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Value Investor
Wealth Building Opportunites for the Active Value Investor

Cabot Undervalued Stocks Advisor 820

Here is the August 2020 issue of Cabot Undervalued Stocks Advisor.

Thank you for subscribing to the Cabot Undervalued Stocks Advisor. It’s earnings season, and in this issue we review fresh reports from MKS Instruments (MKSI), Tyson Foods (TSN), Columbia Sportswear (COLM), Amazon.com (AMZN) and Marathon Petroleum (MPC). Marathon also announced a deal to sell their Speedway retail gas station business for $21 billion in an all-cash deal, which we discuss.

As a newsletter looking for undervalued stocks in a market full of enthusiasm for only a select few mega-sized tech companies, we almost feel a moral obligation to highlight contrarian ideas. In this issue, we recommend a stable but meaningfully out-of-favor company that has the potential to provide solid long-term returns. “Out-of-favor” implies that it doesn’t have the immediate profit potential of a “digital economy” stock, but that lack of zest produces the opportunity. With low expectations comes upside surprises. We believe global beverage company Molson Coors (TAP) fits the bill.

You may notice that we are tweaking some of the components of the Cabot Undervalued Stocks Advisor letter. For example, we’re bringing back the portfolio tables to every weekly and monthly issue. A “Hold” rating means that we believe the stock is fine to hold in the portfolio, but that the risk/return trade-off isn’t compelling enough to warrant a “Buy” nor unfavorable enough to warrant a “Sell.” Also, for the monthly issue, we may not always have a “Feature” stock in each portfolio – that doesn’t mean we don’t like any of the names, it probably just means that we featured it recently and want to avoid being repetitive to save you time and effort.

Please feel free to send me your questions and comments. This newsletter is written for you and the best way to get more out of the letter is to let me know what you are looking for.

I’m best reachable at Bruce@CabotWealth.com. I’ll do my best to respond as quickly as possible.

Cabot Undervalued Stocks Advisor 820

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A Few Thoughts on Rising Market Speculation
The stock market continues to favor high-tech “digital economy” growth companies, particularly after the remarkably strong earnings reports from Apple, Amazon and others. The performance spread between “digital economy” stocks and “physical economy” stocks suggest that speculative enthusiasm is increasing.

This enthusiasm is illustrated by the sharp gains in upstart electric truck makers like Nikola (NKLA) and Lordstown (DPHC) that have recently started trading by merging with special purpose acquisition companies (or SPACs). SPACs are often called “blank check companies” because they are created to raise cash to buy a yet-to-be-named business. Investors in essence give the SPAC a blank check to buy whatever business they want. Combining a young upstart company with a SPAC is a form of double-speculation. Hedge fund manager Bill Ackman’s plans to launch a $4 billion SPAC adds to the speculative nature of the market. Historically, rapid growth in SPAC offerings has been associated with stock market peaks.

The Cabot Undervalued Stocks Advisor is gradually trimming out of its successful but highly valued tech stocks, while adding newer names with clear undervaluation supported by solid fundamentals. While these may not provide the immediate rewards that Amazon or others provide, they can provide defensive traits as well as strong upside potential, particularly if the “digital economy” stocks suffer the same fate that the dot-com stocks did two decades ago.

Please send me your comments and questions – I’ll work to respond as quickly and helpfully as I can.

Upcoming Earnings Releases
August 5: Voya (VOYA)
August 6: Bristol-Myers Squibb (BMY); Equitable Holdings (EQH); Universal Electronics (UEIC); Quanta Services (PWR)

Today’s Portfolio Changes
Molson Coors Beverage Company (TAP) new Buy.
Nvidia (NVDA) moves from Buy to Hold.

Portfolio Changes During the Past Month
Added Chart Industries (GTLS) as new Buy.
Added Columbia Sportswear (COLM) as new Buy.
Quanta Services (PWR) moves from Hold to Buy.
Relocated Marathon Petroleum (MPC) to the Special Situations/Movie Star Portfolio; Moved from Buy to Hold.
Nvidia (NVDA) moved from Strong Buy to Buy.
Dow (DOW) moves from Buy to Hold.
Netflix (NFLX) moves from Hold to retired.
Adobe (ADBE) was retired on valuation.
VanEck Vectors Oil Refiners ETF (CRAK) moves to Hold, then to Sell.

Share prices in the table reflect Tuesday (August 4) closing prices. Please send your questions and comments to Bruce@CabotWealth.com.

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.

Growth Portfolio
Stock (Symbol)Date AddedPrice AddedPrice 8/4/20Capital Gain/LossCurrent Dividend YieldRating
Chart Industries (GTLS)07-15-20537236.6%Buy
MKS Instruments (MKSI)02-19-201171289.6%0.6%Hold
Quanta Services (PWR)12-03-1941424.3%0.5%Buy
Tyson Foods (TSN)12-10-198964-27.8%2.6%Buy
Universal Electronics (UEIC)11-04-165748-16.1%Strong Buy
Voya Financial (VOYA)05-31-185250-3.8%1.2%Strong 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.

Chart shares have gained 26% since it reported second-quarter earnings earlier in July. While sales growth was flat and adjusted per-share earnings fell about 7% from a year ago, the results were sharply higher than consensus estimates, with per-share earnings of $0.63 compared to the $0.41 estimate. Revenues were about 7% above consensus. The company reinstated its earnings guidance for full-year 2020 that was above estimates. Chart provided encouraging updates on its cost savings programs and described new initiatives and orders in hydrogen-based energy equipment. Overall, the company is performing well in an otherwise difficult economy.

The valuation remains reasonable at 19.1x estimated 2021 earnings of $3.67/share and 11.5x estimated 2021 cash operating profits. Earnings for 2021 have increased 15% since the earnings report. The shares look poised to continue their recovery. BUY.

GTLS-080420

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. The company recently promoted 13-year company veteran Dr. John T.C. Lee to CEO.

MKS reported strong results on July 29. Revenues increased 15% from a year ago and were about 11% higher than consensus estimates. The company continues to benefit from strong demand for semiconductor equipment. Adjusted earnings per share of $1.62 were 49% higher than a year ago and about 37% above consensus estimates. Operating and free cash flow, which hit record levels, are helping the company whittle down its debt. Its debt balance, net of cash, was $223 million, down from $360 million at year-end. Management said that new export rules from the Department of Commerce won’t have a significant impact on the company’s financial results. The ESI acquisition added incrementally but its full potential has yet to be realized.

The company raised its 3Q guidance substantially: new guidance is for revenues of $560 million (midpoint of range) and adjusted earnings per share of $1.75 (midpoint). These compare to consensus estimates of $475 million in revenues and $1.14 earnings.

MKSI shares have continued to rise and have eclipsed their previous all-time high set in 2018. The results were impressive enough that we think traders can hold onto their positions for a bit longer.

For longer-term holders of MKSI, the shares have narrowly started to accelerate above the Philadelphia Semiconductor Index (SOX). Estimates for 2021 earnings have increased by 13% since the report – more than the stock price has increased, which has the effect of reducing the 2021 earnings multiple. At 16.5x estimated 2021 earnings of $7.80, we consider the shares reasonably undervalued. HOLD.

MKSI-080420

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. Quanta achieved record annual revenues, operating income and backlog in 2019, and is pursuing a multi-year goal of increasing margins. Dividend payouts and share repurchase activity have continued uninterrupted during the pandemic.

We view this company as high quality, well run and resilient. The market views PWR shares as a safe haven in an unpredictable market and economy, helping the shares to fully recover from their March 2020 lows. The new 15-year contract to operate and modernize Puerto Rico’s energy grid is an encouraging positive as the company is seeking to shift toward a capital-light, recurring profit model. Quanta Services was featured in the July monthly issue of Cabot Undervalued Stocks Advisor.

Quanta confirmed that they will report earnings on Thursday, August 6. The consensus estimate remains at $0.47/share. Analysts estimate that full-year earnings per share will dip about 5% in 2020 to $3.16, due to disruption costs related to the pandemic, then rebound over 22% to $3.86 in 2021.

PWR shares ticked up about 4% over the past week. On 2021 estimated earnings, the P/E is a reasonable 10.8x. Traders may consider exiting near 43. For long-term holders, Quanta stock looks well-positioned to continue to prosper. New investors should establish a starter position now and look to add on weakness. BUY.

PWR-080420

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. Tyson Foods was featured in the June issue of Cabot Undervalued Stocks Advisor.

Unlike many of its food company peers whose shares have fully recovered this year, or better, Tyson’s shares remain 29% below their year-end price and appear poised to break out above their 58-65 range.

Tyson reported a strong quarter. Revenues fell 8% from a year ago but was about 5% ahead of consensus estimates. Adjusted per share earnings of $1.40 was 46% higher than the $0.96 consensus. Profits benefitted from higher beef and pork prices, although these were partly offset by weak results in chicken and prepared foods. Tyson absorbed $340 million of direct Covid-related costs. The company is producing strong cash flow, and its balance sheet and liquidity remain strong.

Tyson promoted president Dean Banks to the CEO role. Banks joined Tyson in 2017, bringing valuable technology and leadership experience gained at Google and elsewhere. While he has very limited consumer products experience, which presents a bit of a risk, we like his outsider experience and two-year evaluation period at Tyson.

TSN shares have moved upward since the report and are chipping away at their peer-lagging returns this year. The company has more work to do to convince investors that the future is brighter, particularly as more of a commodity company (and hence lower margins) compared to its food processor peers, but this quarter’s results should help.

Tyson’s estimates are now higher, reflecting the quarter’s higher earnings, at $4.98/share for 2020 and $5.83/share for 2021. The shares trade at a relatively low 11.0x estimated 2021 earnings and offer a 2.7% dividend yield. BUY.

TSN-080420

Universal Electronics (UEIC) is a dominant 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 extensive and valuable proprietary technology. Clients include every major cable and satellite company: AT&T, Cox, Dish, Comcast, Samsung, LG, Sony, Liberty, Daikin, Sky and more.

Strong and steady revenue and earnings growth drove the shares to over 80 by mid-2016, from only about 12 in mid-2012. However, the shares have stumbled and remain down about 45% from their peak. UEIC is a volatile, undervalued, micro-cap growth stock, appropriate for risk-tolerant investors and traders. Over the short-term, its shares generally correlate with overall market and economic re-opening sentiment. The company reports earnings tomorrow, August 6. The consensus estimate is $0.85/share.

UEIC shares ticked down slightly in the past week, and trade at 12.8x estimated 2020 earnings of $3.71, and 10.5x estimated 2021 earnings of $4.52. Attractive buying opportunities are appearing as the shares remain near the midpoint of their recent range. STRONG BUY.

UEIC-080420

Voya Financial (VOYA) is a U.S. retirement, investment and insurance company serving 13.8 million individual and institutional customers. Voya has $603 billion in total 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, taking a major step in this direction by selling its life insurance business, which should close in the third quarter. Some of the released capital could be used to repurchase shares. Also, it won’t be a cash tax payer for as many as five years due to its deferred tax assets. Voya is generating considerable free cash flow. And, its diversified and highly-regarded product base offers steady long-term revenue strength.

Near-term issues for Voya are its Covid-related claims (readily manageable but probably not accurately modeled into estimates), the size of the positive impact of rising equity markets and the potential markdowns on its other investment assets. Voya will provide more color on these, along with an update on its life insurance exit, when it reports earnings on August 6. The consensus estimate is $0.90/share.

Per share earnings in 2021 are expected to jump 42% compared to 2020, to $6.01. The shares are ticked up modestly in the past week and continue to trade at an attractive 8.3x estimated 2021 earnings and 0.84x book value. VOYA is a mid-cap stock, appropriate for growth and value investors and traders. STRONG BUY.

VOYA-080420

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.

Growth & Income Portfolio
Stock (Symbol)Date AddedPrice AddedPrice 8/4/20Capital Gain/LossCurrent Dividend YieldRating
Bristol-Myers Squibb (BMY)04-01-2055609.2%3.0%Strong Buy
Broadcom (AVGO)12-17-193233291.8%3.9%Hold
Dow Inc (DOW)06-05-186842-38.6%6.7%Hold
Total S.A. (TOT)09-04-186240-35.3%7.4%Hold

Bristol-Myers Squibb Company (BMY) is a global biopharmaceutical company. Following its controversial acquisition of Celgene for $74 billion in November 2019, the merged company markets a long list of pharmaceuticals, including Revlimid, Eliquis and Opdivo, which treat cardiovascular, oncology and immunological diseases. The company expects revenue and profit growth to come from four areas: sales volume increases from current products, development and launch of new medicines, life cycle management and synergies from the Celgene acquisition. Bristol-Myers’ financial priorities include debt repayment, investment in innovation, share repurchases and annual dividend increases. Investors will want to be aware that the Celgene deal raised Bristol-Myers’ debt to over $46 billion – a manageable sum yet elevated compared to peers.

The company reports earnings on August 6, with the consensus estimates dropping one cent from a week ago to $1.47/share. Full-year earnings are expected to increase by 33% and 19% in 2020 and 2021, respectively, in large part due to the benefits from the Celgene deal. Its 2020 P/E is a modest 9.3x, and 7.8x on next year’s estimate. BMY shares provide a generous 3.1% yield, well covered by its enormous $13.5 billion in free cash flow this year.

The shares were essentially unchanged past week. They have price and valuation support at around 55-56, and offer defensive traits during “risk-off” trading days, as well as the potential to ride some sentiment tailwinds surrounding the pharmaceutical sector in general. STRONG BUY.

BMY-080420

Broadcom (AVGO) is a global technology leader that designs, develops and supplies semiconductor and infrastructure software solutions that serve the world’s most successful companies. CFO Tom Krause expects to continue paying the dividend and paying down debt in 2020 (none of which is maturing this year), even under poor economic conditions. Share buybacks and M&A activity are on the back burner for now.

The company reports earnings on September 3. The shares jumped about 6% in the past week, largely due to the strong earnings report from Apple, which is a 20% customer. The shares trade just above their all-time closing high of 324 set on January 24.

Broadcom is an undervalued growth and income stock as well as a useful trading stock. Full-year profits are expected to grow 1% and 12% in FY2020 and FY2021, respectively, and the FY2020 P/E is 13.5. HOLD.

AVGO-080420

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 petrochemical prices, which often are correlated with oil prices and global growth, along with competitors’ production volumes.

Dow’s second-quarter earnings were satisfactory. Revenues fell 24% to $8.4 billion, a tad better than consensus estimates, with weakness across all four of Dow’s product groups. Volumes fell by 14% and pricing fell by 9%, reflecting sluggish global economic conditions that saw little demand for Dow’s commodity chemicals. The per-share loss of $(0.26) was in line with estimates.

Cash flow was strong, as the company released cash tied up in working capital. Dow increased its 2020 cost-cutting program to $500 million and initiated a 2021 cost-cutting program of another $300 million. The company’s liquidity and balance sheet remain sturdy. The company maintained its dividend (now yielding 6.6%) and appears both committed and capable of retaining it. Dow will weather the downturn but its outlook is more subdued than we anticipated. Dow shares have declined about 3% over the past week.

Analysts expect full-year 2020 EPS of $0.72 and full-year 2021 earnings of $2.08. Valuation at 20.0x estimated 2021 earnings is becoming less meaningful as the recovery is not likely to fully arrive until 2022 or so. On estimated 2022 earnings, the shares trade at a more reasonable 15.8x, although this is two years away.

The high 7.0% dividend yield is particularly appealing for income-oriented investors. It has a small risk of a cut if the cycle remains subdued, although management makes a convincing case that the dividend will be sustained. HOLD.

DOW-080420

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, which 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 reported adjusted 3Q earnings of $0.03/share, an encouraging result given the sharp declines in oil and gas prices and the shriveling of refining margins. Operating cash flow was reasonably healthy at $3.1 billion, and free cash flow net of asset buy/sales was $947 million. The company reiterated its confidence in its ability to maintain its dividend as long as oil prices are above $40/barrel. With Brent prices reasonably steady at $44, the high 7.7% dividend yield appears safe for now.

Updated consensus estimates point to full-year EPS of $1.24 and $2.48 in 2020 and 2021, respectively. The P/E multiple of 15.8x estimated 2021 earnings reflects only partial recovery toward normalized earnings of around $4.00. The shares remain rangebound. Value, growth and income investors should add to positions below 38. HOLD.

TOT-080420

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.

Buy Low Opportunities Portfolio
Stock (Symbol)Date AddedPrice AddedPrice 8/4/20Capital Gain/LossCurrent Dividend YieldRating
Columbia Sportswear (COLM)06-30-208077-4.2%Buy
General Motors (GM)12-31-193726-28.8%Strong Buy
Molson Coors (TAP)8-4-2037370.1%Buy

Featured Stock: Molson Coors Beverage Company (TAP)
Molson Coors Beverage Company is one of the world’s largest beverage companies, producing the highly-recognized Coors, Molson, Miller and Blue Moon brands as well as numerous local, craft and specialty beers. About two-thirds of its revenues come from the United States, where it holds a 24% share of the beer market. Canada-based Molson (founded in 1786) and Colorado-based Coors (founded in 1873) combined in a 2005 merger of equals. In 2016, the company completed its multi-step acquisition of Miller’s global operations.

Enthusiasm for its post-consolidation prospects drove TAP shares to over 110 in October 2016. Supporting the stock was a modestly favorable revenue outlook, substantial opportunities to reduce redundant costs and inefficiencies and $2.4 billion in tax benefits. However, since then, the share price has collapsed, initially due to a lack of growth, continued margin pressure and more recently as Covid-19 stay-at-home orders temporarily dried up much of the company’s revenues. Elevated debt also weighs on the shares.

The appeal of Molson Coors is two-fold: it is a reasonably stable company selling at a remarkably discounted price.

Molson Coors has highly recognized and relevant brands, which help it produce annual revenues of around $10 billion. Cash operating profits have also been steady at around $2.2 billion, with free cash flow running about $1.0 to $1.2 billion a year. Results this year have been dampened by the global closing of restaurants, pubs and sports venues due to the pandemic, but even with this disruption, second-quarter sales fell only 15% from a year ago. Cost-cutting measures and a temporary pullback in marketing spending allowed the company to generate an increase in quarterly profits compared to a year ago.

While its $8.7 billion debt is elevated, it is partly offset by $800 million in cash and can be readily serviced by Molson Coors’ cash flow. The company suspended its dividend in May to provide financial flexibility during the pandemic and to fund debt paydowns that will help it maintain its investment grade credit rating.

The company has a new CEO, who is leading a program to accelerate new product introductions while also boosting efficiency.

At just under 37, the shares trade at a highly discounted 10x estimated 2020 earnings of $3.65/share, and about 9.7x estimated 2021 per share earnings. On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 8x estimates. This is 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 strong momentum-driven market, TAP shares have considerable contrarian appeal. BUY.

TAP-080420

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.

In its second-quarter report last week, Columbia’s sales fell 40% compared to a year ago, driven by high levels of store and wholesaler closures. Net income turned to a $(0.77)/share loss compared to a $0.34/share profit a year ago. However, both sales and earnings were better than consensus estimates.

At quarter’s end, nearly all of their owned stores were open. Trends in the third quarter are showing meaningful improvement compared to the second quarter. Inventories are higher than a year ago, but the company commented that it is well-positioned for winter gear whereas that can’t be said of some of its competitors. Columbia’s new mobile app is ready for launching, and it is introducing several new products. The company is on track to reduce its operating costs by $100 million, or about 4% of revenues, this year. The company is likely to remain healthy as consumers seek its highly relevant products.

Operating cash flow was at negative-$37 million, much of which reflected an increase in inventories. The balance sheet remains sturdy, with $476 million in cash yet a miniscule $3 million (not billion) in total debt.

Columbia’s shares fell about 8% in the past week, despite the strong report. Some investors may have expected a stronger earnings “beat.”

Full-year estimates are $2.11 and $4.16 for 2020 and 2021, respectively. For comparison, the company earned $4.83/share in 2019. On next year’s estimates, the shares trade at a P/E of 17.8x. 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-080420

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. GM’s much-improved North America cost structure allow it to remain profitable at perhaps an 11 million vehicle industry volume. 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, and the size of credit losses in its GM Financial unit.

GM had an encouraging quarterly report last week, reporting a $(0.50)/share adjusted loss that was vastly better than the consensus estimate for a loss of $(1.78)/share. Despite a 53% decline in revenues, operating profits were nearly break-even, reflecting the company’s aggressive cost-cutting efforts. GM remains fully committed to investing in all-electric cars and other promising technologies. Much of the $9 billion in negative cash flow in the automotive segment reflected the build-up of inventory as part of the production ramp-up. GM Financial’s credit metrics were steady. GM’s market share increased and dealer inventories are lean. The company’s liquidity and balance sheet remain healthy. Overall, an encouraging report.

GM shares remain essentially unchanged in the past week. Current Wall Street estimates project EPS of $2.40 (2x the prior estimate of $1.21) and $4.57 in 2020 and 2021, respectively. GM remains an attractive cyclical stock for investors and traders. STRONG BUY.

GM-080420

Special Situation & MOVIE STAR PORTFOLIO

This is a portfolio for capital gain opportunities that do not conveniently fit into the other three portfolios. These stocks will often be glamorous companies, which I call “movie star stocks,” that investors love to own and follow, such as Amazon.com, Apple Inc. and Walt Disney Co. These movie star stocks currently have relatively low prices or valuations in comparison to their trading histories.

Special Situation and Movie Star Portfolio
Stock (Symbol)Date AddedPrice AddedPrice 8/4/20Capital Gain/LossCurrent Dividend YieldRating
Adobe Systems (ADBE)05-07-19Retired 7/15/20
Amazon (AMZN)11-07-191,8023,19577.3%Hold
Equitable Holdings (EQH)11-15-192421-12.9%3.3%Strong Buy
Marathon Petroleum (MPC)09-04-188437-56.1%6.3%Hold
Netflix (NFLX)01-23-20Retired 7/22/20
Nvidia (NVDA)03-04-2027645364.2%0.1%Hold
VanEck Vectors Oil ETF (CRAK)10-15-19Retired 7/15/20

Amazon.com (AMZN) remains nearly perfectly positioned for a pandemic world. Its to-your-doorstep shopping marketplace allows consumers to safely shop for just about anything without leaving their homes. As the world accelerates its transition to the digital world, the Amazon Web Services (AWS) cloud business will continue to produce vast and growing profits ($20 billion in operating profits next year, up 20% from the prior year and comprising nearly 65% of total company operating profits). Also, Amazon’s innovations and forays into new industries are disrupting established global businesses, including freight companies, retailers, entertainment and technology companies.

Amazon reported impressive results last week. Net revenues grew 41% to $88.9 billion, which was about 9% ahead of estimates. Net income of $5.2 billion, or $10.30/share, doubled from a year ago and multiples of the $1.61/share consensus estimate. AWS sales grew 29%, a deceleration from 37% a year ago and continuing a deceleration that has lasted for many quarters. AWS profit increased by 58%. Remarkably, the North America non-AWS revenues grew 43% and profits grew 37%. Prime membership growth was strong. The company produced a monstrous $32 billion in free cash flow. Amazon’s 3Q profit guidance points to above-consensus results.

For all of 2020, analysts expect earnings to increase from $23.01 in 2019 to $31.35 in 2020, then rise another 40% to $44.13 in 2021. AMZN shares ticked up about 5% since the earnings report. This stock is clearly the iconic stock of its era. How long this will last is hard to say.

Investors may want to start trimming out of their Amazon positions, although for now we are maintaining our rating of HOLD.

AMZN-080420

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.

Equitable, with a 161-year history, was acquired by French insurer AXA in 1992. Starting in 2018, AXA began to spin off Equitable with an initial public offering of part of its ownership. Part of the motivation behind the spin-off was to fund AXA’s $15 billion acquisition of insurer XL Group Ltd. Through subsequent stock sales, AXA currently owns less than 10% of Equitable. With its newfound independence, Equitable is free to pursue opportunities that it was unable to as a subsidiary of AXA.

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. AllianceBernstein’s assets under management (AUM) as of June was $600 billion. While this year’s profits will decline about 13% due to higher mortality costs, they will like recover next year. Equitable expects to continue delivering a 50-60% payout ratio through dividends and share repurchases. The shares offer a 3.4% dividend yield.

Equitable reports earnings tomorrow, with consensus earnings estimate of $0.87/share.

EQH shares are undervalued, with a 2020 P/E of 4.9x. Like many insurance companies, investors also value Equitable on a book value basis. With its $37.78 in per-share book value, EQH trades at 55% of book value, a significant discount. EQH shares also trade fractionally above their 20 IPO price, which was a disappointment at the time relative to the 24-27 price range that bankers had targeted. Since then Equitable has arguably become a better company and any sale of AllianceBernstein is likely to unlock further value. EHQ shares are appropriate for dividend investors, growth investors and traders. While the shares may trade in sync with the overall stock market, given its investment-driven operations, we see more upside than downside. STRONG BUY.

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NVIDIA (NVDA) is the pioneer and leading designer of graphics processing unit (GPU) chips, which initially were built into computers to improve video gaming quality. However, they were discovered to be nearly ideal for other uses that required immense and accelerated processing power, including data centers and artificial intelligence applications such as professional visualization, robotics and self-driving cars. In April, NVIDIA completed the $6.9 billion acquisition of Mellanox Technologies, an innovator in high-performance interconnect technology routinely used in supercomputers and hyperscale data centers. NVIDIA’s data center business now represents about 50% of total revenues.

NVIDIA is a high-P/E, aggressive growth/momentum stock. Its shares have increased 17x since the start of 2015 and now trade essentially at their all-time high. The pullback earlier this week still leaves the stock above where it was trading only 4 sessions ago. Yet, part of the reason behind the gains is that cloud-based computing is the biggest secular trend in technology, and the most powerful. No one knows how large the industry will ultimately become, but “larger than it is today” seems like the correct answer for many days and years into the future. Until this open-ended growth appears to peak, it would be difficult to bet against it. The only question for momentum investors is when to stop betting on it. The valuation of 45x estimated fiscal year 2022 earnings is high and on the edge of astronomical, particularly for a company its size.

Wall Street expects EPS to grow 21% in fiscal 2022 (January year-end) compared to fiscal 2021. The company reports its earnings in September. We’re reducing our rating to HOLD, despite the impressive fundamentals. We are closer to moving NVDA to “Retired” but are reluctant to move too quickly. NVDA shares are on a short leash.

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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.

Marathon announced a definitive deal 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 receive $16.5 billion in net proceeds. Related to the deal, Marathon entered into a long-term supply agreement to provide 7.7 billion gallons of fuel to Speedway. The deal is worth slightly more, at $25.40/share in after-tax proceeds, than our $24.00 estimate.

Post-sale, Marathon will be losing a huge source of annual cash flow but also 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. Also, the company will likely have a leaner cost structure as it is closing two unprofitable refiners and cutting close to $1 billion in operating expenses.

Following the deal news, Marathon reported its second-quarter earnings. Weak refining and marketing operations led to a $(1.33)/share loss, compared to a profit of $1.73/share a year ago. The loss compared to estimates for a much larger $(1.76/share) loss. Adjusted EBITDA, a measure of cash operating profits, fell 89%, to $653 million, compared to a year ago.

All of the decline in profits was produced by the refining and marketing segment, as the retail, midstream and corporate segments produced results that were essentially the same as a year ago. Lower throughput volumes and lower crack spreads (margins) drove the weakness.

At about 38, MPC shares are interesting and appealing but not enough to warrant a return to a Buy rating. We are working through the number and management commentary for more clarity on the post-sale Marathon. Meanwhile, the shares offer a reasonably sustainable 6.0% dividend yield.

The shares will continue to trade near-term around the pace of the re-opening of the economy, on overall oil prices and the currently wide refiner margins. Its earnings recovery appears to be slower in coming, reflected in declining earnings estimates.

Wall Street analysts are forecasting a 2020 full-year loss of $(2.94)/share, continuing a trend downwards. Estimates for 2021 earnings also fell, now at $1.78/share. However, these include almost no effects from the quarterly results or the sale of Speedway.

Like most energy stocks, MPC offers a useful vehicle for traders: its economics are closely tied to oil prices yet the company has a more stable business, with its refining, MPLX midstream, and retail operations that dampen its volatility and provide more downside protection relative to pure exploration or energy service companies. HOLD.

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Strong Buy and Buy – This stock meets most of my fundamental investment criteria.
Hold – The shares are worth keeping but the risk/return trade-off is not favorable enough to warrant a Buy nor unfavorable enough to warrant a Retire or Sell.
Retired – This stock has been removed from the portfolio for a specific reason, yet remains an attractive holding for long-term investors who would rather minimize portfolio turnover.
Sell – This stock has a problem that increases portfolio risk. Sell it.


The next Cabot Undervalued Stocks Advisor issue will be published on September 2, 2020.

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