Gains Have Been Huge, What is the Next Step?

It has been a little over five months since encouraging news about COVID-19 vaccine data came out, which launched a huge rally in dormant value stocks. While I was very enthusiastic at the time of our November issue, I did not expect a rally to the extent we had, with the Russell 3000 Value Index now up 35% since the start of November.

I am very pleased with the way our stocks have performed in the rally. For the most part, they have exceeded the lofty gains since November. We now have a situation though, where many of our stocks are bumping against our target prices, some of which have already been raised. Therefore, the question is, what do we do for an encore?

I believe the next step is to wait for our companies to report earnings before deciding which names can even work their way higher, or which ones perhaps need to be sold. The earnings outlook for most of our companies is strong this year, and while their valuations are much higher than they were five months ago, they do not necessarily reflect a new interest environment where the 10-year Treasury note yield rarely goes above 2.5%, thanks to significant intervention by central banks on a global basis. The rally in value stocks still could have some ways to go if earnings for 2021 can meet investors’ expectations.

I do not want to leave the impression we are without risks here. Higher input costs and taxes threaten estimates, and inflation could make the Federal Reserve’s efforts to control interest rates difficult. Let us stay the course for now though, while being alert to make all necessary adjustments.

MLI: An Underappreciated Steady Performer

Mueller Industries (MLI) may not be a household name. And, while this small-cap stock ($2.5 billion) is somewhat obscure, the company has been around since 1917. In addition, the quality niche products it makes has given the company quite the international audience, with 27% of its sales last year coming from outside of the United States.

Mueller’s business segments include Piping Systems, Climate Products and Industrial Metals. Through these divisions, the company makes copper tubes, fittings, brass and aluminum forgings, brass rods, copper alloys, refrigeration valves and protective devices and tubular assemblies used for refrigeration. It serves markets that range from plumbing, heating, air conditioning, refrigeration, appliance, medical, automotive, military and defense, marine and recreational.

The company has seen revenues decline slightly over the past two years due to lower copper prices and the slump in manufacturing brought on by COVID-19. Revenues of $2.5 billion in 2018 fell to $2.4 billion by 2020. However, operating income continued to advance as the company benefited from an improved revenue mix, better margins on copper products despite the lower prices and good execution on costs. Earnings per share (EPS) improved from $1.84 to $2.85 over the two-year period.

Management is confident about the outlook for the company in 2021, as the winding down of the pandemic should bring along top-line growth to go along with the recent improvements the company made in operating efficiencies. EPS of $3.15 seems realistic, and at 14X this estimate, the company is attractively valued in the industrial segment, where many companies sell for over 20X earnings.

MLI has historically been a consistent company and a great cash generator. Its balance sheet is strong, with long-term debt only 29% of total capitalization, and $476 million of cash and receivables. With some improved top-line results, the stock should be able to realize a better price-to-earnings (P/E) multiple. Buy MLI below $48. My target is $52.

Position Review

I am raising my target price for 3M (MMM) to $205, or roughly 20X a reasonable 2022 EPS estimate of $10.25, to better reflect current marketplace valuations. The company will report first-quarter earnings on April 27 before the market opens, with expectations of EPS of $2.29 vs. $2.16 on a 4.8% increase in revenues. While health care comparisons will be more difficult due to pandemic demand last year, other segments will make up for this, and continued improvement in the transportation and electronics segment could lead to an earnings beat. My new buy under price for MMM is $185.

Cognizant Technology Solutions (CTSH) will report first-quarter earnings on May 5, expectations are for EPS of $0.94 vs. $0.96, on a 3% revenue gain, as continued investment in new technologies will limit profitability. However, except for last quarter, which was weak due to a canceled project, the company has reliably beaten estimates. With momentum growing in new services, I believe there is a good chance CTSH will do so again. If the company can avoid the missteps of the fourth quarter, I believe my $85 target could be achieved soon and perhaps be raised. CTSH is making excellent progress in digital and other new client services. If the stock can reach a market multiple, the stock could reach $90 or more next year. Buy CTSH under $75.

Dollar Tree (DLTR), last month’s new pick, has been a strong performer, aided by the strength in the retail sector in general. I do expect the strength to continue, given DLTR’s current sales momentum, and the promise of its new “combination” stores, which utilize the best of the Dollar Tree and Family Dollar store formats, in small markets. My $125 target is just 20X this fiscal year’s EPS estimate of $6.25. This is a very reasonable multiple in the current market environment, considering the non-cyclical nature of DLTR’s business and the company’s growth prospects. DLTR is a buy under $110.

General Mills (GIS) has recovered some of its losses post its fiscal third-quarter earnings report. (Read my review here.) Despite the cost pressures and difficult top-line comparisons the company faces over the next few quarters, I still like the stock here. GIS is a quality operator, and the shares are cheap at 16X forward EPS estimates with a 3.4% dividend yield. Buy GIS under $59. My target is $65.

Ingredion (INGR) will report first-quarter earnings results in the first week of May, with expectations for EPS of $1.61 vs. $1.59 on a 2.5% increase in revenues, as improving trends in the food-service business, as lockdowns are slowly lifted, should start to kick in.

The shares have stalled following their strong rally post fourth quarter. This could reflect the recent rise in corn prices, an important input cost for the company. However, the stock remains very cheap at 13.6X 2021 EPS estimates with a 2.8% dividend yield, and the company could eventually pass on price increases to its customers. Buy INGR under $85. My target is $100.

Keurig Dr. Pepper (KDP) will report first-quarter results in the last week of April. Expectations are for EPS of $0.32 vs. $0.29 on a 4% gain in revenue, as unit demand for both coffee and soft drinks should continue to see low-to-mid single-digit-percentage growth. Selling at 22X this year’s EPS estimates, the stock still sells at a discount to Coke (KO) and Pepsi (PEP). The stock is very close to my $36 target, and I will let you know our next step once the target is achieved. Hold KDP for now.

Kronos (KRO) will report first-quarter earnings in the first week of May. With the market for titanium dioxide still tightening, EPS should surpass the $0.22 a share earned last year. However, high costs could be an offsetting factor, provided the global economy remains firm and inflationary fears are on the rise. I would want to hold the stock to at least my $17 target. KRO is a buy under $13.50.

Old Republic (ORI) will report first-quarter earnings on April 22, with expectations for EPS of $0.46 vs. $0.47 the prior year. While comparisons will be hurt by a decline in the company’s title insurance business from a strong quarter last year, improvement in workmen’s compensation and specialty lines could drive upside to expectations.

The stock is closing in on my $24 target. However, a potential year-end book value of $21.50 a share could justify a higher target. I will let you know our next step shortly. Hold the shares for now.

Safety Insurance (SAFT) will report first-quarter earnings sometime in early May, and the results should be better than the $1.57 a share earned in the first quarter of 2020. This is due to continued lockdowns and a relatively moderate winter in Massachusetts. Based on normalized annual EPS of $6.50 to $7.00 a share, and a year-end book value of $62.50 a share, I believe my $88 target is reasonable. SAFT is a buy below $78.

Valvoline (VVV) will report fiscal second-quarter results sometime in the first week of May, with expectations for EPS of $0.37 vs. $0.39 on a 14% gain in revenue. Profitability will be held back by the expedited expansion of the company’s Quick Lube franchises and additional safety expenses related to COVID-19. The pause in expected profitability has led to a flattish performance of the shares in recent weeks, but I think that once the market gains improved confidence that the company can meet expected EPS of $1.65 this fiscal year and $1.85 in the September 2022 fiscal year, the stock could move beyond my $27 target. VVV is a buy below $23.50.