Still Like Value at This Time

The first eight months of the year were not kind to value stocks.

The Russell 3000 Value Index has only returned 5.04% year-to-date, and that is not enough to erase last year’s 8.04% loss. Outside of energy stocks, which have outperformed strongly over the past two years, returns for value stocks were considerably worse. On the other hand, growth stocks have had a banner year so far, with the Russell 3000 Growth Index up 30.6% this year.

This year’s underperformance of value stocks can be traced to two factors. First, there has been a lot of excitement surrounding Artificial Intelligence (AI), which has driven technology stocks’ strong performance year-to-date. Second, while the economy is still sound, there remains an underlying fear that the Federal Reserve’s tightening will eventually cause a recession. And this fear has driven weakness in economically sensitive sectors that tend to be value-oriented stocks.

Now, I realize these market dynamics have been frustrating for you and your fellow Value Authority subscribers. But the good news is that I believe relief may be coming soon.

Many value stocks, including those in our Buy List, have already discounted lower earnings estimates, and a mild to moderate recession could provide a relief for value stocks, as it would take an element of uncertainty out of the way. A recession would also likely pave the way for the Fed to cut rates, which would be a major plus for value stocks, especially the ones with attractive dividend yields.

Of course, we may not have a recession next year. If this becomes clear, traders could still regain interest in value stocks. The fact is that many growth names, especially the megacap ones, are extended technically, which makes value stocks’ valuations even more attractive.

Overall, I cannot say that value stocks will do well in any market or economic scenario. However, I can say with a good deal of confidence that the odds for a better performance than we have seen in most names over the past two years is pretty high. The high dividend yields on the majority of our stocks can help us be patient while we wait for the inevitable recovery to begin.

KHC: Stable Cash Flows Will Drive Performance

Back on September 5, we added The Kraft Heinz Company (KHC) to the Buy List.

The company was formed through a merger between Kraft Foods Group Inc. and H.J. Heinz Holding Corporation in 2015. The new entity became the fifth-largest food company in the world and the third-largest in the U.S. In addition to the iconic Heinz Ketchup, Kraft Cheese, Kraft Macaroni and Cheese and Philadelphia Cream Cheese brands, the company also controls brands such as Oscar Mayer, Jell-O, Kool-Aid, Lunchables and Grey Poupon.

Now Kraft Heinz struggled immediately following its formation. Due to the merger, the company had too much debt, and the situation was only made worse by acquisitions. There was even the bizarre situation where the company attempted to acquire Unilever (UL), which is a considerably larger company. Although the attempts to buy Unilever were abandoned, it was an initial distraction for the newly formed Kraft Heinz.

As a result, earnings declined with EPS falling from $3.48 in 2018 to $2.85 in 2019. So, the company decided to make a change in leadership, appointing Miguel Patricio, who was previously head of InBev’s Special Global Products. Mr. Patrico sought to streamline the company by selling non-core brands, including the sale of the Planters nuts business in 2021.

Mr. Patricio’s efforts have had mixed success. He was able to greatly reduce the company’s debt burden, which fell from $27.5 billion (net of cash and investments) at the end of 2019 to $19.0 billion currently. However, the divestitures were dilutive to EPS, and lower interest expense and attempts to grow remaining brands could not compensate. The company only earned $2.78 a share last year, little changed from 2019.

However, through the first six months of this year, the company has benefitted from food inflation. EPS has risen from $1.30 in the first six months of 2022 to $1.48 in the first six months of 2023. Sales rose 4.9% due to price increases. Interestingly, sales growth slowed to 2.6% in the second quarter, with volumes down 7% as consumers sought alternatives due to the company’s price increases. While consumers are pushing back and the company faces tough comparisons in the second half of the year, I believe the company can reach the high end of its EPS guidance for $2.83 to $2.91 in 2023.

On January 1, 2024, Carlos Abrams Rivera, head of the Company’s North America operations, will take over as CEO, with Miguel Patricio becoming the Chairman of the Board. I take the management change as a sign the company is through with the divestitures, and it will now focus on growing brands and, at the same time, continuing to reduce debt.

While the largest benefits of price increases are behind the company, the ones put into place along with lower interest expenses should allow the company to earn $3.00 a share next year. I do not think the new leadership will produce significant volume growth, but KHC has great brands and cash flow should remain stable. The stock is too cheap at 11X next year’s EPS, with a dividend yield of close to 5%. Down from a high of $42 earlier in the year, the stock is close to a bottom. KHC is a buy below $35. My $40 target is just over 13X next year’s EPS estimate.

Position Review: Shares Set to Recover

Brady Corporation (BRC) has held onto most of its gains since reporting strong earnings on September 5, which we reviewed in our note last week. With near-term earnings visibility good as the company continues to introduce new products, Brady shares should continue to outperform. BRC is a buy under $52. My $62 target is only 15.5X EPS estimates for the July 2024 fiscal year.

Fidelity National Information Servies (FIS) has given up most of its post-earnings gains. However, I think the sale of the company’s Worldpay Merchant Solutions business will put a floor under the stock close to its current prices. Cost controls in the Banking Solutions segment will raise margins, and earnings and the stock price should move in the right direction by next year. FIS is a buy below $60. My target is $72.

Since our last issue, shares of First Busey (BUSE) have weakened, as they’ve been hurt by lowered credit ratings for regional banks and the overall weak market. However, First Busey is in a strong financial position, with a Tier One Common Equity ratio at 12.35%, and a strong deposit base. Its conservative lending strategy should also help if hard times hit the economy. Trading at only 10X next year’s EPS estimates, which assume higher credit losses and additional credit losses, and a dividend yield of 4.8%, the stock is a bargain. BUSE is a buy below $20. My target is $25.

Honeywell (HON), our new pick last month, has moved lower with the market and weakness in the industrial sector. However, the company should continue its historical steady growth in sales and earnings, which will lead to a higher stock price. At 18.5X next year’s EPS estimate, the stock sells for less than many of its industrial peers and is a solid value. HON is a buy below $200. My target is $220.

Newell Brands (NWL) could not follow through on its gains following better-than-expected second-quarter earnings, as concerns persist about the durability of consumer spending. However, NWL has returned to profitability as customers have worked off their excess inventory, and I believe it should stay there. I am also excited about management’s plans to concentrate marketing dollars in areas that have the most promise. EPS estimates of $1.10 for next year may have to be trimmed if consumer spending rolls over, but even if the company only earns $0.80 to $0.90 next year, the stock is cheap. NWL remains a buy below $10. My target is $16.

Occidental Petroleum (OXY) has traded steadily since our last issue, as Saudi Arabia’s decision to extend production costs has kept oil prices elevated. The shares are a good value at 12X next year’s EPS estimates, which does not assume oil prices will go above current levels. Good, low-cost production growth from the Permian Basin will fuel EPS gains for OXY over the next several years. OXY is a buy under $65. My target is $75.

Patterson Companies (PDCO) shares have struggled to regain momentum after reporting fourth-quarter earnings. Results were solid, but investors appeared disappointed that earnings did not have the solid upside of third-quarter results. The stock is reasonably valued at less than 12X the current fiscal year’s EPS, and it has a 3.6% dividend yield. PDCO is a dominant player in dental supplies, and I believe the stock should trade at a higher multiple. PDCO is a buy below $30. My target is $35.75.

Phibro Animal Health (PAHC) shares are trying to stabilize after post-earnings weakness. The departure of CFO Damain Finio should not be a concern to investors, as Mr. Finio has been appointed to a CFO position at privately-held waste company Terracyle. So, his departure was completely voluntary and not a sign of trouble within the company. Phibro is a great value at 10X forward EPS estimates, as demand for its livestock animal health and pet products should remain stable even if the economy comes under pressure. PAHC is a buy below $15. My target is $18.

Sonoco Products (SON) shares continue to be pressured from economic concerns and ongoing inventory reductions at its customers. However, the company is still expected to earn over $5.00 a share this year, with improvement likely next year as customer inventories will be close to normal by the end of 2023. At less than 11X depressed earnings and with a dividend yield of 3.7%, I believe downside is very limited. Buy Sonoco below $60. My target is $70.

I am a little surprised at the way Sysco Corp. (SYY) shares weakened over the past several weeks after reporting what I thought were pretty solid second-quarter earnings. The fact is any stock that has had anything to do with food has weakened recently, and there may be concerns the company could lose pricing power if food inflation becomes food deflation. SYY is now trading at just 14.7X earnings, despite the company’s long-term consistent growth record. That’s a significant discount to the S&P 500’s multiple of 18X. SYY is a strong company financially that delivers high returns on its invested assets, and I am confident the shares will do well over time. SYY is a buy below $80. My target is $72.

WEC Energy Group (WEC) has been under pressure since our last issue, reflecting the weak performance of utilities in general, as well as the fact that the company has an above average number of rate cases in front of regulators. The selling has left WEC attractively valued at 17X next year’s EPS estimates. While dealing with regulators does produce uncertainty, the company’s good long-term growth proves they have been successful with rate cases historically, and I think the movement to alternative fuels will help the company continue to obtain favorable outcomes.  WEC is a buy under $93. My target is $100.