company’s recovery. The low share price offers a chance to add to or start new positions.
The stock trades at 17.6x estimated 2022 earnings per share of $0.30 (unchanged from a week ago). The 2023 consensus estimate of $0.37 (unchanged) implies a 14.2x multiple. BUY
Aviva, plc (AVVIY), based in London, is a major European insurance company specializing in life insurance, savings and investment management products. Amanda Blanc was hired as the new CEO last year to revitalize Aviva’s laggard prospects. She has divested operations around the world to aggressively re-focus the company on its core geographic markets (UK, Ireland, Canada), and is improving Aviva’s product competitiveness, rebuilding its financial strength and trimming its bloated costs. Aviva’s dividend has been reduced to a more predictable and sustainable level with a modest upward trajectory. Excess cash balances are being directed toward debt reduction and potentially sizeable special dividends.
Much of our interest in Aviva is in what it plans to do with its current and future excess capital, including the proceeds from its divestitures. So far, the company has recently raised its interim dividend by 5% to £0.0735/share (about $0.20 per ADS, as there are 2 underlying common shares per ADS, and the exchange rate is about $1.38) and will return at least £4 billion (about $5.5 billion) by 2H 2022, mostly through share buybacks. It will complete £750 million “immediately.” The balance of the divestiture proceeds will go toward debt paydown.
We anticipate that the company will pay a final (year-end) dividend of about twice its interim dividend, for a full-year total recurring dividend of about $0.61/ADS. On this, the shares would produce an annual dividend yield of about 5.7% – rather appealing in an era when AA-rated corporate bonds yield about 1.7%
Aviva is embroiled in several class-action lawsuits in Canada that could result in at least C$300 million in claim awards for business interruption insurance provided to thousands of Canadian businesses. There is no reasonable way to gauge the odds of a payout, although in the US there have been few if any successful efforts by policyholders to receive payments for this type of claim.
Aviva shares fell 4% this past week and have about 31% upside to our 14 price target.
The stock trades at 8.3x estimated 2022 earnings per ADS of $1.30 (unchanged in the past week), which is lower than estimated 2021 earnings due to Aviva’s divestitures. Interestingly, the 2023 estimate is $1.44 (unchanged from a week ago), implying more than a full recovery from 2021 results. The stock trades at about 94% of tangible book value. BUY
Barrick Gold (GOLD), based in Toronto, is one of the world’s largest and highest-quality gold mining companies. About 50% of its production comes from North America, with the balance from Africa/Middle East (32%) and Latin America/Asia Pacific (18%). The market has little interest in Barrick shares. Yet, Barrick will continue to improve its operating performance (led by its new and highly capable CEO), generate strong free cash flow at current gold prices, and return much of that free cash flow to investors while making minor but sensible acquisitions. Also, Barrick shares offer optionality – if the unusual economic and fiscal conditions drive up the price of gold, Barrick’s shares will rise with it. Given their attractive valuation, the shares don’t need this second (optionality) point to work – it offers extra upside. Barrick’s balance sheet has more cash than debt. Major risks include the possibility of a decline in gold prices, production problems at its mines, a major acquisition and/or an expropriation of one or more of its mines.
The threat of local governments taking control of gold mines remains. As the free world shrinks, autocratic governments become more assertive about taking assets from Western companies. Most of Barrick’s production comes from countries unlikely to expropriate, but takings at the margin will weigh on the shares.
CEO Mark Bristow spoke at an industry confab last week, and emphasized growth through exploration rather than acquisitions. He said they have no interest in a mine in Zambia that was recently appropriated from Glencore Plc, nor any interest in Freeport-McMoRan (likely due more to price than lack of fit). He also said they are focusing on completing a deal to restart production in Papua New Guinea. In terms of size, he wants a mine (interesting that he didn’t say “company”) that can produce 500,000 ounces of gold/year for many years, and that is profitable at $1,200/ounce gold prices. He also emphasized that acquisitions would be lower priority than internal growth.
Commodity gold prices slipped about 2% to $1,780/ounce while the 10-year Treasury yield ticked up to 1.32%. Gold prices seems range-bound for now.
Barrick shares fell 4% this past week and have about 45% upside to our 27 price target. The price target is based on 7.5x estimated steady-state EBITDA and a modest premium to our estimate of $25/share of net asset value.
Earnings estimates have ticked up in the past week, as quarter-end approaches and gold prices remain above many analysts’ estimates.
On its recurring $.09/quarter dividend, GOLD shares offer a reasonable 1.9% dividend yield. Barrick will pay an additional $0.42/share in special distributions this year (no clarity on 2022 special dividends), lifting the effective dividend yield to 4.2%. BUY
General Motors (GM) is making immense progress with its years-long turnaround. It is perhaps 90% of the way through its gas-powered vehicle turnaround, and is well-positioned but in the early stages of its electric vehicle (EV) development. GM Financial will likely continue to be a sizeable profit generator. GM is fully charged for both today’s environment and the EV world of the future, although the underlying value of its emerging EV business is unclear.
The shares reflect conservative but reasonably strong gas-powered vehicle profits but assign no value to the EV operations. This zero value almost certainly is wrong but the EV operations have no sales or profits so the valuation is by definition speculative at this point. We’re keeping GM a Hold for now, as the risk/return balance isn’t as favorable as we would like for the Cabot Undervalued Stocks Advisory.
GM said that it has resumed battery production for the Chevy Bolt, and that it will begin shipping replacement batteries next month. A new problem has arisen, as GM is part of a group of nearly two dozen vehicle manufacturers involved in a U.S. government probe of 30 million faulty airbags made by Takata. The government said that “no present safety risk has been identified,” but that further work is needed to evaluate future risk.
Regarding the chip shortage, GM is now working directly with chip manufacturers to improve its access to chips, whereas in the past it had relied on its component suppliers.
We are sensing that third-quarter results could be a bit sloppy for GM and the car industry overall, as chip supplies continue to create a drag on production.
GM shares declined 2% this past week and have 39% upside to our 69 price target.
On a P/E basis, the shares trade at 7.2x estimated calendar 2022 earnings of $6.92 (down 2 cents this past week). On estimated 2023 earnings of $6.80 (unchanged), the shares trade at about 7.3x. Investors appear to have little confidence in the 2023 estimate, as the estimates suggest that profits will peak yet essentially remain stable next year.
The P/E multiple is helpful, but not a precise measure of GM’s value, as it has numerous valuable assets that generate no earnings (like its Cruise unit, which is developing self-driving cars and produces a loss), its nascent battery operations, and its other businesses with a complex reporting structure, nor does it factor in GM’s high but unearning cash balance which offsets its interest-bearing debt. However, it is useful as a rule-of-thumb metric, and provides some indication of the direction of earnings estimates, and so we will continue its use here. We are raising our rating to BUY.
Molson Coors Beverage Company (TAP) is one of the world’s largest beverage companies, producing the highly recognized Coors, Molson, Miller and Blue Moon brands as well as numerous local, craft and specialty beers. About two-thirds of its revenues come from the United States, where it holds a 24% market share. Investors worry about Molson Coors’ lack of revenue growth due to its relatively limited offerings of fast-growing hard seltzers and other trendier beverages. Our thesis for this company is straight-forward – a reasonably stable company whose shares sell at an overly-discounted price. Its revenues are resilient, it produces generous cash flow and is reducing its debt. A new CEO is helping improve its operating efficiency and expand carefully into more growthier products. The company recently re-instated its dividend.
Molson Coors said it will start distributing Topo Chico Hard Seltzer nationwide starting in January, after a partial rollout earlier this year. Separately, the company’s updated investor slide deck included its current revenue and earnings guidance – saying it neither reaffirmed nor updated its guidance, but by including it Coors is in essence saying that it is still valid.
TAP shares fell 3% in the past week and have dropped 26% since their peak in June at about 61. This decline brings the shares back to their April 2020 (17 months ago) price and well-below a fair value for their steady and improving business.
The shares have about 53% upside to our 69 price target. They trade at 10.5x estimated 2022 earnings of $4.30 (down a cent this past week) and 9.9x estimated earnings of $4.54 (down a cent) in 2023.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 7.8x estimated 2022 results, still among the lowest valuations in the consumer staples group and below other brewing companies. BUY
Organon & Company (OGN) was recently spun off from Merck. It specializes in patented women’s healthcare products and biosimilars, and also has a portfolio of mostly off-patent treatments. Organon will produce better internal growth with some boost through smart yet modest-sized acquisitions. It may eventually divest its Established Brands segment. The management and board appear capable, the company produces robust free cash flow, has modestly elevated debt and will pay a reasonable dividend. Investors have ignored the company, but we believe that Organon will produce at least stable and large free cash flows with a reasonable potential for growth. At our initial recommendation, the stock traded at a highly attractive 4x earnings.
Organon presented at Morgan Stanley’s Annual Global Healthcare Conference last week. The company spoke confidently about its prospects. It is actively searching for acquisition targets – we anticipate at least one deal to be announced this year. The company is working to extend its Nexplanon patent to 2030, and that international growth remains robust. Organon said the Jada post-partem hemorrhaging control treatment, which came with its acquisition of Alydia Health, is a “sleeper” with much more potential than investors appreciate. The company spoke about a large opportunity for its Humira biosimilar, which will be launched in summer 2023. For its established businesses (generally, those with slow growth or expiring patents), Organon is seeing slow erosion due to price, not volume, and China revenues appear likely to stabilize next year.
OGN shares fell 2% in the past week and have about 40% upside to our 46 price target (using the same target as the Cabot Turnaround Letter). The shares trade at 5.4x estimated 2022 earnings of $6.03 (unchanged in the past week) and 5.2x estimated 2023 earnings of $6.28 (unchanged). This stronger 2023 estimate is consistent with our view that Organon can generate at least steady revenues and profits. Organon shares offer an attractive 3.4% dividend yield. BUY
Sensata Technologies (ST)is a $3.8 billion (revenues) producer of nearly 47,000 highly engineered sensors used by automotive (60% of revenues), heavy vehicle, industrial and aerospace customers. About two-thirds of its revenues are generated outside of the United States, with China producing about 21%. Investors undervalue Sensata’s durable franchise. Its sensors are typically critical components that generally produce high profit margins. Also, as the sensors’ reliability is vital to safely and performance, customers are reluctant to switch to another supplier that may have lower prices but also lower or unproven quality. Sensata has an arguably under-leveraged balance sheet and generates healthy free cash flow. The relatively new CEO will likely continue to expand the company’s growth potential through acquisitions.
Once a threat, electric vehicles are now an opportunity, as the company’s expanded product offering (largely acquired) allows it to sell more content into an EV than it can into an internal combustion engine vehicle. Risks include a possible automotive cycle slowdown, chip supply issues, geopolitical issues with China, currency and over-paying/weak integration related to its acquisitions.
The company introduced its battery management system, which came with the Lithium Balance acquisition. This system sounds encouraging, as it could develop into a major product in a key category for electric vehicles.
ST shares fell 5% this past week and have about 37% upside to our 75 price target. Investors appear to be selling off ST along with auto-related stocks in general. While we recognize the company’s reliance on the auto industry, it has other interesting growth prospects (like the battery management system) that provide appeal beyond “just cars.”
The stock trades at 13.2x estimated 2022 earnings of $4.16 (down a cent this past week) and 12.0x estimated 2023 earnings of $4.55 (unchanged). We expect this 2023 estimate will move around a lot. On an EV/EBITDA basis, ST trades at 10.6x estimated 2022 EBITDA. BUY
Note for stock table: For stocks rated Sell, the current price is the sell date price.
Disclosure:The chief analyst of the Cabot Undervalued Stocks Advisor personally holds shares of every recommended security, except for “New Buy” recommendations. The chief analyst may purchase or sell recommended securities but not before the fourth day after any changes in recommendation ratings has been emailed to subscribers. “New Buy” recommendations will be purchased by the chief analyst as soon as practical following the fourth day after the newsletter issue has been emailed to subscribers.
| Growth/Income Portfolio | |||||||
| Stock (Symbol) | Date Added | Price Added | 9/21/21 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Bristol-Myers Squibb (BMY) | 04-01-20 | 54.82 | 60.33 | 10.1% | 3.2% | 78.00 | Buy |
| Cisco Systems (CSCO) | 11-18-20 | 41.32 | 55.26 | 33.7% | 2.6% | 60.00 | Buy |
| Coca-Cola (KO) | 11-11-20 | 53.58 | 54.05 | 0.9% | 3.0% | 64.00 | Buy |
| Dow Inc (DOW) * | 04-01-19 | 53.50 | 55.53 | 3.8% | 5.0% | 78.00 | Buy |
| Merck (MRK) | 12-9-20 | 83.47 | 71.97 | -13.8% | 3.6% | 99.00 | Buy |
| Otter Tail Corporaton (OTTR) | 5-25-21 | 47.10 | 54.67 | 16.1% | 2.9% | 57.00 | Buy |
| Buy Low Opportunities Portfolio | |||||||
| Stock (Symbol) | Date Added | Price Added | 9/21/21 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Arcos Dorados (ARCO) | 04-28-21 | 5.41 | 5.19 | -4.1% | — | 7.50 | Buy |
| Aviva (AVVIY) | 03-03-21 | 10.75 | 10.76 | 0.1% | 5.5% | 14.00 | Buy |
| Barrick Gold (GOLD) | 03-17-21 | 21.13 | 18.49 | -12.5% | 1.9% | 27.00 | Buy |
| General Motors (GM) | 12-31-19 | 36.60 | 49.37 | 34.9% | — | 69.00 | Buy |
| Molson Coors (TAP) | 08-05-20 | 36.53 | 44.80 | 22.6% | — | 69.00 | Buy |
| Organon (OGN) | 06-07-21 | 31.42 | 32.89 | 4.7% | — | 46.00 | Buy |
| Sensata Technologies (ST) | 02-17-21 | 58.57 | 54.75 | -6.5% | — | 75.00 | Buy |
*Note: DOW price is based on April 1, 2019 closing price following spin-off from DWDP.
Buy – This stock is worth buying.
Strong Buy – This stock offers an unusually favorable risk/reward trade-off, often one that has been rated as a Buy yet the market has sold aggressively for temporary reasons. We recommend adding to existing positions.
Hold – The shares are worth keeping but the risk/return trade-off is not favorable enough for more buying nor unfavorable enough to warrant selling.
Sell – This stock is approaching or has reached our price target, its value has become permanently impaired or changes in its risk or other traits warrant a sale.
Note for stock table: For stocks rated Sell, the current price is the sell date price.