A Tough Blow, But Not a Knockout

Wall Street was clearly not prepared for today’s Consumer Price Index (CPI) report.

Investors were shocked when CPI came in with a higher-than-expected 0.1% increase in August, given that estimates called for a decline of 0.1%. Core CPI, which excludes food and energy, also rose 0.6% last month, versus expectations for 0.3%.  Investors’ disappointment in this morning’s CPI report was enough to immediately wipe out 75% of the gains made over the past week, with the S&P 500 dropping more than 3% at one point.

With inflation still elevated, the Federal Reserve will now undoubtedly raise the Fed Funds Rate 0.75% next week. Until then, the market will remain on edge as it contemplates what the Fed’s plans for future rate hikes will be when they meet next week. In my opinion, we are likely in a “higher for longer” time for interest rates. A recession, which would cause even worse issues for stocks, is perhaps the only way we will see rates move meaningfully lower in the near term.

Today’s developments are not welcome for value investors like us. But the good news is that we are still in much better shape to weather the storm than those following S&P 500 index strategies. Valuations for our stocks are hardly excessive, and while higher rates may slow the economy, we are a long way from a recession.

Still, we need to be aware that today is not the end of near-term weakness. Remember, we are in a seasonally weak time of the year, and there’s still a bit of nervousness over what we can expect in the third-quarter earnings season. I do not think earnings will be bad, and when it becomes apparent that the lows of the year will not be breached, we could have a good year-end rally.

So, my best advice is to sit tight and be aware that there may be a few rough weeks ahead. Again, I think our stocks will weather any near-term weakness and they should still end the year higher than where they are now.

LOW: Growth from the Pros!

I am sure most of you are familiar with Lowe’s (LOW), given that it is one of the biggest home improvement retailers globally. The company operates nearly 2,200 home improvement and hardware stores in all 50 U.S. states and in Canada, as well as has 15 distribution centers in North America. The company’s stores are large, with an average size of 105,530 square feet—and they cater to not just your “do-it-yourself” consumers but also to professional contractors.

A typical Lowe’s-branded home improvement store stocks approximately 40,000 items, with over two million additional items available through online selling channels. Specifically, Lowe’s offers a complete line of products for construction, maintenance, repair, remodeling, and decorating. Home improvement products are offered in several categories, including Appliances, Seasonal & Outdoor Living, Lawn & Garden, Lumber, Kitchens & Bath, Tools, Paint, Millwork, Hardware, Flooring, Rough Plumbing, Building Materials, Décor, Lighting, and Electrical. And the company also offers installation services.

Lowe’s largest sales categories are appliances, lumber and seasonal and outdoor living. These categories accounted for 14%, 10% and 9% of sales, respectively, in the January 2022 fiscal year.

Thanks to the strong housing market, fiscal stimulus and pent-up demand following the outbreak of the pandemic, Lowe’s reported a strong January 2022 fiscal year. Revenues were up 7.4%, including a 6.9% increase in same store sales. The company’s operating margin increased from 12.6% to 10.8%, benefitting from favorable pricing and lower COVID expenses. EPS rose to $12.04 from $7.75, benefiting from a nearly 10% decline in the share count as LOW bought back stock aggressively.

Now, Lowe’s has not been immune from the slowdown in consumer spending on big ticket items so far in the fiscal 2023 year. Bad spring weather also impacted sales of seasonal categories. However, this has been offset by a double-digit gain in sales to professional contractors, and the bottom line was aided by greater efficiency in store labor.

Revenues for the first six months of the year were down 1.8%. EPS increased to $4.67 from $4.25, reflecting a 10% decline in the share count as LOW continued to buy back shares aggressively. Aided by these buybacks and an additional week in the fiscal year, the company expects EPS between $13.10 and $13.60 in the January 2023 fiscal year, versus the $12.04 last year.

Longer-term, Lowe’s is a mature company, and CEO Marvin Ellison still believes there is room for further growth. Lowe’s and Home Depot (HD) dominate the home improvement market, accounting for $250 billion of sales in a $900 billion industry. However, Mr. Ellison believes this is enough fragmentation for Lowe’s to expand its shares of the professional contractor market, which accounts for 25% of sales. The company plans to enhance its “pro” offerings through better fulfillment capabilities, digital sales and a new Pro MVP Loyalty Program.

I believe the company can earn at least $14 a share in the January 2024 fiscal year, and with shares trading at less than 15X this estimate, there is good value in the stock, which sold at $260 at the start of the year. LOW is a buy below $215. My target is $260.

Position Review: Attractively Valued in Current Market

Cognizant Technology Solutions (CTSH) bounced nicely off its lows last week, but the company is still being penalized for the lackluster orders that it reported for the second quarter last week. I still believe this is an overreaction, as the company’s revenues and earnings should continue to advance at a mid to high single-digit growth rate. The stock remains attractively valued at 15.5X this year’s EPS estimates. CTSH is a buy under $80. My target is $95.

Fidelity National Information Services (FIS) traded lower last week after an analyst issued warnings that fintech stocks could suffer from slower consumer spending, which will result from the Fed’s continued tightening. However, the stock is already discounting a lot of bad news at its current price, and it is a bit unfair to hit FIS over an issue that will impact just about every company. At 13X this year’s EPS estimate, the stock is a good value relative to its upper single-digit earnings growth prospects. FIS is a buy below $110. My target is $130.

First Busey (BUSE) shares remain somewhat rangebound between $22 and $25. I believe, at some point between now and the end of the year, BUSE has a great chance to break out of this range. It should also do very well if confidence increases that the Fed tightening will not lead to a recession next year. Loan growth is good, and BUSE should benefit from the higher interest rates. The stock sells for less than 10X this year’s EPS estimate. The 4.0% dividend yield adds to the attractiveness of the stock. Buy BUSE under $24. My target is $29.

Newell Brands (NWL) lowered EPS guidance for the third quarter and the year last week, as retailers adjust to declining consumer demand. Third-quarter earnings are now expected to be between $0.46 and $0.51 a share, versus previous EPS guidance of $0.50 to $0.54. For the year, the company now sees EPS of $1.56 to $1.70, as opposed to the previously expected $1.79 to $1.86. The announcement was not much of a surprise, and the stock rose on the news.

There were doubts about NWL’s EPS given the issues with their retail customers, and it was good to quantify how much lower estimates had to go. I think after earning $1.65 this year, earnings can recover to $1.75 next year, and a modest multiple of 15X this number gives me a new target of $26.25. This little macro caused shortfall should not take away from the great job management has done. The 5.1% dividend yield is safe and will add to total returns. NWL is now a buy below $19.50. My new target is $26.25.

After performing very well for an extended period, Old Republic International (ORI) had an unusual sharp drop on September 1. The decline was not on large volume, and the stocks has recovered some of the lost ground since then.  While I will keep looking for a cause, it is not something I am overly worried about. The company remains on pace to earn at least $2.50 a share this year, and this insurer with a solid long-term record is cheap at 9X this estimate. The stock also has a 4.1% dividend yield. Buy ORI under $24. My target is $27.

Omnicom (OMC) has fought back in the past week to regain practically all the ground it lost in the recent market slide. Recent portfolio changes, which rid the company of businesses in decline and add marketing analytics, will improve growth for Omnicom over time. The stock is very cheap at 11X forward earnings estimates, and the stock has a 4.2% dividend yield. OMC is a buy below $70. My target is $80.

Phibro Animal Health (PAHC) has continued to slip lower following its disappointing guidance for fiscal 2023 after reporting fourth-quarter earnings last month. One of the problems impacting the stock is that is has become a microcap, with a capitalization of just over $600 million. That makes the stock more difficult to trade for institutional investors. However, the stock is now very cheap at 12X the midpoint of the company’s EPS guidance of $1.28 to $1.38 for the June 2023 fiscal year. The company’s top line also continues to grow, and it is investing in its future. Given the continued weakness in the price of the stock, I am lowering my buy under price for PAHC to $18. My new target is $23.

Sonoco Products (SON) continues to be a steady performer, with a high degree of visibility on earnings estimates due to price increases and benefits from the Ball Metalpack acquisition. Beyond these benefits, the company’s long-term history of consistent results and high returns on capital should help the stock in the long run. Valuation remains favorable with the company selling at just over 10X this year’s EPS estimates. Buy SON below $65. My target is $75.

Target (TGT) climbed higher last week after the fall in oil prices, which game investors hope that lower gas prices would enable more discretionary spending for Target’s customers. However, even without a sharp dip in gasoline prices, I am confident TGT can earn $12 a share next year, as that does not assume Target’s sales of higher margin furnishings will return to 2021 levels. TGT is a buy below $163.  Depending on market conditions, my $180 target price could be raised soon.

Universal Health Services (UHS) has come roaring back in the rally over the past four trading days. The move higher may reflect the hope that lower inflation and even a slower economy will make it easier for hospitals to staff personnel at rates that will not further impact profitability. EPS estimates for the year were once over $12 but are now at $10.60 largely due to personnel shortages. However, the stock is still cheap at the current estimate, and if third-quarter earnings show no signs of further deterioration, the stock should do very well. Buy UHS under $110. My target is $130.