Earnings Will Provide Clarity, Which Is All We Need

Sometimes it feels like the only thing holding cautious optimists back is the irrational dread of other investors. But while their moods can temporarily weigh on the market weather, ultimately fundamental reality always guides stocks where they need to go.

That’s why I am eager to get earnings season underway and start converting uncertainties into clarity, one quarterly report at a time until we know exactly where corporate executives collectively think we’re going.

The big banks, traditional linchpins of the value investment universe, start the process tomorrow. Once the sky clears around that side of the market, theme after theme will get a chance to fight its way clear of the market’s doubts . . . or if not, we’ll know where the dead money is for the coming season.

Either way, it’s been a bumpy month. Value has done its job, holding up relatively well while more growth-oriented and sometimes speculative stocks crumple under Wall Street’s accumulated anxieties.

The Russell 3000 Value index is now down 2.7% from its peak, which compares favorably to both the broad Russell 3000 (down 4.2%) and its growth-heavy counterpart, down 5.4%. That’s good news in itself. Because stocks like ours are not inflated, they aren’t taking the brunt of recent selling.

However, we’re looking for upside as well as downside protection. For our end of the market to get back to work, earnings need to cooperate.

While the post-pandemic economy still should be a tailwind for results, supply chain issues and rising costs may become a real challenge, forcing analysts to revise estimates lower to avoid getting caught unawares.

Of course, quantifying potential threats before they even materialize is extremely difficult because corporate management routinely exaggerates risk factors in order to engineer an upside surprise down the road. For now, we’re in a world of exaggerated threats. The upside will come.

And once we get through this earnings season and out of the current seasonally weak time of the year, we could be set up for a refreshing Santa rally. After all, there are now fewer than three months left before we welcome 2022. The days are flying.

Beyond earnings season, many value stocks are factoring in an immediate return to normal interest rates, when financing costs are more likely to remain much lower than average for an extended period. The Fed has revealed as much. We simply need to trust their devotion to supporting the market.

Either way, I would not change our current posture unless conditions change dramatically. Like always, our stocks have valuations in line with historical averages or lower.

Most have dividend yields above the current 1.6% yield offered on long-term Treasury debt. I can’t stress this enough. As bond substitutes, we’re ahead of the curve. Buy, hold and cash the quarterly checks.

And with favorable growth prospects, we also enjoy the benefits of the conventional stock market. Positions we’ve closed this year have generated 17% apiece in total return . . . and we haven’t lost money on any exit since the early days of the pandemic, well over a year ago.

Instead, we’ve banked big wins in stormy circumstances. Nothing changed when it came to pushing the “buy” button on our current recommendations, which have moved well into profitable territory in the aggregate.

That bodes well for the future. All we need is for the rest of the market to figure it out.

FIS: Value and Good Growth Prospects

Our latest recommendation Fidelity National Information Services (FIS) is a leading provider of technology solutions for merchants, banks, and capital markets firms globally. The company attempts help its clients use technology in innovative ways to solve business-critical challenges and deliver superior experiences for their customers.

The company operates three major segments:

Merchant Solutions provides retailers and other sellers with the technology to accept electronic payments, including e-wallet and card-not-present payments. These services cover all aspects of transactions, including authorization, fee payments, security and fraud prevention.

Banking Solutions provides banks with transaction processing software and related services. These solutions are sold under long-term contracts providing FIS with stable cash flow.

Capital Market Solutions provides brokerage firms and asset managers with securities processing and record keeping, trade execution, and risk and portfolio management solutions.

The company has historically used acquisitions to enhance its technical capabilities. In 2015, FIS acquired SunGard for $9.1 billion, opening up new markets for financial technology services

In 2019, FIS acquired Worldpay, a global leader in e-commerce and payments, for a total consideration of $43 billion including the assumption of debt. Once again, the deal greatly enhanced the platform with expanded payment capabilities and distribution.

Admittedly, FIS benefitted from the growth of electronic payments and strong capital markets in the second half of the last decade. EPS increased from $3.22 in 2015 to $5.61 in 2019 before the pandemic in 2020 reversed the trend.

While revenue artificially increased 21% last year due to the Wordplay acquisition, organic sales actually declined 1%. On a brighter note, cost synergies from the merger started to kick in towards the end of the year, limiting the decline in EPS to less than 3%.

Results have come roaring back so far this year. Revenue growth was 10.9% in the first 6 months of 2021, with practically all the growth coming from organic improvement in all three operating segments. Meanwhile, cost and revenue synergies continue to materialize.

Full-year guidance for EPS of $6.45 to $6.60 a share on roughly 11% revenue growth implied continued success. The only clear disappointment was that the expansion curve won’t be even steeper than it is as a more aggressive management style requires increased incentive pay.

Another reason for the stock’s weakness is concerns about growing competition in the payments industry. This has taken a toll on higher fliers like PayPal (PYPL) and Square (SQ) in recent weeks, with investors pondering whether PYPL’s 25% operating margins are sustainable for the long term.

However, unlike PYPL or SQ, FIS is now trading at only 15.4X next year’s EPS estimates of $7.50, which is very inexpensive considering its solid long-term record.  I believe the stock can do well even if 2022 estimates need to come down a little. Buy FIS under $125. My target is $140.

Position Review

3M (MMM) will report third quarter earnings on October 26 before the market opens. Expectations are for EPS of $2.25 vs. $2.43 as cost inflation and a less productive revenue mix will wipe out the benefits of an expected 4.3% gain in sales. While the stock has been under considerable pressure since management last warned us that inflation has become a drag, the earnings impact should only be about 2%.

MMM is cheap in the current environment at 16.5X next year’s earnings and a 3.3% dividend yield will add to total returns. MMM is now a buy under $175. My target is $200.

Cognizant Technology Solutions (CTSH) will report third-quarter earnings on October 27 after the market closes. Expectations are for EPS of $1.05 vs. $0.97 on an 11% rise in revenue as the company continues to benefit from new services and digital offerings. Higher salary costs are expected to cut into margins, but the company has consistently beat expectations in recent quarters and I would not be surprised if it does so again.

At 16.8X next year’s EPS estimates, the stock is very attractively valued considering its upper single digit earnings growth potential. I am raising my buy under for CTSH to $75. My target is $90.

Dollar Tree (DLTR) has recovered nicely from disappointing earnings guidance for the second half of the year and concerns about rising freight costs . . . all it took was the announcement that flagship stores will start selling merchandise for more than $1.

In addition, the company raised its share buyback authorization by $1 billion and has now committed to repurchasing about 11% of the stock, a significant amount considering a current market cap just above $22 billion. While higher costs will pressure earnings this year and next, growth initiatives are showing some success. With a potential for EPS over $7.00 once costs return to normal levels, DLTR is a buy under $96. My target is $110.

Fulton Financial (FULT) will report third-quarter earnings before the market opens on October 19. Expectations are for EPS of $0.33 vs. $0.38 as the company will not benefit as much from the release of loan reserves as last year.

However, I look for continued loan growth to drive a 4% increase in revenue. The company has the potential to earn $1.30 a share next year with no further help from releasing loan reserves. FULT is a buy below $16. My target is $18.50. The 3.5% dividend yield adds to the attraction here.

General Mills (GIS) has been trading well since reporting fiscal first-quarter EPS of $0.99 vs. $1.03, much better than expectations of $0.89. Results had been expected to fall due to tough comparisons with more at-home eating last year due to COVID. However, sales surprisingly gained 4.1%, driven by a 25% gain in pet foods. Sales also benefitted from price increases, which partially offset higher costs.

The company is still looking for sales to decline 1% to 3% for the entire fiscal year, but that seems very conservative. And I think there is a good chance EPS can end the year flat at $3.79. There remains good value in the stock at 16X this year’s earnings estimates with a 3.3% dividend yield. GIS is a buy below $59. My target is $65.

Ingredion (INGR) will report third-quarter earnings on November 2 before the market opens. Expectations are for EPS of $1.39 vs. $1.77, with the year-ago period providing unusually difficult comparisons. While margins can be volatile here, I think current estimates may be too low as corn prices decline.

I believe the market senses this . . .  a reason the stock has done very well recently. Either way, at less than 14X next year’s EPS target of over $7.00, INGR remains cheap, and I believe there is a good chance the strong performance can continue. Buy INGR under $90. My target is $105.

Juniper Networks (JNPR) will report third-quarter earnings after the market closes on October 26. Expectations are for EPS of $0.46 vs, $0.43 on a 6% increase in revenue. The company’s recent sales momentum from new products may be challenged by semiconductor shortages.

However, I believe JNPR should be able to sustain its recent top-line momentum over the next several quarters even if it experiences a slight hiccup in the current quarter. At 15X next year’s EPS target, the stock remains attractively valued, with strong cash flow and a 2.7% dividend yield. Buy JNPR below $28. My target is $32.

Kronos Worldwide (KRO) continues to be a lackluster performer, but from a technical analysis perspective, the stock is forming a base from which to commence a rally. The quarterly report will come in the first week of November, with expectations for EPS of $0.26 vs. a dismal pandemic-impacted $0.07 last year.

Titanium dioxide prices remain elevated but have cooled slightly in recent months as inventories have been built due to increasingly brittle supply chains. Still, the company should be able to earn $0.90 a share this year and over $1.00 in 2022 if production issues improve as they have over the past 2 quarters. KRO is a buy below $13. My target is $16.

Molson Coors Beverage (TAP) will report third-quarter earnings on October 28 before the market opens. Expectations are for EPS of $1.56 vs. $1.62 on a 7% sales gain. The company has easy revenue comparisons due to the pandemic, and core brands Miller Lite and Coors Lite should show stable market trends. The growing popularity of Blue Moon will also add to revenue growth. However, higher costs for glass and battles will impact margins.

Despite the near-term headwinds, TAP appears to be on its way to a meaningful turnaround and I like any stock that sells at only 11X next year’s earnings estimates. Buy TAP below $50. My target is $57.

Newell Brands (NWL) has been under pressure due to freight cost and supply chain concerns that the company warned about a few months ago. Third-quarter results will be reported in the fourth week of October, with expectations for EPS of $0.50 vs, $0.84 on unusually tough pandemic comparisons.

I think any reasonable earnings shortfall will be forgiven given NWL’s depressed stock price. The company has become leaner and more focused following its 2018 restructuring and this should produce solid long-term results. NWL is now a buy below $24. My $28.50 target is just 15X expected 2022 EPS of $1.90.

Safety Insurance (SAFT) will report third-quarter earnings in the first week of November. I expected the company to earn $1.70 a share, less than the $2.53 in the prior year, which benefitted from less driving due the pandemic. Abnormally good loss ratios will help.

The stock has done better in recent weeks, although it still struggles to recover its highs of early May, when the broader value market peaked. I feel the stock is still cheap enough to hold to see if quarterly results can be a bit of a catalyst and show the company can earn $7.00 a share in a post-pandemic environment. Buy SAFT under $80. My target is $90. The 4.4% dividend yield will add to total returns.