Despite a rally to start July, value stocks remain under pressure, with the Russell 3000 Index down 15.7% year to date.
What makes this particularly frustrating for value investors is the way that growth stocks have shined at the same time, with the Russell 3000 Growth Index up 13.1% year to date. Growth stocks, despite their extended valuations, have come to be considered as somewhat of a safe haven, given the way that they are perceived as having more recession-proof earnings than growth stocks. In addition, the very easy Fed policy has allowed for rampant speculation in growth names in some cases. For example, Tesla (TSLA) currently has an almost unbelievable market capitalization of $254 billion, making it the 16th largest United-States-listed stock. This means that it is roughly the same size as Intel (INTC), even as TSLA has struggled to achieve profitability.
This level of outperformance from growth stocks is unsustainable. I am hoping that a catalyst for change will come in the form of the upcoming earnings season. There is still a good deal of skepticism about the earnings outlook for most companies, given the recession and ongoing battle with COVID-19. However, weak earnings results are already priced into a lot of stocks, and time is the friend of the value investor here. This is because both the economy and the COVID-19 situation should improve over time. Meanwhile, many growth and technology stocks will also be impacted by the economy and COVID-19, even though no disappointment is priced into their shares. Second-quarter earnings will likely be a reality check for many growth stocks, and I believe that certain disappointments could shift the flow of investable funds away from growth stocks and back to value names.
I feel very comfortable with our current buy list. Our companies are financially sound, and most of them pay very good dividends. These factors will allow our stocks to remain relatively stable until the inevitable improvement in business conditions and investor sentiment towards value takes place. This will allow them to enjoy solid gains. So, while the current situation with value stocks is frustrating, I expect a reversal soon.
Solid Utility Offers Yield and Upside
Public Service Enterprise Group (PEG) is a diversified utility that primarily consists of two businesses.
The biggest one is PSE&G, a regulated utility that distributes electric energy and gas to about 70% of New Jersey’s population. Investments in modernizing the grid and clean energy should drive future rate base growth of 6.5% to 8%, which, in turn, will drive earnings growth as the company gets a set regulated return on these assets.
The second business is PSEG Power (notice the different spelling, this is not an error), a non-regulated, power generation company that produces electricity by operating nuclear, gas, oil-fired and renewable generation assets. PSEG Power serves three markets in the Northeast, with key assets close to power-loading centers. Extensive use of hedging strategies has shielded the company from volatility in commodity prices and has helped keep gross margins and cash flows stable.
In 2019, PSE&G accounted for 76% of PEG’s operating income, PSEG Power accounted for 23% and other operation accounted for the remaining 1%. This solid business mix and efficient operations has allowed the company to realize stable earnings growth over the year, with earnings per share (EPS) increasing from $2.76 in 2014 to $3.28 in 2019.
In the first quarter of 2020, EPS declined to $1.03 from $1.08, largely reflecting the warm winter weather in New Jersey as well as weakness in demand in the last part of the quarter due to the economic shutdown. However, the company still maintained its previous EPS guidance of $3.30 to $3.50 a share. While the shutdown will also have an impact in the second quarter, this will be offset by an increase in regulatory assets and cost controls.
My decision to recommend the stock last week was well-timed, as the stock is off to a good start for us. I also believe that there are further gains to come. Public Service Enterprise is still down approximately 16% for the year, despite the fact that the sharp decline in interest rates is normally bullish for utilities. The company’s 3.8% dividend yield is very attractive in light of the 2.6% yield offered on low investment-grade corporate bonds.
I believe that the COVID-19 fears that are priced into the stock are overdone, and the company still should have a solid performance in the rest of 2020 because New Jersey’s economy is reopening. PEG is a buy below $50. My target is $56, which is where the stock traded as recently as early June. With the number of COVID-19 cases in New Jersey still on the decline, my target has a chance to be achieved relatively quickly.
3M (MMM) will report second-quarter earnings before the market opens on July 28. Expectations are for EPS of $1.77 vs. $2.13 on an 11.5% decline in revenues. Given that the company has already reported sales for April and May, I believe the actual results should be close to estimates. 3M continues to look good in the long-term as it is a steady industrial company that has both good cash flows and the capability to earn close to $10 a share post-recession. Buy 3M under $150. My target is $170. The 3.7% dividend yield will add to total returns.
Cognizant Technology Solutions (CTSH) will report second-quarter earnings sometime in the last week of July. Expectations are for EPS of $0.69 vs. $0.94 on a 7.8% decline in revenue. While the current quarter will be impacted by lower demand and higher costs due to COVID-19 and a recent ransomware attack on the company’s clients, this quarter will represent a low point. Results will stabilize through the end of the year. Under the surface, new services and business wins are preparing Cognizant for a much better 2021. Given the likely stabilization of results and the good chance that the company will earn close to $4 a share next year, I am raising my buy-under price to $60 and my target to $80.
Genuine Parts (GPC) will report second-quarter earnings before the market opens on July 30. Expectations are for EPS of $0.84 vs. $1.57 on a 13% decline in revenues, as the shutdown of the economy and a big decline in the number of miles that were driven had a significant impact this quarter. However, with economies starting to reopen, and with another complete lockdown unlikely, even with the recent increase in the number of coronavirus infections, results should improve from here. I am looking for EPS to improve from $4 this year to more than $5 next year. This should support my $100 price target. GPC is a buy below $85.
HP Inc. (HPQ) will report earnings sometime in late August as its fiscal third-quarter concludes at the end of July. Based on commentary from semiconductor companies, I believe that personal computer (PC) demand remains good, and the company should have a decent quarter. The investment idea behind HPQ is that the company’s businesses are much more resilient than the market believes that they are. The stock is also incredibly cheap at 8.5X this fiscal year’s earnings estimate and sports a 4.1% dividend yield. Buy HPQ under $19. My target is $23.
Ingredion (INGR) will report second-quarter earnings no later than the first week of August. Expectations are for EPS of $1.35 vs. $1.66 on a 3.7% decline in revenues, with the weakness primarily reflecting softness in the food service business due to the COVID-19 shutdowns. However, I look for the company to continue its recent trend of having better-than-expected results, and the recent weakness of the dollar could help INGR beat expectations again. With EPS for the year still likely to be over $6 a share despite the COVID-19 issues, the stock remains attractively valued, especially considering the very low interest rate environment. Continue to buy INGR under $90. My target is $105.
MSC Industrial Direct (MSM) will report earnings this coming Thursday, July 8. Expectations are for EPS of $1.13 vs. $1.45 on a 6% decline in revenues. The sales of janitorial products helped damper the impact of the economic shutdown over the course of the quarter. If the company achieves these estimates, and they should with the revenue numbers that have already been released, I think that this is a good result when we consider the shutdown. This result also speaks to a good future for the company. Ongoing margin enhancement efforts will also aid the company in the long term. The shares are close to my $75 price target. Hold MSM in front of earnings. I will let you know our next step after earnings are reported on Thursday.
Old Republic (ORI) will report earnings in late July, with expectations for EPS of $0.40 vs. $0.45 on flat revenues, with higher operating expenses cutting into profitability. While the quarter should see a sharp rise in ORI’s book value, we need to keep in mind that quarterly operating results for insurance companies are volatile due to the uncertainty of the level of claims in a quarter. However, ORI is an excellent manager of long-term risks, and its sound underwriting practices will add value over time. Thus, there should be a sharp rise in book value this quarter to around $19 a share due to the strong stock market. The shares of this quality company are a great value at 84% of this projected book value. Old Republic is a buy below $18. My target is $22.
Universal Health Services (UHS) will report second-quarter earnings sometime in the last week of July. EPS expectations are in a very wide range that runs from $1.89 to a loss of $0.26, vs. $2.76 last year, because COVID-19 has thrown a lot of uncertainty into the quarter. While I believe that the company should earn at least $0.50 a share in the current quarter, I am somewhat concerned about the third quarter as Texas, an important state for the company, has decided to suspend non-emergency procedures again. However, while the rest of the year could be rocky for UHS, I expect the company to earn at least $4 a share this year, with a good chance to improve to $10 a share next year as the fear of the virus should fade. My new buy under for UHS is $100. My target is now $120.
Valvoline (VVV) will report third-quarter earnings in the last week of July. Expectations are for EPS of $0.23 vs. $0.37 on a decline in revenue of close to 20%. However, as we discussed in last month’s issue, the company gave a mid-quarter update, which showed that trends were improving dramatically. I believe that EPS for 2021 should be at least $1.25 vs. the $1.39 the company earned last year. Despite the strong bounce of its lows, the stock remains cheap and I look for more upside. I am raising my buy under price for VVV to $19. My target remains $24.
New Kramer Capital Report: Breakout consumer brands are often born in periods of disruption and I’ve spotted a start-up company reporting truly stunning growth numbers despite the pandemic. While it doesn’t work with our short-term options strategy here, I wanted to make sure you have all the data you need to get in on your radar now. Click here to download it.
Join me at the MoneyShow in Las Vegas on Tuesday, August 16, for my special presentation Building Wealth with Stocks and the Master Class Value Investing with a Growth-&-Income Twist. Register at Kramer.MoneyShow.com. The event will take place at Bally’s and the Paris right on the Strip. I hope to see you there!