While the S&P 500 and NASDAQ have already made several new all-time highs in 2020, the Russell 3000 Value Index is barely higher on the year.
While the Federal Reserve will provide plenty of market liquidity since it will continue its repurchase agreement program through at least April, the liquidity is going largely into growth names. In the meantime, value stocks seem to have discounted all the potential risks from the coronavirus and the tepid global economy.
In addition, value-oriented segments have to deal with their own specific issues. Financials have been hurt by the flattening of the yield curve, while the energy sector has sold off sharply with the decline in oil prices since December.
Unfortunately, this is not a new phenomenon. Since January 31, 2018, The Russell 3000 Value Index has returned 5.55% a year, while the Russell 3000 Growth Index has returned 15.26% per year. Since the momentum that growth stocks have builds on itself, money managers feel obligated to participate. If they do not, they run the risk of underperforming their benchmarks.
While I cannot say for sure when the underperformance in value stocks will end, I believe it will be sooner rather than later. Most growth stocks, including the high-flying software names that have driven much of the rally, are discounting several years of rapid growth in earnings that, in all likelihood, will never happen, given their total addressable markets.
Meanwhile, most of my recommended Value Authority companies trade at modest multiples of 15X earnings per share (EPS) or lower. They also have generous dividend yields and reasonable growth prospects. All that is needed to get things going in the right direction for value stocks is some type of catalyst. I think that will come when there is more evidence that the coronavirus will not turn into a global pandemic and that there is no recession on the horizon.
At that point, long-term interest rates will rise, oil prices will recover and the trading patterns we have seen since the start of the year will reverse themselves. In the meantime, stay patient and stick with our names. I have a high degree of confidence that they will be trading meaningfully higher by the year’s end.
Carnival Corp.: The Rough Seas Will Calm
Carnival Corp. (CCL) refers to itself as the world’s leisure company as it operates 104 cruise ships that carried 12.9 million guests in 2019. In addition to the Carnival name, the company operates under well-known U.S. brands such as Princess, Holland America, Seabourn and foreign brands such as Costa (Italy), Aida (Germany) and P&O Cruises (the United Kingdom and Australia).
I believe that the recent selling in the stock will give investors a good chance to invest in a growing company that is part of a growing industry at a favorable price. According to the Cruise Lines International Association (CLIA), the number of cruise passengers grew from 17.8 million in 2009 to an estimated 30 million last year, representing an annual growth rate of 5.3%. The growth has been driven by the good value that cruises offer consumers, along with the recent trend of consumers choosing to spend more money on experiences rather than on things.
Carnival, as the leading player in the industry, has been a benefactor of this growth, with revenue increasing from $15.4 billion in the fiscal year that ended in November 2012 to $18.8 billion in the year that ended in November 2018. EPS over the same period increased from $1.87 to $4.26, as gross margins expanded on lower oil prices, a more efficient fleet and increased sales of higher margins for onboard services.
The company did stumble slightly in fiscal 2019. Revenues increased by 10% to $20.8 billion, but EPS gains lagged as they increased only slightly to $4.40 a share. Higher cruise operating expenses, weak results in Continental Europe and Alaska that were caused by industry-wide overcapacity issues and political and weather events that caused the cancellation of several cruises all contributed to the weaker-than-expected profitability for the year. At its lowest point, the stock fell roughly 33% from where it started the fiscal year.
However, the company did end the year strongly, with fourth-quarter earnings beating expectations by $0.12. News about fully booked occupancy for 2020 allowed the stock to start the year at record levels, and the stock rallied briskly until news of the coronavirus hit. While the virus likely ended what was looking like a strong year for the company, I still strongly believe in CCL’s long-term trajectory as cruise traffic should continue to increase as more people retire and have more leisure time. The company will also continue to launch more efficient ships and find ways to improve profitability per customer.
With China only 5% of CCL’s capacity, the coronavirus crisis is manageable. The stock is also very cheap in a market where many stocks are extended. While there may be some headline risks ahead, they should pass over in the next few months. Buy CCL under $44. My target is $50. Also, keep in mind that the stock traded at $52 before the coronavirus news came out. The 4.7% dividend yield will add to total returns.
Position Review
Chevron (CVX) had a nice bounce off of its lows after the price of oil stabilized. While I believe the stock may not be able to sustain a rally until there is more evidence that the coronavirus is controlled (which will help get the price of oil out of its current slump), the stock is very cheap right now. A meaningful rally should occur at some point this year. Buy CVX under $115 as I target $125.
Cognizant Technology Solutions (CTSH) has held onto most of the gains it made following last week’s earnings report. While the company still has some work to do in order to gain the market’s confidence that it can be a consistent upper single-digit-percentage EPS grower, the progress that the company is making under CEO Brian Humphries is being noticed. Buy CTSH under $66.50. My target is $79.
General Mills (GIS) will not report earnings until March, as its fiscal third-quarter ends on Feb. 28. The stock has not moved much, but with unit volume returning last quarter, the shares are very attractively valued at a little over 16X forward EPS estimates. GIS also has a 3.2% dividend yield. Continue to buy GIS under $54. My target is $60.
Genuine Parts (GPC) will report fourth-quarter results before the market opens on Feb. 19. Expectations are for EPS of $1.30 vs. $1.35 on a 1.8% increase in revenues to $4.7 billion, as the company continues to feel the impact of rising freight and wage costs. However, these pressures should ease this year. Furthermore, when GPC reports, everyone’s attention will not be on its fourth-quarter earnings.
Rather, investors want to know how much the warm winter will hurt GPC’s first-quarter results. While some reduction of the current first-quarter earnings estimates is likely, I do not think it will be overly severe. EPS estimates for the whole of 2020 will likely fall to $5.75 from $5.90. Considering its historically stable results, the stock remains a strong value with this level of earnings, and the 3.2% dividend yield should also provide support. GPC is a buy below $100. My target is $110.
The Cheesecake Factory (CAKE) will report earnings after the market closes on Feb. 19. Expectations are for EPS of $0.60, with a 20% increase in revenues reflecting the recent acquisitions of North Italia and Fox Restaurant Concepts. Recent price increases will also add to the top line, but they may be offset by weak traffic as many mall-based retailers struggled this past holiday season.
CAKE shares have been volatile in a narrow range, but there seems to be an underlying bid in the shares as they are trading at only 14X EPS estimates and offer a 3.5% dividend yield. If fourth-quarter results can ease the concerns about traffic trends, the stock will do well. As a result, I believe that The Cheesecake Factory offers a superior consumer value proposition that will continue to drive customers to the restaurant. This should allow the company to achieve long-term success despite the pressure on malls. CAKE is a buy below $41. My target is $46.
Ingredion (INGR) reported fourth-quarter earnings this morning. EPS of $1.61, flat from the prior year, was $0.12 better than expectations. However, most of the upside to the estimates was provided by a lower-than-expected tax rate and share buybacks. Operating income declined 5% on an expected 1% sales increase, as currency issues, weakness in South American markets and the China trade situation all weighed on results.
The company guided for 2020 EPS in a wide range of $6.60 to $7.20, versus expectations of $6.89 per share and the $6.65 per share that was earned in 2019. With currency and commodity prices less of a drag and with continued benefits of share buybacks in place, I believe $7.00 per share is a realistic estimate for the year. At 15X this estimate, I also believe that my $105 target is achievable. Buy INGR when it sells below $90.
Since going ex the special $5.00 a share dividend on Jan. 21, MSC Industrial Direct (MSM) has weakened due to global economic concerns. I still believe that the industrial economy and the outlook for MSM will both improve as the year goes on. With the shares just trading at 14.5X the current fiscal year’s EPS estimates and sporting a 4.2% dividend yield, MSM has room to run on the upside. The company is a buy below $73. My target is $83.
Despite reporting good fourth-quarter results, Valley National (VLY) has declined so far this year, as long-term interest rates have dipped largely due to fears of a global slowdown following the outbreak of the coronavirus. However, Valley National’s fourth-quarter earnings have showed that the company should be able to manage the flattening yield curve. Meanwhile, loan growth remains strong and VLY continues to benefit from its cost efficiency program. EPS should be close to $1.00 a share this year, and I continue to recommend the shares below $10.50. My target price is $12.50, with the 4% dividend yield adding to total returns.
Valvoline (VVV) has given up some of its post-earnings gains from last week. However, at roughly 15X fiscal September 2020 EPS estimates, and with the company still enjoying good growth from Quick Lube, I still see strong value and upside potential in the shares. Buy VVV under $22.50 as I target $26.