February 28, 2022

With the war in Ukraine taking center stage, it’s very hard to predict what markets will do. But we don’t need to. All we need to do is keep following proven investing systems.
The only change to the portfolio today is the downgrade of Veeco (VECO) to Hold.

As for the new recommendation, it’s probably a household name for folks in the Chicago area, but it’s a new one for me. And it’s a new stock, as well, having just come public in October.

Details inside.

New Recommendation

Just a few months ago, Covid was the market’s biggest worry. Then came inflation. But now, with the Russian invasion of Ukraine well under way, those prior worries slip to second and third place. I have been to Ukraine. I have friends in Ukraine. And it saddens me to know that because Ukraine could not use its 30 years of independence to build a strong economy, Putin now sees opportunity to take it back. Anything can happen from here, and the results could certainly affect the market, but predicting not only the course of war but its effect on investments is terribly difficult, so the best I can do for you is to simply keep on course, relaying the most appropriate investments that have been recommended by Cabot’s team of expert analysts. Today’s recommendation is a name that folks in the Chicago area will be familiar with, though it’s new to me, and I like the diversification it will supply to our portfolio. The stock was originally recommended by Tyler Laundon in Cabot Early Opportunities and here are Tyler’s latest thoughts.

Portillo’s (PTLO)
Portillo’s (PTLO) is a fast-casual restaurant chain that began in 1963 when Dick Portillo opened the first Portillo’s hot dog stand in Villa Park, IL. He invested $1,100 in the stand, which he called “The Dog House.”

Over the years, Portillo’s has become a well-known restaurant brand in the Chicago area. Success has led the company to expand into nearly 70 locations across nine states and to take the company public (IPO was in October). Most locations are in the upper Midwest, with a few scattered across Florida, Arizona and California. Portillo’s currently has a market cap of $867 million.

The restaurant is knowns for famous Chicago-style hot dogs, Italian beef sandwiches, chopped salad, cheese fries, homemade chocolate cake and chocolate cake shakes. I’ve never been to one but have heard great things from friends that have.

According to Portillo’s website their Italian beef is “... slow-roasted for four hours, thinly sliced, and served on freshly baked French bread. Then, it’s dipped in hot gravy made with our homemade blend of seasonings that we’ve been perfecting for 50 years.” That sounds pretty good to me!

The average per-person spend at Portillo’s is less than $10. That’s much lower than other, high-volume, fast-casual restaurants. But this is a very efficient business with diners coming in across weekends, different times of the days and through both drive-in and lobby locations. The average works out to roughly 50-50 lunch/dinner. Average daily guests per restaurant surpasses 2,500. That’s more than McDonalds (MCD), which pulls in around 1,600 a day.

Investments in technology are part of the reason Portillo’s can keep costs down and customer turnover quick. The company has drive-thrus (53% of revenue), delivery (6% of revenue) and dine-in (41% of revenue), all supported by online ordering and mobile app capabilities. Around 20% of orders come through digital channels. Food costs are higher than is typical in fast casual, while labor costs are lower. All in, Portillo’s unit-level returns hover around 30%, which is higher than the industry average.

This is the type of business that could explode over the next decade. Portillo’s has been in business for over 50 years. The company’s brand recognition and story are authentic and time-tested, should consumers in new geographies want to embrace it. It’s also in the fastest-growing area of the restaurant industry. And Portillo’s has an aggressive expansion strategy to grow to 600 locations by 2039, implying average annual growth of 13%.

While stores around the Chicago area tend to have higher sales volume (up to $9 million versus $6 million outside of that area), there is room for those locations to turn up the dial as brand awareness and restaurant density spreads. Expect management to focus on growing store count in current geographic areas before it spreads out to new states. In 2022 we should see seven new stores open. That should mean revenue grows by around 10%, to $590 million. That’s somewhat slower than the 19% growth rate expected when 2021 is in the books. But there’s likely some upside room to consensus estimates. As a final sweetener, Portillo’s is expected to turn profitable this year and deliver adjusted EPS of $0.32. Investors will get the next update when Portillo’s reports Q4 2021 results on March 10.

PTLO came public at 20 on December 21 and jumped 46% the first day. Shares kept climbing all the way to an intra-day high of 57.8 by November 18. Following the November earnings report it became clear the stock was stretched, and over the following weeks PTLO slid by 48%.

A brief rally began in late December carried PTLO back to 40, but another slide pulled shares down into the low 20s by the end of January. PTLO has since found support twice around the 22 level (the latest time being last week). Shares appear to have meaningful upside from the current level, provided support at 22 holds and 2022 guidance meets or exceeds expectations.

Current Recommendations and Changes

Current Recommendations

Officially, the broad market is now in a downtrend, so a defensive posture is warranted. But what exactly is defensive? It could be short-selling—which is difficult and risky, given that the market’s long-term trend is up. It could be a shift to stocks that do well in the difficult environment. Our energy stocks are doing very well, and we could certainly add another. And it could be cash—but I can’t find a single stock that I want to sell today; four of ours have hit new highs recently and the remainder are holding above their January lows, ripe for advance. So, the only change today is a downgrade of Veeco Instruments (VECO) to Hold. Details below.

Changes Since Last Week’s Update
Veeco Instruments (VECO) to Hold

Arista Networks (ANET), previously recommended by Mike Cintolo in Cabot Growth Investor, broke through support at 120 when the invasion began, but it quickly bounced with the market and thus is still viable. In his update last Thursday, Mike wrote, “Arista has nosedived with the rest of the market in recent days, falling a quick 25 points or so from its post-earnings high to this morning’s panic low before staging a good-looking rebound. Frankly, we have a growing loss here and we don’t want to let the position get away from us much from here—but tonight, we’re holding on for a few reasons that we’ve gone over before. Fundamentally, Arista is a (very) rare growth bird these days, offering not just growth but dependability, with an order book that’s chock full for the next few quarters, mostly thanks to the hyperscale cloud players (the ‘Cloud Titans’ in Arista’s language) that are just starting a huge expansion cycle, but also due to enterprise and campus demand, which are smaller pieces of the pie but growing rapidly. Analysts see earnings up 27% this year and mid-double-digits for a few years afterwards, and for 2022 anyways, those estimates include some baked-in supply chain headwinds and cost pressures. And technically, while it’s hard to say something that’s 20% off its high in just a few weeks looks amazing, there’s no doubt ANET’s pullback looks normal overall (you wouldn’t know growth stocks have crashed looking at this chart). Moreover, we do think today’s headline-driven selling and rebound has a shot at least at marking another workable low. Long story short, we’ve been aiming to give this stock every chance to hold up, as we think it has all the makings of a winner during the next sustained rally—so tonight, we’ll hold on, though if the selling from this morning returns, we could revisit that thought.” HOLD

Bristol-Myers Squibb Company (BMY), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor for his Growth/Income Portfolio, continues to climb! In his update last week, Bruce wrote, “BMY shares sell at a low valuation due to worries over patent expirations for Revlimid (starting in 2022) and Opdivo and Eliquis (starting in 2026). However, the company is working to replace the eventual revenue losses by developing its robust product pipeline while also acquiring new treatments (notably with its acquisitions of Celgene and MyoKardia), and by signing agreements with generics competitors to forestall their competitive entry. The likely worst-case scenario is flat revenues over the next 3-5 years. Bristol should continue to generate vast free cash flow, has a solid, investment-grade balance sheet, and trades at a sizeable discount to its peers.

On February 4, Bristol-Myers reported healthy fourth-quarter results and reiterated its reasonably encouraging full-year 2022 guidance for flat revenues and a 4% earnings per share growth. The core business appears likely to perform well even as sales of Revlimid (27% of total revenues) could slide by 25% as the treatment loses patent protection. Sales rose 8% (ex-currency) and were in line with estimates, while adjusted earnings rose 25% and were modestly above estimates.

The company maintained its long-term 2-5% revenue growth and low to mid-40s operating margin targets as well as its outlook that it will generate $45-$50 billion in free cash flow from 2022-2024. If met, these results would be plenty strong enough to boost Bristol’s shares significantly. Bristol’s balance sheet remains sturdy.

BMY shares have about 16% upside to our 78 price target. Valuation remains low at 8.6x estimated 2022 earnings, compared to 11x or better for its major peer companies. The stock’s 8.1x EV/EBITDA multiple is similarly cheap, compared to 9-10x or better for peers. Assuming an average of $15 billion/year in free cash flow, the shares trade at a 10% free cash flow yield.” BUY

Broadcom (AVGO), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, has moved with the market in recent days but remains way above its low of late January (513), which is very encouraging. In his update last week, Tom wrote, “We’re riding out the tech route with this legendary technology company stock. The recent ride should be worth it because business is booming as Broadcom benefits from the 5G rollout and should also benefit from increased internet usage further out. The tech selloff has leveled off and AVGO is well off the recent lows. Investors never sour on technology for too long; it’s where all the growth is. I expect AVGO to be a lot higher later in the year.” Fourth-quarter results will be released Thursday, March 3, after the market close. HOLD

Brookfield Infrastructure Partners (BIP), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, provides a 3.5% yield with little drama, and the chart looks great, with the main trend slowly and steadily up. HOLD

Cisco Systems (CSCO), originally recommended by Bruce Kaser in the Growth/Income Portfolio of Cabot Undervalued Stocks Advisor, pulled back with the market last week but remains above its pre-earnings report low. In his update last week, Bruce wrote, “On February 16, Cisco reported encouraging fiscal second-quarter results that suggest that the company is making progress with its growth initiatives. Revenues rose 6% from a year ago (although 2 points of this were due to acquisitions) and were in line with the consensus estimate. Adjusted earnings of $0.84/share increased 6% and were about 4% above the $0.81 consensus estimate. Cisco removes stock-based compensation expenses from its adjusted earnings – a dubious practice but because they consistently do this, we can gauge the changes in underlying earnings with reasonable effectiveness. Forward guidance for the third quarter and full year were also encouraging as these pointed toward respectable revenue and earnings growth.

The company said that product orders rose a healthy 33%, such that it has a record-high product backlog of $14 billion, up 150% from a year ago. Demand for Cisco’s products remains strong, yet the backlog increase is partly due to unfilled orders that are accumulating due to supply constraints. Services revenue fell 1% as the company said that it couldn’t deliver on hardware support contracts due to supply constraints. The annualized recurring revenue base grew 11%, indicating better visibility as the company transitions to a subscription-based model.

Cisco’s gross margin of 65.5% eroded from 66.9% a year ago but improved from the first quarter. The decay is due to the rising importance of products, which generally carry lower margins than services, as well as decaying product margins. Healthy control of operating expenses helped maintain a relatively steady operating margin.

The company raised its dividend by 3% (or 1 cent). It also increased its share repurchase program by $15 billion to a total of $18 billion but assigned no end date. Cisco repurchased an impressive $4.8 billion of shares in the second quarter. The balance sheet has $9.6 billion of debt net of cash, down 26% from the July fiscal year end. Cash flow was healthy but restrained by advance payments to secure components.

CSCO shares have 17% upside to our 66 price target. The dividend yield is an attractive 2.7%.” HOLD

Devon Energy (DVN), originally recommended by Mike Cintolo in Cabot Growth Investor, hit another record high last Tuesday! In his update on Thursday, Mike wrote, “Commodity stocks remain generally strong, and of course, for energy names anyway, a lot of that has to do with global events: Even after giving up its gains today, oil prices are still hovering north of $90 as Russia’s invasion threatens to throw the global energy markets into at least temporary chaos. That’s obviously good news for DVN, which remains in a solid uptrend (still north of its 25-day line), though to be fair, we are seeing some ‘sell the news’ selling pressure pop up of late. We can’t rule out further selling pressure if some investors game out a rotation of sorts; it’s possible we could take partial profits if we see any real change in character, especially given that DVN is a huge part of our overall portfolio. Still, at this point, we’re viewing these wiggles as short-term profit taking that’s based mostly on oil price movements and occasionally jerks around the group—but the evidence has been building in recent months that more and more big investors are looking at names like Devon from a cash flow perspective, and because of that, dips have generally been bought up. Some of that support could show up from Devon itself, which just reloaded its share buyback program, while the upcoming $1 per share dividend (for those that own the stock on March 11; payable March 30) could keep some income investors interested. At $85 oil (8% below current prices) and $4 natural gas (14% below current prices), Devon’s free cash flow would total something like $7.30 per share for 2022, with around $4 paid out in dividends and a bunch more going to share buybacks. (So far this quarter, oil prices have averaged $86 and gas $4.25.) All in all, we’re sort of splitting our view into two camps: Bigger picture, we think the energy story can play out for a while longer as perception of the cash flow potential improves, though short term, we see risk being a bit elevated given all the good news (for energy firms) and the weak and whippy market. Hold on if you own some, but if you want to buy, we suggest aiming for dips of at least a couple of points.” BUY

Harley-Davidson (HOG), originally recommended by Carl Delfeld in Cabot Explorer and featured here last week, has a great American brand and is working on building another with its all-electric LiveWire motorcycle division, which will spin off into a SPAC later this year. The stock roared to life three weeks ago after the company reported an excellent fourth quarter (revenues up 40% from the prior year) and it’s pulled back to its 200-day moving average since, providing a decent entry point. BUY

Organon (OGN), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, was spun off from Merck in June 2021 and is a member of the S&P 500—but undervalued by the market according to Bruce. And on Friday it closed at a record high! In last week’s update, Bruce wrote, “On February 17, Organon reported an acceptable quarter. Revenues of $1.6 billion fell 1% from a year ago but were about 1% above estimates. Adjusted earnings of $1.37/share fell 30% from a year ago but were about 7% above estimates.

Women’s Health segment revenues rose 6% as its key Nexplanon sales rebounded by 37%. The rebound helped build management’s credibility as there was considerable investor skepticism around their confidence in Nexplanon. Biosimilars treatments, a source of future growth, rose an encouraging 15%. Established Brands sales slipped 2% but we consider this an improvement toward stability against headwinds from patent expirations and tighter pricing in China.

Adjusted EBITDA of $549 million fell 19% from a year ago, primarily due to higher costs that Organon is incurring as a public company compared to its subsidiary status a year ago.

Guidance for 2022 suggests that the year will basically look like 2021. Revenue growth will be flat while the adjusted EBITDA margin (and dollars) will dip about 8%. Higher research and development spending will weigh on profits. However, how Organon gets to flat revenues is encouraging – the decay rate of its products has flattened out and the trajectory is up. If one could look at the four years of 2020-2023 as four points on the letter ‘U,’ we are now at the lower-left bottom part of the ‘U’ and moving to the right. It seems like little is changing, but the transition from down to up is starting. Still, the company needs to execute, and more work remains ahead.

The balance sheet weakened fractionally from the third quarter due to acquisitions but is stronger than at the spin-off date. Cash is $737 million while total debt is $9.1 billion, for net debt of $8.4 billion. This is about 7% below net debt of $9.0 billion just after its spin-off. We would like to see more debt reduction.

Separately from earnings, Organon announced that it has acquired from German pharmaceuticals maker Bayer the rights to two daily contraceptive pills in China as well as Hong Kong, Macau and Vietnam. Organon already owns the rights to these products in 20 other markets and these transactions in effect give the company full global rights with the exception of South Korea, cleaning up an otherwise complicated global distribution map. No terms were disclosed.

OGN shares have about 27% upside to our 46 price target. The shares continue to trade at a remarkably low valuation while offering an attractive 3.1% dividend yield.” BUY

Pioneer Natural Resources (PXD), originally recommended by Mike Cintolo in Cabot Top Ten Trader, hit a new high last Tuesday and has pulled back minimally since. As noted previously, the sector is strong now, but that won’t last forever, so we’ll just ride the trend until it ends. If you haven’t bought, try to get in on a pullback. BUY

Sensata Technologies (ST), originally recommended by Bruce Kaser for the Buy Low Opportunities Portfolio of Cabot Undervalued Stocks Advisor, was at a record high of 65 at the start of the year, but today it’s back down in its trading range between 55 and 65, where the stock has spent much of the past year. In his update last week, Bruce wrote, “Sensata is a $3.8 billion (revenues) producer of nearly 47,000 highly engineered sensors used by automotive (60% of revenues), heavy vehicle, industrial and aerospace customers. About two-thirds of its revenues are generated outside of the United States, with China producing about 21%. Investors undervalue Sensata’s durable franchise. Its sensors are typically critical components that generally produce high profit margins. As the sensors’ reliability is vital to safely and performance, customers are reluctant to switch to another supplier that may have lower prices but also lower or unproven quality. Sensata has an arguably under-leveraged balance sheet and generates healthy free cash flow. The relatively new CEO will likely continue to expand the company’s growth potential through acquisitions. Electric vehicles are an opportunity as they expand Sensata’s reachable market. Sensata continues to generate sizeable free cash flow, has a strong balance sheet and announced a new $500 million share repurchase program – a good move in our view as the shares are undervalued. ST shares have about 32% upside to our 75 price target.” BUY

Stifel Financial (SF), originally recommended by Mike Cintolo in Cabot Growth Investor and featured here two weeks ago, is a global wealth management company that has seen 26 straight years of record revenue and should thrive in an environment of rising interest rates. In fact, management is so optimistic that they recently doubled the dividend to 1.5%. The stock has pulled back from its record high of three weeks ago and is an attractive buy here. BUY

TaskUs (TASK), originally recommended by Tyler Laundon in Cabot Early Opportunities, and featured here three weeks ago, is due to release its fourth-quarter report after the market close today, so if you haven’t bought yet, it’s probably best to wait. TASK provides customer support and customer experience (CX) services to “new economy” companies like Zoom (ZM), Uber (UBER), Netflix (NFLX), Coinbase (COIN), DoorDash (DASH) and Meta Platform’s (FB) Instagram, among others. The stock came public in June at 30, bottomed at 26, ran up to 85 by September, but fell back down to the 26 area in January as growth stocks retreated, and the stock has been basing there since. BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was the biggest gainer in the portfolio this morning, as Panasonic announced that it would manufacture Tesla’s new battery at a production facility in Japan. But one day doesn’t mean much. Looking at the big picture, the stock continues to trade around its 200-day moving average in the 800 region, neither strong nor week but still in a long-term uptrend. The company’s Austin Gigafactory is now up and running, while its Berlin Gigafactory, which has been slowed by a stricter approval process, is likely to receive its final approval this week, and production in China could eventually double as a new factory is added. And all that has competitors in the automotive world scrambling to catch up. But I still think there’s even greater potential in the energy business, as Tesla’s batteries, run by intelligent software, can store and release energy and enable a distributed electrical grid that is both more robust and cheaper. HOLD

U.S. Bancorp (USB), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, sold off a month ago after a disappointing quarterly report, but the stock has bounced right back up again, so technically, is still in the trading range between 55 and 60 that’s constrained it since May. In his update last week, Tom wrote, “This regional bank stock took a hit in the recent down market and is attempting a recovery from there. But I think the environment should be very supportive this year as the economy still grows above trend and interest rates likely rise. It’s tough to say what the stock will do in the near term, but I expect it to be higher six months from now.” BUY

Veeco Instruments (VECO), originally recommended by Carl Delfeld in Cabot Explorer, was hitting new highs in early January and now it’s back in the middle of its uptrending channel. In his update last week, Carl wrote, “VECO shares pulled back two points after gaining two points last week. Veeco reported last week quarterly earnings of $0.43 per share, an earnings surprise of 19.4%. Revenue for 2021 was $583 million, 28% growth over 2020, driven by semiconductor and data storage. Veeco makes the equipment and technology essential for the chip fabrication game, a business with technological and high-capital barriers to entry which leads to high margins and return on equity. Veeco is a quality idea but I’m moving this to a hold until markets settle down.” I’ll do the same. HOLD

Verano Holdings (VRNOF), recommended by yours truly in Cabot SX Cannabis Advisor, bottomed with the entire cannabis sector late last year, and has been building an increasingly long and strong base at 10, where it has found support since October. Trouble is, there’s no upside power in the sector yet, and VRNOF is this portfolio’s biggest loser (and as you know, cutting losses short is important to me), so selling is a possibility. Still, I do think the sector has bottomed, and that fourth-quarter reports from the industry’s leaders, the first of which (from GTBIF) arrives tomorrow morning, have the potential to light a spark—so I’m sticking with it. If you don’t own it yet, you could buy here. BUY

Visa (V), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, has pulled back a bit over the past few weeks, but remains way above its low of late January (196). In his update last week, Tom wrote, “The card company stock has been pulling back after a big surge. That’s normal for this stock. But as long as business remains strong, I expect V to find a higher level in the months ahead. International business is picking up as are the very profitable cross-border transactions as travel returns. The stock should continue to have a good year as the international recovery complements already booming U.S. business.” BUY

The next Cabot Stock of the Week issue will be published on March 7, 2022.