Before we jump into your Value Authority Issue for March, I wanted to make you aware of a new feature that we added to the website. You can now submit your questions about the market and our stocks, as well as ask any questions you may have about the service or your account. The “Got a Question?” feature is located on the homepage of the Value Authority website. I look forward to hearing from you!
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Any wishful thinking on what Federal Reserve Chairman Jerome Powell would say in his testimony to Congress today was quickly put to rest. In his prepared statements, Mr. Powell clearly indicated that rates may go higher than previously anticipated and stay there longer.
Mr. Powell’s hawkishness should not have come as a surprise, as he is determined to bring inflation back down to the Fed’s 2% target and recent data showed that inflation remains stubbornly high. However, short-term traders are always looking for an edge, and they were willing to take on some added risk in recent days, hoping to realize outsized rewards if Mr. Powell gave any hint of dovishness.
The market responded quickly to Mr. Powell’s comments, with the S&P 500 and Dow both falling more than 1.2%. Interestingly, stock averages still remain well above where they were on Thursday morning, and yields on long-term bonds are lower. That is likely because Mr. Powell has been consistent in his battle with inflation, even if he remains data dependent.
What we need to remember is that Mr. Powell’s hawkish comments today will not change overnight. Now, they could be softened somewhat if the Employment Report on Friday shows that jobs expanded less than the expected 225,000, and the Consumer Price Index (CPI) report next Tuesday shows prices on a core basis rose less than the expected 0.4%. So, this is a situation that is still somewhat fluid.
Whatever Mr. Powell’s future actions are, the bottom line is this: Any significant rally from current prices and improvement in valuations will need to come from a “soft landing” for the economy. This would allow the Fed to eventually lower the Fed Funds rate from the current level of 4.5% to 4.75%. We also need to see the 10-year Treasury yield not rise too much above current yields of 4%, even with the threat of a recession declining. In addition, the economy needs to remain firm enough to allow earnings growth to improve to around 8% next year, versus expectations for relatively flat results this year.
While this scenario is tricky, it is not impossible. Significant recessions in recent times have only come from extraordinary events, e.g., the NASDAQ bubble of 2000 followed by the terrorists’ attacks of September 11, 2001, the 2008 financial crisis, and the COVID outbreak. Such tragedies are always possible, yet they do not seem to be part of any base case scenario right now.
Therefore, while the market will have its ups and downs, buying good companies at attractive valuations should provide positive results over the next one to two years. I will endeavor to do my best to find such opportunities and remain confident we will have good long-term performance.
WEC: Power for the Future
With operations in the Midwest, WEC Energy Corp. (WEC) is one of the largest natural gas and electric utilities in the U.S. The company provides energy services to 4.6 million retail customers, who primarily reside in Wisconsin and Illinois, though the company also has smaller operations in Minnesota and Michigan.
WEC Energy also owns a 60% ownership in a transmission (moving electricity for long distances) company, American Transmission, as well as operates non-utility energy infrastructure operations through W.E. Power and Bluewater Natural Gas Holding. In addition, the company owns WEC Infrastructure, which provides infrastructure services, and owns several renewable energy generating facilities. Overall, WEC Energy operates 71,000 miles of electric distribution lines, 51,400 miles of natural gas distribution and transmission lines, and 7,700 megawatts of power.
Renewable energy has become a big part of the company’s Efficiency, Sustainability and Growth (ESG) plan, as it has invested heavily to reduce its carbon footprint. In fact, WEC Energy plans to invest $5.4 billion in regulated renewables, including solar, battery and wind, which would quadruple the company’s carbon-free generation. The company also plans to eliminate coal from operations by 2035 and be net carbon neutral by 2050.
If this scares you because you think renewable energy is not efficient, it should not. These are regulated assets that are guaranteed a return on investment, with a regulated return of equity of 9.8% in Wisconsin, the company’s largest operation.
I should also add WEC Energy has a long history of operational excellence. WEC ranks second among the 10 largest integrated utilities in non-fuel cost per megawatt hour of electricity produced at $15.60, compared to the average of $27.60. In addition, according to consulting and data science firm E Source, the company has the highest ranking of customer satisfaction among large utilities companies.
Although the company does not operate in areas of high population growth, increases in the size of its asset base along with the company’s strong operating efficiency has helped drive exceptional long-term earnings growth. EPS increased from roughly $0.90 in 2004 to an expected $4.58 to $4.62 this year, representing annual compound growth of 9% per year.
Dividends, a critical component of utility investing, have also grown, rising from $0.80 a share in 2010 to $2.91 a share in 2022. The company recently raised its dividend by 7.2%, so dividends over the next 12 month should be $3.12 a share, giving the company an attractive dividend yield of 3.5%.
The outlook for further earnings growth is bright as well. WEC Energy expects its asset base to grow 7.7% from 2022 to 2027, aided by the increase in renewable generation assets. This will enable EPS to grow an additional 6.5% to 7% this year, with dividends likely to grow by a similar amount.
The rise in interest rates over the past 14 months has helped drive the price of the stock down from its high last year of $108.39 a share to its present price around $90 a share. Trading at approximately 19X this year’s EPS estimate, the stock is attractively valued for a utility with a good growth history and strong future prospects. While the stock has some vulnerability to further increases in long-term rates, I believe, at its current valuation, it has less risk to rising rates than the average stock.
In addition, if we continue to see pressure on earnings estimates, we could see investors move to quality utilities like WEC with their regulated returns. And once we reach a point where the Fed may be able to lower rates, the company’s dividend yield will be even more attractive. WEC is a buy below $92. My target is $100.
Position Review: Poised to Bounce in 2023
Brady Corp. (BRC) continues to trade firmly following the release of fiscal second-quarter earnings that showed no negative impact from the economy and good cost control efforts. If there continues to be little sign of a recession coming, I think the stock can trade up to my $62 target, which, at only 18X this year’s EPS estimate is reasonable for a company of Brady’s quality, even in the high interest rate environment. BRC is a buy below $50. My target is $62.
Fidelity National Information Services (FIS) continues to be held back due to concerns about ongoing margin pressure from increasing competition, as well as uncertainty over the valuation of its merchant services business spin off. The stock is now selling at only 11X depressed earnings, which should benefit next year from the massive cost cuts that the company is taking. My patience with this one could run out at some point, but I think the stock could do well from this washed-out price. Buy FIS under $60. My target is $72.
First Busey (BUSE) has drifted lower in recent weeks, like most bank stocks. While $25 is proving to be an area of a lot of technical resistance, I think the stock can break through this price once investors gain greater confidence the company can earn $2.60 a share this year. That could will hopefully occur as early as next month when first-quarter earnings are released. There are growing concerns in the commercial office space with vacancy rates still high, but I believe credit conditions are still favorable, and higher rates and loan growth will help BUSE have a good 2023. BUSE is a buy below $23. My target is $28.
After a stable start following last week’s earnings release, Lowe’s Companies (LOW) sold off after the company’s conference call revealed consumers remain wary of a recession. Investors are now somewhat doubtful that Lowe’s relatively stable earnings guidance for 2023 is attainable. However, the cautionary comments were typical of any good company. Furthermore, even if EPS guidance fall 10% from the current range of $13.60 to $14.00, the stock is still attractive at current prices. The country’s aging housing stock and LOW’s strong competitive position gives the company excellent long-term earnings growth prospects. LOW is a buy below $215. My target is $260.
Newell Brands (NWL) has not been a stellar performer since giving disappointing earnings guidance for 2023, and it had a particularly bad day yesterday when small-cap cyclical stocks were weak. However, as long as the company can earn $1.00 a share this year and shows signs of improvement next year with inventories back to normal levels and cost cuts kicking in, I think we will see improvement in the share price. I am raising my buy under price for NWL to $13.50 and my target to $17.50, which is 13.5X a reasonable 2024 EPS estimate of $1.30.
Old Republic (ORI) cannot quite make it to my $27 target, with perhaps some recent weakness related to concerns that the title insurance business will continue. However, comparisons in this business get a lot easier in the second half of the year, and steadiness in the general insurance business will still allow the company to earn $2.40 a share this year, versus the abnormally strong $2.79 last year. And an improvement to $2.60 next year is a possibility, as higher interest rates will help investment income. ORI is a buy below $24. My target remains $27.
Patterson Companies (PDCO) is slightly higher since reporting fiscal third-quarter results last week. EPS of $0.62, vs. $0.55 last year, was $0.02 better than expectations. Overall sales were little changed, as a 3.8% decline in dental sales due to weakness in CAD-CAM equipment and infection control profits with lower COVID-related sales, was offset by a 4.6% gain in animal health products. Despite the flat sales, the company was able to increase margins on good cost controls and a greater contribution from value-added services.
With one quarter left in the current fiscal year, the company expects EPS of $2.25 to $2.30. While I am somewhat concerned about the weakness in dental, the company’s good execution on margins and strength in animal health gives me confidence the company can earn at least $2.40 a share in the next fiscal year and move closer to my $33 target. PDCO is a buy below $29.50. The 3.85% dividend will help support the stock.
Phibro Animal Health (PAHC) has traded in a stable manner through the recent market turbulence. The stock remains cheap at 13X earnings for the current fiscal year, with earnings likely bottoming out as inflation eases and the company’s growth initiatives begin to payoff. PAHC is a buy under $16. My target is $20.
Sonoco Products (SON) has been a frustrating performer, with the stock locked in a tight range despite the fact that the company continues to do well, and earnings estimates remain relatively stable. Trading at just over 10X this year’s earnings, I think an economic slowdown is at least partially baked into estimates, and the stock will do well barring a severe recession. SON is a buy below $65. My target is $75. The 3.3% dividend yield will add to total returns.
Sysco Corp. (SYY), which last month’s new pick, has traded in a typical pattern for the stock, i.e., it hasn’t moved that much. However, I remain confident that earnings are moving in the right direction, as the company will benefit from value gains and cost cuts. Trading at 17X earnings estimates for the June 2024 fiscal, this high-quality company remains cheap by historical standards, and I look for a higher stock price over the next 12 months. SYY is a buy below $80. My target is $92.