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Value Investor
Wealth Building Opportunites for the Active Value Investor

Cabot Undervalued Stocks Advisor 1020

This month and early November will be jammed with possibly market-moving events: earnings season, presidential (and now importantly, vice presidential) debates, the actual elections, a likely new federal stimulus package, possible change (in either direction) in the pandemic’s course, and perhaps news about a vaccine solution.

But for now, we’re stuck in Limbo-Land, with the worst (hopefully) of the pandemic behind us, yet so many unknowns just ahead. We outline some basic suggestions that we follow when in this type of market.

Cabot Undervalued Stocks Advisor 1020

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We’re in Limbo-Land … Now What?
There seems to be so much going on, and yet investors are stuck in the middle with no direction.

We’ve passed the worst (hopefully) of the pandemic, yet there isn’t a clear-cut solution in sight. The domestic economy continues to grow but we have little visibility into 2021. After 18 months of a grueling presidential campaign season (for candidates and voters), we still have two presidential debates, a (newly important?) vice-presidential debate, and the actual presidential, Senate and House elections on the horizon, all with unknowable outcomes. There is a lot of chatter about a new federal stimulus package, but so far it is only chatter.

Earnings season is just around the corner. It might include some fireworks that expose terribly mispriced stocks (in both directions) or perhaps the entire season will be a yawner, producing little in the way of insight into the future. The third-quarter results don’t seem to be as important as the second quarter’s, which included valuable color on how each company fared at the depths of the downturn.

Overall, third-quarter earnings for the S&P500 are likely to be down 21% from a year ago. Yet, this is the first time in over two years that quarterly estimates have risen throughout the quarter. In most periods, estimates tend to decline as overzealous analysts have to rein in their numbers. So, here too, it’s hard to draw any meaningful conclusions. We’ll just have to wait.

The stock market has bounced around but hasn’t gone anywhere for a few months. Mega-cap tech stocks like Apple, Microsoft and Amazon look stalled, though the rest of the stock market seems to be showing some strength. Other markets, including bonds, gold and oil, also have produced some volatility, yet remain directionless.

Only on valuations does the market appear to be edging toward an extreme. The S&P 500 trades at a multiple of 20.5x estimated 2022 earnings, well above the average range of 15-18x one-year-ahead earnings. But, with interest rates at rock-bottom levels and perhaps a higher “new normal” valuation range to reflect the secular shift toward tech stocks, one can’t conclusively say the market is terribly overvalued.

There are traditional signs of speculation, including a very strong IPO market, many large highly-priced acquisitions and a surge in speculative Special Purpose Acquisition Companies, or SPACs. Yet, it’s not certain that these indicate a market top – they may just be steps along the way.

In this limbo-land, we’re reminded of a quote from long-ago baseball great and widely-recognized mangler of the spoken phrase, Yogi Berra, who once said that “… it has a 50-50 chance of going one way or the other.” The unknowns will become known at some point – if the outcome is favorable the market and our stocks will probably go up. If the outcomes turn out to be unfavorable, we could see a downturn.

In a directionless market, with many potentially strong catalysts but one that is pricing in a strong earnings recovery that may not happen, what can an investor do? We usually focus on a few steps.

First, we keep our overall market exposure within comfortable levels – not too aggressive or too light. We want to have some cash reserves to dampen any downturn and possibly deploy at bargain prices, yet work to avoid being too conservative as the market may resume its upward march.

We want to make sure we know what we own and why we own it. If the market gets sporty, we want the conviction to stay the course.

And, be on the lookout for new ideas. Investors can get complacent, meaning that some opportunities are bound to emerge. We anticipate finding some appealing bargains in the coming weeks.

On a separate note: As the Special Situations/Movie Star portfolio has only two stocks, neither of which could remotely be considered glamorous, we are eliminating this sub-portfolio category. Equitable Holdings (EQH) and Marathon Petroleum (MPC) are moving to the Buy Low Opportunities Portfolio.

Please send me your questions and comments – I’ll work to respond as quickly and helpfully as I can. You can reach me at Bruce@CabotWealth.com.

Upcoming Earnings Releases

  • October 22: Dow, Inc. (DOW)
  • October 22: Chart Industries (GTLS)
  • October 22: MKS Instruments (MKSI)
  • October 29: Columbia Sportswear (COLM)
  • October 29: Molson Coors Beverage Company (TAP)
  • October 30: Total S.A. (TOT)
  • October 20: Voya (VOYA)

Today’s Portfolio Changes
Bristol-Myers Squibb (BMY) – Moves from Strong Buy to Hold

Portfolio Changes During the Past Month
Molson Coors Beverage Company (TAP) – Moves from Buy to Strong Buy
Voya (VOYA) – Moves from Strong Buy to Buy

Share prices in the table reflect Tuesday (October 6) closing prices.

Growth Portfolio

Growth Portfolio stocks have bullish charts, strong projected earnings growth, little or no dividends, low-to-moderate P/Es (price/earnings ratios) and low-to-moderate debt levels.

Stock (Symbol)Date AddedPrice AddedPrice 10/6/20Capital Gain/LossCurrent Dividend YieldRating
Chart Industries (GTLS)07-15-20537133.9%Buy
MKS Instruments (MKSI)02-19-20117111-4.6%0.7%Hold
Quanta Services (PWR)12-03-19415739.8%0.4%Buy
Tyson Foods (TSN)12-10-198959-34.2%2.9%Buy
Universal Electronics (UEIC)11-04-165738-33.5%Buy
Voya Financial (VOYA)05-31-185250-4.5%1.2%Buy

Chart Industries (GTLS) is a leading global manufacturer of highly-engineered equipment used in the production, transportation, storage and end-use of liquid gases (primarily atmospheric, natural gas, industrial and life sciences gases). Its equipment cools these gases, often to cryogenic temperatures that approach absolute zero. Chart has no direct peers, offering turnkey solutions with a much broader set of products than other industry participants. The company was featured in “Cabot’s 10 Best Stocks to Buy and Hold for 2020.”

The company generates positive free cash flow and is prioritizing reducing its modestly elevated debt from its 2019 cash acquisition of Harsco’s Industrial Air-X-Changers business, as well as continuing its sizeable cost-savings program.

There was essentially no news on the stock this past week.

GTLS shares rose about 2% in the past week after nearly reach a new year-to-date high then falling back sharply on Tuesday. The shares have about 4% upside to our 79 price target.

The current valuation remains reasonable at 22.7x estimated 2021 earnings of $3.12 and 17.4x estimated 2022 earnings of $4.06. Estimates have stabilized. We continue to like Chart’s prospects but are watching as it approaches our price target. BUY

GTLS

MKS Instruments (MKSI) generates about 49% of its revenues from producing critical components that become part of equipment used to make semiconductors. MKS’ products are generally in the stronger segments of this currently healthy market. While MKSI shares closely track the broad semiconductor indices, the expansion of its Advanced Markets segment, including its 2016 acquisition of Newport Corporation, as well as its 2019 acquisition of semiconductor-related Electro Scientific Industries, may allow its shares to break out. MKS recently promoted 13-year company veteran Dr. John T.C. Lee to CEO.

There was essentially no news on the stock this past week.

MKSI shares were unchanged in the past week, but appear to be generally moving upward, continuing their correlation with the Philadelphia Semiconductor Index (SOX). The shares have about 17% upside to our 130 price target.

Valuation remains reasonable at 14.2x estimated 2021 earnings of $7.83. The estimate is unchanged from last week.

Traders might want to nibble here. Tech price momentum is notoriously hard to trade but the shares seem to have found a floor of sorts. HOLD

MKSI

Quanta Services (PWR) is a leading specialty infrastructure solutions provider serving the utility, energy and communication industries. Their infrastructure projects have meaningful exposure to highly predictable, largely non-discretionary spending across multiple end-markets, with 65% of revenues coming from regulated electric, gas and other utility companies. We view this company as high-quality, well-run and resilient. Quanta achieved record annual revenues, operating income and backlog in 2019, and reported strong second-quarter 2020 results. The company is pursuing a multi-year goal of increasing margins while maintaining low capital intensity. Dividend payouts and share repurchase activity have continued uninterrupted during the pandemic.

There was essentially no news on the stock this past week.

PWR shares moved up about 8% and reached a new record high on Monday. The stock currently has about 7% upside to our 61 price target.

The stock trades at 16.9x estimated 2020 earnings of $3.35 and about 13.9x estimated 2021 earnings of $4.07. The 2020 estimate ticked up fractionally in the past week. Quanta looks well positioned to continue to prosper. We are watching this stock as it approaches our price target. BUY

PWR

Tyson Foods (TSN) is one of the world’s largest food companies, with over $42 billion in revenues last year. Beef products generate about 36% of total revenues, while chicken (31%), pork (10%), and prepared/other contribute the remaining revenues. It has the #1 domestic position in beef and chicken with roughly 21% market share in each. Its well-known brands include Tyson, Jimmy Dean, Hillshire Farms, Ball Park, Wright and Aidells. As only 13% of its sales come from outside the United States, Tyson’s long-term growth strategy is to participate in the growing global demand for protein. Second quarter results were strong. The company has more work to do to convince investors that the future is brighter, particularly as it is more of a commodity company (and hence has lower margins) compared to its food processor peers.

New CEO Dean Banks officially took the CEO role on October 3. Given his lack of industry experience but strengths in technology, we will be watching what changes he will be making.

One such like change is in automation, as domestic meat-packing companies like Tyson continue to struggle with protecting their workers from Covid. Tyson will likely be increasing its use of robots to de-bone and otherwise process its poultry, pork and beef products. By one estimate, U.S. meat processors spend only about $1 billion collectively on robots compared to about $215 billion by all industrial companies. While perhaps not a major driver of earnings or valuation, higher automation may reduce Tyson’s costs and pandemic risk several years from now.

TSN shares slipped about 1% this past week and are just above the bottom of their 58-65 trading range. The stock has 27% upside to our 75 price target.

Tyson currently trades at 11.7x estimated 2020 earnings of $5.01/share and 9.9x estimated 2021 earnings of $5.91. Both estimates ticked up a few cents from last week. Currently the stock offers a 2.9% dividend yield. While the shares may take some time to recover, we are staying with the name. BUY

TSN

Universal Electronics (UEIC) is a major producer of universal remote controls that subscription broadcasters (cable and satellite), TV/set top box/audio manufacturers and others provide to their customers. The company pioneered the universal remote, named the ‘One for All’, which was quickly adopted by consumers after its launch in 1986. Since then, the company has expanded into a range of remote control devices for smart homes, safety and security and other residential and commercial applications, driven by its proprietary technology. The company has a global roster of customers, with about 40% of sales produced outside the United States. Comcast is a 10%+ customer and they hold warrants for up to 5% of Universal’s shares.

For UEIC shares to start a sustained move upward, their revenues need to stop declining and turn (even if slightly) positive. While expanding profit margins help, the shares aren’t cheap enough for this to make much of a difference yet.

Stable/rising revenues could come from a recovery in net cable subscriptions, particularly upon the return of live sports (a major driver of new subscriptions) or when in-home installations resume. Another source of revenue growth may come from upgraded products that allow better control of set top boxes that manage a wide range of media including cable, Netflix/etc., and other digital technologies. Also, the company is expanding into Alexa-like home devices, which could boost revenue growth.

UEIC shares rose about 1% in the past week, and have 24% upside to our 47 price target.

UEIC shares trade at 10.7x estimated 2020 earnings of $3.57 and 8.8x estimated 2021 earnings of 4.31. The estimates remain unchanged from last week and appear to have bottomed out.

We are patient for now with UEIC shares because of the larger opportunity on the horizon, potential for better results in the third and/or fourth quarters, and the increasingly low valuation. BUY.

UEIC

Voya Financial (VOYA) is a U.S. retirement, investment and insurance company serving 13.8 million individual and institutional customers, with $606 billion in assets under management and administration. The company previously was the U.S. arm of Dutch financial conglomerate ING Group, from which it was spun off in 2013. Voya has several appealing traits. Even though it is well capitalized, it is migrating toward a capital-light model, which should allow it to use some of its excess capital to repurchase shares. Strong earnings and cash flows, lower capital intensity and share repurchases should help boost its share price to our 62 target (32% implied upside).

There was essentially no news on the stock this past week. For Voya’s upcoming earnings report, we expect some higher costs related to Covid mortality and write-offs related to lower interest rates. We anticipate an update on the pending closing of its life insurance business. When completed, Voya will likely step up its share repurchases.

Voya shares rose 5% in the past week. The shares will likely continue to move with the overall market, reflecting theoretical changes in the value of its investment portfolio, and thus its book value. However, the company is relatively well-hedged, and the fixed income markets remain sturdy, limiting the effects on Voya’s balance sheet strength. The stock has about 26% upside to our 62 price target.

VOYA trades at 13.5x estimated 2020 per-share earnings of $3.69 and 8.3x estimated per-share earnings of $6.03. The 2021 estimate fell by 1 cent this past week. BUY.

VOYA

Growth & Income Portfolio

Growth & Income Portfolio stocks have bullish charts, good projected earnings growth, dividends of 1.5% and higher, low-to-moderate P/Es (price/earnings ratios), and low-to-moderate debt levels.

Stock (Symbol)Date AddedPrice AddedPrice 10/6/20Capital Gain/LossCurrent Dividend YieldRating
Bristol-Myers Squibb (BMY)04-01-2055585.7%3.1%Hold
Broadcom (AVGO)12-17-1932336412.6%3.6%Hold
Dow Inc (DOW)06-05-186848-30.0%5.8%Hold
Total S.A. (TOT)09-04-186234-44.8%9.0%Hold

Bristol-Myers Squibb Company (BMY) is a New York-based global biopharmaceutical company. In November 2019, the company acquired Celgene for a total value of $80.3 billion, including $35.7 billion in cash and $40.4 billion in stock. We are looking for Bristol-Myers to return to overall revenue growth, both from resilience in their key franchises (Opdivo, Revlimid and Eliquis) and from new products currently in their pipeline. We also want to see the company execute on its $2.5 billion cost-cutting program.

Bristol-Myers announced on Monday a deal to acquire MyoKardia (MYOK), a biotech company, for $13 billion in cash. The 225/share price is a large 61% premium to MYOK’s prior closing price and a steep 210% premium to its year-end closing price of 72.89. Bristol will receive a $458 million break-up fee if the deal is terminated under certain conditions.

We have mixed views on this deal. Cash-rich “big pharma” companies are acting like the “big oil” companies of perhaps a decade ago. Producing vast free cash flow but having uninspiring internally-generated growth prospects, major oil companies were drawn to faster-growing but expensive and speculative oil and gas exploration companies. Like moths drawn to the flame, most of these deals led to burns. Recently, Gilead Sciences and now Bristol-Myers were cash-flow producers with respectable balance sheets and uninspiring growth prospects that have succumbed to the glittering flame of exciting acquisitions. Whether these deals, unencumbered by valuation metrics (no revenues, no earnings, so no multiples), live up to their hopes is pure speculation for most investors as the odds of FDA approval are essentially unknowable.

For MyoKardia, its $13 billion price tag implies that its treatments will eventually produce perhaps $2.5-4.0 billion in annual revenues, on the rough assumption that a decent multiple for a solid franchise is 3-5x revenues. That assumes that the treatments are approved, widely-used and subject to only limited competitive threat (from others’ patented products, as generics won’t likely be available for many years).

For now, we are moving BMY shares to a HOLD while we learn more about this acquisition. On one hand, it is essentially a $13 billion bet on a promising treatment – a large speculation with shareholder money that may not work. On the other hand, while huge, the deal doesn’t radically change Bristol’s balance sheet given the huge amount of cash it currently carries, and the generous cash the business produces each year.

BMY shares fell about 4% in the past week, including a 2.5% drop on the MyoKardia news. The shares have about 32% upside to our 78 price target, but this is under review given the acquisition.

The stock trades at a low 7.8x estimated 2021 earnings of $7.43 (estimate fell 3 cents from last week). The generous 3.1% dividend yield is well covered by the company’s enormous $13.5 billion in free cash flow likely this year. HOLD.

BMY

Broadcom, Inc. (AVGO) designs, develops and markets semiconductors (about 72% of revenues) that facilitate wireless communications. The company’s foundation is its #1 industry position in high performance RFIC (radio frequency integrated circuits), whose use in high-end smartphones has driven Broadcom’s growth and profits. About 25% of total revenues come from chips that go into high-end smartphones, with Apple providing about 20% of Broadcom’s total revenues. The company also provides software that runs technology infrastructure including telecom and corporate networks (about 28% of total revenue).

Some incrementally positive news: Chip maker ST Microelectronics reported strong earnings and guidance. STM is a major Apple supplier, so any indication that Apple is buying in volume from them suggests possibly strong volume buying from Broadcom as well.

AVGO shares were unchanged in the past week and remain just below their record-high close of 375. The stock has about 12% upside to our 410 price target.

The shares trade at 16.5x estimated FY2020 earnings of $22.02 and 14.5x estimated FY2021 earnings of $25.18. The 2021 estimate ticked down a few cents in the past week. The shares pay a 3.6% dividend yield. HOLD.

AVGO

Dow Inc. (DOW) is a commodity chemicals company with manufacturing facilities in 31 countries. In 2017, Dow merged with DuPont to temporarily create DowDuPont, then split into three parts in 2019 based on the newly combined product lines. Today, Dow is the world’s largest producer of ethylene/polyethylene, which are the world’s most widely-used plastics. Dow is primarily a cash-flow story driven by two forces: 1) petrochemical prices, which are often correlated with oil prices and global growth, along with competitors’ production volumes; and 2) ongoing efficiency improvements (a never-ending quest for all commodity companies to maintain their margins).

The company said its cost-cutting programs are on track, and that it will take a $500-600 million restructuring charge in the third quarter.

Brokerage firm Morgan Stanley raised their price target for Dow by 15% to 52, and commented on their optimism for stronger chemical prices next year as demand increases but supply growth should peak.

Dow shares rose about 3% this past week and have about 24% upside to our 60 price target.

The shares trade at a reasonable 15.9x estimated 2022 earnings of $3.01, although this is two years away. We note that this earnings estimate ticked up fractionally since last week. Valuation on estimated 2020 earnings of $0.85 is less meaningful as this assumes no recovery.

The high 5.8% dividend yield is particularly appealing for income-oriented investors. It has a small risk of a cut if the economic and commodity cycles remain subdued, although management makes a convincing case that the dividend will be sustained. HOLD.

DOW

Total S.A. (TOT), based in France, is among the world’s largest integrated energy companies, with a global oil and natural gas production business, one of Europe’s largest oil refining/ petrochemical operations, and a sizeable gasoline retail presence. The company is also expanding somewhat aggressively into renewable and power generation business lines, including its 51% stake in SunPower (SPWR) and its holdings of recent spinoff Maxeon Solar Technologies (MAXN). Overall, the alternative energy initiatives may either be highly profitable or value-destructive.

While low energy prices have hurt Total like all integrated producers, the company’s low production costs (management claims its costs are below $30/barrel), efficient operations and sturdy balance sheet position it well relative to its peers. Also, the company’s production growth profile may still be among the best in the industry despite sharp capital spending reductions.

Total hosted its Strategy and Outlook 2020 presentation last week. Overall, its energy production is targeted for modest annual growth, while the mix is expected to change. The company outlined its base-case scenario in which oil demand plateaus around 2030 then falls off, while natural gas demand continues to grow. Total is following these anticipated trends by emphasizing natural gas production, electricity generation (largely from renewables) and carbon sinks, while de-emphasizing petroleum production and refining. It is working toward net-zero on carbon emissions by 2050.

Management reiterated their guidance that the dividend would be maintained as long as oil remains at or above $40/barrel. Brent is currently trading at about $40. Also, the company said they would be able to manage the energy transition without meaningfully increasing capital spending. Achieving all of this is a somewhat tall order but fortunately the future comes only one day at a time and for now we remain comfortable with Total’s plans and ability to execute.

This year (2020) will be a bit of a tight year for Total’s earnings, but next year should be easier as cost-cutting efforts pay off. Total remains highly sensitive to oil prices – if Brent oil went to $46/barrel (only 10% or so higher than the current price), investors would breathe a sigh of relief and likely bid TOT shares higher.

TOT shares have been volatile this week with the net effect of rising about 3%. Brent crude (the London-based benchmark) prices have been fairly volatile but traded at around $42 recently.

Total’s shares have about 25% upside to our 43 price target.

TOT shares trade at 12.2x estimated 2021 earnings of $2.82 and 8.1x estimated 2022 earnings of $4.21. We would consider the 2022 estimate to reflect “normalized” earnings. The 2021 estimate ticked up a cent in the past week.

Given the increasingly volatile commodity prices, we are now less likely to want to add to our position on weakness. The shares appear to have bounced off of long-term support at 33. The company’s ADRs trade on the NYSE with one TOT share equal to one ordinary share. HOLD.

TOT

Buy Low Opportunities Portfolio

Buy Low Opportunities Portfolio stocks appear capable of a big rebound from recent lows. They have strong projected earnings growth; low-to-moderate price/earnings ratios (P/Es); no dividend requirement and low-to-moderate debt levels. Investors should expect volatility as the stock market alternately embraces the companies’ current successes and remains wary of the stocks’ recent downturns.

Stock (Symbol)Date AddedPrice AddedPrice 10/6/20Capital Gain/LossCurrent Dividend YieldRating
Columbia Sportswear (COLM)06-30-20809012.1%Buy
Equitable Holdings (EQH)11-15-192419-18.3%3.5%Strong Buy
General Motors (GM)12-31-193730-16.8%Strong Buy
Marathon Petroleum (MPC)09-04-188429-65.7%8.0%Hold
Molson Coors (TAP)08-04-203735-5.0%Strong Buy
ViacomCBS (VIAC)08-26-2028283.2%3.4%Buy

Columbia Sportswear (COLM) produces the highly recognizable Columbia brand outdoor and active lifestyle apparel and accessories, as well as SOREL, Mountain Hardware, and prAna products. For decades, the company was successfully led by the one-of-a-kind Gert Boyle, who passed away late last year. The Boyle family retains a 36% ownership stake and Gert’s son Timothy Boyle remains at the helm.

Columbia’s shares rose 4% this past week. The shares have about 10% more upside to our 100 price target.

The shares currently trade at 21.6x estimated 2021 earnings of $4.16. The earnings estimate is unchanged from last week. For comparison, the company earned $4.83/share in 2019. The stock has appeal for value investors and for growth investors with patience for what might be a slower recovery than other growth stocks. Traders will find COLM shares appealing given their sensitivity to consumer and economic re-opening trends. BUY.

COLM

Equitable Holdings (EQH) owns two principal businesses: Equitable Financial Life Insurance Co. and a majority (65%) stake in AllianceBernstein Holdings L.P. (AB), a highly respected investment management and research firm. Acquired by French insurer AXA in 1992, Equitable began its return to independence with its 2018 initial public offering as part of a spinoff. AXA currently owns less than 10% of Equitable. With its newfound independence, Equitable is free to pursue new opportunities.

The company is well-capitalized and has significant liquidity. Its diverse, high-quality investment portfolio is hedged against adverse changes in interest rates and equity markets. Equitable has continued its share repurchase program through the pandemic.

There was essentially no news on the stock this past week. For Equitable’s upcoming earnings report, we expect some higher costs related to Covid mortality and write-offs related to lower interest rates.

EQH shares rose about 6% this past week and have about 44% upside to our 28 price target. The shares still trade below their 20 IPO price.

EQH has recently traded with a magnified correlation with the stock market. This mostly appears to indicate investor worries about the effect of the stock market on the value of the company’s investment portfolio, and thus its book value. The small gains in the stock market since September 23rd have pushed EQH shares up about 8-9%.

Like many insurance companies, investors often value Equitable on a book value basis. On this basis, EQH shares trade at 67% of its $28.68 tangible book value, a considerable discount. We note that the book value will likely move around some in the third and fourth quarters, depending on the timing of the mark-to-market of its private equity investments and other factors.

EQH shares are also undervalued on earnings, trading at 4.4x estimated 2020 earnings of $4.42 (estimate is up a cent from a week ago). While the shares may trade in sync with the overall stock market, given its investment-driven operations, we see more upside than downside. The shares offer a 3.5% dividend yield. STRONG BUY.

EQH

General Motors (GM) under CEO Mary Barra (since 2014) has transformed from a lumbering giant to a well-run and (almost) respected auto maker. The company has smartly exited many chronically unprofitable geographies (notably Europe) and trimmed its passenger car roster while boosting its North American market share with increasingly competitive vehicles, particularly light trucks. We consider its electric and autonomous vehicle efforts to be near industry-leading. Its GM Credit operations are well-capitalized but will be tested in the pandemic. The shares will remain volatile based on the pace of the economic re-opening, U.S.-China relations, its successes in improving its relevance to Chinese consumers, the size of credit losses in its GM Financial unit and news related to new technologies.

No definitive news has emerged yet on the outcome of the Nikola negotiations. We think that GM will likely retain the partnership but take a higher equity stake either directly or through some type of warrants.

GM sold its credit card operations to Goldman Sachs for $2.5 billion. This seems reasonably straightforward – Goldman is paying a respectable cash price as they build out their consumer credit business. Also, Goldman can probably borrow at lower interest rates than GM, which gives it an edge. GM offloads some credit risk in a business that is tangential at best to its core automobile operations. Over time, the car could become an electronic wallet, of sorts, if more consumers decide to buy goods and services while in their cars. This sale probably has very little impact on GM’s ability to profit from in-car purchases down the road.

Light vehicle sales continued to improve in September compared to prior months. Consumers continue to buy trucks and SUVs relative to cars, which is helping support average selling prices and likely profit margins as these kinds of vehicles are highly profitable. Also, with inventories tight, dealers have been reducing purchase incentives. Overall, third quarter sales for GM were down 10% from a year ago and year-to-date sales were down 17.4% from a year ago. Despite these quarterly and YTD numbers being weak, they are much stronger than anyone could have credibly forecast when we were at the depths of the pandemic in April.

This past week, GM shares rose about 6%. The stock has about 45% upside to our 45 price target. The target price implies 8.2x multiple on 2022 estimated earnings of $5.50.

GM shares trade at 11.7x estimated 2020 earnings of $2.59 and 6.7x estimated 2021 earnings of $4.49. Both estimates ticked up from a week ago. GM remains an attractive cyclical stock. STRONG BUY.

GM

Marathon Petroleum (MPC) is a leading integrated downstream energy company and the nation’s largest energy refiner, with 16 refineries, a majority interest in midstream company MPLX LP, 10,000 miles of oil pipelines, and product sales in 11,700 retail stores.

Following its agreement to sell its Speedway retail gas station chain to the Japanese company Seven & i Holdings, the parent of the 7-Eleven chain, for $21 billion in cash, Marathon will be losing a huge source of annual cash flow but also will be shedding as much as 30% of its $32 billion in debt (including debt of its MPLX pipeline subsidiary). Some of the proceeds will likely be returned to shareholders through share repurchases.

This past week, Marathon announced that it will be laying off 12% of its U.S. workforce, excluding Speedway, due to weak refining market conditions. This move makes sense to us.

MPC shares fell about 2% in the past week. Like many of our cyclical stocks, a 2-3% mid-day rise on Tuesday was reversed in later trading on news that a federal stimulus may not be forthcoming soon. Although the shares have 40% upside to our 41 price target, the uncertainty around the margin outlook keeps us, for now, from raising the shares to a Buy rating.

The shares will continue to trade near-term around the pace of the re-opening of the economy, on oil prices and refiner margins, and possibly on any hurricane-related sentiment (the season technically runs until November 30).

The shares trade at 9.3x estimated 2022 earnings of $3.09. That year would be a reasonable proxy for “normalized” even though it is two years away. Estimates are for a loss of $(3.70) this year and a profit of $0.14 in 2021. Both years’ estimates continue to decline as the recovery is being pushed out.

Like most energy stocks, MPC offers a useful vehicle for traders: its economics are closely tied to oil prices yet the company has stabilizing operations like its refining and MPLX midstream businesses. The large and pending cash inflow from the Speedway sale provides additional balance sheet stability and downside protection relative to most other energy companies. The 8.0% dividend yield looks reasonably sustainable. HOLD.

MPC

Molson Coors Beverage Company (TAP) – The thesis for this company is straightforward – a reasonably stable company whose shares sell at a highly discounted price.

One of the world’s largest beverage companies, Molson Coors produces the highly recognized Coors, Molson, Miller and Blue Moon brands as well as numerous local, craft and specialty beers. About two-thirds of its $10 billion in net revenues are produced in the United States, where it holds a 24% share of the beer market.

Investors’ primary worry about Molson Coors is its lack of meaningful (or any) revenue growth as it has relatively few of the fast-growing hard seltzers and other trendier beverages in its product portfolio. So, the key is for revenues to be stable or slightly positive – rapid growth is not necessary for the stock to work as this is a revenue and cash-flow stability story.

Any indication that it is building its “alternative” beverage capabilities would be positive, as would resilience/recovery in its core beer volumes. Other concerns, like its modestly elevated (but investment grade) debt and the size/stability of its free cash flow, generally stem from the revenue debate. Recent financial results have been encouraging. A new CEO is overseeing efforts to improve execution.

We anticipate that the company will resume paying a dividend mid-next year. A $0.35/share quarterly dividend is possible, which would provide a generous 4.2% yield on the current price.

TAP shares rose 4% in the past week. The shares have about 69% upside to our 59 price target.

The shares trade at 9.6x estimated 2020 earnings of $3.62 and 9.0x estimated 2021 earnings of $3.88. Both estimates are unchanged in the past week. These valuations are remarkably low. One way to look at this low multiple is to think about what it implies about investors’ views on earnings. If investors applied a very conservative 12x multiple on 2021 earnings, it suggests that investors expect about $2.81 in earnings that year. We think it is highly unlikely that earnings would drop 22%, or even drop at all. It is almost bizarre that a company like Molson Coors trades with such low expectations.

On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 7.8x estimates, among the lowest valuations in the consumer staples group and well below other brewing companies.

For investors looking for a stable company trading at an unreasonably low valuation in a momentum-driven market, TAP shares have considerable contrarian appeal. Patience is the key with Molson Coors shares. We think the value is solid although it might take a year or two to be recognized by the market. STRONG BUY.

TAP

ViacomCBS (VIAC) is a major media and entertainment company, owning highly recognized properties including Nickelodeon, Comedy Central, MTV and BET, the Paramount movie studios, Showtime and all of the CBS-related media assets. The company’s brands are powerful and enduring, typically holding the #1 market shares in the highest-valued demographic groups in the country. ViacomCBS’ reach extends into 180 countries around the world. Viacom and CBS re-merged in late 2019 and are now under the capable leadership of former Viacom CEO Robert Bakish.

Viacom is being overhauled to stabilize its revenues, boost its relevancy for current/future viewing habits and improve its free cash flow. Its challenges include the steady secular shift away from cable TV subscriptions, which is pressuring advertising and subscription revenues. The pandemic-related reductions in major sports are also weighing on VIAC shares. However, ViacomCBS’ extensive reach, strong market position and strategic value to other, much larger media companies, and its low share valuation, make the stock appealing.

VIAC shares slipped about 2% this past week and have about 51% upside to our 43 price target.

ViacomCBS shares trade at about 7.6x estimated 2021 EBITDA, which we believe undervalues the company’s impressive leadership and assets. On a price/earnings basis, VIAC shares trade at 6.2x estimated 2021 earnings of $4.62 (estimate is unchanged from last week). ViacomCBS shares offer a sustainable 3.4% dividend yield and look attractive here. BUY.

VIAC

Strong Buy and Buy – This stock is worth buying.
Hold – The shares are worth keeping but the risk/return trade-off is not favorable enough for more buying nor unfavorable enough to warrant selling.
Retired – This stock has been removed from the portfolio, primarily for being fully valued. We generally view the company as fundamentally solid with few problems. Investors may choose to hold these shares to minimize portfolio turnover, seek to capture continued upward share price momentum, or other reasons.
Sell – This stock is approaching or has reached our price target, its value has become permanently impaired or changes in its risk or other traits warrant a sale.


The next Cabot Undervalued Stocks Advisor issue will be published on November 4, 2020.

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