July 11, 2024

The Stock Picker’s Bull Market Continues

If it feels like value stocks are missing the bull market party this year, take comfort in knowing they’re not alone.

Thanks to the Magnificent Seven and a few other mega-cap tech stocks and red-hot artificial intelligence plays, the S&P 500 and the Nasdaq have posted very strong returns through the first half of 2024, up 17.6% and 24.8%, respectively. But most other indexes and funds have had very average years. The Dow is up a mere 4.2%. The Russell 2000 (small-cap stocks) is up 0.8%. And the Equal Weight S&P 500 index is up 3.7% and is well off its late-March peak.

By comparison, the 7.4% YTD return in value stocks – as measured by the Vanguard Value Fund ETF (VTV) – isn’t so bad. That puts large-cap value stocks on track for their first double-digit percentage annual return since 2021. That’s a welcome change for a group that didn’t budge for two whole years, from 2022-2023.

And still, there are more gains to squeeze out there. As I wrote in this space several weeks ago, nine of the 11 sectors have underperformed the S&P 500, with Technology and Communication Services doing most of the heavy lifting. And all nine of the underperforming sectors carry a forward price-to-earnings ratio that’s below the S&P’s total forward P/E (22.57 as of this writing, before second-quarter earnings season begins).

So, most corners of the market are still undervalued, even with the headline numbers at all-time highs. Perhaps when the Fed starts to cut interest rates it will wake up all those moribund sectors and stocks. Or maybe it won’t happen until after the usual post-presidential election sigh of relief. Who knows when the rest of the market will join this historically exclusive bull market party. But eventually, it will happen.

Until it does, we will continue to search for a blend of growth and value, or growth at value prices. Some may take longer to marinate than others, especially in a stock picker’s bull market (a term I just invented) like this one. But if we stick with the approach, soon enough the record amount of cash on the sidelines – $6.4 trillion (and counting) is in money market funds! – will find a home in the legions of unloved bargains that are sitting out there right now, several of which reside in our portfolio.

Note to new subscribers: You can find additional commentary on past earnings reports and other news on recommended companies in prior editions and weekly updates of the Cabot Value Investor on the Cabot website.

Send questions and comments to chris@cabotwealth.com.

Also, please join me and my colleague Brad Simmerman on our weekly investment podcast, Cabot Street Check. You can find it wherever you get your podcasts, or you can watch us on the Cabot Wealth Network YouTube channel.

This Week’s Portfolio Changes
CNH Industrial (CNH) – Moves from Buy to Hold

Last Week’s Portfolio Changes
Dick’s Sporting Goods (DKS) – New Buy with a 250 Price Target

Upcoming Earnings Reports
Wednesday, July 17 – United Airlines (UAL)

Growth & Income Portfolio

Growth & Income Portfolio stocks are generally higher-quality, larger-cap companies that have fallen out of favor. They usually have some combination of attractive earnings growth and an above-average dividend yield. Risk levels tend to be relatively moderate, with reasonable debt levels and modest share valuations.

Canadian Solar Inc. (CSIQ) is not only Canada’s largest solar energy company; it’s a global leader in the solar space. And it’s gotten much larger in the last two years, since the Canadian government announced a 50% income tax cut for zero-emission technology manufacturers (which the new 2023 legislation extended by three years). Canadian Solar’s revenues were up 41.5% in 2022, another 2% in 2023 (both record highs), and are on track to tack on another 1.2% this year and a whopping 20.2% in 2025. If it meets those estimates, the company will have gone from $3.5 billion in annual revenues to $8.25 billion in just five years. Earnings per share have more than doubled since 2021, and while they’re expected to take a step back this year, they’re projected to reach new highs of $4.75 per share next year.

And the company is right in the sweet spot for the North American solar boom. It manufactures solar photovoltaic modules and runs large-scale solar projects across Canada, and in 29 other countries, even spinning off a subsidiary – CSI Solar Ltd. – last year that trades on the Shanghai Stock Exchange. The company boasts 61 gigawatt (GW) module capacity, is up to 125GW solar module shipments, and has a project pipeline of 26.3GW. That doesn’t include its battery storage shipments (4.5 GW hours, or GWh) or capacity (20GWh expected by year’s end).

It’s a big company that operates on a global scale, and it’s growing fast. And yet … the stock is a small cap, with a market capitalization of a mere $1 billion. It used to be four times as big, trading as high as 63 a share in January 2021. Today, it trades at 15 a share, and at less than 7x forward earnings, 41% of book value, and a paltry 0.15x sales. The latter two numbers are the cheapest the stock has ever been.

There was no company-specific news for Canadian Solar this week, though the stock continued its modest recovery, up 2.5% after getting back 1.5% the week before. Having fallen from a hair under 20 all the way 14 in June, the tick back up toward the high 15s qualifies as real progress; perhaps the worst is over for CSIQ and solar stocks as a group. I’ve been writing for weeks that the selling in renewable energy stocks is way overdone, with the WilderHill Clean Energy ETF (PBW) dipping to seven-year lows, and 85% below its early-2021 peak. While renewable energy stocks have a checkered history, they’ve rarely been this cheap, and Canadian Solar is one of the fastest growing of the bunch.

CSIQ shares have a whopping 77% upside to our 28 price target. BUY

Dick’s Sporting Goods (DKS) has been growing steadily for years.

From 2016 to 2023, the sporting goods chain’s revenues have improved 64%, from just under $8 billion to just under $13 billion. This year, the top line is on track to top $13 billion for the first time. It should top $13.5 billion next year.

Dick’s, in fact, has grown sales in each of the last seven years – including in 2020 and 2021, when most other retailers saw sales nosedive due to Covid restrictions. But Dick’s all-weather ability to keep growing no matter what’s happening in the world or the economy speaks to its versatility. Since Covid ended, however, Dick’s sales have entered another stratosphere. As youth sports returned in 2021, Dick’s revenues jumped from $9.58 billion to $12.29 billion. They’ve been rising steadily each year since and are expected to do so again this year.

But Dick’s isn’t purely a growth stock—it’s also undervalued. DKS shares currently trade at 15x forward earnings estimates and at 1.29x sales. To be sure, it’s not the cheapest stock in our portfolio. But it is one of the fastest growing – and pays a solid dividend to boot.

There was no company-specific news for Dick’s in its first week in the portfolio. DKS shares were up marginally and appear to have bottomed about 10 days ago – right before we added the stock to our Growth & Income portfolio. We set a price target of 250, giving it 24% upside. Considering it was trading near 230 just three weeks ago, that target may be conservative – especially given this stock’s recent history of outperformance. BUY

Honda Motor Co. (HMC) – After years of declining sales, Honda was rejuvenated in 2023 thanks to hybrids. The Japanese automaker sold 1.3 million cars last year, up 33% from 2022; a quarter of the cars it sold were hybrids, led by its popular CR-V sport utility vehicle (SUV) and Accord mid-size sedan. The CR-V was the best-selling hybrid in the U.S. last year, with 197,317 units sold. The Accord wasn’t far behind, with 96,323 sold. All told, Honda’s hybrid sales nearly tripled in 2023, to 294,000 units.

So, Honda is making the full pivot to hybrids, with the Civic soon to become the latest addition to its hybrid fleet. Investors have started gravitating more to the companies that sell them. Invariably, those are well-established, big-name car companies made famous by many decades of selling internal combustion engine vehicles; most aren’t ready to fully abandon their roots but want to tap into the surging national (and global) appetite for electric, so they instead are turning to hybrids as a compromise. As a result, these once-stodgy car companies are tapping into new revenue streams, and their share prices are surging accordingly.

Among the hybrid-rejuvenated, brand-name automakers, Honda offers the best value.

Honda is collaborating with Nissan to co-develop electric vehicle software and build charging networks in an effort to reduce costs and develop new technologies. It’s the latest evidence of Honda prioritizing beefing up its electric/hybrid offerings and capabilities. The news was minor enough to not move the needle much with Honda shares, which were mostly unchanged this week, and the stock remains in the same 31-32 range it’s been in for more than a month. But it could have a noticeable impact down the road.

HMC shares have 39% upside to our 45 price target. The 4.2% dividend yield adds to the appeal. BUY

Philip Morris International (PM) – Based in Connecticut, Philip Morris owns the global non-U.S. rights to sell Marlboro cigarettes, the world’s best-selling cigarette brand. Cigarettes comprise about 65% of PMI’s revenues. The balance of its revenues is produced by smoke-free tobacco products. The cigarette franchise produces steady revenues and profits while its smoke-free products are profitable and growing quickly. The upcoming full launch of IQOS products in the United States, a wider launch of the IQOS ILUMA product and the recent $14 billion acquisition of Swedish Match should help drive new growth.

The company is highly profitable, generates strong free cash flow and carries only modestly elevated debt (at about 3.2x EBITDA) which it will whittle lower over the next few years. The share valuation at about 14.9x EBITDA and 16.4x per-share earnings estimates is too low in our view. Primary risks include an acceleration of volume declines and/or deteriorating pricing, higher excise taxes, new regulatory or legal issues, slowing adoption of its new products, and higher marketing costs. A strong U.S. dollar will weigh on reported results. While unlikely, Philip Morris could acquire Altria, thus reuniting the global Marlboro franchise.

There was no company-specific news for Philip Morris this week, though the stock was up marginally. The company reports second-quarter earnings on July 23.

PM shares have 17% upside to our 120 price target. The 5.1% dividend yield essentially doubles our total return since the stock was added to the portfolio last September. BUY

United Airlines (UAL) – People are flying in planes again in Covid’s aftermath, and no major airline is taking advantage of it quite like United.

United Airlines is the fastest-growing major U.S. airline. The third-largest airline carrier in the world by revenues behind Delta (DAL) and American (AAL), United is expected to grow sales by 7.4% in 2024 – more than its two larger competitors – and that’s with revenues already topping a record $50 billion in 2023 – 19.6% higher than in 2022, which was also a record year. For United, business has not only returned to pre-pandemic levels; it’s better.

Meanwhile, the stock is super cheap. It trades at less than 5x forward earnings estimates, with a price-to-sales ratio of just 0.29 and a price-to-book value of 1692. The stock peaked at 96 a share in November 2018; it’s currently in the upper 40s.

A company that’s making more money than ever before (gross profits reached a record $15.2 billion last year, though earnings were still second to 2019 levels on a per-share basis), and yet its stock trades at barely more than half its peak from five and a half years ago. A true growth-at-value-prices opportunity.

United Airlines will report earnings next Wednesday, July 17. Analysts are looking for 6.8% sales growth but a 20% decline in earnings per share due to higher costs of fuel and labor – salaries and related costs are expected to have gotten a 12.5% year-over-year bump. Keep in mind, however, that those EPS estimates may be conservative – United has beaten earnings estimates for four straight quarters, three times by double-digit percentages.

UAL shares were down 3% in the last week and have 48% upside to our 70 price target. BUY

Buy Low Opportunities Portfolio

Buy Low Opportunities Portfolio stocks include a wide range of value opportunities. These stocks carry higher risk than our Growth & Income stocks yet also offer more potential upside. This group may include stocks across the quality and market cap spectrum, including those with relatively high levels of debt and a less clear earnings outlook. The stocks may not pay a dividend. In all cases, the shares will trade at meaningful discounts to our estimate of fair value.

Agnico Eagle Mines (AEM) is the world’s third-largest and likely the highest-quality and lowest-risk gold mining company. Its strategy of “proven geological potential in premier jurisdictions” appropriately describes its exclusive focus on quality mines in the legally safe countries of Canada, Mexico, Australia and Finland. In the past few years, Agnico has made several in-region acquisitions including Kirkland Lake in 2022 for $11 billion and Yamana Gold’s Canadian assets for $2.6 billion. The plan for the next five years is to fully integrate and improve these operations and grow production in its existing mines.

As the owner of some of the industry’s highest-quality mines, Agnico has production volumes that look steady for years to come. While some of its ten major mines will see tapering output, nearly all of the others will have steady increases, driven by continued investment and exploration. Agnico’s gold reserves are high quality and increased 11% last year, supporting its outlook for at least stable production volumes. In 2023, the company’s production came in at the high end of its guidance range.

Agnico continues to be an efficient operator, with all-in sustaining costs (or AISC) of about $1,200/ounce, which is roughly 12% below the industry average. Helping its economics are the quality of its mines, the close geographic proximity of its Ontario and Quebec mines and the surplus capacity in its Detour Lake facility that will allow for higher throughput with minimal incremental costs.

Agnico shares were up 6.5% in the past week on no news. The stock is now hitting new 52-week highs above 72.

Resurgent gold prices this month are no doubt contributing to AEM’s run. The price of gold is now back near $2,400 an ounce just two weeks after briefly falling below $2,300.

AEM shares are now within 3% of our 75 price target. We now have a 29% gain in just three and a half months. If the stock reaches our 75 price target in the coming days/weeks, we will reassess whether to bump up our target price or sell if we think the stock has reached its “peak” intermediate-term value. For now, I will keep it at Buy. BUY

Aviva, plc (AVVIY), based in London, is a major European company specializing in life insurance, savings and investment management products. Amanda Blanc, hired as CEO in July 2020, is revitalizing Aviva’s core U.K., Ireland and Canada operations following her divestiture of other global businesses. The company now has excess capital which it is returning to shareholders as likely hefty dividends following a sizeable share repurchase program. While activist investor Cevian Capital has closed out its previous 5.2% stake, highly regarded value investor Dodge & Cox now holds a 5.0% stake, providing a valuable imprimatur and as well as ongoing pressure on the company to maintain shareholder-friendly actions.

There was no company-specific news for Aviva this past week.

AVVIY shares were up 2.5% this week but remain in the low 12s, where they’ve been for the past six weeks since flirting with new highs above 12.7 in late May. Any break above that level would be bullish. The stock remains cheap, trading at less than 12x earnings estimates, with a price-to-sales ratio of 0.41 and a price-to-book of 1.41. Shares have 13% upside to our 14 price target. The 6.8% dividend yield adds to our strong total return thus far. BUY

CNH Industrial (CNH) – This company is a major producer of agriculture (80% of sales) and construction (20% of sales) equipment and is the #2 ag equipment producer in North America (behind Deere). Its shares have slid from their peak and now trade essentially unchanged over the past 20 years. While investors see an average cyclical company at the cusp of a downturn, with a complicated history and share structure, we see a high-quality and financially strong company that is improving its business prospects and is simplifying itself yet whose shares are trading at a highly discounted price.

There was no company-specific news for CNH Industrial this week.

In May, the company reported earnings that were a bit mixed.

Both sales (-9.8%) and earnings per share (-5.7%) declined from the same quarter a year ago. However, both figures beat modest estimates, with EPS (33 cents) coming in well ahead of the 26 cents that were estimated.

Broken down by segment, CNH’s Agriculture wing (its largest at $3.37 billion, or 70% of total revenues) saw a 14.1% decline in sales year over year. Construction revenues dipped 10.7% year over year. Financial Services were the lone bright spot, with revenues increasing 24.8% over last year.

Overall, CNH’s cash/cash equivalents dipped to $3.24 billion from $4.32 billion at the end of 2023. Total debt was up a tick, to $27.8 billion. But cash from operating activities improved to $894 million from $701 million.

CNH shares are down sharply since the report, getting an initial bump but giving back about 19% since, as Wall Street seems to have decided there was more bad than good in the results. The stock appeared to stabilize just below 10 in late June, but this week it fell another 4% to reach the mid-9s, a 52-week low. I’m starting to lose patience with this one. The only potential saving grace is that the company reports Q2 earnings on July 31, though that could always backfire, and the estimates are less than flattering.

The 5% dividend yield helps cushion the recent blow, so let’s hang in there for now and see if CNH can stop the bleeding as we head into earnings. But I’m going to downgrade it to Hold until that happens. MOVE FROM BUY TO HOLD

Gates Industrial Corp, plc (GTES) – Gates is a specialized producer of industrial drive belts and tubing. While this niche might sound unimpressive, Gates has become a leading global manufacturer by producing premium and innovative products. Its customers depend on heavy-duty vehicles, robots, production and warehouse machines and other equipment to operate without fail, so the belts and hydraulic tubing that power these must be exceptionally reliable. Few buyers would balk at a reasonable price premium on a small-priced part from Gates if it means their million-dollar equipment keeps running. Even in automobiles, which comprise roughly 43% of its revenues, Gates’ belts are nearly industry-standard for their reliability and value. Helping provide revenue stability, over 60% of its sales are for replacements. Gates is well-positioned to prosper in an electric vehicle world, as its average content per EV, which require water pumps and other thermal management components for the battery and inverters, is likely to be considerably higher than its average content per gas-powered vehicle.

The company produces wide EBITDA margins, has a reasonable debt balance and generates considerable free cash flow. The management is high-quality. In 2014, private equity firm Blackstone acquired Gates and significantly improved its product line-up and quality, operating efficiency, culture and financial performance. Gates completed its IPO in 2018. Following several sell-downs, Blackstone has a 27% stake today.

There was no company-specific news for Gates this week.

Like CNH, Gates is coming off some mixed earnings results in May. The 31-cent EPS results outpaced analyst estimates of 30 cents and was up 20% from the 25 cents it earned in the first quarter a year ago. However, sales of $862.6 million even more narrowly missed analyst estimates and, more importantly, represented a 3.9% decline from the $897.7 million in revenue from Q1 a year ago. The underwhelming results sent GTES tumbling about 8.7% in the immediate aftermath; it has continued to trickle downward, dipping to 15.17, a 2024 low.

The difference between GTES and CNH is that GTES is our best-performing stock even with the recent weakness. And the stock has 32% upside to our 20 price target. GTES trades at less than 11x earnings, 1.16x sales and 1.25x book value, so the shares remain undervalued by traditional measures. Like CNH, Gates reports earnings on July 31. BUY

NOV, Inc (NOV) – This high-quality, mid-cap company, formerly named National Oilwell Varco, builds drilling rigs and produces a wide range of gear, aftermarket parts and related services for efficiently drilling and completing wells, producing oil and natural gas, constructing wind towers and kitting drillships. About 64% of its revenues are generated outside of the United States. Its emphasis on proprietary technologies makes it a leader in both hardware, software and digital innovations, while strong economies of scale in manufacturing and distribution as well as research and development further boost its competitive edge. The company’s large installed base helps stabilize its revenues through recurring sales of replacement parts and related services.

We see the consensus view as overly pessimistic, given the company’s strong position in an industry with improving conditions, backed by capable company leadership and a conservative balance sheet.

There was no company-specific news for NOV this week. The company will report earnings on July 25.

The energy sector has improved of late, with crude oil prices up to $82 a barrel after reaching as low as $73 a month ago. NOV shares got an initial bump, but have since sagged a bit, falling 4% this week. The share price is still comfortably above its March and June lows, however.

NOV has 35% upside to our 24 price target. It trades at just 11.4x forward earnings estimates and 0.8x sales, with a modest 1.3% dividend yield helping the cause a bit. But with the stock flat for the 14-plus months since it was added to the portfolio, anything shy of a strong earnings report and ensuing share price bump will have us reassessing its place in the Cabot Value Investor portfolio. For now … BUY

Note for stock table: For stocks rated Sell, the current price is the sell date price.

Current price is yesterday’s mid-day price.

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