Some Clouds, But Value Looks Good Right Now

November, so far, has been a continuation of what we’ve seen happening in the market and economy in recent months. Long-term interest rates are close to their recent highs, with the 10-year Treasury near 4.2%. The Federal Reserve raised key interest rates by another 75 basis points, and Fed Chair Jerome Powell indicated the tightening cycle still has further to go.

Yet, despite all this, value bulls are trying to make a stand.

In fact, economically sensitive stocks, like banks, energy and industrials, have been bid higher on hopes that decent earnings growth can continue into 2023. While we’re all pleased to see these stocks start to climb higher, there are some question marks behind this logic.

Many of the companies with good earnings saw their results improve strictly due to price increases. A good example of this is United Parcel Services (UPS), which reported an increase in revenues and earnings despite lower shipment volumes.

In addition, there are signs that the Fed’s tightening is starting to take a bite out of the economy. As an example, auto retailers had generally sluggish unit sales, as rising loan rates make cars less affordable. A decline in used auto prices is also a threat to the economy, with banks potentially experiencing losses from recent buyers whose cars are now worth less than the amount left on their loans.

Still, we cannot ignore this rally right now, as it may have further to rise. The fact is that any signs that inflation is starting to slow, which could happen as early as Thursday’s CPI report, will shift the market into another gear higher.

Plus, most of our stocks are still cheap, some ridiculously so, even with the recent market rally. I think many of our current positions are just one good earnings report away from a big rally. We actually saw this recently with Universal Health Services (UHS), which is up about 25% since its quarterly report. I feel big moves like this can happen with the other depressed names on our Buy List.

Now, there could come a time to be a little more cautious and trim some names as we enter 2023. But, for now, I think we should see our names continue to move nicely higher.

USB: Cheap with Good Earnings Momentum

U.S. Bancorp (USB) is a “super regional” bank holding company with more than $600 billion in assets, which makes it the fifth-largest bank in the U.S. in terms of asset size. The majority of its more than 3,000 branches are located in 25 states in the Midwest and West and operate under the name U.S. Bank. USB has several diversified lines of business:

  • Consumer and Business Banking (28.5% of net income in 2021): Accepts deposits and provides loans and other banking services to individuals and small businesses.
  • Corporate and Commercial banking (24%): Offers lending, leasing and Treasury services to mid-market companies and large corporations.
  • Payment Services (21.6%): Provides credit and debit cards to individuals and businesses, as well as Treasury services to larger businesses.
  • Wealth Management and Investment Services (11%): Offers investment advisory and retail brokerage services, and private banking services to wealthy individuals.
  • Treasury and Corporate Support (19%): Focuses on incomes from the company’s investment portfolios, interest rate management activities and tax advantaged projects.

In the third quarter of this year, interest income, net of bad expense, accounted for 58.3% of the company’s revenues. Other services, outlined above, contributed the remaining 41.7%.

We added USB to the Buy List earlier this month because the stock does not trade far from where it did in the middle of last decade. However, its earnings power is much higher now (total loans of $337 billion currently as opposed to $254 billion at the end of the third quarter of 2015), and the company has not had any significant credit issues since the financial crisis.

Concerns about a potential recession are the reason for the current depressed stock price, with the stock down from its January high of $63.57. However, I believe a mild to moderate recession, which may trim annual EPS by $1.00 a share, is largely discounted in the current stock price.

Meanwhile, the company is benefitting significantly from the higher short-term interest rates that have been engineered by the Federal Reserve this year. Net interest income of $3.8 billion in the third quarter was up 20.5% from the third quarter of last year and up 10.2% from the second quarter this year. With rates going higher, and the company’s loan balance up 15% from the prior year, net interest income is also poised to move higher.

Higher net interest income, along with stable results in the company’s other businesses, will likely allow EPS to move higher in coming quarters. From a base of $1.16 in the current quarter, which included a $362 million provision in loan losses, EPS between $4.80 and $5.00 next year appears to be very realistic, even if credit costs continue to rise. At just over 8X expected EPS, with an attractive dividend yield of 4.5%, the stock is a solid buy here.

Overall, USB is well-run bank with a strong franchise in the markets it serves. The stock has not bounced as strongly as other banks in the recent market rally, which I attribute to the company being unable to buy back stock for the next year due to its pending acquisition of California based MUFG bank for $8 billion. However, I do not view this as an intermediate- to long-term restriction on stock performance. USB is a buy below $44. My target is $49.

Position Review: Our Stocks Bounce Post Earnings

Many of our Buy List positions have announced quarterly results recently. If you missed any of these reports, there is a recap of all of the earnings reports discussed below in the Alert Archive.

Cognizant Technology Solutions (CTSH) shares are trying to rally after last week’s sharp earnings-related decline. The stock is down 40% this year after a 4% decline in earnings estimates for 2023, which to me seems excessive. Management increasing the amount of the shares buyback by $2 billion shows they believe the stock is cheap as well. The company is working to fix the staffing shortage that caused estimates to go down, and I believe the stock is poised to bounce back strongly next year. CTSH is a buy below $60. My target is $70.

Fidelity National Information Services, Inc. (FIS) bounced back strongly following Thursday’s sharp decline after the company reported third-quarter earnings. The company is expected to earn well over $6.00 a share next year, so the current depressed price makes little sense to me. Incoming CEO Stephanie Ferris should do what she can to get the company back on track, including scaling back new businesses pursued by her predecessor. The company is not losing share to new payment systems, and once investors recognize this, the current PE multiple of only 10X forward earnings should expand nicely. FIS is a buy below $80. My target is $100.

First Busey (BUSE) has continued to do well post earnings. Between now and year end, there is a good chance the stock will get close to my $29 target, and then we will decide our next step. Only buy BUSE on market corrections that send the stock below $24.

HP Inc. (HPQ) will report fiscal fourth-quarter EPS on November 22, with expectations for EPS of $0.84, vs. $0.94 last year, on an 11.3% decline in revenues. These estimates may be a little too high, as the PC market may have worsened since HPQ gave guidance following the release of fiscal third-quarter earnings. However, the stock is cheap even if guidance for 2023 comes in 20% below current expectations of $3.70.  HPQ has served as a haven for investors seeking relief from slowing growth of former highfliers, and I think this trend can continue. Buy HPQ below $26.50. My target is $32.

Lowe’s Companies (LOW) will report fiscal third-quarter earnings on November 16, with expectations for EPS of $3.09, vs. $2.73 last year, on a 1% gain in revenues. Margins should be relatively stable as LOW is able to pass cost increases onto consumers, and EPS will rise on a reduced share count. The real question facing LOW is how the slump in existing home sales will affect earnings in the January 2024 fiscal year. While current EPS estimates of $14.42 following $13.52 this year may be too high, continued buybacks should enable LOW to earn at least $13.75. We also need to keep in mind that homeowners may decide to remodel rather than buy another home, which would help LOW in a protracted housing slump. At 13.2X my conservative estimate, the stock has a strong margin of safety here.  Buy LOW under $215. My target is $260.

Newell Brands (NWL) has become a bit of a “show me” story after the company reported third-quarter earnings. It may take two quarters for inventories to be reduced at retailers, which will hurt NWL’s near-term results. However, NWL still owns many good brands, and the streamlined operations put in place by CEO Ravi Saligram since he took over in 2019 will help the company eventually get back to last year’s EPS of $1.82 a share. NWL is a buy below $16. My target is $22.

Old Republic (ORI) continues to trade firmly after earnings. If we do have a typical year-end to early January rally in small-cap stocks, the shares should move closer to my $27 target. The fact is the company has the ability to earn $2.50 a share per year even with the title insurance business slumping with the housing market. Once the Fed decides to stop raising rates, the 4.0% dividend yield on ORI will be increasingly attractive. Buy the stock below $24. My target is 27.

Omnicom Group (OMC) trended higher following its earnings report. While the stock has done well for us, I believe it can go much higher as the market does not fully appreciate the changes the company made in its portfolio of businesses. A slower economy is a risk for the shares, but downside is limited at only 11X forward estimates. Buy OMC below $70. My target is $80.

Phibro Animal Health (PAHC) will report fiscal first-quarter earnings after the close tomorrow. Expectations are for EPS of $0.26, vs. $0.25 last year, on a 5% increase in revenues, with the company passing higher commodity prices onto its customers. Despite the pressures from higher commodity prices and a stronger dollar, the underlying business trends of PAHC have been stable. I believe with the stock cheap at 12X this year’s EPS estimates, the stock should rebound nicely with some moderation in inflation likely next year. PAHC is a buy below $18. My target is $22.

I believe the cash flow issues that impacted Sonoco Products (SON) will reverse sometime next year as the company will slowly reduce its inventory build. EPS estimates for 2023 have not fallen significantly after last week’s earnings report. However, even if current EPS estimates of $5.82 for 2023 are too optimistic by 15% to 20%, the stock remains cheap. SON is a buy below $65. My target is $75.

Target Corporation (TGT) will likely report fiscal third-quarter earnings sometime next week, with expectations for EPS of $2.12, vs. $3.03 last year, on a 3% increase in revenue, as the company continues to discount heavily to eliminate excess inventories. Management has been pleased with the success of their efforts thus far, and if the results prove their optimism justified, the stock has higher to go. It has been a rough year for TGT, but store traffic remains strong. I look to stock to move higher, and for us to gain greater clarity if EPS estimates of $12.00 to $12.20 for next year are likely. TGT is a buy below $163. My target is $180.

Universal Health Services (UHS) is off its recent highs, but still significantly higher than the depressed levels where it traded prior to its third-quarter earnings report. I am confident the company has seen the worst of its costs and admissions issues, and EPS should recover next year to $11.25 from $9.90 this year. UHS is a buy below $110. My target is $130.