A Pause is Possible, But I Am Still Optimistic for 2021


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The Russell 3000 Value Index has added another 6% since its Nov. 9 rally related to the Pfizer (PFE) news regarding successful test results from its COVID-19 vaccine.

While the number of new COVID-19 cases has been rising sharply, and there are signs that the economic recovery is slowing, investors are still willing to bet that 2021 will bring about the dramatic improvement in earnings that is currently being forecast. Patience for a favorable outcome is still being nourished by the significant support of the Federal Reserve, as investors, for the moment, see no reason to sell. Interest rates are very low and there is a good chance that the pandemic will end in 2021.

I do feel we may need to take a breather at some point. The current earnings forecast for the S&P 500 for 2021 of $169 per share, up from $139 this year, will likely come down, as these estimates for the S&P 500 generally start out as too optimistic. At a high valuation, 22X earnings estimates, that will likely be reduced, I believe we could see some softness in the S&P 500 as we start the new year. The softness will likely last until there is a better feel for where earnings in 2021 will eventually end up.

This uncertainty played a part in my selection of Keurig Dr. Pepper (KDP) this month, as the company is not very economically sensitive and has a greater degree of earnings certainty. However, other than last week’s sale of Citigroup (C), which was up an incredible 40% in just over one month, I have kept the pre-vaccine portfolio intact.

While we may see some near-term weakness, there is still decent value in our names. Most still offer good dividend yields at a time when 10-year Treasuries yield less than 1%. I also have a good deal of confidence that our companies will have improved earnings results in 2021. Therefore, there is no need to make a lot of changes, despite the rally.

While I will continue to adjust as needed, I am confident we will see further gains in 2021.

KDP: A New Company Off to a Solid Start

Keurig Dr. Pepper (KDP) is a leading beverage company in North America. The company was formed by the July 2018 merger of Keurig Green Mountain Group, which was owned by the private equity firm JAB Holdings, and the publicly traded Dr. Pepper Snapple Group. Under the terms of the deal, which was valued at $18.7 billion, Dr. Pepper Snapple shareholders received $103.75 in cash per share and a 13% share of the combined entity.

The new company consists of the following businesses:

Coffee Systems (Approximately 40% of sales) — It sells Keurig K-Cup coffee makers and owns related coffee pods from Green Mountain, Coffee Roasters and The Original Donut Shop. It also has licensing agreements with several other leading brands to make pods for Keurig coffee makers.

Packaged Beverages (Approximately 46% of sales) — The company either owns or has distribution rights for well-known brand names like Snapple, Mott’s Yoo-Hoo, Evian and Hawaiian Punch. These beverages are made in the United States and sold through either the company’s distribution system or third-party distributors. Walmart is the company’s largest customer.

Beverages Concentrates — This is the sale of concentrates of brands that are owned by the company. While this segment accounts for only 3% of sales, it generates as much operating income as packaged beverages. These two segments, when combined, contribute approximately 60% of the company’s total operating income.

Latin American Beverages (1% of sales) sells the company’s carbonated and non-carbonated beverages in Latin America, primarily in Mexico.

The combined company has done well financially since the merger. In 2019, the first full year of operations, sales were up 0.9% on a pro-forma basis and were accelerating by the end of the year. Earnings per share (EPS) were up 17.3% to $1.22, aided by cost synergies.

Through the first nine months of this year, sales were up 3.1% on volume gains for both coffee and packaged beverages. Continued cost savings from the merger and lower interest rate expenses, as the company reduced its debt, helped EPS rise by 12.3%. For the full year, the company expects EPS to be on the high end of its guidance of $1.38 to $1.40, and any profit in excess of that amount will likely be reinvested in marketing and brand building.

Given current sales trends, and the company’s continued cost savings and financial deleveraging, EPS estimates of $1.60 next year seem realistic. At 19X these estimates, the stock is selling at less than a market multiple of 22X, and less than the 26X price-to-earnings ratio (P/E) for Coca-Cola Companies (KO) and 24X for PepsiCo. (PEP). While KDO may never reach the same valuation as these rivals, I believe it can close the gap if it can continue its recent strong execution.

KDP is a buy below $31.75. My target is $36. The 2% dividend yield will add to total returns.

Position Review

3M (MMM) announced that it will lay off approximately 3% of its workforce due to continued economic uncertainty from the pandemic. I look favorably on the move, as it will free resources for the company to invest in the faster growing parts of its business. However, the stock has been slumping. I believe that this is due to the fact the shares have become overextended after their strong September run. I believe that the company will still earn over $9 a share next year. I am raising my target to $180. My buy under price is now $164.

I am raising my price target on Cognizant Technology Solutions (CTSH) to $85 a share. CTSH appears to be returning to a stable pattern of growth, thanks to greater digital offerings and cost controls. The company should earn close to $4 a share next year, up from $3.65 this year. As the stock begins to anticipate more earnings gains in 2022, it should reach my new target. CTSH is now a buy below $72.

Genuine Parts (GPC) has stalled, as the recent increased in COVID-19 outbreaks has raised the risk of some states closing their economies. However, I do not believe that this will be a long-term issue, due to the fact that vaccinations are expected to begin shortly. EPS should grow to $5.80 next year from $5.20, in the absence of a major shutdown. While a shutdown will benefit the company’s auto parts distribution, industrial distribution will be aided by a better economy and cost reductions from the streamlining of product offerings. Given the overall rise in the market, I am raising my buy under price for GPC to $95. My new target is $110.

HP Inc. (HPQ) has continued its strong rally following its fiscal fourth-quarter earnings report. While I have recently raised my price target to $24.50 a share, this figure may prove to be conservative. This is still less than 10X EPS estimates of $2.65 for the October 2021 fiscal year, up from $2.28 in the just-completed year. If HPQ can continue to produce solid results and can convince investors that its core PC and printing operations are not facing a rapid secular decline, the stock can go even higher. HPQ remains a buy below $20.

Ingredion (INGR) shares have done a little better recently, but they have still underperformed in 2020. However, I believe that next year will bring a change. The weak dollar should help cost comparisons, and the international food business should pick up as the COVID-19 crisis hopefully ends. I look for EPS to improve to $6.50 in 2021 from $6.00 this year. In today’s market, with low interest rates and expanded (P/E) multiples, a company that is selling staple food items should not be selling for less than 14X forward estimates. In light of the strong market and coming COVID-19 vaccine, I am raising my price target on INGR to $100. My new buy under price is $85.

Kronos Worldwide (KRO) continues to do well, as demand for titanium dioxide has stabilized and should improve with the economy in 2021. Meanwhile, there are no new sources of supply. These factors should lead to a steady improvement in earnings, which should eventually approach the 2017 high of $1.93 per share. KRO is a buy below $13.50. My target is $17. Keep in mind that the stock traded close to $30 in 2017. The 5% dividend yield will add to the attractiveness of the shares. Subscribers who owned the stock on Nov. 30 will receive a $0.18 a share dividend payment on Thursday.

Old Republic (ORI) continues its steady advance, and I believe that there is more upside. The stock still trades below ORI’s book value of $20.39 and its pre-COVID-19 high of $24. While EPS in 2021 will be slightly less than the $1.93 earned this year, as the company’s title insurance business will likely slow, the stock remains attractively valued at 10.5X forward EPS estimates. The stock has a 4.6% dividend yield. ORI is a buy below $18. My target is $22.

Safety Insurance (SAFT) has not been a strong performer during the rally, perhaps due to investors wanting to take bigger risks during the upswing. However, SAFT looks good, as it is priced at 12.5X next year’s EPS estimates and has a 4.9% dividend yield. I believe that the shares will do well over the course of 2021. The company’s disciplined underwriting should produce solid long-term earnings results. Buy SAFT below $75. My target is $88.

State Street’s (STT) share price has been recently aided by the strong market and an increase in interest rates. If this trajectory continues, it can help the company’s interest margins. These have been under pressure in recent years, with net interest income down 14.5% in the most recent quarter. The stock is relatively close to my $80 target, but with a lot of momentum behind the stock, I want to hold on until my target is either achieved or surpassed. STT is a buy below $70.

Despite the increase in the number of COVID-19 cases, Valvoline (VVV) continues to trade close to a 52-week high. While the stock has fallen back from when it traded at this price over the past 52 weeks, I am confident that it can break through to my $27 target this time. The company’s Quick Lube operations should continue to provide steady growth, something that is not fully reflected in the stock price. VVV is trading at a very reasonable 14X EPS estimates of $1.65 for the September 2021 fiscal year, up from $1.48 last year. Buy VVV under $21.