After a sluggish summer for most value stocks, the value universe is starting to come to life and adding a little more than 3% from the start of September going into today. I think investors took notice that many retail companies’ earnings reports from late August showed that the consumer was still spending. Furthermore, when hopes of a trade agreement rose last week when China stated that it would meet with U.S. trade officials in October, the stage was set for many depressed value stocks to rise.
For this recent rally to continue through the year’s end, we will need recession fears to recede. I think there is potential for this to happen even though there is currently a slight slump in manufacturing, based on last week’s global Institute of Supply Chain Management’s (ISMs) manufacturing reports. However, this reflects, at least in part, the impact of tariffs. Furthermore, should we get a comprehensive trade agreement, there will likely be an improvement in manufacturing activity
Meanwhile, most other sectors of the company appear to be doing well and central banks are committed to easy monetary policy. While one could debate how necessary and effective a further rate cut will be when the Federal Reserve updates their policy statement next Wednesday, Sept. 18, a rate cut would help a lot with market and economic psychology.
With many value stocks still deeply depressed, the rally we have seen so far in September can continue, given a positive economy landscape. This should be a major boost for our recommended companies, especially some of our laggards. They have seen their stocks take a hit even though their earnings estimates for the year have changed little since either the start of the year or from the time I made my recommendation. A sound economy would build confidence for 2020 estimates and should send these stocks higher.
We already have had six realized gains this year and have had good results with recent picks Valvoline (VVV) and Intel (INTC). While I believe we are positioned to close the year in a strong position, I will be vigilant in my approach and make adjustments where necessary.
The New Intel
This is not your father’s Intel. The company has evolved considerably from being primarily a provider of microprocessors for personal computers and servers to a diversified semiconductor company with exposure to growth areas. The company has achieved this through leveraging its core competencies and through acquisitions. The most notable acquisitions include Altera, which makes programmable chips used in industrial and computing applications, for $16.75 billion in 2015, and MobilEye, which makes devices used for driver assistance in automobiles and has autonomous driving technology, for $15.3 billion in 2017. In the most recent quarter, PC-centric businesses accounted for 53% of revenues; the company’s Data Center Group, which helps enable cloud computing, accounted for 30% of revenues; the Internet of Things businesses 6%, memory chips 5%, and the remaining 5% came from MobileEye and Altera.
The Data Center Group and other growth businesses, along with the acquisitions, allowed INTC to enjoy a nice spurt of growth between 2015 and 2018, with revenues increasing from $55.3 billion to $70.8 billion in that period. This was an average gain of 8.5% per year. Earnings per share (EPS) increased from $2.49 to $4.58 over the same period, with the lower corporate tax rate aiding results in 2018. However, sales and earnings are being pressured this year by a decline in the Data Center Group business, as giant providers of web services like Microsoft (MSFT) and Amazon.com (AMZN) overbuilt their infrastructure in 2018 and are currently working off the excess inventory that they purchased from vendors like Intel. Data Center sales declined 10% in the second quarter. For the year, the company is forecasting a 1.8% decline in total revenues to $69.5 billion and a 3.9% decline in EPS to $4.40.
While results for this year have been disappointing for Intel, such “inventory corrections” are common in the chip industry, and the decline in this year’s earnings should not be a major concern. While the growth rate that INTC realized from 2015 through 2018 may not be sustainable, the company should be able to grow the top line from low-to mid-single digits and leverage that to high single-digit earnings per share (EPS) increases through operating leverage, share buybacks and debt reduction. Intel expects to generate $15 billion in free cash flow this year, which should allow the company to add to shareholder value through share buybacks, while at the same time maintaining its solid balance sheet and dividends.
The shares have done very well since my recommendation last week. In addition to a very attractive valuation of under 11X this year’s EPS estimates at the time of recommendation, the stock has benefited from better news on trade talks, which has lifted most chip stocks, as well as the renewed interest in value-oriented stocks. With these trends likely in place for the time being, I look for the stock to drive closer to my $55 target. My buy-below price remains $48.
Position Review
Big Lots (BIG) has been able to hold onto to most of its gains following a solid fiscal second-quarter earnings report. My discussion of that report can be found here. The shares should continue to trade with a better tone, and the progress the company continues to make with its “stores of the future” and positive consumer response to merchandising changes gives me confidence the current very depressed valuation of 6.5X this year’s EPS will eventually increase considerably. BIG is a buy below $26. My target is $38.
There has not been much in the way of new news at Cognizant Technology Systems (CTSH). The company has participated nicely in the market’s recent bounce, and I am confident that the changes that are being put in place by new CEO Brian Humphries will enable the company to resume the consistent growth it enjoyed for years. There is good value in the stock at 16X this year’s EPS estimates. Buy CTSH below $65. My target is $79.
F5 Networks (FFIV) snapped back very strongly as the market rallied last week. The stock still has a very attractive valuation of 13X this year’s EPS, even with the company investing heavily to become more of a software-based company. Concerns over cloud and database spending from enterprise customers may weigh on the stock from time to time, but at the current valuation and with a healthy contribution from stable services businesses, the risk versus reward characteristics of the stock look favorable. Buy FFIV below $145. My target is $165.
Like most other banks, shares of First Hawaiian Inc. (FHB) have come under pressure due to the recent decline in long-term interest rates. Not only could this potentially hurt interest margins over the long term, this change is also being interpreted by many as a sign that a recession is coming. While I will keep a close eye on macro trends, I do not believe a recession is imminent. Instead, I believe the yield curve should widen once markets get over their recession fears. Meanwhile, the company is executing well, with good loan growth and cost controls evident in the second quarter. This should help earnings the remainder of the year. Buy FHB below $26. My target remains $30.
I still believe shares of Ingredion (INGR) can move much higher from their current price. The stock still trades below the $85 level it reached at after it reported better-than-expected earnings back in July. This happened despite the fact that corn prices, whose rise over most of 2019 have pressured margins, have corrected 10% in recent weeks. At just 12X this year’s EPS estimates and with earnings headwinds lifting (possibly including tariffs), the stock should do well for the remainder of the year. Buy INGR below $90. My target is $105.
Morgan Stanley (MS) did not see it shares bounce as much as other financial stocks last week, which is perhaps attributable to concerns over Brexit raising the costs for the company’s European operations. We may hear more about this issue when the company releases its third quarter earnings next month, but I do not feel it will have a major long-term impact. With the stock selling for just 1.1X tangible book value, and with the global markets and the economy looking better, continue to buy the shares. My new buy under price is $44 and my target is $50.
Packaging Corporation of America (PKG) has been trading in a very narrow range since August despite a good deal of market volatility. I believe that this reflects the fact that some investors are reluctant to buy PKG and have questions about the economy and declining container board prices. On the other hand, I do not think there are a lot of sellers either, given the company just sells for 14X next year’s EPS estimates, which bake in the lower container board prices. In addition, the 3.1% dividend yield and the company’s strong balance sheet adds to the attraction of the shares. I am sticking with my view that once the markets gain confidence in the economic outlook for 2020, the shares will do very well. Buy PKG under $100. My target is $115.
Party City (PRTY) has jumped off of its post second-quarter earnings lows, aided by a more positive outlook for a trade agreement as well as deeply oversold conditions. I remain optimistic that, when third-quarter earnings and critical Halloween sales are released in early November, the results will show progress on the company’s goals of reducing its inventory and improving cash flow. While it has been a very disappointing year for the company’s financial results and the stock, many of the issues that are impacting PRTY earnings this year are one-time in nature, and the stock should move significantly higher over time. Buy PRTY under $5.50. My target is $9.
Valley National Bancorp (VLY) is executing very well, delivering for shareholders on cost cuts and a smooth expansion of its Florida operations. However, its stock is being held back by macroeconomic issues, specifically the flatter yield curve and concerns over a recession. However, I do believe the economy will not slip into a recession. In time, the yield curve will steepen as long-term interest rates will recover. With the stock selling at less than 12X this year’s EPS estimates and with an attractive 4.3% yield, I look for the shares to do much better over the next 12 months. Buy VLY below $10. My target is $12.
Valvoline (VVV) continues to trade solidly, as investors continue to reward the company for its strong second quarter. The stock is still reasonable at 17X this year’s EPS estimates, with growth likely to continue next year from both the company’s Quik Lube auto service operations and the fading of foreign currency headwinds from its lubricant business. Buy VVV when it trades below $21.50. My target is $25.
I went to a meeting and a dinner last night with Steve Forbes, who always offers useful insights about the markets.
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