While many investors are finding the start of 2022 painful, Value Authority subscribers are already doing well following a strong 2021. Higher interest rates and slowing growth among tech companies have investors seeking shelter in value stocks like ours.
Given that growth and tech stocks remain overbought and overvalued, with many stocks selling for 100X this year’s EPS estimates or more, I believe the relative outperformance of value can last through 2022.
However, it should be noted that value stocks are not as attractively valued as they were in October. Furthermore, while the rise in interest rates can provide an additional boost to value as money moves out of growth names, the potential for a slower economy from higher rates is not a positive.
This is especially true for bank stocks. While the narrative on financial media is that higher rates boost bank interest margins, at some point the yield curve could flatten, which is the last things banks want. In addition, the higher rates bring added risk to the economy and the potential for greater loan losses.
I have been taking profits in fully valued names in the rally. We want to take risk off when the market mood weakens, not take it on.
After all, there will be better opportunities to buy these or similar stocks at lower prices sometime this year. Meanwhile, I think our remaining names have good upside potential.
We have entered a Fed tightening cycle, which is often a tricky time. However, by keeping our discipline, I am confident we can preserve and add to our gains made since 2018.
PAHC: Fallen Angel With Turnaround Prospects
Phibro Animal Health (PAHC) develops and manufactures products that maintain and enhance the health of livestock, such as poultry, beef and dairy cattle, and swine. The company sells more than 1,625 products to 3,725 customers in 80 countries. The company’s customers include livestock producers, farmers and veterinarians.
Phibro divides its operations into three segments:
Animal Health sells antibacterials, anticoccidials that stop the spread of parasites, nutritional specialty products and vaccines. This segment accounted for 66% of sales and 83% of operating income in fiscal 2021.
Mineral Nutrition sells trace minerals including zinc, manganese, copper and iron used to fortify animals’ diets. This segment accounted for 26% of sales and 11% of operating income in fiscal 2021.
Performance Products is a small segment that makes industrial chemicals and personal care products for human consumption. This segment accounted for 8% of sales and 6% of operating income in fiscal 2021.
Phibro had its IPO on April 10, 2014, at $14 a share. The stock initially did very well, reaching a peak of $54 in July 2018. Some had envisioned PAHC as a potential growth company, as demand for additional meat from Asian countries with a growing middle class would benefit the overall veterinary space. However, the growth story did not materialize and the stock retreated.
Even so, while Phibro is not growing at fast rates, it has realized consistent earnings, and it is now attractively valued at 16X a reasonable estimate of $1.32 for the June 2021 fiscal year.
Furthermore, there are some encouraging signs that anticipated growth will start to kick in now. Revenue in the first quarter of fiscal 2022 was strong at 10.2% expansion, driven by a strong market for vaccines as well as demand for cattle and poultry products in foreign markets
While EPS after adjustments declined in the quarter 8% (reflecting supply chain costs and increased investments for future growth), the company has started to implement price increases and surcharges that will boost profitability in fiscal 2022 from the $1.27 per share earned last year.
Another potential source of growth will come from the company moving into the domestic pet care market. Phibro recently introduced Rejensa, a supplement to improve animal joint health. The company feels that the product can be a big winner, with an active ingredient (Gluco Blu) that has proven superior in tests to current products that use glucosamine, the traditional active ingredient used in the market leader. Cosequin.
Shares of PAHC have done well since my recommendation. The next catalyst could come from fiscal second quarter earnings that will be released on February 9. Expectations are for flat EPS of $0.34 on a 5% increase in revenue as higher costs from increased wages and supply chain issues will limit margin expansion. However, given the top-line momentum, I feel the numbers have a chance to surprise to the upside. Keep in mind the stock traded as high as $31 on July 1, so I believe even a minor surprise on the upside could bring a major lift here.
In summary, I think Phibro Animal Health has good risk/reward characteristics at the current price. The stock sells close to a 20% discount to a market P/E, top-line trends are good and price pressures impacting earnings will subside. PAHC is a buy below $20.50. My target is $25.
Position Review
3M (MMM) will report earnings in the final week of the month. Expectations are for EPS of $2.02 vs. $2.38 on flat revenue . . . difficult comparisons from a year ago on the top line, while inflation pressures hit the bottom line. However, results should improve throughout 2022 as higher costs are amortized and management achieves some price increases. I believe the company can earn $10.20 a share in 2022, up from an expected $9.87 last year. As confidence in the outlook for 2022 grows, I expect 3M to achieve my $200 target. 3M is a buy below $175. The 3.2% dividend yield adds to the attraction of the shares.
Cognizant Technology Solutions (CTSH) will report earnings in the first week of February, with expectations for EPS of $1.03 vs. $0.67 on 14% revenue growth. Comparisons to last year are very easy due to a complicated project that had to be abandoned last year. The stock has been a strong performer recently, aided by strong results from competitor Accenture (ACN), which benefitted from clients’ digital transformation. CTSH touched my $90 target briefly before pulling back. However, I want to wait until earnings before recommending an exit. If it appears the company can earn $4.50 a share this year and $5.00 in 2023, I believe the stock can surpass my $90 target. Hold CTSH into earnings, and I will then advise you of our next step.
Fidelity Information Services (FIS) will likely report results prior to out next issue. Expectations are for EPS of $1.92 vs. $1.62 on a 12% gain in revenue, as strength in consumer spending should translate into more transactions for the company to process. However, the question facing the stock is not the state of current operations, but whether competition from “buy now pay later” and new payment systems will cut into the company’s credit card business. On the last earnings conference call, management made a strong case how they are needed in the financial ecosystem, and I would expect similar comments in the upcoming call. The stock has been acting much better this year, and I continue to believe the competitive threat to credit cards is overblown. FIS is a buy below $125. My target is $140.
Fulton Financial (FULT) will report EPS sometime next week, with expectations for EPS of $0.37 vs. $0.30 on a 1.8% increase in revenue. This will likely be the last quarter Fulton benefits from the release of loan loss reserves accrued for the anticipated impact of COVID on the economy, so earnings could vary based on the amount of reserves released. Without the benefit of reserve releases, FULT could earn $1.30 per this year and $1.40 in 2023. The stock is at my $18.50 target, and there is a chance I could recommend sale before next week’s earnings. With momentum strong for banks, hold FULT for now.
Johnson & Johnson (JNJ) will report earnings on January 25, with expectations for EPS of $2.12 vs. $1.86 on a 12% gain in revenue. It should be noted that some of the rise in revenue will come from COVID vaccines, which the company does not consider profitable. However, business should be strong across all three of the major segments. Growth in Pharma will be led by Stelara and Darzalex, while Medical Instruments should get some help from less restrictive COVID policies in hospitals compared to a year ago. JNJ has done very well since my recommendation and pharma stocks have been in demand. While the stock still sells below its 2021 highs, I think can continue to push higher. Buy JNJ under $162. My target is $180.
Molson Coors Beverages (TAP) will report earnings in mid-February, I will have an update in next month’s issue. The stock has been doing well lately, as supply chain and cost inflation concerns which have been holding it back evaporate in the face of steady market share and strong cash flow . . . which management has used to lower debt. At just 12.5X this year’s EPS estimates, I believe there is further upside. TAP is a buy below $50. My target is $57.
Newell Products (NWL) will also report earnings in mid-February and I will have an update in next month’s issue. The stock has been weighed down by supply chain concerns and the likelihood of slower unit sales growth. However, at just 12.5X this year’s EPS estimates, a 4% dividend yield provides is a strong margin of safety in the shares. Any earnings disappointment will not be punished too severely. The company has put price increases into place that will help offset the cost issues. Buy NWL under $24. My target is $28.50.
Sonoco Products (SON) is slightly off its recent best levels, which perhaps reflects concerns that higher interest rates will slow the economy and reduce demand for packaging products. However, I want to stick with the shares of this high-quality company as I still expect good earnings growth this year, driven by higher prices and an improved supply chain situation. SON is a buy below $63. My target is $70.