The “Santa Claus” rally that has lifted the S&P 500 and the NASDAQ to new highs seemingly every day has not yet come for value stocks, with the Russell 3000 Value Index selling close to the same price that it did on Dec. 20.
Concerns about the economy and earnings in 2020 have slowed the start of the year for value shares, while growth stocks have not been affected by these worries. However, I feel that this represents a temporary fervor of speculation that is going on with regards to several growth names such as Tesla (TSLA), instead of a trend that will last throughout the year.
I continue to believe that we will see economic growth reaccelerate at some point in 2020. As this will cause fears of a recession to go away, value stocks will rise. Not only has the economy been doing decently despite a weak manufacturing sector, we should get improvement in the realm of manufacturing since trade war fears have weakened. As a result, this shift could unleash some pent-up demand. The fact that the Fed is making sure there is ample liquidity in the banking system will help credit markets remain healthy, as interest rates are close to all-time lows.
While I believe that the upcoming earnings season will not be exceptionally strong, I anticipate that it will be good enough to allow the market to stay buoyant while it waits for better results. With interest rates so low, there will be no rush to sell stocks at their current prices unless there is a recession or a sharp decline in earnings. However, neither of these events are on the horizon.
I do believe our current Buy List is solid. All our companies have reasonable valuations, all but two have dividend yields of 3% or higher and all should see earnings growth in 2020 even if the anticipated reacceleration in the economy does not happen. Thus, I am optimistic that we will have good results with our current companies, and more good opportunities should develop over the course of the year.
CAKE: Soon Serving a Higher Stock Price
The Cheesecake Factory (CAKE) owns and operates 289 restaurants in the United States and Canada. It also licenses 24 restaurants in several Middle Eastern countries. The company seeks to offer a differentiated dining experience in its Cheesecake Factory locations, with 250 menu items made from scratch and over 70 cheesecake and other dessert items. Superior ambiance, service and hospitality, along with an average check price of only $23, make eating at CAKE a superior value proposition for consumers.
The company’s desserts are made in two U.S. bakeries. CAKE’s desserts are also sold outside of the company’s restaurants and contribute approximately 7.5% to CAKE’s operating profits.
The company recently completed an acquisition to diversify operations and increase growth. On Oct. 2, the company acquired both North Italia and Fox Restaurant Concepts for $286 million. CAKE had previously invested $80 million in these businesses.
North Italia operates 21 restaurants in 10 states and Washington, D.C., and offers homemade dishes that are made from scratch every day. Its strong private dining business helps drive good operating margins of between 16% to 18%, which CAKE believes can grow to 18% to 20%. North Italia has annual revenues of approximately $150 million with comparable store sales growth of 5%.
Fox Restaurant Concepts will serve as an incubator for 10 different restaurant brands. Currently, there are 48 restaurants with annual sales of $250 million. CAKE will look to develop these concepts carefully to avoid profit dilution and make investments to spark growth in the names that are showing the most promise.
CAKE’s stock has come under pressure in recent years and has fallen from a high of over $67 a share in May 2017. Two of the reasons why its earnings have stumbled are due to higher labor costs and lackluster sales trends. Earnings per share (EPS) fell from $2.83 in 2016 to $2.60 in 2017 and dropped again to $2.43 in 2018.
There was some stability through the first nine months of 2019 because gross margins improved and depreciation expenses declined. EPS increased to $2.04 from $1.87 over the same period. However, the stock has remained weak since traffic trends have been soft. The company also depended on price increases to grow its sales by 2.3% through the first three quarters of 2019.
I do believe a lot of risk is discounted in the stock at the present time, and the bar has been set low for an improved stock price this year. CAKE is only selling at 14X 2020 EPS estimates of $2.80, up from $2.63 this year. I believe that this estimate is achievable, as traffic trends have stabilized since July, wage pressures have moderated somewhat and average shares outstanding will continue to decline by 2% to 3% as a results of CAKE’s steady share repurchases.
The company’s strong free cash flow generation will allow for continued share repurchases and payment of the $1.44 annual dividend without straining the balance sheet. In the long term, the North Italia and Fox Restaurant Concepts acquisitions will give the company better growth and location diversity beyond the company’s traditional mall settings. Buy CAKE under $41. My target is $46. The 3.6% annual dividend will add to total returns.
Position Review
Chevron (CVX) will report fourth-quarter earnings before the market opens on Friday, Jan. 31. Expectations are for EPS of $1.52 vs. $1.95 on a 7.5% decline in revenues, which primarily reflects lower oil and natural gas prices. However, despite the fall in oil prices so far this year, earnings comparisons should start to become easier for CVX. Furthermore, higher prices, when combined with solid production growth, should allow for EPS improvement in 2020. Continue to buy CVX under $119. My target is $130.
Cognizant Technology Solutions (CTSH) will report fourth-quarter earnings after the market closes on Wednesday, Feb. 5. Expectations are for EPS of $1.04 vs. $1.13 on a 2.4% increase in revenues, as investments for future growth will hurt the company’s bottom line. The market is clearly in a wait-and-see mode when it comes to CTSH and will apparently want to see earnings go higher before sending the stock upward. However, I believe that the company is taking the right steps by investing in new initiatives while cutting costs in legacy businesses. I think that EPS comparisons will turn positive shortly. Buy CTSH under $65. My target is $79.
General Mills (GIS) has not been able to sustain a rally, even after it reported strong earnings four weeks ago. However, I anticipate that a rally will occur at some point in time, perhaps during a period where markets have become more risk adverse and are looking for safer options. Operations are steady, the company is realizing unit growth and the stock is cheap at 15.4X fiscal May 2020 EPS estimates with a dividend yield of 3.7%. Buy GIS under $54. My target is $60.
Ingredion (INGR) will report fourth-quarter earnings in the first week of February. Expectations are for EPS of $1.49 vs. $1.61, as higher corn prices and the impact of tariffs will affect margins once again. However, corn prices and the dollar have reversed course and could be a benefit to earnings in 2020 even though EPS estimates of $6.90, up from $6.52 in 2019, have not yet recognized these facts. The stock rebounded strongly in the fourth quarter, and although it is not as cheap as it once was, there is still good value here. The stock is currently selling at 13.3X this year’s EPS estimate. INGR is a buy below $90. My target is $105.
Shares of Genuine Parts (GPC) have come under pressure to start 2020. The weakness has most likely been caused by the warm winter so far in the United States, which could potentially cut the need for some replacement parts. However, while such news can hurt in a market that has become very momentum focused, this is not a long-term issue for GPC. I look for the shares to recover once earnings are reported in mid-February. Buy GPC under $100. My target is $110.
Last week, MSC Industrial Direct (MSM) reported fiscal first-quarter EPS of $1.21 vs. $1.33 on a 1% decline in revenue, as results continue to be negatively impacted by the weak industrial and metalworking markets. While results were $0.03 better than expectations, guidance for the second-quarter EPS of $0.97 vs. $1.03 on an expected 2% decline in revenues compared unfavorably to analysts’ EPS estimates of $1.14. Despite the disappointing outlook, the stock has changed little since the results were reported. The stock is still attractively valued, and investors remain optimistic about an improvement in both the industrial economy and MSM’s plans to provide more value-added services to customers. Keep in mind that a special $5 dividend will be paid on Feb. 5 and the stock will go ex-dividend on Jan. 21. Continue to buy MSM under $76. My target is $85. These values will be adjusted after the $5 a share dividend is paid.
Valley National Bancorp (VLY) will report fourth-quarter earnings before the market opens on Thursday, Jan. 30. Expectations are for EPS of $0.23 vs. $0.21, as the company will benefit from a rise in net interest income and cost-elimination measures. However, the stock has come under pressure as long-term bond rates remain depressed. Thus, I am interested to hear the company’s comments on what may happen with interest margins in future quarters, given the sustained low rates. However, strong loan growth, combined with its cost cuts, should help EPS improve this year to $1.00 from an expected $0.91 in 2019. Based on this estimate, the stock is quite cheap. Buy VLY under $10.50. My target is $12.50. The 3.8% dividend yield will add to total returns.
Valvoline (VVV) will report fiscal first-quarter earnings sometime before our next issue. Expectations are for EPS of $0.30 vs. $0.27 on a 4.5% gain in revenues. Strength in the company’s Quick Lube operations will lead the gains, while results from the lubricant segment will be relatively steady. Even though the stock has been unable to hold its gains from a strong earnings report last quarter, I think that the results will show steady growth. The shares should follow suit. Buy VVV under $22.50. My target is $26.
Join me for the Orlando MoneyShow, Feb. 6-8, 2020, at the Omni Orlando Resort at ChampionsGate. I will be speaking Friday, Feb. 7, 3:00 p.m. about The Stealth Value Investor: Ten Amazing Dividend Yield Plays Flying Under the Radar. On Saturday, Feb. 8, I will talk at 5:15 a.m. about Identifying the Real Future GameChanger Stocks: Ten Companies Positioned to Double – Even if the Bears Take Over Wall Street. Other investment experts who will be speaking include retirement and estate planning specialist Bob Carlson, income and options expert Bryan Perry and world-traveling, free-market economist Mark Skousen, who leads the Forecasts & Strategies newsletter. Register by clicking here or call 1-800-970-4355 and mention my priority code of 049252.