The Rally Is Back! But For How Long?

The rally is back. It did not take long for the Russell 3000 Value Index (IUSV) to rebound to just within sight of its all-time high of 75.92, erasing a month of retreat in the process.

Evidently a little reassurance that the omicron variant of COVID-19 would likely not be enough to cause economic shutdowns is all it takes to trigger back-to-back surges in a once-nervous market. Good news.

However, we are far from sounding an “all clear” horn. While omicron is apparently not a significant threat, the Fed will almost surely soon begin tapering their monthly purchase of fixed-income securities and stop growing the balance sheet entirely by the middle of next year.

Earnings estimates for next year still face a challenge from supply chain issues and perhaps slower economic growth as fiscal stimulus recedes from the federal budget. Finally, and although this is still an emerging issue, trouble for major property developers in China could be a drag on global growth as the world’s second largest economy could be forced to retrench.

Despite all these clouds, I love the way our Buy List looks. I think it represents a good balance between low volatility income-oriented names and more aggressive stocks with good capital gains potential.

We have captured a few wins in the past month and should be liquid, while capturing new opportunities as they arise. Let the macro environment twist. Value stocks remain reservoirs of shareholder value either way.

JNJ: A Rock-Solid Name Attractively Valued

Perhaps the most attractive aspect of Johnson & Johnson (JNJ) and what makes it such an attractive investment is balance. The company is balanced geographically, with 52% of sales coming from inside the United States and 48% internationally. JNJ also has three strong segments, with pharmaceuticals accounting for 55% pf revenues, medical devices 29% and consumer products 16%.

Furthermore, the company is balanced within these segments. The company largest-selling pharmaceutical Stelara, which is used in the treatment of Crohn’s Disease, accounts for just 18% of the segment’s sales. The medical device segment gets solid contributions from its intravenous, orthopedic, surgery and vision product lines, with surgery only coming in at 35% of overall sales on that side. The consumer health segment owns several strong franchises, including over the counter medications Tylenol, Benadryl and Listerine among many.

Another notable feature which adds to JNJ’s stability is its financial strength. Cash and marketable securities of just over $30 billion offset roughly the same amount of long-term debt. Interest income is also currently slightly higher than interest expense. The solid balance sheet along with the strength of its operations, makes JNJ one of the two companies that have a AAA debt rating from Standard & Poor’s, the other being Microsoft (MSFT).

JNJ has realized slow but steady growth over the years, with revenues increasing from $71.3 billion in 2013 to $82.6 billion in 2021. Earnings per share over the same period grew from $5.52 to $8.03 a share, having peaked at $8.68 in 2019 before a pandemic-driven 11% decline in medical device sales.

Nonetheless, overall sales were flat in 2020 and are reaccelerating now. The third quarter spotlighted strength across the board, with pharmaceutical sales up 13.8%, medical device sales up 7.6% and consumer health sales up 5.7%. Revenue guidance is coming in at 9.9% to 10.5% not counting COVID-19 vaccines, which should boost sales about 3 percentage points but provide no profit. Earnings guidance for the year is $9.77 to $9.82 . . . showing 13% expansion since 2013.

But even while earnings are shifting into record gear, the stock has corrected from a high of roughly $180 over the last four months. At this point,  I believe JNJ is a good value at just 15.3X next year’s EPS estimates of $10.40 a share with a 2.7% dividend yield.

While earnings in 2023 may be a little challenging as Stelara comes off patent, I believe JNJ should be able the manage to limit its impact. In the longer term, the company has over 10 new pharmaceutical products or new indications for existing products in Phase III FDA clinical trials, so the outlook for the pharmaceutical division is bright.

Lest we forget, JNJ plans to separate its consumer health business into its own corporate entity, keeping the drugs and devices separate. While it may not be a reason to buy the stock, it is also not a reason to avoid it. With Fed tightening likely and COVID risks rising, I believe safe havens like JNJ could do well the first half of 2022. Buy the stock under $162. My target is $180.

Position Review

3M (MMM) has weakened as industrial names have been under pressure on concerns of a less robust global economy. However, the shares rallied sharply with the market yesterday from an oversold condition. Operational efficiency and diversified businesses have historically given MMM stability during difficult economic times, so the shares can do well even if we see a weaker than expected environment next year. MMM is attractively valued at less than 18X next year’s EPS estimate with a 3.5% dividend yield. Buy MMM under $175. My target is $200.

Cognizant Technology Solutions (CTSH) has held on during the recent market turmoil and I believe the stock will continue to outperform. The company managed very well during the severe delta variant outbreak in India during the spring, and I believe it can handle any threat omicron may provide. Growth is back on  track and at 17X next year’s earnings estimates, valuation is favorable. Buy CTSH under $75. My target is $90.

Fidelity National Information Services (FIS) saw a post-earnings rally fail as payment-related stocks struggle under the threat of more intense competition. However, I remain confident that “buy now and pay later” will not account for a significant number of total transactions and FIS should continue its consistent growth.

There are current media reports that the company will sell its capital markets transaction business for $2 billion. While I do not think this will serve to unlock significant value, it does show management remains very confident in its core businesses. FIS remains a buy under $125 as I target $140, which is 19X next year’s earnings estimates.

Fulton Financial (FULT) saw its stock bounce nicely yesterday and the shares continue to outperform their large-cap bank peers. Provided credit conditions remain favorable, FULT should earn $1.30 a share next year, which should get the stock close to my $18.50 target. FULT is a buy below $16. The 3.5% dividend yield adds to the attraction of the stock.

Juniper Networks (JNPR) has slid with the markets although it has stabilized over the past few days. Giving recent earnings momentum and new products, I remain a confident holder of the stock. Buy JNPR under $29. My target is $33, or 16.5X next year’s earnings estimates. The 2.5% dividend yield is also attractive.

Given the recent weakness in small cap and materials stocks, relatively stable price performance for Kronos Worldwide (KRO) is encouraging. Titanium dioxide prices remain strong and the company showed improved operational execution in third quarter. If the global economy remains firm, KRO has a chance to earn $1.20 a share in 2022, which could make my $16 target conservative. KRO is a buy under $13. The 5% dividend yield will add to total returns.

Molson Coors Beverage (TAP) has traded erratically in a narrow range. The latest concerns are that omicron will make supply chain challenges more complicated. However, I believe investors need to step back and look at the bigger picture here. Coors Lite and Miller Lite, the company’s biggest brands, have seen market share stabilize. Management continues to reduce debt and free cash flow generation remains strong. Finally, valuation is very attractive at 11X next year’s EPS estimates. TAP is a buy below $50. My target is $57.

Newell Brands (NWL) has been a disappointment as the market remains focused on the company’s cost inflation and supply chain challenges. However, cost cutting and price increases are not fully reflected in current earnings and should provide a tailwind for results as we enter 2022. The stock remains very cheap 12.5X  my admittedly conservative EPS target of $1.80 for 2022, and at the current price the stock should still be OK even if earnings estimates slip by as much as 10%. The $0.23 quarterly dividend is secure and the 4.2% yield will add support. NWL is a buy below $24. My target is $28.50.

Safety Insurance (SAFT) remains a solid pick, although thin trading is making it more difficult for the stock to make a big move. Recent earnings show the company can earn $7.00 a share in a post-COVID environment and valuation is just over 11X this relatively robust result. I think there is a decent chance we could see a strong year-end rally here as small caps bounce after recent selling. SAFT is a buy under $80. My target is $90. The 4.5% dividend yield will add to total returns.

Last month’s pick, Sonoco Products (SON), has been a relatively stable name despite market volatility . . . exactly what I was looking for when I recommended the shares. Earnings growth will accelerate in 2022, with EPS increasing from $3.53 to $3.84 as the supply chain situation improves and price hikes kick in. SON is a buy below $63. My target is $70.