Restoring Some Balance?
Across almost the entire length of the yield curve, interest rates are ticking up. The benchmark 10-year Treasury yield reached 1.53% and may be headed back toward its December 2019 rate of about 1.90%. In an economy that is showing rapid growth, with inflation well above the Fed’s 2% target and likely at 6% or more if housing prices were properly factored in, a sub-2% 10-year Treasury yield doesn’t seem to make sense.
Super-easy money and near-zero interest rates have produced an unbalanced investment market. In this climate, few assets are priced to realistically reflect their long-term value. Hyper-growth tech and biotech companies, with their hopes of developing huge franchises in (mostly) worthy new markets, have stocks that seem to assume no risks, just opportunity.
At least for today (Tuesday), with the Nasdaq down over 2% compared to the Dow Jones Industrial Average down only 1%, investors are incrementally adjusting valuations toward more realistic levels. If interest rates continue to rise, most stocks will likely decline as few can withstand the weight of a higher discount rate. As a value investor, I’d be fine with seeing some of the speculative “assets” like cryptocurrencies, meme stocks and NFTs fall sharply. Stocks with solid fundamental value, like those we recommend in the Cabot Undervalued Stocks Advisor, should shine.
On average, mid-day today, our recommended stocks have declined about 0.85%, a modest slippage compared to the major indices.
Share prices in the table reflect Tuesday (September 28) closing prices. Please note that prices in the discussion below are based on mid-day September 28 prices.
Note to new subscribers: You can find additional color on our thesis, recent earnings reports and other news on recommended companies in prior editions of the Cabot Undervalued Stocks Advisor, particularly the monthly edition, on the Cabot website.
Send questions and comments to Bruce@CabotWealth.com.
Today’s Portfolio Changes
ConocoPhillips (COP) – New Buy on September 24 via Special Bulletin
Last Week’s Portfolio Changes
Dow (DOW) – Moving from HOLD to BUY.
General Motors (GM) – Moving from HOLD to BUY.
GROWTH/INCOME PORTFOLIO
Bristol Myers Squibb Company (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, helped by a $2.5 billion cost-cutting program, and has a relatively modest debt level.
Merck appears close to buying Acceleron Pharmaceuticals (XLRN), beating out what was likely a bid by Bristol. No agreement has been announced, so it is possible that Bristol will counter-bid for Acceleron or that no deal will be struck.
Acceleron is a Boston-based early-stage biotech company that is developing sotatercept, an experimental and highly promising treatment for a rare form of heart disease, which is the major source of Acceleron’s value. Acceleron also markets Reblozyl, an FDA-approved anemia treatment with decent potential. Acceleron is estimated to generate about $100 million in revenues, but post a sizeable loss, this year.
Complicating a deal is that Bristol owns an 11.5% stake in Acceleron, worth about $1.3 billion at the current share price of about $183. Bristol received this stake, along with a 20%+ royalty on all sotatercept sales and likely a sizeable royalty on sales of Reblozyl, as part of its Celgene acquisition.
If Merck wins the deal, Bristol could book a pre-tax profit of close to $1 billion, and perhaps receive a large up-front payout if Merck wants to eliminate the royalties.
BMY shares fell 1% in the past week and have slipped about 14% from their recent high, with about 31% upside to our 78 price target.
We continue to believe that most of the downward pressure on BMY shares is due to worries over new drug price controls in the $3.5 trillion infrastructure bill, although progress on this piece of the bill appears to have stalled recently. However, the exact scope and depth of the proposals won’t be known until at least after the bill is passed (if it is passed). Many investors simply avoid pharma stocks during such a period. We are a bit more optimistic that Congress won’t gut the industry, in part due to the impressive strength of the pharma lobby, and remain patient with BMY shares with strong conviction in the company’s underlying fundamentals.
The stock trades at a low 7.4x estimated 2022 earnings of $8.03 (unchanged in the past week) and 7.1x estimates of $8.45 (unchanged) for 2023. Either we are completely wrong about the company’s fundamental strength, or the market must eventually recognize Bristol’s earnings stability and power. We believe the earning power, low valuation and 3.3% dividend yield that is well-covered by enormous free cash flow make a compelling story. BUY
Cisco Systems (CSCO) is facing revenue pressure as customers migrate to the cloud and thus need less of Cisco’s equipment and one-stop-shop services. Cisco’s prospects are starting to improve under a relatively new CEO, who is shifting Cisco toward a software and subscription model and is rolling out new products, helped by its strong reputation and entrenched position within its customers’ infrastructure. The company is highly profitable, generates vast cash flow (which it returns to shareholders through dividends and buybacks) and has a very strong balance sheet.
There was no significant company-specific news in the past week.
CSCO shares rose 1% in the past week and have about 8% upside to our 60 price target.
The shares trade at 16.2x estimated FY2022 earnings of $3.43 (unchanged in the past week). On FY2023 earnings (which ends in July 2023) of $3.68 (unchanged), the shares trade at 15.1x. On an EV/EBITDA basis on FY2022 estimates, the shares trade at a 11.6x multiple. CSCO shares offer a 2.7% dividend yield. We continue to like Cisco. BUY
Coca-Cola (KO) is best-known for its iconic soft drinks yet nearly 40% of its revenues come from non-soda beverages across the non-alcoholic spectrum. Its global distribution system reaches nearly every human on the planet. Coca-Cola’s longer-term picture looks bright, but the shares remain undervalued due to concerns over the pandemic, the secular trend away from sugary sodas, and a tax dispute which could cost as much as $12 billion (likely worst-case scenario). The relatively new CEO James Quincey (2017) is reinvigorating the company by narrowing its oversized brand portfolio, boosting its innovation and improving its efficiency, as well as improving its health and environmental image. Coca-Cola’s balance sheet is sturdy, and its growth investing, debt service and dividend are well-covered by free cash flow.
There was no significant company-specific news in the past week.
KO shares slipped 3% in the past week and have about 22% upside to our 64 price target.
While the valuation is not statistically cheap, at 21.6x estimated 2022 earnings of $2.43 (unchanged this past week) and 20.1x estimated 2023 earnings of $2.61 (unchanged), the shares remain undervalued given the company’s future earning power and valuable franchise. Also, the value of Coke’s partial ownership of a number of publicly traded companies (including Monster Beverage) is somewhat hidden on the balance sheet, yet is worth about $23 billion, or 9% of Coke’s market value. This $5/share value provides additional cushion supporting our 64 price target. KO shares offer an attractive 3.2% dividend yield. BUY
Dow Inc. (DOW) merged with DuPont to create DowDuPont, then split into three companies in 2019 based on product type. The new Dow is the world’s largest producer of ethylene/polyethylene, the most widely used plastics. Investors undervalue Dow’s hefty cash flows and sturdy balance sheet largely due to its uninspiring secular growth traits and its cyclicality. The shares are driven by: 1) commodity plastics prices, which are often correlated with oil prices and global growth, along with competitors’ production volumes; 2) volume sold, largely driven by global economic conditions, and 3) ongoing efficiency improvements (a never-ending quest of all commodity companies). Investors worry about a cyclical peak and whether Dow will squander its vast free cash flow. We see Dow as having more years of strong profits before capacity increases signal a cyclical peak, and expect the company to continue its strong dividend, reduce its pension and debt obligations, repurchase shares slowly and restrain its capital spending.
There was no significant company-specific news in the past week.
Dow will host an investor day on October 6, starting at 10am ET, which will be accessible via the Dow investor relations website.
Dow shares rose 7% this past week (conveniently, right after our return of DOW to a Buy) and have 32% upside to our 78 price target. On estimated 2022 earnings of $6.03 (unchanged in the past week), the shares trade at a 9.8x multiple. On estimated 2023 earnings of $5.63 (unchanged and slightly higher than 2021 estimated earnings), the shares trade at about 10.5x.
Analysts are somewhat pessimistic about 2022 earnings (they assume a 30% decline from 2021). If the 2022 estimate resumes it upward march, the shares will likely follow, although Dow’s cyclical earnings and investor fears of an eventual downcycle will ultimately limit Dow’s upside. The high 4.7% dividend yield adds to the shares’ appeal – especially in a low-interest-rate environment. In a prolonged downcycle, the dividend could be cut, but that could be years away and even then a cut isn’t a certainty if Dow can manage its balance sheet and down-cycle profits reasonably well. BUY
Merck (MRK) shares are undervalued as investors worry about Keytruda, a blockbuster oncology treatment (about 30% of revenues), facing generic competition in late 2028. Also, its Januvia diabetes treatment may see generic competition next year, and like all pharmaceuticals it is at risk from possible government price controls. Yet, Keytruda is an impressive franchise that is growing at a 20% rate and will produce solid cash flow for nearly seven more years, providing the company with considerable time to replace the potential revenue loss. Merck’s new CEO, previously the CFO, will likely accelerate Merck’s acquisition program, which adds both return potential and risks to the story. The company is highly profitable and has a solid balance sheet. It spun off its Organon business in June and we think it will divest its animal health sometime in the next five years.
Merck is in talks to acquire Acceleron Pharmaceuticals (XLRN), a Boston-based early-stage biotech company that is developing sotatercept, an experimental and highly promising treatment for a rare form of heart disease, which is the major source of Acceleron’s value. Acceleron also markets Reblozyl, an FDA-approved anemia treatment with decent potential. Acceleron is estimated to generate about $100 million in revenues, but post a sizeable loss, this year.
Deal chatter is suggesting a value of around $11 billion. While Merck has telegraphed its intentions to buy promising treatments to expand its pipeline, a deal of this size is larger than we anticipated. Merck can easily afford to buy Acceleron, but it might not have enough capital to make more than one other similarly sized deal.
As an early-stage company, with its sotatercept heart treatment yet to receive FDA approval, Acceleron’s future is somewhat binary. If the treatment receives FDA approval, the estimated $180/share deal price would be a stunning bargain. However, failure could mean the shares are worth maybe $50, producing a large and relatively quick loss for Merck. FDA approval might be a year or more away.
Complicating a deal is that Bristol owns an 11.5% stake in Acceleron, worth about $1.3 billion at the current share price of about $183. Bristol received this stake, along with a 20%+ royalty on all sotatercept sales and likely a sizeable royalty on sales of Reblozyl, as part of its Celgene acquisition. It is possible that Bristol will counterbid for Acceleron or that no deal is completed.
It is likely that Merck is negotiating a termination of these royalties as part of the purchase price, which might result in a sizeable buyout payment to Bristol. No definitive deal has been announced, so we will continue to watch for updates.
Merck shares rose 2% this past week and have about 35% upside to our 99 price target. Valuation is an attractive 11.4x estimated 2022 earnings of $6.44 (unchanged this past week) and 10.6x estimated 2023 earnings of $6.92 (up a cent). We note that Keytruda’s patent expiration doesn’t happen until late 2028. If the company produces earnings close to these estimates and continues to provide evidence of solid post-Keytruda prospects, as we expect, the shares are considerably undervalued.
Merck produces generous free cash flow to fund its current dividend (now yielding 3.5%) as well as likely future dividend increases, although its shift to a more acquisition-driven strategy will slow the pace of increases. BUY
Otter Tail Corporation (OTTR) is a rare utility/industrial hybrid company, with a $2 billion market cap. The electric utility has a solid and high-quality franchise, with a balanced mix of generation, transmission and distribution assets that produce about 75% of the parent company’s earnings, supported by an accommodative regulatory environment. The industrial side includes the Manufacturing and Plastics segments. Otter Tail has an investment grade balance sheet, produces solid earnings and prides itself on steady dividend growth. The unusual utility/manufacturing structure is creating a discounted valuation, which might make the company a target for activists, as the two parts may be worth more separately, perhaps in the hands of larger, specialized companies.
There was no significant company-specific news in the past week.
OTTR shares rose 2% this past week and have about 2% upside to our 57 price target. The stock trades at about 15.6x estimated 2021 earnings of $3.59 (unchanged). On estimated 2022 earnings of $3.13 (unchanged), the shares trade at about 17.9x. Analysts are assuming that the plastics upcycle will fade in 2022, weighing on earnings by about 13%. OTTR shares offer a 2.8% dividend yield. BUY
BUY LOW OPPORTUNITIES PORTFOLIO
New BUY: ConocoPhillips (COP). Based in Houston, Texas, ConocoPhillips is the world’s largest independent E&P company, with about two-thirds of its production in the United States.
Our interest in oil and natural gas exploration and production (E&P) companies has been warming up lately. Many of these stocks are beaten down, yet oil prices have remained resilient, leaving producers like ConocoPhillips meaningfully undervalued.
Four issues seem to be weighing on E&P stocks like ConocoPhillips. First, investors are increasingly looking to avoid climate-unfriendly companies. Also, investors have low interest in exposure to volatile and unpredictable oil and gas prices, especially since the entire energy sector has a tiny 2.6% weighting in the S&P 500 index. Another concern is that company managements will lose their new-found capital spending discipline. And there is always the risk that OPEC+ opens their oil production spigots, sending oil prices down.
Yet, supporting energy prices is resilient demand, which has nearly returned to pre-pandemic levels despite still-subdued jet fuel and gasoline demand. Despite urgent calls for alternative fuels to help mitigate climate change, the challenges to reducing the reliance on carbon-based energy remains daunting, with a wholesale shift likely to be slow-moving and measured in decades.
Subdued supply growth should also support oil prices. Major global energy companies are under increasing pressure to reduce their production to help fight climate change. And, following years of aggressive drilling in the US, shale oil’s most productive days may be in the past. If so, domestic production, now running about 15% below 2019 levels, may be permanently lower.
Given this, we see a contrarian opportunity in ConocoPhillips. With the news that it is acquiring Royal Dutch Shell’s Texas assets for $9.5 billion in cash, we believe the time to buy has arrived.
We like Conoco’s low valuation at about 5x EV/EBITDAX1. It also offers a free cash flow yield of close to 12%2 – an indicator of the company’s strong cash production as well as its discounted price. Most analysts have oil prices of perhaps $55-$60/barrel in their earnings estimates, implying that profits and cash flow will be stronger than estimated, as oil has traded close to $70/barrel for most of the year so far.
Conoco’s balance sheet is robust, with an investment-grade balance sheet. While it is spending most of its cash hoard on Royal Dutch Shell’s Texas assets ($9.0 billion cash balance at the end of the second quarter), we see its strong free cash flow leading to a rebuilding of its balance sheet.
Conoco has publicly stated that it will limit its capital spending to 50% of its annual cash flow, even after its Shell purchase. We believe that the management is unlikely to renege on this commitment. For perspective on the size of this cash flow, at $50 oil, the company said the deal would allow for an incremental $10 billion of cash to be returned to investors over the next decade. This is on top of management’s guidance for $65 billion in next-decade cash distributions before the Shell deal. For perspective, Conoco’s market cap is about $76 billion. This is a remarkably attractive prospect, particularly at $70 oil. Conoco shares currently have a dividend yield of about 2.8%, offering a respectable base-level cash inflow to shareholders that appears rock-solid.
We are placing an 80 price target on ConocoPhillips shares. The shares have jumped some on the Texas acquisition news, so investors may want to buy a partial position now, then wait for any pullbacks. BUY
- EV/EBITDAX is Enterprise value to Earnings before interest, taxes, depreciation, amortization and exploration spending. Similar to EBITDA, the EBITDAX is a proxy for cash earnings, which also excludes exploration costs that run through the income statement.
- Free cash flow yield is the company’s cash flow from operations less capital spending, divided by its market capitalization. It is a measure of how much free cash flow is at the company’s disposal after it maintains its business, which can then be used to pay down debt, pay recurring or special dividends and/or repurchase shares.
Arcos Dorados (ARCO), which is Spanish for “golden arches,” is the world’s largest independent McDonald’s franchisee. Based in stable Uruguay and listed on the NYSE, the company produces about 72% of its revenues in Brazil, Mexico, Argentina and Chile. Arcos’ leadership looks highly capable, led by the founder/chairman who owns a 38% stake. The shares are undervalued as investors worry about the pandemic, as well as political/social unrest, inflation and currency devaluations. However, the company is well-managed and positioned to benefit as local economies reopen, and it has the experience to successfully navigate the complex local conditions. Debt is reasonable relative to post-recovery earnings, and the company is currently producing positive free cash flow.
Macro issues will continue to move ARCO shares. We would like to see stability/strength in the Brazilian currency after its weakness since the pandemic. The pace of vaccinations in Brazil appears to be accelerating, which should boost economic results later this year, likely helping Arcos’ business. The political situation is edgier, as slow job growth increases the pressure on the president, Jair Bolsonaro, in advance of the October 2022 election. See additional comments in our September 1 letter.
There was no significant company-specific news in the past week.
ARCO shares were flat this past week and have about 44% upside to our 7.50 price target. Investors appear to be playing the macro newsflow about Brazil’s political and economic issues and not the company’s underlying fundamentals. We remain steady in our conviction in the company’s recovery. The low share price offers a chance to add to or start new positions.
The stock trades at 17.3x estimated 2022 earnings per share of $0.30 (unchanged from a week ago). The 2023 consensus estimate of $0.37 (unchanged) implies a 14.1x multiple. BUY
Aviva, plc (AVVIY), based in London, is a major European insurance company specializing in life insurance, savings and investment management products. Amanda Blanc was hired as the new CEO last year to revitalize Aviva’s laggard prospects. She has divested operations around the world to aggressively re-focus the company on its core geographic markets (UK, Ireland, Canada), and is improving Aviva’s product competitiveness, rebuilding its financial strength and trimming its bloated costs. Aviva’s dividend has been reduced to a more predictable and sustainable level with a modest upward trajectory. Excess cash balances are being directed toward debt reduction and potentially sizeable special dividends.
Much of our interest in Aviva is in what it plans to do with its current and future excess capital, including the proceeds from its divestitures. So far, the company has recently raised its interim dividend by 5% to £0.0735/share (about $0.20 per ADS, as there are 2 underlying common shares per ADS, and the exchange rate is about $1.38) and will return at least £4 billion (about $5.5 billion) by 2H 2022, mostly through share buybacks. It will complete £750 million “immediately.” The balance of the divestiture proceeds will go toward debt paydown.
We anticipate that the company will pay a final (year-end) dividend of about twice its interim dividend, for a full-year total recurring dividend of about $0.61/ADS. On this, the shares would produce an annual dividend yield of about 5.7% – rather appealing in an era when AA-rated corporate bonds yield about 1.8%
There was no significant company-specific news in the past week.
Aviva shares were flat this past week and have about 30% upside to our 14 price target.
The stock trades at 8.9x estimated 2022 earnings per ADS of $1.22 (down 2 cents due entirely to the weaker British pound), which is lower than estimated 2021 earnings due to Aviva’s divestitures. Interestingly, the 2023 estimate is $1.40 (down 4 cent due to the weaker British pound), implying more than a full recovery from 2021 results. The stock trades at about 94% of tangible book value. BUY
Barrick Gold (GOLD), based in Toronto, is one of the world’s largest and highest-quality gold mining companies. About 50% of its production comes from North America, with the balance from Africa/Middle East (32%) and Latin America/Asia Pacific (18%). The market has little interest in Barrick shares. Yet, Barrick will continue to improve its operating performance (led by its new and highly capable CEO), generate strong free cash flow at current gold prices, and return much of that free cash flow to investors while making minor but sensible acquisitions. Also, Barrick shares offer optionality – if the unusual economic and fiscal conditions drive up the price of gold, Barrick’s shares will rise with it. Given their attractive valuation, the shares don’t need this second (optionality) point to work – it offers extra upside. Barrick’s balance sheet has more cash than debt. Major risks include the possibility of a decline in gold prices, production problems at its mines, a major acquisition and/or an expropriation of one or more of its mines.
The threat of local governments taking control of gold mines remains. As the free world shrinks, autocratic governments become more assertive about taking assets from Western companies. Most of Barrick’s production comes from countries unlikely to expropriate, but takings at the margin will weigh on the shares.
Commodity gold prices slipped 2% to $1,737/ounce while the 10-year Treasury yield rose to 1.53%. Gold prices seems range-bound for now, although they are approaching the bottom end of their year-to-date range of around $1,700.
The market seems to be losing patience with gold stocks, in no small part due to rising interest rates. The 10-year Treasury appears headed toward the upper 1% range, possibly challenging its December 2019 yield of about 1.90%, just in front of the pandemic. At that time, gold was trading at around $1,450, so it appears that investors are worried that gold will slide back to that level. If interest rates keep rising, it certainly is possible that gold prices slip that far. As Barrick’s shares are sensitive to gold prices, it is falling farther and faster, and has the possibility of dipping into the mid-teens. Investors not comfortable with this possibility should probably sell.
Our view is to hang onto Barrick shares, wait until the momentum sellers clear out, then buy more. Fundamentally, the company is doing well, has solid leadership, quality mines and a very strong balance sheet. It might take a long time, but we remain confident that eventually the shares will hit the target price.
Not to get too far into the weeds, but if the U.S. economy stalls out (inevitable at some point), and if/when the stock market tumbles, it seems highly likely that the Fed will return to a zero-rate environment. That would probably be an unmitigated positive for gold prices and for Barrick shares.
Two major Canadian gold miners, Agnico Eagle Mines (AEM) and Kirkland Lake Gold Ltd (KL), have agreed to a merger. While shares of both companies are falling today, other gold miner shares including Barrick are rising. One explanation for this is that investors are relieved that Barrick (and Newmont) won’t be acquiring either of these two companies.
Barrick shares fell 2% this past week and have about 50% upside to our 27 price target. The price target is based on 7.5x estimated steady-state EBITDA and a modest premium to our estimate of $25/share of net asset value.
On its recurring $.09/quarter dividend, GOLD shares offer a reasonable 2.0% dividend yield. Barrick will pay an additional $0.42/share in special distributions this year (no clarity on 2022 special dividends), lifting the effective dividend yield to 4.3%. BUY
General Motors (GM) is making immense progress with its years-long turnaround. It is perhaps 90% of the way through its gas-powered vehicle turnaround and is well-positioned but in the early stages of its electric vehicle (EV) development. GM Financial will likely continue to be a sizeable profit generator. GM is fully charged for both today’s environment and the EV world of the future, although the underlying value of its emerging EV business is unclear.
The shares reflect conservative but reasonably strong gas-powered vehicle profits but assign no value to the EV operations. This zero-value almost certainly is wrong but the EV operations have no sales or profits so the valuation is by definition speculative at this point.
Swedish electric-car maker Polestar announced that it will merge with a SPAC and thus become a publicly traded company. The company is a highly credible competitor to Tesla, GM and other EV producers. With its implied enterprise value of around $20 billion, it provides valuation support for GM’s electric vehicle operations. GM will update investors at its October 6-7 Analyst Day – we hope to get a lot more color on its EV rollout to better assess its positioning relative to Polestar and others. Readers interested in Polestar will want to check out its exceptionally impressive website. (If its cars are anywhere near as good as its website implies, Polestar will do quite well!)
We don’t expect GM shares to fully incorporate a comparable valuation of its EV operations relative to Polestar, Tesla, or others. Shares of these other pure-play EV companies have an investor constituency that is very different from GMs, as these other stocks can become volatile and speculative “bets” whereas GM won’t likely meet those criteria.
GM said it is investing $300 million in Chinese autonomous vehicle producer Momenta. This should provide it with new technology as well as build goodwill.
Industry consultants JD Power and LMC Automotive project that September U.S. new vehicle sales fell 25% from a year ago, as strong demand is meeting tight supplies.
GM shares rose 8% this past week (conveniently, right after our return of GM to a Buy) and have 30% upside to our 69 price target.
On a P/E basis, the shares trade at 7.7x estimated calendar 2022 earnings of $6.90 (down 2 cents this past week). On estimated 2023 earnings of $6.79 (down a cent), the shares trade at about 7.8x.
The P/E multiple is helpful, but not a precise measure of GM’s value, as it has numerous valuable assets that generate no earnings (like its Cruise unit, which is developing self-driving cars and produces a loss), its nascent battery operations, and its other businesses with a complex reporting structure, nor does it factor in GM’s high but unearning cash balance which offsets its interest-bearing debt. However, it is useful as a rule-of-thumb metric, and provides some indication of the direction of earnings estimates, and so we will continue its use here. BUY
Molson Coors Beverage Company (TAP) 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% market share. Investors worry about Molson Coors’ lack of revenue growth due to its relatively limited offerings of fast-growing hard seltzers and other trendier beverages. Our thesis for this company is straight-forward – a reasonably stable company whose shares sell at an overly-discounted price. Its revenues are resilient, it produces generous cash flow and is reducing its debt. A new CEO is helping improve its operating efficiency and expand carefully into more growthier products. The company recently reinstated its dividend.
There was no significant company-specific news in the past week.
TAP shares rose 6% in the past week, perhaps reflecting that the price is well-below fair value for the company’s steady and improving business.
The shares have about 45% upside to our 69 price target. They trade at 11.1x estimated 2022 earnings of $4.30 (unchanged this past week) and 10.5x estimated earnings of $4.54 (unchanged) in 2023.
On an EV/EBITDA basis, or enterprise value/cash operating profits, the shares trade for about 8.2x estimated 2022 results, still among the lowest valuations in the consumer staples group and below other brewing companies. BUY
Organon & Company (OGN) was recently spun off from Merck. It specializes in patented women’s healthcare products and biosimilars, and also has a portfolio of mostly off-patent treatments. Organon will produce better internal growth with some boost through smart yet modest-sized acquisitions. It may eventually divest its Established Brands segment. The management and board appear capable, the company produces robust free cash flow, has modestly elevated debt and will pay a reasonable dividend. Investors have ignored the company, but we believe that Organon will produce at least stable and large free cash flows with a reasonable potential for growth. At our initial recommendation, the stock traded at a highly attractive 4x earnings.
There was no significant company-specific news in the past week.
OGN shares were flat this past week and have about 39% upside to our 46 price target (using the same target as the Cabot Turnaround Letter). The shares trade at 5.5x estimated 2022 earnings of $6.03 (unchanged in the past week) and 5.3x estimated 2023 earnings of $6.28 (unchanged). This stronger 2023 estimate is consistent with our view that Organon can generate at least steady revenues and profits. Organon shares offer an attractive 3.4% dividend yield. BUY
Sensata Technologies (ST)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. Also, 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.
Once a threat, electric vehicles are now an opportunity, as the company’s expanded product offering (largely acquired) allows it to sell more content into an EV than it can into an internal combustion engine vehicle. Risks include a possible automotive cycle slowdown, chip supply issues, geopolitical issues with China, currency and over-paying/weak integration related to its acquisitions.
There was no significant company-specific news in the past week.
ST shares rose 3% this past week and have about 33% upside to our 75 price target.
The stock trades at 13.5x estimated 2022 earnings of $4.14 (down 2 cents this past week) and 12.2x estimated 2023 earnings of $4.63 (up 2%). We expect this 2023 estimate will move around a lot. On an EV/EBITDA basis, ST trades at 11.1x estimated 2022 EBITDA. BUY
Note for stock table: For stocks rated Sell, the current price is the sell date price.
Disclosure:The chief analyst of the Cabot Undervalued Stocks Advisor personally holds shares of every recommended security, except for “New Buy” recommendations. The chief analyst may purchase or sell recommended securities but not before the fourth day after any changes in recommendation ratings has been emailed to subscribers. “New Buy” recommendations will be purchased by the chief analyst as soon as practical following the fourth day after the newsletter issue has been emailed to subscribers.
| Growth/Income Portfolio | |||||||
| Stock (Symbol) | Date Added | Price Added | 9/28/21 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Bristol-Myers Squibb (BMY) | 04-01-20 | 54.82 | 59.84 | 9.2% | 3.3% | 78.00 | Buy |
| Cisco Systems (CSCO) | 11-18-20 | 41.32 | 55.52 | 34.4% | 2.6% | 60.00 | Buy |
| Coca-Cola (KO) | 11-11-20 | 53.58 | 52.64 | -1.8% | 3.1% | 64.00 | Buy |
| Dow Inc (DOW) * | 04-01-19 | 53.50 | 59.46 | 11.1% | 4.7% | 78.00 | Buy |
| Merck (MRK) | 12-9-20 | 83.47 | 73.32 | -12.2% | 3.5% | 99.00 | Buy |
| Otter Tail Corporaton (OTTR) | 5-25-21 | 47.10 | 55.98 | 18.9% | 2.8% | 57.00 | Buy |
| Buy Low Opportunities Portfolio | |||||||
| Stock (Symbol) | Date Added | Price Added | 9/28/21 | Capital Gain/Loss | Current Dividend Yield | Price Target | Rating |
| Arcos Dorados (ARCO) | 04-28-21 | 5.41 | 5.12 | -5.4% | — | 7.50 | Buy |
| Aviva (AVVIY) | 03-03-21 | 10.75 | 10.78 | 0.3% | 5.5% | 14.00 | Buy |
| Barrick Gold (GOLD) | 03-17-21 | 21.13 | 18.10 | -14.3% | 2.0% | 27.00 | Buy |
| ConocoPhillips (COP) | 9-24-21 | 65.02 | 67.80 | 4.3% | 2.7% | 80.00 | New Buy |
| General Motors (GM) | 12-31-19 | 36.60 | 52.85 | 44.4% | — | 69.00 | Buy |
| Molson Coors (TAP) | 08-05-20 | 36.53 | 47.49 | 30.0% | — | 69.00 | Buy |
| Organon (OGN) | 06-07-21 | 31.42 | 33.04 | 5.2% | — | 46.00 | Buy |
| Sensata Technologies (ST) | 02-17-21 | 58.57 | 56.06 | -4.3% | — | 75.00 | Buy |
*Note: DOW price is based on April 1, 2019 closing price following spin-off from DWDP.
Buy – This stock is worth buying.
Strong Buy – This stock offers an unusually favorable risk/reward trade-off, often one that has been rated as a Buy yet the market has sold aggressively for temporary reasons. We recommend adding to existing positions.
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.
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.
Note for stock table: For stocks rated Sell, the current price is the sell date price.