Emerging from the Darkness

The very sharp rally in stocks that we are enjoying this week reflects the growing hope that we will soon be past the worst of the COVID-19 global pandemic and that we will eventually return to normal business activity.

Obviously, the sooner the economy gets restarted, the better. This is because companies have fixed charges they need to pay and debt that must be serviced. It is not as if their businesses can just be put on hold for a few months and then they can restart with no damage.

As recently as five weeks ago, the extent of the shutdown of the economy seemed to be unimaginable. However, once some businesses and governments began to take action to slow the spread of the virus, a consensus emerged which stated that something drastic needed to be done. While it took a few weeks, we are now starting to see the payoff of these actions. Hopefully, we are on our way to a safer and healthier world.

The question now becomes how we will come out of this situation economically. Obviously, this will not be a case where we can just pick up where we left off. All of those who lost their jobs will not be reemployed right away and many employees in the retail industry may not get their jobs back at all because that industry is continuing to shrink. The manufacturing sector, which was already struggling before the coronavirus hit, will likely remain under pressure. In addition, the deep drop in oil prices will slow the American energy boom, which has been an important source of employment in recent years. Finally, while banks are giving forbearance to those who will lose their jobs due to COVID-19, credit costs will weigh on their earnings and stock prices. They will also act as a drag on growth because banks will extend credit more cautiously from now on.

However, even though we face an uncertain environment for the economy and earnings through the remainder of 2020, the good news is that stocks are pricing this in and are set to recover as the economy slowly gets back to normal. The Fed is taking extraordinary steps to mitigate the weakness of the economy through unlimited asset purchases, including corporate bonds, which will act as a backstop for stocks.

Therefore, while we will have our share of ups and downs, I believe that the bias is for stocks to move higher towards the year’s end, with many individual names outperforming the indexes. Many mega-cap stocks have been masking the weakness of individual names thus far in 2020. This is evidenced by the fact that the large-cap Russell 1000 Value Index has been down 24.8% year-to-date going into today, while the small cap Russell 2000 Index was down an almost shocking 36.6%.

I look for this trend to reverse over the course of the rest of the year because this will give us good opportunities in neglected names. While I like the Buy List as it is currently constructed, I will not be afraid to position us in the best 10 to 12 value stocks which are the most likely to produce strong returns over the remainder of the year. There is also a chance that turnover may be higher than normal, so be prepared to take action.

UHS: Hospital Chain Will Not Be Broken by COVID-19

Universal Healthcare (UHS) should be a familiar name with my long-time subscribers, as we have enjoyed two successful trades of the company’s shares in the past. The company operates 26 acute care hospitals, 14 free standing emergency center, six outpatient centers and one surgical hospital in the United States. UHS also operates 349 inpatient and outpatient behavioral health centers in the United States, the United Kingdom and Puerto Rico. Through a combination of patient growth, higher prices, share buybacks and acquisitions, the company has enjoyed a solid growth record, with earnings per share (EPS) increasing from $6.87 a share in 2015 to $9.99 a share last year.

Despite this favorable record, the stock is trading at its lowest levels since 2014 due to coronavirus concerns. There is little doubt that the additional expenses that are required to treat the coronavirus, as well as the postponement of other procedures, will have a significant impact on the financial condition of its hospitals. For example, in a public filing to its bondholders in mid-March, a large Manhattan hospital, New York Presbyterian, indicated that due to the coronavirus, it expected an operating loss this year of between $104 million and $454 million, after previously expecting an operating income of $246 million.

UHS gave EPS guidance for 2020 of $10.30 to $11.00 when it reported fourth-quarter earnings on Feb. 26. Most likely, the company did not consider the potential impact of the coronavirus when making this estimate, as the country, in general, was too complacent about the impact that COVID-19 was about to have on the economy and our way of life. However, while this guidance is now surely too high, I do expect the company to remain profitable and that it will not be forced to raise additional capital this year. This will allow for an earnings recovery next year when our health care system hopefully returns to normal.

I like UHS’s chances to do relatively well when compared to other hospital companies because the company’s behavioral health facilities account for 55% of their operating income, and they the fact thatshould not see the same amount of disruption as acute care hospitals. In addition, the company’s acute care facilities are not located in the hardest hit states of New York, New Jersey, Michigan and Louisiana, so I do not think that they will face the same strain as hospitals like New York Presbyterian. Finally, the company’s comfortable cash on hand can cover its interest expenses by seven times its operating income, giving plenty of breathing room to remain profitable even if operating income dips sharply this year.

The company will report first-quarter earnings in the last week of April. Given that the coronavirus was likely only disruptive during the last two weeks of the quarter, the results should be relatively close to estimated EPS of $2.75 vs. $2.45 on a 5.5% increase in revenues. However, the key will be the guidance for the remainder of the year, and I am confident that the company will indicate that it will earn a profit in 2020. When we combine this fact along with the decline in the number of new cases that we are likely to see soon, the stock could rally sharply in the near future. Buy UHS under $106. My target is $130.

ENV: Market Overreaction Creates a Big Opportunity

Envista (ENV) is a dental product company that was built starting in 2005 through the acquisition of 25 leading dental businesses by former parent Danaher (DHR). The result of these acquisitions was the birth of one of the largest global dental companies in the world. ENV provides 90% of the dental products that are required by dental offices to diagnose and treat patients. Since 2016, the company has utilized Danaher Business Systems, which proved so successful in making DHR one of the greatest industrial companies of the past 20 years that the parent company decided to consolidate the acquired companies into three operating units. This system continues today as Envista Business Systems, or EBS, through which the company hopes to grow leaner, have more focused leadership and continue its efforts to grow.

The company seeks to have above-average growth through exposure to emerging markets, which accounted for 24% of sales in 2019. However, this exposure led to a lackluster financial performance last year due to the strength of the dollar against emerging market currencies. Also hurting performance was the presence of product transitions in high margin dental implants. While sales declined 3.3% for the year, they were flat when you exclude the impact of currency and discontinued products. Margins narrowed on an unfavorable sales mix, and EPS fell to $1.79 a share from $2.01. Before the coronavirus crisis, the company gave guidance for EPS of $1.63 to $1.73 in 2020, which included $0.12 a share of incremental costs for being an independent public company for a full year along with $0.06 of incremental EPS from interest expenses on the debt that was allocated to the company following its separation from Danaher.

Despite these lackluster results and guidance, the market still had enough confidence in NVST as the stock was selling at over $30 a share in early February before the severity of the coronavirus crisis became fully appreciated.  At this price, the stock was discounting future growth off of the $1.68 mid-point EPS guidance. Now, the bar has been lowered substantially, and all it will take for our investment to be successful is for Envista to get past this tough time and emerge with annual EPS of $1.20.

I believe that the company can meet this low bar. While the second quarter will undoubtedly be a difficult one, the company has $200 million in cash on hand, which should eliminate the need to take measures that will dilute EPS, including selling stock or issuing debt. By the second half of the year, the level of dental activity may not be all the way back to where it was before, but it will be close enough to normal for the company to be profitable for the year and set itself up for a better 2021.

While the company has some cyclical exposure, with 68% of operating income derived from high-priced procedures like orthodontics and implants, the other 32% of its operating income comes from consumable products, which should return to normal levels of consumption relatively quickly. The company’s decision to speed up the costs cuts that it was already considering should also bolster profitability.

Considering all the factors involved, I am confident that the company can emerge from 2020 with EPS of at least $1.20 next year, and the stock is very cheap at 11X this conservative estimate. Once it appears that the number of new coronavirus cases is declining, NVST could rally very quickly. Buy NVST below $15.50. My target is $24.

Position Review

3M (MMM) will report earnings on April 28. The company has not as of yet provided any revised guidance due to the coronavirus. While current expectations for EPS of $9.45 for the year are unrealistic, I believe that the company should still earn around $5.00 a share this year, and it will likely have a stronger second half of what will certainly be a weak second quarter. MMM has held on relatively well since my Feb. 26 recommendation, which was when it was near the top of the market. The company’s strong franchises and solid financial position should continue to allow it to be a steady performer this year. Let me also say that while the company’s mask business has gotten the company both favorable and unfavorable attention in recent weeks, I only expect this business to be modestly additive to earnings this year. Furthermore, I anticipate that any unfavorable attention the company is currently getting will fade. 3M is now a buy below $140. My target is $165.

Chevron (CVX) will report earnings on May 1, and I expect that the company will have a small profit for the first quarter. The stock has rallied significantly off of its lows, and while it is not likely to continue in a completely upward direction, it should work its way higher. An eventual deal between Russia and Saudi Arabia to limit production, a gradual recovery in oil demand and the self-correcting supply mechanism due to the amount of drilling being cut back significantly should lead to a higher commodity and stock price over the next year. CVX is a now a buy below $75. My target is $95.

Cognizant Technology Solutions (CTSH) shares rallied over 11% yesterday due to the confidence that we are close to seeing the apex of the number of new coronavirus cases. Currently, CTSH consultants have been forced to work at home, which is less efficient and has caused the company to raise salaries by 25% for most of its workforce in India in order to compensate for the extra work that they have been putting in. However, I believe that the negative impact from the coronavirus will fade as the year goes on, and the company will remain profitable and ready for a strong 2021. CTSH is a buy under $66.50. My target is $79.

Genuine Parts (GPC) announced after the markets closed yesterday that it was withdrawing guidance for the year as a result of the coronavirus. The company also indicated that it was suspending share buybacks, expanding the $100 million cost savings program that it announced last year and working with banks to stay within its loan covenants. On the bright side, the company said that it would pay its regular quarterly dividend of $0.70 a share on July 1 for shareholders as of record on June 5. The company will have new guidance for the year when it reports earnings on May 6.

I continue to believe that the company has the financial power to withstand the crisis, and the company should be able to come close to earning the $5.69 a share it earned a year ago once again in 2022. My new buy under price for GPC is $90. My target is $100.

Ingredion (INGR) will likely report earnings in the first week of May. Expectations are for EPS of $1.55 vs. $1.54 on a 5.8% increase in revenue to $1.5 billion. While it is hard to judge the impact of the coronavirus in the company’s earnings, I believe that this company has the best chance of coming closest to its original estimates than any company currently on our Buy List. This is because I do not believe that the demand for the company’s starches and sugars or its supply chains have faced any interruptions. I believe that the recent strength in the stock should continue, and I recommend purchasing the stock under $90. My target is $105.

MSC Industrial Direct (MSM) will report fiscal second-quarter earnings before the market opens tomorrow. Expectations are for EPS of $0.99 vs. $1.24 on a 4.4% decline in revenue to $790 million. The decline will be driven by the fall in global manufacturing activity that was in place before the coronavirus hit. The additional economic weakness could drive expected EPS of $4.30 for the August 2020 fiscal year to below $4.00. However, a lot of the expected weakness is already priced in the stock. MSM is a quality company and should remain profitable through the recession. This will enable it to support its share price. MSM is a buy below $60. My target is $75.

Valley National Bancorp (VLY) will report first-quarter earnings sometime in the last week of the month. Given the economic disruptions that have been caused by the coronavirus, the company will take up a significant increase in loan loss reserves. While the amount of the reserve increase is difficult to forecast, I believe that it will be manageable as mortgages and other secured loans make up the majority of the company’s lending activity. This will limit losses and will likely allow VLY to remain profitable for the year. Given the Federal Reserve’s extraordinary steps to support housing and other asset prices, I do not anticipate the sharp decline in home prices that we saw during the 2008 financial crisis. This will also help keep losses manageable.  My new buy under price for VLY is $9. My target is $11.

Valvoline (VVV) withdrew its earnings guidance for the year on March 24 and indicated that it had drawn $450 million from its line of credit to insure liquidity through the potential temporary closures of Quick Lube stores and lower volume in its lubricant business. I believe that this will be more than enough cash to get VVV through the next two quarters, which will be difficult ones due to reduced driving volumes.

The company may do no better than breakeven in its September 2020 fiscal year after having EPS of $1.39 the previous year. However, even with higher interest payments as a result of the debt that it incurred to get themselves through the crisis, I believe that VVV can earn $1.30 a share in the following year. The stock remains oversold, and I anticipate a sharp bounce shortly. My new buy under price for VVV is $17. My target is $21.