We Have Traveled a Long Way, but Still Have Further to Go

The Russell 3000 Value Index is now trading above its pre-COVID-19 prices.

Although liquidity from the Federal Reserve and the resulting lower interest rates since March 2020 have surely helped stock investors, most companies’ earnings have held up decently during the COVID-19 crisis. Thus, many companies outside of travel and leisure are expected to report record results this year or by 2022.

We have done well in the rally, with many sizeable unrealized gains among our recommended positions, in addition to a few realized winners, most recently in State Street (STT). I think we can extend these gains.

Although value stocks are not as cheap as they were following news of successful COVID-19 vaccine clinical trials in November, I still do not think they fully reflect the perhaps permanently lower interest rates engineered by the Federal Reserve. The S&P 500 now trades at 23X this year’s earnings expectations, many of our recommended companies, which I believe have growth prospects and risk factors as favorable as many S&P 500 names, trade at much-reduced multiples.

It will not be straight up from here, and we will meet with the occasional pullback. However, I think our Value Authority stocks can do well through year-end. I will also be willing to sell any names that are fully valued and will use the dips as buying opportunities as I seek to offer recommended positions in value stocks that should outperform over a 6-to-12-month period.

GIS — Still a Four-Star General

This is the second time General Mills (GIS) has been on the Buy List in less than a year. I recommended the sale of the stock last March 17, as it was flying higher while the rest of the market was sinking on COVID-19 fears. At the time, I did not think the stock could continue its significant outperformance with better values developing elsewhere. Sure enough, GIS now trades slightly below where it did when I recommended its sale, while the Russell 3000 Value Index is up approximately 40%. Now, I feel the pendulum has swung too far the other way, and GSI is attractive at 15.6X forward earnings per share (EPS) estimates, with a dividend yield of 3.6%. The yield on the dividend is especially attractive when you consider General Mills recently offered 30-year bonds at a rate of only 3.0%. With the company likely to raise its dividend annually, the stock seems cheaply priced compared to the company’s bonds.

General Mills’ product line is well-diversified, with the company owning iconic brands, including Cheerios, Betty Crocker, Blue Buffalo Pet Food, Haagen-Dazs, Nature Valley, Yoplait, Old El Paso and Pillsbury. Sales by product line are Snacks, 20%; Cereals, 16%; Convenient Meals, 16%; Yogurt, 12%; Dough, 10%; Pet, 10%; Baking Mixes, 9%; Super Premium Ice Cream, 4%; and Vegetables, 3%.

Helped by this broad product line, General Mills has realized consistent results in recent years while many other food companies have struggled with changing consumer tastes and the introduction of many specialty brands. EPS increases from $2.99 a share in the May 2016 fiscal year to $3.61 in the May 2020 fiscal year.

The current year has been exceptionally strong due to the pandemic, which has led to more at-home eating. Through the first six months of fiscal 2021, sales have increased 8% and EPS gained 21%. Yet, the pandemic-driven strong results will lead to difficult comparisons by the fourth quarter. However, given less promotional activity in the industry, and the strength the company is seeing in the pet business, which is not impacted by COVID-19, I believe expectations for only a 1% gain in sales and a 4% increase in EPS to $3.76 for the entire fiscal year may prove to be too conservative.

I think the uncertainty about how the company will do when comparisons become difficult is holding back the stock now, along with money managers’ preference for more aggressive names. However, I believe the company can still earn at least $3.65 per share after the pandemic. Normalized volume gains of 1% to 2% post-COVID-19 could be enhanced by the potential of food inflation, given the U.S. government’s determination to help those hurt by COVID-19 through high levels of stimulus. Therefore, longer-term mid-single-digit EPS growth is possible. Given this level of growth, the stock is very attractive at less than 16X post-COVID-19 EPS, nearly a 44% discount to the S&P 500 with minimal cyclical risks. When the current favor of aggressive name fades, GIS should do very well.

Buy General Mills under $59. My target is $65. The 3.6% dividend yield will add to total returns.

Position Review

3M (MMM) stock briefly spiked significantly higher following its strong first-quarter earnings report. It quickly pulled back, but it now is heading in the right direction again. The stock still offers good value at 18.5X this year’s EPS estimates in the current market environment, with the company likely to enjoy low-to-mid-single-digit-percentage revenue growth. While I would not ignore a potentially sharp increase in environmental liability, its leaders indicated on the conference call that they can manage any additional costs. I am raising my buy under for 3M to $172. My price target is now $190.

Black Hills Corporation (BKH) will report fourth-quarter earnings after the close, with expectations for EPS of $1.15 vs. $1.13, with continued investments in regulatory assets offsetting the negative impact of COVID-19. I expect the company to give positive guidance for 2021 tonight on continued investment and favorable rate actions. BKH is a buy below $62. My target is $67. I will have a further update following earnings.

Cognizant Technology Solutions (CTSH) partially recovered some of its share price pullback following last Wednesday’s disappointing earnings report, but it remains well below the $80.60 the shares were at prior to the earnings release. Although investors are likely worried, there are other projects in the company’s current engagements that may be canceled, like the one that caused estimates to fall well short of estimates last week. I am willing to give CTSH the benefit of the doubt for now, with top-line growth returning and strong orders indicating a continued recovery in 2021. CTSH is a buy below $75. My target is $85.

Genuine Parts (GPC) will report fourth-quarter earnings on Feb. 17 before the market opens. Expectations are for flat EPS of $1.35 on an 8% decline in revenues, reflecting the rationalization of product lines to improve profitability. However, GPC has been outperforming expectations consistently, and I would not be surprised if there is upside in the quarter. With increased driving and the economy reopening, 2021 should be a good one for GPC, which trades at a below-market price-to-earnings ratio of 17.4 estimates. GPC is a buy below $95. My target is $110.

Ingredion (INGR) has continued its post-earnings rally I discussed last week. While earnings may show some quarter-to-quarter volatility, the company generates good cash flow consistently over the course of the year, and I view the stock as fundamentally undervalued at 14X this year’s EPS estimate. Continue to buy INGR under $85. My target is $100.

HP Inc. (HPQ) will report fiscal first-quarter earnings after the close on Feb. 25. Expectations are for EPS of $0.66 vs. $0.65 on a 2.5% increase in revenues, with continued strength in personal computers offsetting weakness in printing. With heavy share repurchases and cost-cutting in printing, I believe there is a good chance that results will exceed expectations. HPQ has done very well for us, and valuation remains very reasonable at 10X this fiscal year’s earnings estimates. However, I remain somewhat concerned about the tough PC comparisons the company will face in the second half of the year, and I could recommend sale should the stock get close to my $27.50 price target. Hold the stock for now, and I will let you know what our next step will be.

Kronos Worldwide (KRO) should report fourth-quarter earnings in early March. While EPS is expected to decline to $0.05 from $0.08 a share, the more important news is that titanium dioxide market conditions are tightening globally, with producers asking for price increases. While the stock has struggled since early January, an improving global economy should send titanium dioxide prices higher, and the stock should eventually follow. Buy KRO under $13.50. My target is $17. Both prices could be raised after earnings are reported. The 4.9% dividend yield adds to the attraction of the shares.

Keurig Dr. Pepper (KDP) will report fourth-quarter earnings after the close on Feb. 25. Expectations are for EPS of $0.40 vs. $0.35 on a 3.3% gain in revenues, as favorable trends in both coffee and beverages should continue. KDP has been a steady performer since my Dec. 7 recommendation of the stock, and I believe its share price can continue to rise as the company should close the valuation gap with its mega-cap peers. At 20X this year’s EPS estimates, KDP trades at a meaningful discount to Pepsi Co. (PEP), which sells for 23X this year’s estimate. KDP also trades at a discount to Coke (KO), which sells at 24X this year’s estimate. Buy KDP under $31.75. My target is $36.

Old Republic (ORI) reported fourth-quarter EPS of $0.75 vs. $0.47, which was $0.32 above expectations. Premium growth of 13% far exceeded expectations, as title insurance premiums grew 30% with the continued strength in the housing market. Tough underwriting standards in auto insurance helped drive a 10% decline in claims in the quarter, which was another significant driver of earnings growth.

EPS estimates for 2021 went to $1.95 from $1.80 after the report, but still lower than the $2.25 the company enjoyed in an exceptional 2020. However, I think there is possible upside from the higher estimates. With the stock still selling below book value of $20.75 and last year’s upside of $23.50, I think there is more upside potential to the stock. Buy ORI under $18. My target is $22.

Safety Insurance (SAFT) will report fourth-quarter earnings sometime in the first week of March. EPS should come in above the $1.44 earned in the prior year, with reduced accidents due to COVID-19 shutdowns. However, Massachusetts regulators forced down the price of auto insurance due to the lower number of accidents, so earnings outperformance may not be as great as it was in previous quarters. While the company will not match the $7.50 a share that I think it will earn this year in 2020 as accidents will likely increase in 2021, the company should still earn at least $6.50 a share, and the stock should get closer to its October 2019 high of $100 a share in the current market environment. Buy SAFT under $78. My target is $88.

Valvoline (VVV) bounced back nicely in Monday’s trading, recovering some of the ground lost following last week’s solid earnings report. The stock is running into technical resistance just above $25 a share, but with fundamentals looking good and valuation very reasonable, I believe the stock can reach my $27 target in the first half of this year. VVV is a buy below $22.50.