Not Out of the Woods Yet

After a painful January, bargain hunters are starting to return and dip their toes back into the stock market. Many stocks are now well off their January lows. I’m pleased to report that many of these stocks are value stocks like the ones we own. But still, I must urge some caution as there remains an unsteadiness about the market.

We saw this firsthand on Friday and Monday when the market experienced significant last hour selloffs. It’s also been apparent in individual stocks, even if they report good earnings.

As an example, the market cheered the strong earnings report by Alphabet (GOOGL) last week, sending shares nearly 10% higher from its pre-earnings close at one point. However, GOOGL has now given back practically all its gains. Industrial giant Illinois Tool Works (ITW) is another example of a company that soared post earnings, only to see those gains dissipate. In fact, ITW shares are now lower than they were pre-earnings despite posting solid results and giving strong guidance for 2022.

What is going on here? I believe a few factors are in play.

First, the economy looks good right now, with the latest GDP estimate showing the U.S. grew at a 6.9% annual pace in the fourth quarter. However, there are concerns about how the Federal Reserve’s planned series of key interest rate hikes will impact the economy this year. The International Monetary Fund currently projects the U.S. will grow at a 4.0% annual pace in 2022, down from the estimated 5.7% annual pace in 2021.

Second, tech stocks remain a thorn in many investors’ sides. Results remain strong for most of the tech giants that dominate the index weightings, which should, in turn, have a big impact on the averages. However, some investors believe these companies will see growth dramatically slow over the next few years. Keep in mind, these concerns are coming at a time when stocks are not cheap, with the S&P 500 selling close to 20X current earnings estimates of $230.

And third, there is the ongoing threat from cost inflation and supply chain issues. This has impacted not only the broader market but also many of our stocks recently. The majority of our Value Authority companies will report results over the next week or two, and we’ll then know just how much these issues have impacted earnings. Even if our companies provide earnings and guidance a little softer-than-expected because of these issues, I remain confident in our companies’ ability to generate free cash flow and add value over the long-term. The fact is that many of our companies remain attractively valued and should be able to withstand slightly lower expectations for 2022.

In conclusion, the bumpy road may not be over yet. But don’t be discouraged; I remain very confident that our current list of Value Authority names will do well over the next year or two. Remember, interest rates remain historically low even with recent rises, and many of our stocks offer dividends well above the 1.9% yield on 10-year Treasuries and even the 3.0% yield on low-end investment grade bonds. Companies that produce the consistent cash flow that we seek will be rewarded eventually, so I plan to stick with our discipline despite the nervous market.

BUSE: Growth to Accelerate

First Busey Corporation (BUSE) is a holding company that primarily operates Busey Bank, a community bank with 58 banking centers; 46 of which are in Illinois and the remainder are in Missouri, Florida and Indiana. The bank generates most of its revenues through lending, with commercial loans, primarily real estate related, making up 76% of the company’s $7.2 billion loan portfolio. Mortgages and other consumer loans make up the remaining 24%.

Busey Bank also provides investment management, trust and brokerage services, which accounted for 13% of revenues in 2021. BUSE also has a subsidiary, FirsTech, that offers payment processing and online bill paying solutions. FirsTech accounted for 5% of revenues in 2021.

BUSE was enjoying a period of good earnings growth shortly before the pandemic, with EPS increasing from $1.76 in 2017 to $2.15 in 2019. The bank was benefitting from good organic loan growth and rising interest margins as the Federal Reserve raised interest rates. In addition, First Busey benefitted from a series of acquisitions the company made between 2015 and 2018. BUSE acquired four small banks that fit well with its Illinois and Missouri footprint for $850 million, and it was able to realize good cost synergies from the mergers.

Unfortunately, COVID took away a lot of the momentum the company was building. EPS slipped to $1.98 in 2020 on higher credit costs and lower interest margins when interest rates declined.

EPS bounced back to $2.45 last year, largely due to a reversal of credit costs as the bank overestimated loan losses related to the pandemic in 2020. Absent this benefit, EPS was $2.23 in 2021, with net interest income down 4.2% as margins continued to contract.

However, there are signs the company will soon come out of this slightly soft period and start reporting better earnings gains. Primarily, the Fed is committed to raise rates again. This will get margins moving in the right direction, aided by the company’s large checking account deposit base, as well as the fact that the interest on their loans will go up sooner than the interest on their liabilities. Core loan growth has been steady, and it was up 2% in the fourth quarter of 2021. The investment management division and FirsTech both have strong momentum, with double-digit revenue gains that should continue into 2022. The company should also benefit as it realized synergies from last year’s acquisition of Glenview State Bank in Illinois for $187 million.

BUSE earned approximately $0.54 a share excluding the benefit of income from credit loss reversals. Given the positives discussed above, this run rate should accelerate, and I believe BUSE can earn $2.35 this year. After that, momentum should be strong into 2023 if the economy remains firm.

At 12X this estimate, and with a dividend yield of 3.3%, BUSE has the potential for solid total returns in 2023. Buy the stock under $29. My target is $32.

Position Review

Last week, Cognizant Technology Solutions (CTSH) reported fourth-quarter EPS of $1.10 vs. $0.67 last year and $0.06 better than expectations, on a 14% rise in revenues. Comparisons were very easy due to an abandoned project in last year’s quarter. Digital revenues continued to lead the way higher, up 20%, and revenues gained across all industries served. The company gave EPS guidance for 2022 of $4.46 to $4.60 versus $4.12 last year on an expected revenue gain of 7.8% versus 10.8%. Given the company’s strong recent execution and 20% gain in bookings in the fourth quarter, I am confident CTSH can achieve at least the high end of these ranges this year. I am raising my buy under and target price on CTSH. Buy CTSH under $80. My new target is $95.

Fidelity National Information Services (FIS) will report fourth-quarter results on February 14th before the market opens. I previewed results in last month’s issue, with EPS of $1.90 on 11.9% revenue growth expected. Although the stock is off of its lows of late last year, it remains very cheap given the ongoing concerns of new competition in the credit card industry and banks looking at new alternatives to traditional credit card processing. On the earnings conference call next week, I believe FIS will once again make the case for their critical services to the industry like they did on the previous call. In turn, I expect the stock will react well to earnings. FIS is a buy under $125. My $140 target is 19.2X a reasonable 2022 EPS estimate of $7.30.

Johnson & Johnson (JNJ) continues to trade firmly following the release of its first-quarter earnings, which we highlighted in an alert last month. The company is currently firing on all cylinders, and even though earnings growth will slow next year when its psoriatic arthritis drug Stelara comes off patent, JNJ is very well diversified and cheap at 16.5X this year’s EPS estimate. JNJ will be a safe haven for investors during the current period of market turbulence. Buy the stock under $162. My target is $180. The 2.4% dividend yield will add to total returns.

Molson Coors Beverage Company (TAP) will report fourth-quarter earnings on Wednesday February 23rd before the market opens. Expectations are for EPS of $0.86 vs. $0.40 last year on an 11.2% gain in revenues in the absence of COVID restrictions and expenses impacting last year’s results. The stock has pulled back recently on supply chain and cost inflation concerns, and these could remain issues over the near-term. However, I remain confident that the company’s lower cost structure, ongoing debt reduction and steady performance of leading brands like Miller Lite and Coors Lite will eventually drive this very cheap stock higher. I believe TAP will earn over $4.00 a share this year, so the stock sells at only 12X expected earnings. Buy TAP under $50. My target is $57.

Newell Brands (NWL) will report results on Friday before the market opens, with expectations for EPS of $0.32 vs. $0.34 last year on a 1.3% decline in revenues. Supply chain and cost inflation concerns following’s (AMZN) earnings hit the stock last Friday, and it would be reasonable to expect some impact in the company’s earnings report and guidance. However, longer-term, I expect the company will benefit from its leaner cost structure and emphasis on cash flow generation. Trading at 11.4X current 2022 EPS estimates of $1.85, I believe the shares are already discounting some guidance disappointment for this year, and I expect the stock to bounce back on any reasonable result. Buy NWL under $24. My target is $28.50. The 4.2% dividend yield will add to total returns.

Phibro Animal Health Corporation (PAHC) will report fiscal second-quarter earnings after the close tomorrow. Expectations are for EPS of $0.33 vs. $0.34 last year on a 5% gain in revenues, as rising commodity prices will offset price increases. The stock has been under pressure with commodity prices up sharply so far this year, and this could potentially negatively impact forward earnings guidance. However, I do expect some relief in commodity prices this year, and renewed growth in developing countries will also help offset the higher costs. PAHC is a buy below $20.50. My target is $25.

Sonoco Products Company (SON) will report fourth-quarter earnings after the close on Thursday. Expectations are for EPS of $0.89 vs. $0.82 last year on a 2.3% rise in revenues, as the company continues to benefit from a strong economy. The stock has been a little soft on fears that Fed tightening will weaken the economy. However, the company has been getting price increases, which indicates that demand is strong. The very favorable financing terms the company received for the issuance of new debt shows that SON is respected as a quality company, and I would look for the stock to do well this year provided the economy remains firm. Buy SON under $63. My target is $70. The 3.2% dividend yield adds to the attraction of the shares.