Looking for Hope to Break Through the Storm Clouds

Hurricane season officially begins in June, but the storms didn’t start brewing until September. Since September 1, there have been several tropical storms and two category 4 storms, including Ian, wreaking havoc in the Atlantic Ocean and Gulf of Mexico. The devastation in the wake of the recent category 4 storms of Ian and Fiona was enough to say it’s been a bad season—and there’s still two months left in the official hurricane season.

Wall Street dealt with its own set of destructive storms in September: Higher-than-expected inflation and global central banks aggressive interest rate increases drove the S&P 500 more than 9% lower. The S&P 500 is now down 25% year-to-date, which has left many traders wondering if the storm clouds will break in the final months of the year.

Right now, stocks remain under pressure, as Wall Street considers how global central bank tightening will impact the economy and financial systems. Some strains have already been felt, with the Bank of England (BOE) increasing its emergency bond buying operations today. The BOE wants to reduce the impact that losses on U.K. gilts could have on its banking system.

It will take some more time to see how central bank tightening will ultimately impact the economy—and such uncertainty is never good for the market.

However, there are a few rays of light set to break through the clouds in the near term. First, earnings season is about to start. Given diminishing expectations for results and increasingly attractive valuations, earnings season could bring some relief to the markets. Second, the Consumer Price Index (CPI) will be reported on Thursday morning. If it shows favorable trends, we could see a strong near-term rally like we did last Monday and Tuesday. And third, any hint that the Fed may change course or at least slow down tightening will provide a strong rally from current prices, especially as we head into the seasonally strong time of the year for stocks.

Now, I know it has been a tough year, and I cannot promise we are at the bottom. However, I can say with a fair amount of confidence that the worst of the selling is behind us, and our stocks are currently priced to bring strong returns in the years ahead.

In fact, the stocks on our Buy List are now among the cheapest they have been since we started Value Authority in 2014 (with the start of the pandemic as the one exception). Practically all of our stocks trade at 12X next year’s earnings or less. So, even with higher interest rates, stocks of solid companies are very attractive at that valuation.

HPQ: Industry Softening, But Stock Too Cheap to Ignore

Back in November 2015, the old Hewlett Packard split its business into two separate companies: HP Inc. (HPQ) and Hewlett Packard Enterprises (HPE). HPQ operates the PC and Printing businesses of the old Hewlett Packard, while HPE sells products designed for corporate use, such as servers, storage and networking equipment.

In the most recent fiscal year, the PC business, or Personal Systems as HPQ calls it, accounted for 68% of total revenues, with 70.4% of personal systems coming from laptops. Printing accounting for 32% of total revenues, with 62.6% of printing revenues coming from supplies. Supplies are the highest margin product for HPQ, and printing contributes 54% of total operating profit for HPQ.

The company plans to further diversify its product line with its recent acquisition of Poly (the former Plantronics) for $3.3 billion. HPQ will sell Poly’s headsets and video equipment to corporate customers.

Still, PCS and Printers remain the company’s bread and butter. In fact, in the latest fiscal year, demand for PCS and Printers grew above long-term potential as demand was pushed forward by the pandemic, with additional people working from home or spending more on the Internet. Revenues increased 12% from $56.6 billion in the October 2020 fiscal year to $63.5 billion in the October 2021 fiscal year, with EPS increasing from $2.28 to $3.79 over the same period. Personal Systems revenues rose 11%, while printing was up 14% in the 2021 fiscal year. EPS comparisons benefitted from a big share buyback, with HP spending $6.2 billion to retire 224 million shares, a quite significant 17% of all outstanding shares.

In their recent third-quarter earnings report, the company lowered EPS expectations for the current quarter, as PC sales have started to decline after their recent hot run. HPQ expects EPS of $0.79 to $0.89, versus previous expectations for EPS $1.06 and EPS of $0.94 in the prior year. Still, EPS for the entire year should exceed $4.00, as the year started strong for HPQ, and the company has retired an additional 6.2% of total shares.

Still, with the overall industry slumping, investors are concerned with how low EPS can go in the October 2023 fiscal year. I believe even in a worst-case scenario, which assumes sales decline 10%, HPQ should still earn $3.00 a share for the year. The company’s balance sheet and cash generation continue to finance share buybacks, which are very accretive with the stock at its current price and will support earnings comparisons.

At 8X this estimate, the stock is incredibly cheap—and I believe we can see long-term PE multiple expansion for HPQ. While printing and PCs may not be great growth businesses, they generate significant cash flow, and they are not going to go away as product lines. HPQ will be a top competitor in an industry that has become an oligopoly. HPQ is a buy below $26.50. My target is $32. The 4% dividend yield adds to the attraction of the shares.

Position Review: Well-Positioned for Earnings Season

Cognizant Technology Solutions (CTSH) will report third-quarter earnings in the last week of October. Expectations are for EPS of $1.16 vs. $1.06 last year on a 6% gain in revenues. The stock has remained under significant pressure due to concerns over slowing orders and the strength of the dollar. However, the selling is completely overdone, with the shares selling at 13X this year’s EPS estimate. Given this bargain valuation, any decent earnings report, along with a better market, should send the stock sharply higher. The earnings momentum the company has enjoyed over the past several quarters may slow, but earnings growth will remain positive. Buy CTSH under $80. My target is $95.

Fidelity National Information Services (FIS) will report third-quarter earnings in the first week of November. Expectations are for EPS of $1.76 vs. $1.73 last year on a 3% increase in revenues. EPS growth will be limited by higher interest expense and the acquisition of Payrix, a payments company, earlier in the year. FIS also has been hit hard by concerns that slower consumer spending will lead to less transactions for the company to process. However, with the stock selling for at 11X this year’s EPS estimates, a lot of bad news is already priced into the stock, and FIS should do well when the market turns. Buy FIS under $110. My target is $130.

First Busey (BUSE) shares have done relatively well in recent months considering the overall damage done to the market in general and bank stocks in particular. The company will report third-quarter earnings in the last week of October, with expectations for EPS of $0.64 vs. $0.46 a year ago. Results should benefit from loan growth and higher interest margins. While there is a possibility that the company could use the expected strong operating results to raise loan loss reserves in the event of a recession, I believe this is already anticipated by the market to a certain extent. So, provided the company’s actual losses remain low, I would expect earnings to be a bullish catalyst for the shares. Buy BUSE under $24. My $29 target is 11X next year’s EPS estimate of $2.62. The 4% dividend yield will add to total returns.

Lowe’s Companies (LOW), last month’s new pick, has moved lower but has significantly outperformed the averages since my recommendation. Higher mortgage rates may make homeowners less likely to upgrade to a better home, and instead, they are expected to spend more to improve their existing homes, which will benefit Lowe’s. It is too early to say if this scenario will actually play out favorably for Lowe’s, but Lowe’s is a quality company with a very strong franchise that sells nearly 25% below its 52-week high and at just 14.5X this year’s EPS estimate. Buy LOW under $215. My target is $260.

Newell Brands (NWL) will report third-quarter earnings in the last week of October, with the company already pre-announcing expectations for a 1% to 5% decline in sales and EPS between $0.50 and $0.54 versus $0.54 in the third quarter of 2021. While the near-term outlook has been hurt by retailers’ efforts to offload their inventories, Newell’s strategy of making operations more efficient and reducing debt will pay off in the long-term. Even if there is a recession that forces earnings estimates to come down from $1.65 to between $1.35 and $1.40 a share next year, there is still a lot of value in the stock at the present time and patient investors will be rewarded. NWL is now a buy below $17. My new target is $24.

Old Republic (ORI) will report third-quarter earnings in the last week of October, with expectations for EPS of $0.62 vs. $0.79 last year. The decline in earnings is related to softening in the company’s title insurance business, which was abnormally strong last year. Despite the expected earnings pressure, the stock has performed relatively well for us, especially in light of the $1.00 a share dividend that was paid on September 15.  Selling at just 9X this year’s expected earnings, ORI is an ideal stock for the current environment with its long-term operational consistency. Buy ORI under $24. My target is $27.

Omnicom (OMC) will report third-quarter earnings next week. Expectations are for EPS of $1.68 vs. $1.65 last year on a 2.5% decline in revenues. Results continue to reflect divestitures made by OMC that are dilutive near-term but will improve OMC’s growth and profitability in the long run. The main interest from investors will not be on current results, but the near-term outlook of the ad market with the economy weakening. I believe a lot of potential economic weakness is already priced into the shares with the stock selling at just at 10X forward earnings estimates. Longer-term, the company’s repositioning into higher growth businesses like digital marketing should pay off for shareholders. OMC is a buy below $70. My target is $80. The 4.3% dividend yield adds to the attraction of the shares.

Phibro Animal Health (PAHC) will report fiscal first-quarter earnings Wednesday, November 9, so I will preview results in next month’s issue on November 8. More than any other stock on the buy list, PAHC has been hurt by the strength of the U.S. dollar, given the company has considerable operations in emerging markets. However, the company’s products are non-discretionary to livestock producers and remain important to meet the world’s growing demand for protein. The stock has become incredibly cheap at 10X EPS estimates for the current fiscal year.  PAHC is a buy below $18. My target is $22.

Sonoco Products (SON) will report third-quarter earnings on October 31, with expectations for EPS of $1.39 vs. $0.91 last year on a 34.5% increase in revenues. The company continues to benefit from higher container prices. The real issue facing the stock is what happens to earnings next year when the company potentially faces a softer economy and the price hikes anniversary. While EPS will likely fall short of this year’s expected $6.24, results in the range of $4.50 to $5.00 are a good conservative estimate. The stock remains attractively valued even in this scenario. SON is a buy below $65. My target is $75.

Target Corporation (TGT) has been under pressure with the market on consumer spending concerns, and the fact that the company has started Black Friday sales early to eliminate excess inventory. This year has long been written off by the market as a lost cause, but if the company is successful in clearing excess inventory, it should be able to earn $12.00 a share next year even if discretionary consumer spending remains subdued and profit margins remain below last year’s elevated levels. TGT remains a great franchise with increasing traffic, and I view the issues this year as temporary. TGT is a buy below $163. My target is $180.

Universal Health Services (UHS) will report third-quarter earnings in the last week of October, with expectations for EPS of $2.44 vs. $2.67 last year on a 5.8% increase in revenues. Profitability remains under pressure due to higher labor costs. While the company has struggled with staffing costs all year, UHS should earn $10.00 a share this year, with further improvement next year as costs moderate. At just over 9X expected earnings and the stock trading near pre-pandemic prices, the risk/reward characteristics of UHS shares are compelling. Buy UHS under $110. My target is $130.