Cabot Stock of the Week 324

The market continues to strengthen, and thus you should become more heavily invested; it’s possible this strength could run to the end of the year!

But predictions aren’t necessary; what’s necessary is listening to your stocks and acting accordingly.

Today, doing exactly that leads us to sell one stock, so that we can make room for today’s recommendation, a company that’s built one of the biggest brands in the world.

Cabot Stock of the Week 324

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The bull market rolls on, with today’s news about Moderna’s vaccine providing a high-profile reason to be optimistic about reopening the economy. And what better symbol of the economy is there than a Coca-Cola? The stock is strong, it’s cheap and it pays a 3% dividend. It was originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor and here are Bruce’s latest thoughts.

Coca-Cola (KO)
Coca-Cola is one of the world’s largest beverage companies. While it is best known for its iconic soft drinks, the company has a strong portfolio of non-soda brands, including PowerAde, Fuze Tea, Glaceau, Dasani, Minute Maid and Schweppes. Nearly 40% of its revenues now come from non-soda products across the non-alcoholic spectrum, including juice/dairy/plant beverages, water/hydration drinks, tea and coffee, and energy drinks.

Its global distribution system of 30 million customer outlets offers it the capability of reaching essentially every human on the planet. This allows it access to growing emerging countries where its market share has considerable potential to expand.

Relatively new CEO James Quincey, who took the helm in 2017, is a highly regarded company veteran with a track record of producing profit growth and making successful acquisitions. The $5 billion acquisition of Costa Coffee in January 2019, while perhaps unluckily timed only a year in front of the pandemic, still offers considerable potential. It added nearly 3,900 coffee shops throughout Europe, China, India and the Middle East, giving Coca-Cola a valuable entree into coffee as well as a new channel to expand its distribution.

To improve its global operations, Coca-Cola is reorganizing to become more effective and more efficient. The former 17 business units are being concentrated into nine operating units, with a stronger emphasis on building the connections between these units. Product category teams will focus on improving marketing as well as introducing new and innovative beverages. Innovation efforts will be more clearly driven by their ability to either significantly increase the number of new drinkers, their frequency of consumption, or the value (profit) per consumption. The company is also culling its vast portfolio of over 400 brands by 50% to focus on its highest-priority offerings.

To capture more of the value of Coca-Cola’s vast global scale, back-office administrative services are being centralized and standardized across the system. A sizeable round of staffing reductions (about 4,000) should lead directly to lower costs, as well.

All of these changes should accelerate the number and success rate of new products while expanding the overall profits of the company.

While Coca-Cola has much more ground to cover to improve its image (and the reality of selling sugar-intensive beverages that are packaged in environmentally insensitive plastic), the company is accelerating its efforts. Eighteen of its top 20 brands, including Coke Zero, are now either low/no sugar or offer a low/no sugar option, with 29% of its total volume now in low/no sugar beverages. The company’s packaging has risen from only 3% recyclable to 88% recyclable, with many additional programs in place to further improve.

Coca-Cola has a sturdy balance sheet, with its $53 billion in debt well covered by cash flow and partly offset by over $21 billion in cash. Its $0.41/share quarterly dividend is also well covered by solid free cash flow, and the company is committed to growing this dividend. It is targeting a 75% payout (of free cash flow) over time. The dividend yield is currently a respectable 3.1%.

Recent results point to a recovery from pandemic-depressed volumes. While second quarter global volumes fell 16%, and revenues fell 28%, third quarter volumes fell only 4% while revenues were only 9% below the prior year. Management commentary points to continued improvements in October. Third quarter revenues and profits were higher than consensus estimates, suggesting that investors don’t fully appreciate the strength of the company’s fundamentals.

Impressively, Coca-Cola’s comparable operating profit margin increased to 30.4% from 28.1% a year ago, despite lower revenues. When the higher-margin away-from-home business returns as restaurants, stadiums and other venues re-open, the company’s margins could expand further. Comparable earnings per share fell only 2% compared to a year ago.

While the near-term outlook is clouded by pandemic-related restrictions, the trend away from sugary sodas, high exposure to foreign currencies and always-aggressive competition, the longer-term picture looks bright.

KO shares are not statistically cheap at 25x 2021 estimated earnings, but they are undervalued. They remain about 11% below their February 2020 high, while the company has arguably become more valuable. We are placing a 64 price target on the stock, about 20% above the current price.

Current Recommendations

The addition of Coca-Cola means we are once more over our cap of 20 stocks and therefore something must go—and this time, the choice is easy. It’s Agnico Eagle Mines (AEM), as explained below. Otherwise, our stocks are performing well.

Changes
Agnico Eagle Mines (AEM) to Sell

Agnico Eagle Mines (AEM), originally recommended by Mike Cintolo in Cabot Growth Investor, has fallen out of the trading range that had contained it since August, and that, combined with the fact that the stock is our biggest loser (though not that big), means it now gets evicted from the portfolio. SELL.

Azek (AZEK), originally recommended by Tyler Laundon in Cabot Early Opportunities advisory, rebounded to its 50-day moving average last week, but that line is now trending down, which is a bit worrisome. However, the long-term trend can still be seen as up, and given that the fundamental story is still intact here (greater demand for home construction will spur demand for Azek’s wood substitutes), I’ll remain patient. HOLD.

B&G Foods Inc. (BGS), originally recommended by Tom Hutchinson for the High Yield Tier of Cabot Dividend Investor, continues to trade just under its 50-day moving average, neither strong nor weak. In his update last week, Bruce wrote, “It’s been a crazy week for this packaged food company. Great earnings were reported for the third quarter last week. The company grew earnings per share over last year’s quarter by 37%, not bad for a company that had seen average earnings growth of 3% over the past five years. It also soundly beat expectations. But the stock fell over 5% in the euphoric Pfizer (PFE) vaccine market yesterday because short term investors consider BDS a pandemic trade that will come back to earth as the problem goes away. But sooner or later the pandemic was sure to fade. The stock was purchased in this portfolio with that understanding. An increased level of business and growth is sure to last beyond the pandemic, making the stock a good value with a safe and high dividend. The one-day reaction doesn’t tell the story, and the stock should outperform in the future.” BUY.

Columbia Sportswear (COLM) originally recommended by Bruce Kaser for the Buy Low Opportunities portfolio of Cabot Undervalued Stocks Advisor, sold off three weeks ago after a disappointing earnings report, but now seems to be building a base in the upper 70s and Bruce has upgraded it to buy. In his update last week, he wrote, “The company said that orders continued to strengthen in the fourth quarter, raised its cost-cutting goal to $100 million this year and announced the retirement/replacement of its chief operating officer and other senior operations executives. Columbia’s balance sheet remains solid, holding $315 million in cash and no debt, providing it with considerable financial flexibility. As price-sensitive investors, we moved Columbia shares back to a BUY. Columbia’s long-term earning power appears unimpeded but is being pushed out into the future. Also, we think the company is being exceptionally conservative with its forward guidance, given the wide range of uncertainties and the danger that another significant “miss” would more severely damage their credibility. The shares have about 26% more upside to our 100 price target. The shares trade at 21.1x estimated 2021 earnings of $3.77. The earnings estimate was unchanged from last week. For comparison, the company earned $4.83/share in 2019.” BUY.

Digital Realty Trust (DLR), originally recommended by Tom Hutchinson for the Dividend Growth Tier of Cabot Dividend Investor, found solid support after an initial selloff last week and still has more upside potential. In his update last week, Tom wrote, “This data center REIT is another stock that moves to its own drummer. Yesterday that was a bad thing as DLR fell 5.77% when the market had a big up day. The market rewarded stocks that have not benefited in this recovery and punished others that have. DLR had been up 25% YTD compared to just 11% for the market. But data centers and technology will continue to grow strongly after the pandemic. This is no pandemic flash in the pan. DLR has average an 18% total return over the last five years. It should also benefit from the growth of 5G going forward.” HOLD.

Eli Lilly & Company (LLY), originally recommended by Tom Hutchinson for the Dividend Growth Tier of Cabot Dividend Investor, remains under its 50-day moving average, but the stock is looking stronger. In his update last week, Tom wrote, “Lilly got a huge bump on the day after the election as the health care sector reveled in the likelihood of divided government, making any draconian changes to the industry all but impossible. LLY shot 14.5% higher, the most of its peers. It may have gotten an additional boost from positive FDA news about a competitor’s Alzheimer’s drug because Lilly has a promising Alzheimer’s disease blood test in trials. Recent news aside, this is a great company with a fantastic pipeline that should continue to perform well going forward.” BUY.

General Motors (GM), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor and featured here just two weeks ago, is strong, hitting levels it hasn’t seen since 2017. In his update last week, Bruce wrote, “GM produced a remarkable third quarter. Adjusted earnings of $2.83/share were 65% higher than the pre-pandemic earnings a year ago and nearly double the $1.43 consensus estimate. From a different perspective, the company’s revenues were the same as a year ago, but the $5.3 billion in adjusted operating profits was $2.3 billion, or 78%, higher. GM North America profits grew by $1.3 billion and GM Financial profits rose by $500 million. GM International, including China, and Cruise showed profit increases as well. The Automotive segment generated $9 billion in free cash flow, partly offsetting $7.6 billion in negative free cash flow in the first half of the year. Compared to the pandemic-stricken $(500) million loss in the second quarter, GM has produced a remarkable recovery.

On the conference call, GM discussed its impressive array of electric vehicle and autonomous vehicle initiatives. There are many – we won’t go through all of them here – so the key takeaway is that the company continues to aggressively develop its capabilities, and clearly has the necessary financial capacity. The company said it would likely reinstate its dividend in mid-2021. The stock has about 10% upside to our 45 price target. The target price implies an 8.2x multiple on 2022 estimated earnings of $5.50. GM shares trade at 8.5x estimated 2020 earnings of $4.83 and 7.1x estimated 2021 earnings of $5.71. The 2020 estimate jumped about 72% on the strong 3Q results and 4Q commentary. The 2021 estimate increased by about 19%. GM remains an attractive cyclical stock.” BUY.

Huazhu Group Limited (HTHT), originally recommended in Cabot Global Stocks Explorer, is China’s largest hotel operator, with 6,507 hotels and 637,087 hotel rooms in operation in 16 countries—and we’re in it for the long haul, as the long-term prospects are great. Today the stock is strong, trading near its recent highs, as the reopened Chinese economy, once again on a growth track, inspires buyers. HOLD.

Molson Coors Beverage (TAP), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, continues to climb, as the company’s turnaround continues. In Bruce’s update last week, he wrote, “Molson Coors third quarter results showed that the company is making progress with its turnaround and that investors underestimate this progress. Net revenues of $2.75 billion fell 3.1% from a year ago, but were about 4% better than consensus estimates. Adjusted per share earnings of $1.62 were nearly 60% better than estimates. Underlying EBITDA of $713 million was 1% higher than a year ago and 26% higher than estimates. The company produced generous cash from operations and reduced its debt by $266 million. In many ways, these are the most two important statistics for the Molson Coors story – if cash flows and debt repayment remain healthy, eventually the company’s underlying value will become obvious to the market, as will its ability to pay a respectable dividend. The shares have about 39% upside to our 59 price target. The shares trade at 10.1x estimated 2020 earnings of $4.18 and 10.2x estimated 2021 earnings of $4.16. Both estimates rose from last week. These valuations are remarkably low. On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 7.9x estimates, among the lowest valuations in the consumer staples group and well below other brewing companies.” BUY

NextEra Energy (NEE), originally recommended by Tom Hutchinson of Cabot Dividend Investor for his Safe Income Tier, continues to trend higher, as alternative energy boosts returns for the big utility. HOLD.

Novocure (NVCR), originally recommended by Mike Cintolo in Cabot Top Ten Trader and featured here last week, has done nothing for us yet, but the chart is very healthy, building a little base as the 50-day moving average approaches. If you’d like a piece of a company with great cancer-fighting technology, it’s not too late to buy. BUY.

Nuance Communications (NUAN), originally recommended by Tyler Laundon in Cabot Early Opportunities, hit a record high last Thursday and has pulled back minimally since. If you want to invest in the leader in conversational artificial intelligence, you can buy here. BUY.

Pinterest (PINS), originally recommended by Mike Cintolo in Cabot Growth Investor, continues to consolidate the gains made when it gapped up to record highs three weeks ago. Mike has recommended taking partial profits since then, because the stock is still extended, but long term prospects remain bright. BUY.

Qualcomm (QCOM), originally recommended by Mike Cintolo in Cabot Growth Investor and now recommended by Tom Hutchinson in Cabot Dividend Investor, continues to consolidate the gains made when it gapped up big-time after an excellent quarterly report. In Tom’s update last week, he wrote, “This chip maker blew away expectations with earnings last week. Revenues grew 35.1% and earnings were 26% higher than last year’s quarter. Revenues were $6.5 billion versus an expected $5.9 billion, and earnings far exceeded the expected $1.17 per share with an actual $1.45 per share. In addition, the company significantly raised guidance for next quarter. The rollout of the 5G phones is having an even bigger impact than expected.” And that strength earned the stock a recommendation in Cabot Top Ten Trader, where Mike Cintolo wrote, “Qualcomm is front and center in the commercialization of the 5G phone market and continues to expand its portfolio of 5G mobile platforms, all of which is resulting in some huge growth. Management says that the 5G rollout is progressing even faster than 4G did and believes 2021 will be the “sweet spot” for 5G, with all major handset makers paying the company royalties on their 5G phones (including higher licensing fees from Apple and Huawei, who finally stuck deals with the company during the past couple of years). Qualcomm had blowout earnings in its fiscal fourth quarter, reporting a stronger-than-expected handset market. The company reported a hefty 35% jump in its Q4 top line to $6.5 billion (plus an additional, one-time $2 billion licensing payment from Huawei) and earnings of $1.45 per share (up 86% and 28 cents above expectations). It further reported solid revenue growth in its Internet of Things (IoT) solutions thanks to higher demand in networking, retail, industrial, tracking and utilities verticals. Management also guided for strong demand for 5G devices in the current fourth quarter, forecasting revenues of $8.2 billion or so, far exceeding the consensus estimate of $7.2 billion. With over 110 licensing agreements for 5G with smartphone original equipment manufacturers (OEMs), the firm believes there will be around 500 million 5G smartphones shipped in 2021, up significantly from this year’s estimated 200 million. And analysts are buying in—earnings for the current fiscal year (which just began) should leap to $7 per share, leaving plenty of room for dividend hikes and share buybacks if the top brass go that direction. Qualcomm remains our favorite mega-cap story.” BUY.

Sea, Ltd. (SE), originally recommended by Mike Cintolo in Cabot Top Ten Trader, and then Carl Delfeld in Cabot Global Stocks Explorer, hit record highs two weeks ago and has pulled back normally since. In his update last week, Carl wrote, “Shares pulled back early this week from 185 to 156 before rebounding sharply to 169. The pullback was probably a mix of profit taking, an analyst downgrade, and the announcement of a potential vaccine by Pfizer, which seemed to hit digital stocks. Separately, a new report from Google, Temasek Holdings, and Bain & Company showed that demand in Southeast Asia for online services, including e-commerce and digital payments, has skyrocketed. Sea’s gaming division, Garena, is its big profit center, thanks mostly to their Free Fire game, which is extremely popular in Latin America and Southeast Asia. More recently, Garena has entered the India market. Aggressive investors can add to their position at these levels, but I will keep Sea as a hold.” HOLD.

Taiwan Semiconductor (TSM), originally recommended by Carl Delfeld of Cabot Global Stocks Explorer, gapped up to record highs this morning as chip stocks surged. In his update last week, Carl wrote, “Shares moved sideways this past week as the big news was the launch of new Mac laptops using its homegrown M-1 chips. The initial rave reviews are bad news for rival Intel. China also recently announced major investments in its semiconductor industry, though the country is several generations behind Taiwan Semiconductor, which dominates global chip fabrication with a market share of 56%. The company delivered an impressive return on equity of 31% in its most recent quarter. I maintain a buy rating on the stock.” BUY.

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, remains in the consolidation pattern that has occupied it over the past two-plus months, but there’s little doubt in my mind that higher prices are ahead. And Mike thinks so too, as he maintains it in his Watch List in Cabot Growth Investor. Last week he wrote, “TSLA is now 11 weeks into a sideways, low-volume consolidation. Some more shaking and baking wouldn’t shock us but, until proven otherwise, the next big move is likely up.” HOLD.

Trulieve (TCNNF), recommended by yours truly in Cabot Marijuana Investor, is one of the leading vertically integrated multi-state operators in the U.S.—with particular strength in Florida, where it has roughly 50% market share. And it’s one of the most well-run, too, posting profits since 2017—while many peers are still losing money. Best of all, the stock is strong, achieving a record closing high yesterday as investors pile into stocks expected to benefit from the overwhelming voter support of marijuana legalization in all five states where it was on the ballot two weeks ago. And the company continues to expand its footprint. Last week Trulieve closed on the acquisition of PurePenn and Keystone Relief Centers, which gets the company into Pennsylvania for the first time. At a cost of $66 million, this acquisition gets the company a 35,000 sq. ft. growing and processing facility (soon to be expanded to 90,000 sq. ft.) and three operational medical marijuana dispensaries in the state. Third quarter results will be released tomorrow, November 17, before the market opens. BUY.

Virgin Galactic (SPCE), originally recommended by Carl Delfeld in Cabot Global Stocks Explorer, is a volatile stock, and today the movement is in the downward direction—but the long-term trend is up. In his update last week, Carl wrote, “Shares jumped from 18 to just under 22 despite the general consensus that revenue will be more modest in 2021 than the earlier projection of $31 million. Instead, Virgin Galactic Holdings’ seven analysts are now forecasting revenues of $24 million in 2021. As the only pure play space tourism stock in public markets, this remains your best way to gain exposure to this megatrend. If the next two missions run smoothly, Virgin Galactic plans to send founder Richard Branson up in the first quarter of 2021. Aggressive investors should be buying at these levels ahead of 2021 developments.” BUY.

Zoom Video (ZM), originally recommended by Mike Cintolo in Cabot Top Ten Trader, sold off last Monday as fears that a Covid vaccine would hurt business triggered profit-taking, but the stock bottomed Tuesday and it remains above that level today. I’ve previously recommended partial profit-taking, given that ZM was one the most high-profile of the Covid “winners” but I still have high hopes that this could be a big long-term holding—because video-conferencing is not going away. Third quarter results will be released after the market close on Monday, November 30. HOLD.

The next Cabot Stock of the Week issue will be published on November 23, 2020.

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