Did Santa Claus Come Early?

With the holiday season upon us, it’s about the time of year when the financial media always talks about a Santa Claus rally. The fact is one usually materializes before yearend. This year, the jolly man may have made an early appearance on Wall Street.

The S&P 500 soared 1.6% higher this morning and is still up about 0.7% this afternoon, as stocks have put aside fears about the economy and celebrated a better-than-expected Consumer Price Index (CPI). Headline CPI showed prices were up only 0.1% on a monthly basis, while core CPI, which excludes food and energy, rose 0.2% on a monthly basis. Results were better than the expected gain of 0.3% on both a headline and a core basis.

With inflation lower than anticipated, investors are hopeful the Federal Reserve will give the market its own holiday gift and soon stop raising interest rates.

We will hear from the Fed tomorrow, and unfortunately, I think Fed Chair Jerome Powell will be a bit more like Scrooge than Santa Claus. The fact is that I don’t expect Mr. Powell will deviate much from his speech two weeks ago. You may recall he talked about slower rate increases in the future, with a likely hike of 50 basis points tomorrow. However, he may try to tamper investor enthusiasm about the prospect of rate cuts next year, which is currently priced into the bond market. Therefore, some reversal of the gains from the past two days is a possibility.

The good news for value investors is that the better inflation news makes it less likely the Fed will keep raising rates in the face of a slower economy. So, at the worst, we will only have mild recession, and that is already priced into the stock prices. Also, there now is an improved chance we will have a “soft landing” and avoid a recession entirely even as we experience slower economic growth.

Even if there is a first half slowdown, economic activity should improve by the end of 2023. Keep in mind that the stock market is forward looking, and stocks always anticipate. The anticipation of an improving economy and a more accommodative Fed by yearend should lead to good returns for our names.

Overall, I am looking forward to a strong 2023 for Value Authority. Our stocks have very attractive valuations, with earnings estimates that assume a tougher year economically.

BRC: Safety and Security Drives Profits

Milwaukee-based Brady Corporation (BRC) was founded in 1914, first offering promotional calendars and colorful displays for businesses. Over the past 108 years, though, the company has evolved to become a global provider of solutions for compliance, identification and safety.

Through its 70 locations in 33 countries, Brady offers labels, signs, safety devices, printing systems and software that help its customers enhance and improve the performance, productivity, safety and security of their business. Speaking of its customers, the company serves a wide range of industries, including electronics, construction, manufacturing, medical and aerospace. The company is international in nature, with 50% of sales coming from outside the U.S.

Specifically, Brady operates out of two main segments: Identification Solutions (IDS, 77.6% of sales in the most recent fiscal year) sells products for product identification, including bar code scanners, brand protection labels, and facility safety products like signs and floor marking tape. Workplace Safety (WPS, accounts for the remaining 22.4% of sales) provides safety and compliance labels and markings, asset tracking labels, and facility safety and personal protection equipment.

Despite some softness at times due to the pandemic, Brady has grown nicely over the years. From the July 2018 to July 2022 fiscal year, revenues increased from $1.17 billion to $1.3 billion, operating income increased from $158 million to $195 million, and EPS rose from $2.04 to $3.15. Growth was driven by new products in IDS, which were met with strong demand from factories that are becoming increasingly automated. Cost cuts in WPS also helped the bottom line, and EPS was aided by the 2017 tax legislation.

Operational momentum remains strong with fiscal 2023 underway, although the company is being significantly impacted by the stronger dollar. Revenues in the first quarter rose 0.3%. Organic sales increased 6.9%, while currency negatively impacted the topline by 6.6%. Currency didn’t have nearly as big of an impact on the bottom line, as operating income increased 15.9% to $51.4 million. EPS rose to $0.84 from $0.72.

BRC maintained its guidance for the current fiscal year of $3.30 to $3.60 a share. At 13.6X the mid-point of this guidance, the stock is an excellent value now. BRC is a quality company, with a high return on assets of over 14%. It also has a strong balance sheet, with long-term debt of $99 million compared to a cash balance of $114 million, and consistent free cash flow generations. Continued innovation and a focus on customer service will help drive future growth, and the stock price should follow. BRC is a buy below $50. My target is $67.

Position Review: Ready for 2023

Cognizant Technology Solutions (CTSH) has given back some of its gains in the recent market downturn after bouncing nicely off its post-third-quarter earnings lows. While it has been a difficult year for CTSH shares, the company will still grow earnings this year and likely next as well, once it works through the staffing issues that will hurt near-term results. Valuation is currently very attractive at 1.25X 2023 EPS estimates of $4.70 a share. CTSH is a buy below $60. My $70 target could prove to be conservative.

Fidelity National Information Services (FIS) has recovered a lot of the ground it lost post-third-quarter earnings, as the selling was a significant overreaction. The stock remains very cheap. Growth will be limited over the next few quarters by higher expenses and investments, but I believe with the company’s strong transactions processing franchises, growth will resume over the long run. Valuation is compelling at just over 10X 2023 EPS estimates. FIS is a buy below $80. My target is $100.

First Busey (BUSE) has slumped with other bank stocks in recent weeks. Although there is a risk of higher credit losses for the industry next year, I believe BUSE will be able to get through higher losses without a significant impact to earnings. The company’s $0.23 quarterly dividend, which gives the stock a very attractive 3.7% dividend yield, will also be safe. And there is a good chance the company’s stock will benefit from a seasonal rally in small-capitalization stocks at the end of this year or the beginning of next year. BUSE is a buy below $24. My target is $29.

Lowe’s (LOW) held an analyst meeting last week, where it reiterated guidance for the current fiscal year. The company expects EPS of $13.65 to $13.80. Lowe’s also added $15 billion to a stock buyback program that currently had $6.4 billion of buybacks remaining. At the meeting, the company outlined its next phase of growth, seeking to improve its professional business to become the one-stop choice for contractors, and to grow sales in online channels as well. While the January 2024 fiscal year remains a bit of an uncertainty for LOW with the current slump in housing transactions, the benefit of a lower share count should help bring EPS above $14.00 a share.  With the company well-positioned for the long-term, buy LOW below $215. My $260 target is where the stock traded at the start of this year, and a better macro-outlook could get us back there.

Newell Brands (NWL) has done a little better in recent sessions, perhaps benefiting from lower oil prices that could lower costs for the company and help with consumer spending. NWL remains very cheap at less than 10X EPS estimates for 2023, with momentum strong by year end as retailers work off excess inventories in the first half of the year. While slower consumer spending has taken a toll on NWL and future estimates, I do not think it takes anything away from the good job management has done restructuring the company, and I believe shareholders will be rewarded. NWL is a buy below $16. My target is $22.

Old Republic (ORI) continues to trade steadily, and with insurance pricing still firm, I look for continued gains in earnings and the stock price next year. The stock remains attractively valued at 10X next year’s EPS estimates and 1.3X book value, which should shoot up nicely in the current quarter with the better stock market. The 3.8% dividend yield will add to total returns. ORI is a buy below $24. My target is $27.

Phibro Animal Health (PAHC) shares have also acted better over the past week, and the stock is poised to do well should we have a year-end rally in small-capitalization stocks. The stock has overreacted in recent months considering earnings estimates for the current fiscal year moving 8% lower on higher costs and investments. The stock is now trading at 10.5X August estimates for the June 2022 fiscal year, a very low multiple for a company that experiences stable demand for its products and has some growth opportunities. PAHC has been a disappointment, but I am looking for a significant rebound. Buy PAHC under $16. My target is $20.

Sonoco Products (SON) has tried to regain the ground it lost following the release of third-quarter earnings, where the company cautioned about macroeconomic headwinds hitting some sectors in future quarters. While analysts expected some decline from the very strong results that the company will report this year, management recently said they would be disappointed if operating income declined next year. The stock remains cheap even if expected EPS of $6.40 this year declines to $5.00 next year. Current estimates are for EPS of $5.79 next year. SON has a good long-term history of delivering good returns on capital, and I would expect the company to manage the current macro environment well. Buy SON under $65. My target is $75.

The only time U.S. Bancorp (USB) traded below its current price over the past five years was during the pandemic period from March to November 2020. I believe concerns over a recession and higher credit losses are more than priced into the stock, with the bank only trading at 8.5X next year’s EPS estimates. Higher short-term rates and recent loan growth will likely be an earnings tailwind in the first part of next year. The 4.4% dividend yield adds to the attraction of the shares. Buy USB under $44. My target is $49.