Cabot Stock of the Month Issue: June 13, 2024

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Markets have been sideways in the past month, affected by wars, upcoming elections, and analysts see-sawing on the possibility of a Fed rate reduction. The Federal Reserve is meeting this week, and predictions for a rate cut this year are all over the board: none, one, or two.

I expect we’ll have more volatility as we near the fall election cycle.

In the meantime, economic stats look good! Manufacturing continues to climb, jobs are still being added at a rapid pace (272,000 vs. the estimate of 190,000), and the unemployment rate—at 3.9%—remains steady.

All eyes are on the Fed and the upcoming inflation report.

Growth stocks remain the market’s leaders, with large-cap growth stocks producing the best gains so far this year, up 15.87%. That’s considerably more than the next best gainer, large-cap value stocks, which have risen 6.18%.

Sector-wise, Communication Services (up16.16%), Technology (+12.01%), and Utilities (10.44%) are the leaders and Real Estate (down 5.22%), Consumer Discretionary (-0.64%), and Basic Materials (+4.97%) are the laggards.

Here at Cabot, we see the stock story as mixed. Let’s be choosy, looking for the equities that are seeing incoming cash flow, taking profits when we can, and ridding ourselves of those issues that are not going anywhere.

And while I love all styles—growth and value, large, midcap, and small-cap issues, I’m feeling a little cautious. So, this month, I’m bringing you an idea that really incorporates growth, value, and dividends—always a nice way to boost your income.

Feature Recommendation

McKesson Corporation (MCK): 191 Years Old and Still Going Strong!

Recommended by Tom Hutchinson, Chief Analyst, Cabot Dividend Investor and Cabot Income Advisor

Investors often discount the advantages of dividend-paying stocks. Yet more than 400 of the stocks in the S&P 500 Index now pay dividends—even some of the high-flying tech companies like Microsoft (MSFT) and Apple (AAPL). In fact, from 1940–2023, dividends’ contribution to the total return of the S&P 500 Index averaged 34%. Consequently, I believe stocks that offer dividends should be in every investor’s portfolio. And when I’m looking for a strong stock that also pays dividends, I turn to Cabot’s dividend expert, Tom Hutchinson.

“The pandemic aftermath made us acutely aware of the importance of supply chains. The Oxford Dictionary defines a ‘supply chain’ as the processes involved in the production and distribution of a commodity. It is how stuff gets from the producer into your hands. It involves pickup and delivery with transportation, storage, distribution centers and networks in the middle.

“The pandemic shutdown greatly disrupted these vital supply chains for a while. Many previously abundant products became in short supply. It was tougher to buy a car, get eggs, and many other things. Prices soared as a result. And the previously taken-for-granted supply chains became part of the national vocabulary.

“Efficient distribution is what makes this whole consumer economy work. Producers and retailers are not distribution experts. This vital function is mostly done by companies that specialize. Maintaining supply chains is crucial to a functioning economy. In some cases, it is vital to maintaining people’s health and even surviving, such as with the delivery of vital medicines and pharmaceuticals.

“McKesson Corporation (MCK) is a leading domestic wholesaler of branded, generic, and specialty pharmaceutical products. The company operates a supply chain that delivers products from 1,300 drug manufacturers to over 180,000 points of dispensation throughout the country. It has a solid base of over 40,000 customers and supplies about one-third of the U.S. drug distribution market. The stock performance has been quietly spectacular. And there is every reason for the stellar returns to continue. McKesson is an oligopoly in a market that continues to grow all by itself because of the aging population.

“McKesson buys drugs from manufacturers, delivers them, and resells them to retailers at a profit. Established in 1833, the company has been honing the process for nearly two centuries. It delivers from 1,300 producers to over 180,000 retailers by using 29 strategically located distribution centers throughout the country. Naturally, it has strategic partnerships with companies like CVS (CVS), Walmart (WMT), and Rite Aid (RAD).

“The extensive distribution network and enormous scale provide tremendous bargaining leverage with suppliers and customers that can’t be easily duplicated by would-be competitors. That’s why the business is an oligopoly. McKesson, Cencora Inc. (COR) and Cardinal Health (CAH) account for 95% of the drug wholesale distribution market in the United States. There are very high switching costs among the providers, so they rarely lose business to the other two companies.

“McKesson operates in four business segments: U.S. Pharmaceuticals, Prescription Technology Solutions (RxTS), Medical-Surgical Solutions, and International. But the U.S. Pharmaceutical segment is by far the main event, accounting for 90% of revenue in fiscal 2023. This segment delivers the spectrum of branded, generic, specialty, biosimilar, and over-the-counter pharmaceuticals.

“McKesson indicated earnings growth of 14% to 17% for this year in the last quarterly report. MCK just continues to forge quietly higher while no one seems to notice. The pharmaceutical supply chain goliath dominates a market that grows all by itself because of the aging population.

“While the past is no guarantee of the future, there are reasons to believe the stock can continue to deliver market-beating performance going forward. For one, the management is very shareholder-friendly. The company currently has an $8.9 billion share buyback program over the next few years. It plans to buy back $3.9 billion worth of those shares in fiscal 2024.

“McKesson is also focusing on high-growth areas in oncology and biopharmaceutical services. In fact, its oncology network already serves 15% of new patients. Management knows the business and where the best opportunities are to deliver pharmaceuticals and services. The company also has plenty of free cash flow it can use to expand and make acquisitions.

“That’s all well and good. It has a solid plan to proactively grow its business. But it doesn’t have to go crazy doing that because the main growth catalyst is the growth in existing markets. Pharmaceutical demand continues to rise every year at a solid pace because of the aging population. It has a huge share of a business that will grow all by itself. That’s the advantage of a massive tailwind like the aging population megatrend. Buy”

McKesson is the largest pharmaceutical distributor to hospitals, retail drug stores and physicians’ offices.

The company’s U.S. Pharmaceutical segment (about 90% of the company’s revenues) distributes branded, generic, specialty, biosimilar and over-the-counter pharmaceutical drugs, and other healthcare-related products. This segment also offers practice management, technology, clinical support, and business solutions to community-based oncology and other specialty practices, consulting, outsourcing, technological, and other services, and sells financial, operational, and clinical solutions to pharmacies.

The RxTS segment serves biopharma and life sciences partners, and patients to address medication challenges for patients by working across healthcare; connects patients, pharmacies, providers, pharmacy benefit managers, health plans, and biopharma companies to deliver innovative solutions to help people get the medicine needed to live healthier lives; and provides prescription price transparency, benefit insight, dispensing support, third-party logistics, and wholesale distribution support services.

The Medical-Surgical Solutions segment offers medical-surgical supply distribution, logistics, and other services to healthcare providers, including physician offices, surgery centers, nursing homes, hospital reference labs, and home health care agencies.

The International segment provides distribution and services to wholesale, institutional, and retail customers in Europe and Canada.

MCK is considered one of those “retirement-proof” stocks due to its strong fundamentals, great earnings history, and rising momentum.

As one of the top three companies in the drug distribution space, McKesson has very little competition. Its revenues in the past five years have risen 7.5% annually, and I see no sign of that slowing down as our population ages, obesity rises (giving a boost to the GLP-1 drug demand), and the need for oncology drugs (one of McKesson’s specialties) continues to escalate.

McKesson has strong cash flow which has enabled it to buy back shares, reducing its float by 25% in the past few years.

In its fourth-quarter earnings report, the company posted adjusted earnings per share (EPS) of $6.18, which did miss the consensus estimate by 2.52%, although GAAP EPS rose 5.4%, to $6.02. Revenues rose 11%, up 5.4% to $76.3 billion, from a year ago.

For the year, revenues climbed 12%, to $309 billion, with adjusted EPS of $27.44, a 6% gain over last year.

Looking forward, the company expects EPS in 2025 to be in the range of $31.25-$32.05, a 14% to 17% growth rate, with a similar growth rate for its revenues.

With growth, a dividend, and trading at a forward P/E around 18, this stock looks attractive at these levels. Buy

About the Analyst: Tom Hutchinson, Chief Analyst, Cabot Dividend Investor and Cabot Income Advisor

Tom Hutchinson is a Wall Street veteran with extensive experience in multiple investing and finance disciplines. Tom’s expertise includes specialized areas of mortgage banking, commodity trading, and in a financial advisory capacity for several of the nation’s largest investment banks.

For more than a decade, Tom created and actively managed investment portfolios for private investors, corporate clients, pension plans and 401(k)s. He has a long track record of successfully building wealth and providing a high income while maintaining and growing principal. As a financial writer, Tom’s byline has appeared in The Motley Fool, StreetAuthority, Newsmax and more.

He has written newsletters and articles for several of the nation’s largest online publications, conducted seminars and appeared on several national financial TV programs. For the past 13 years, Tom has authored a highly successful dividend and income portfolio with a stellar track record of success.

For this month’s issue, I asked Tom for a stock recommendation from his Cabot Dividend Investor portfolio and also requested that he bring us up to date on his thoughts about the market and certain sectors.

Here is our interview:

Nancy: In an end-of-the month update to Cabot Dividend Investor, you said, “I still doubt there will be rate hikes this year. The economy is still solid while inflation remains well above the 2% target.” Most analysts seem to agree with that thinking, and I’ve even seen comments predicting another rate hike. Have you changed your thinking since your last update? Why or why not?

Tom: I still do not believe the Fed will cut rates this year. Inflation is sticky and still high even after interest rates have risen to the highest levels in decades. Rate cuts could make things worse. Meanwhile, there is no compelling reason to lower rates while the economy is still solid.

Inflation has historically been a nightmare to kill. The Fed does not want to risk taking its foot off its neck and having it be a problem for the rest of the decade, especially when this inflation is partly of the Fed’s own making. Unless something materially changes later this year, I don’t expect any rate cuts.

Nancy: The companies in the S&P 500 currently average a dividend yield of 1.35%, considerably lower than the historical 2.91% average, due primarily to the escalation in the markets. With those payments at such lows, what case can be made for persuading investors to buy dividend-paying stocks, instead of growth stocks, which have been averaging double-digit returns for some time?

Tom: The market is likely to be a lot flatter in the months ahead as it gradually sinks in that rates won’t significantly fall until the economy rolls over.

Dividends still ring the register when prices go nowhere. Dividend stocks tend to be better during down or flat markets. Plus, many dividend stocks offer returns that do compete with those of growth stocks in recent years.

Nancy: As you predicted when we last talked, commercial Real Estate Investment Trusts have not been great investments in the past 6 months. Would you buy them at this level?

Tom: Although I remain selective about REITs (I would stay away from office properties and certain kinds of retail), the overall sector is oversold and likely to perform better going forward. Sectors don’t stay this out of favor. Consider this: Utility stocks were the worst last year and are the second best-performing sector in the S&P so far this year.

Nancy: The one REIT group that has performed very well recently is Specialty REITs, returning more than 11% year to date. Would you please tell my subscribers what constitutes a Specialty REIT, and share your current view on the sector?

Tom: Conventional REITs own properties in the retail, office and residential spaces. Specialty REITs have different kinds of properties like data centers, cell towers, and nursing homes. If there is a compelling appeal for the specialty, a REIT can perform well even in a lousy overall market for the sector.

Nancy: You recently recommended FS KKR Capital Corp (FSK), a business development company (BDC) with a double-digit yield. What factors, besides the high yield, attracted you to this company? And would you discuss the pros and cons of investing in high-yield stocks?

Tom: I’m not a fan of most high-yield stocks. They tend to offer little in terms of appreciation and are first to cut the dividend when the economy tanks. I made an exception with FSK because I have watched it for several years and the price performance has been very steady. FSK is a way to boost overall portfolio yield ahead of a likely more sideways market and I feel I can get away with it for the foreseeable future.

Nancy: Are there any sectors or sub-sectors that you currently see as oversold?

Tom: The more defensive sectors in REITs, utilities, and healthcare are oversold.

Nancy: What are the three to five most critical challenges to the growth of the stocks in your portfolio right now?

Tom: The biggest challenges to the portfolio are interest rates, recession, the wars, and the election. The market has already priced in the notion that interest rates have peaked for this cycle. If that proves not to be the case, there will be an unwinding of stock prices. It will also be a problem if the economy falters toward recession. The wars and the election pose event and headline risks that could roil the market.

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Portfolio Updates

Tom updated his thoughts on Qualcomm Inc. (QCOM), commenting, “It looks like the end of the recent surge, which was inevitable at some point. QCOM pulled back 7% from the recent high. It soared nearly 40% at its high between April 19th and last week. Earnings beat estimates and the company raised earnings guidance for 2024. But the real excitement is the growing talk about artificial intelligence coming to smartphones, and Qualcomm as a major beneficiary of the upgrade cycle. Several analysts are contending that an AI-driven super cycle is coming soon. Qualcomm is at the leading edge of chips that enable AI for smartphones and PCs and should benefit mightily. BUY”

The Semiconductor Industry Association (SIA) reported that “global semiconductor sales totaled $46.4 billion in April, up 1.1% from March’s total of $45.9 billion. Year over year, semiconductor sales jumped 15.8% in April.”

And that’s good news for Qualcomm, which is predicting that its earnings will grow 17.1% this year. That may be conservative, according to research by Counterpoint Research that estimates a total of 1 billion AI-enabled smartphones could be shipped between 2024 and 2027, with 80% of them powered by Qualcomm.

Our shares are up more than 45%. Let’s take some profits—Sell Half your holdings.

Chris Preston, Chief Analyst of Cabot Value Investor and Cabot Stock of the Week, reported that there wasn’t any important news on Citigroup (C), but shares are up 19% year to date. And the shares are still trading at a discount, with a P/E of 11.

Continue to Hold.

Michael Brush, Chief Analyst of Cabot Cannabis Investor, reported that “The Drug Enforcement Agency (DEA) has published its proposed rescheduling rule, which would move cannabis to Schedule III from Schedule I under the Controlled Substances Act. This change would provide a huge boost to cannabis companies by exempting them from an onerous Internal Revenue rule called 280E which bars them from deducting operating expenses. Our Curaleaf (CURLF), for example, would get a $150 million cash boost this year if the change took place. The top five cannabis companies (all portfolio names) would save $560 million a year in taxes, based on their 2023 tax bills.

The DEA’s proposed rule is now in a 60-day comment period.

Curaleaf says more than 350,000 patients rely on the company’s medical cannabis.

Continue to Hold.

Tyler Laundon, Chief Analyst of Cabot Small-Cap Confidential and Cabot Early Opportunities, noted that TransMedics Group (TMDX) “hit yet another all-time high this week, though shares are trading down a little today. Still holding onto a gain of over 300%. HOLD A QUARTER”

Let’s continue to Hold our remaining shares.

Tom also updated his views on Brookfield Infrastructure Partners (BIP), saying, “It’s been a wild ride on the current interest rate narrative for this infrastructure company. It was an awful first half of April as the stock fell about 20% in the first two weeks. But Brookfield reported strong earnings and the company has rallied to make up some of that dip since. It was going good for a while but has been sputtering over the last couple of weeks as the interest rate narrative turned sour again. But earnings were solid. The company also raised the next quarterly dividend by 6%. Solid earnings and a dividend raise are indicative of a company that is operationally strong. (This security generates a K-1 form at tax time.) BUY”

Since 2008, Brookfield has increased its funds from operations (FFO) per share at a 15% compound annual rate, which enabled the company to grow its annual distribution by 9%.

Looking forward, Brookfield is forecasting 10% annual growth in FFO over the next few years.

The company recently announced a 6% increase in its dividend, to $1.62 annually.

Continue to Buy.

Chris Preston also updated his outlook on NOV, Inc (NOV), saying, “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. Buy.”

Wall Street has been raising its earnings estimates for the company, now predicting EPS of $1.56 per share for this year, up by $0.02.

Continue to Buy.

International Business Machines (IBM) was reviewed by Carl Delfeld, Chief Analyst of Cabot Explorer, noting, “The stock sells at a discount to the S&P 500 multiple and the information technology sector’s forward earnings multiple. IBM has paid a dividend every quarter since 1916 and has had 28 consecutive years of dividend increases. Buy a half”

Analysts are expecting at least a 20% price appreciation for IBM’s stock, due to AI opportunities, high free cash flow payout, and a strong balance sheet.

Continue to Hold. Our shares are ahead 26%. I’ll look to take some profits soon.

Gates Industrial Corp, plc (GTES) was also updated by Chris Preston, commenting, “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 have 22% upside to our 20 price target. They trade at less than 12x earnings, 1.24x sales and 1.33x book value, so they remain undervalued by traditional measures. GTES remains our best-performing stock, with a return of 53% in less than two years. BUY”

Continue to Hold our remaining shares.

Our holdings in UnitedHealth Group Inc. (UNH) were also reviewed by Tom, who said, “The stock reversed its negative course after earnings put fears about the hacking to rest. UnitedHealth reported earnings last month that soundly beat expectations with an 8.6% revenue rise and a better than 10% increase in adjusted earnings from last year’s quarter. The company also issued strong guidance. The stock rose about 20% after the report but has since given some back. The stock was under pressure last week after management raised a red flag about Medicare reimbursement rates, but the stock has regained its footing since. BUY”

UNH announced a 11.7% increase to its dividend, to $2.10 per share. The company is forecasting operating cash flow for 2024 to be between $30 billion and $31 billion, an increase from $29.1 billion in 2023.

Wall Street estimates that adjusted earnings for UNH at $27.57 per share.

Continue to Buy.

Novo Nordisk (NVO) is one of “Europe’s Equivalent to Magnificent Seven Stocks,” part of the “Fantastic Five of Europe,” according to Thornburg portfolio manager Nicholas Anderson, due to “performance, resilience, growth and valuation.”

Buy on pullbacks.

Matt Warder, Chief Analyst of Cabot Turnaround Letter, informs us that “Baxter International (BAX) announced that it will pay a dividend of $0.29 per share on the 1st of July.”

I’m not thrilled with Baxter’s recent performance. Let’s change our recommendation to Hold for now.

Chris Preston also shared his latest thoughts on Honda Motor Co. (HMC), “While there was no major news with Honda the company this past week, there was some good news: Morgan Stanley hiked its price targets on HMC and fellow Japanese automaker Toyota Motors (TM), but highlighted Honda as its top pick, saying it liked the company’s ever-expanding hybrid car model options and improving supply. It also singled out Honda’s motorcycle division, which has improving margins thanks to reduced costs. Meanwhile, the stock remains dirt cheap at 7.7x forward earnings and with a price-to-sales ratio of 0.41.

“The stock was down another 1.5% this week – though almost all of those losses came today, on no news – and has now fallen more than 14% from its late-March highs above 37. I don’t expect it to stay down much longer: HMC has 39% upside to our 45 price target. BUY”

Morgan Stanley increased its price target on Honda to 2,250 yen from 2,200 yen, based on “a wider lineup of hybrid electric vehicles (HEV) and improving supply of the sector.”

Continue to Buy.

Our newest recommendation, FTAI Aviation (FTAI), was also reviewed by Tyler, noting, “FTAI is trading uncharacteristically lower today after pricing a $171.4 million (roughly 2.1 million shares) secondary offering last night by selling shareholder FIG LLC. The implied price per share is $82 (FTAI is trading near 78.5 midday today).

“This news comes right after an announcement that FTAI will move its outsourced management and advisory operations from FIG LLC back in-house. The cost to terminate this agreement is 1.9 million shares and $150 million in cash, and management says it will save $30 million this year and a lot more as time goes on (no profit sharing moving forward).

“This amounts to a lot of back-office-type changes but doesn’t change anything about what the business does. I suspect shares will trade down for a couple of days as the secondary offering flows through; then the stock will firm up. A number of analysts increased their price target following news of operations coming in-house. I am not concerned about the stock and think it’s OK to buy the dip. BUY”

Continue to Buy.

Portfolio

*Aggressive (A), Moderate (M), Conservative (C)

ETF Strategies

Our ETF portfolio is still going strong, with more than half of the ETFs up double-digits. But Global X Lithium & Battery Tech ETF (LIT) remains in the doldrums. I’m tired of waiting on any action in this ETF, so let’s Sell our shares.

I’m staying picky this month with our ETFs. Once I see some momentum with staying power, I’ll add another ETF to our portfolio.

In the meantime, these ETFs remain on our Watch List:

• Vanguard Small-Cap Growth Index Fund (VBK)
• Midcap Growth ETF Vanguard (VOT)
• Total Intl Stock ETF Vanguard (VXUS)

Obesity, Cancer, and Chronic Conditions are Feeding Pharmaceutical (and Distribution) Growth

Drugs are big business. Especially obesity drugs. Over the past few years, their growth has been stratospheric. And it’s not over yet. According to the IQVIA Institute’s Global Use of Medicines 2024 report, “Global obesity spending reached nearly $24 billion in 2023, an over sevenfold growth in value in just three years, driven by the advent of new agents, and from 2024 onwards the market is forecasted to accelerate rapidly, with a possible 24-27% CAGR to 2028, and a potential value of up to $131bn by 2028.”

That is sure padding the pockets of the pharma industry, along with oncology drugs, which are expected to reach $114.6 billion in sales this year. The total projected revenue for the Pharmaceuticals market in the United States is on track to rise to $636.90 billion in 2024, growing by 5.96% annually to a sales volume of $802.80 billion by 2028.

The pharmaceutical market in the United States is experiencing a surge in demand for personalized medicine and targeted therapies.

And since the volume of drugs is rapidly rising, it stands to reason that the distribution market will grow accordingly, which puts McKesson in the driver’s seat.

A recent report by Visiongain says that the pharmaceutical wholesale and distribution market is worth some $844.2 billion right now and is expected to grow at a CAGR of 8.7% until 2034.

And as you can see from the following graph, the top three distributors (including McKesson) are on track to take the lion’s share of that increase.

We Forecast Combined Sales for Big Three Distributors to Surpass $1 Trillion

The drug market has changed pretty radically since COVID. While pandemic drugs boosted revenues during that period, that revenue growth has now been replaced by obesity and oncology drug demand, as well as the need for more cardiovascular, chronic respiratory disease, diabetes mellitus, and stroke drugs.

The industry has seen some backswings due to the decline in generic drug prices, which have squeezed margins. However, companies have responded by boosting their investments in specialty assets, such as offering higher-margin services to manufacturers, pharmacies, clinics, and hospitals (one of McKesson’s segments) in the areas of oncology and other specialty therapeutic areas.

These additions have widened the distribution company’s focus (and revenue opportunities) by combining their distribution prowess with services such as data, business strategy, and industry insights.

And they are paying off in terms of stock appreciation.

Although McKesson isn’t going to be a “barn-burner,” the shares have shown some very nice appreciation, continued growth looks solid, and you get a dividend. What’s not to like?

Portfolio

*Aggressive (A), Moderate (M), Conservative (C)

**Purchase price reflects a 3-for-1 stock split

The next Cabot Money Club Stock of the Month issue will be

published on July 11, 2024.

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