June 20, 2024

The 2024 Market Paradox: Record Highs, But with Plenty of Bargains

The market is at all-time highs. But most stocks are undervalued.

That’s the strange but true reality in today’s Magnificent 7/AI-centric bull market. Yes, if you’ve invested in the seven largest mega-caps or a handful of artificial intelligence-related stocks (Broadcom (AVGO), Palantir (PLTR), Super Micro Computer (SMCI), Taiwan Semiconductor (TSM), etc.), you’ve done quite well. But most other sectors have lagged.

To wit: nine of the 11 S&P sectors are cheaper on a forward price-to-earnings basis than the S&P itself (forward P/E of roughly 21). Meanwhile, the more sober (and perhaps more market-reflective these days) Dow is up a mere 3%, the S&P Equal Weight Index is up 4%, and the Russell 2000 (small-cap stocks) is flat in 2024.

Translation? There’s still a lot of value out there, even with the S&P and the Nasdaq on relentless tears for nearly eight months. The energy (forward P/E of 9.5), financial (12.8), and basic materials (13.9) sectors are all especially cheap, which could spell opportunity down the road.

But here’s the thing: As I’ve written several times in recent months, attempting to swim against the market’s current is futile. And right now, it’s a riptide. Growth – namely AI, semiconductors and certain other new-age subsectors like weight-loss drugs – is king. The rallies in those select few chosen asset classes may soon run out of steam. Until they do, though, they’re in charge, and scouring solely for beaten-down value stocks might not bear much fruit. That’s why I’ve been laser-focused on growth at value prices – companies that are still thriving, but for whatever reason (perhaps because they’re not involved in AI or they don’t sell a weight-loss drug) have been ignored by the market for months, maybe years. Fortunately, there are plenty of those to choose from right now, and we’ve already added three stocks that fit that description since taking the reins of this advisory in early April.

Really, it’s an ideal environment, with a bull market in full swing but with most stocks yet to join the party. Sure, there’s bound to be more speedbumps ahead, especially with a presidential election just four and a half months away. Another pullback like we saw in April wouldn’t surprise me one bit. But a year from now, my guess is stocks will be higher. And the stocks that have been sitting patiently on the sidelines for the last two and a half years have the most upside.

Right now, that applies to most stocks.

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.

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This Week’s Portfolio Changes
None

Last Week’s Portfolio Changes
Citigroup (C) Moved from Buy to Sell

Upcoming Earnings Reports
Wednesday, June 26: Worthington Enterprises (WOR)

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 $1.1 billion. It used to be three times as big, trading as high as 63 a share in January 2021. Today, it trades at 16 a share, and at just 7x forward earnings, 0.43x book value, and a paltry 0.16x sales. The latter two numbers are the cheapest the stock has ever been.

There was no company-specific news for Canadian Solar this week, but the stock tumbled more than 10% anyway. Solar stocks as a group, as measured by the Invesco Solar ETF (TAN), were down more than 4%, while small-cap stocks pulled back slightly. Since CSIQ belongs to both those groups, perhaps it’s guilty by association on two fronts. Typically, when a stock gets knocked flat for no good reason, it’s a good time to buy.

The stock now has 70% upside to our 28 price target. 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.

The only real news for Honda this week is that it’s launching a micro-sized electric van in Japan, set for release in October. The van is intended for Japan’s delivery industry and has a range of 152 miles. It’s an interesting innovation that further boosts Honda’s leadership position in Japan’s blossoming “kei” micro-sized cars industry. But it probably doesn’t move the needle much for the multinational company’s bottom line or its share price.

Indeed, HMC shares were down about 3% this week, giving back its gains from the previous week. The stock has retreated from 37 to 31 since late March and has yet to find a clear bottom. Year to date, it’s still up 3% and trades at a mere 7.5x forward earnings and 0.40x sales, so it’s still a Buy with 41% upside to our 45 price target. The 4.2% dividend yield helps soften the recent blow. 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.

Philip Morris has halted online sales of its popular Zyn nicotine pouch after being accused of selling flavored pouches in Washington, D.C., where flavored nicotine products are banned. The company acknowledged the error, saying it’s “predominantly related to certain online sales platforms and some independent retailers.” Since this is just one major city affected, and because online sales make up a small portion of Philip Morris’ total sales, the damage done here is likely minimal. I’d view today’s modest selling as a buying opportunity.

Zyn sales were up 80% in the first quarter and are a major driver of the company’s renewed growth. Zyn also accounts for 74% of the nicotine pouch market.

PM shares have 18% upside to our 120 price target. The 5.1% dividend yield adds to the appeal. 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 0.31 and a price-to-book value of 1.80. The stock peaked at 96 a share in November 2018; it’s currently in the low 50s.

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.

There’s been no major news for United lately. A busy summer travel season could help move the needle, however. UAL shares were up 15% in June and July last year, as air travelers returned in droves in a post-Covid world.

The stock has 40% 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.

There was no company-specific news for Agnico this week. Gold stocks and gold miners have lost some momentum of late as gold prices have stagnated a bit. But they still remain historically high at more than $2,300 an ounce, though down from their May peak above $2,430 an ounce.

AEM shares are down about 1.5% since our last issue, but we still have a 17% gain on them in less than four months. They have 17% upside to our 75 price target. As long as gold prices remain elevated, AEM should have more room to run. 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 flat this week and have remained in the low to mid-12s since flirting with new highs above 12.7 last month. 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 0.40 and a price-to-book of 1.42. Shares have 15% upside to our 14 price target. The 6.9% 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.

Last month, 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 $27.78 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 13% since as Wall Street seems to have decided there was more bad than good in the results. The stock does seem to have stabilized, however, and is up slightly in the last two weeks. Trading at less than 7x earnings (and just 0.57x sales), CNHI shares have 38% upside to our 14 price target. The 4.5% dividend yield is at least providing a life raft as the stock has taken on water in recent weeks. BUY

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 from earlier this month. 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 recovered all the losses but has since sunk back nearly to post-earnings levels in the mid-16s.

GTES shares were down 2% this week after rising 2% last week, but it does seem like the stock has found support in the low 16s. It has 23% upside to our 20 price target. GTES trades at less than 12x earnings, 1.23x sales and 1.32x book value, so they remain undervalued by traditional measures. GTES remains our best-performing stock, with a return of 52% in less than two years. 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, but the energy sector is starting to gather momentum as oil prices have risen to $81 a barrel after dipping as low as $73 earlier this month. NOV shares have followed suit, advancing nearly 6% in the last two weeks. Crude prices being back above $80 for the first time since April could serve as a tailwind for NOV shares going forward.

The stock still has 31% upside to our 24 price target. It trades at just 11.7x forward earnings estimates and 0.82x sales. BUY

Worthington Enterprises (WOR) – Following the split-up of Worthington Industries late last year, “Enterprises” focuses on producing specialized building products (42% of sales) and consumer products (48%). The value of these operations was previously obscured by the market’s perception that the original Worthington Industries was primarily a steel processor. While the market sees an average company with a mix of only partly related products, we see a high-quality company with strong positions in valuable and profitable niches, backed by capable management and a solid balance sheet.

Worthington is set to report fiscal fourth-quarter earnings results next Wednesday, June 26. Fortunately, the report comes out before the market opens, so I will have details on it for you in next Thursday’s update. Analysts are expecting doom and gloom: a -70.8% decline in revenue and a -65.6% slide in earnings per share. Hopefully, those estimates are overly pessimistic; judging by recent quarters – Worthington has topped EPS estimates in each of the last four quarters – that’s likely to be the case. Stay tuned.

WOR shares were down 2% this week on no news. They have 40% upside to our 75 price target. BUY

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

Current price is Tuesday’s mid-day price.

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