Barron's Cover – Main: 28 Barron’s Roundtable Picks to Beat the Market
In America, it was a week of momentous change, as one president’s term ended and another’s began. But on Wall Street, it was business as usual: The stock market hit another high, and the biggest tech stocks continued to soar. Small wonder that many investors now decry a dearth of bargains—except for those who still think Tesla is cheap at 200 times earnings, and those who know how to spot genuine deals.
The members of the Barron’s Roundtable belong to the second group, as you’ll see from this week’s Roundtable installment, which highlights 28 investment recommendations from Rupal J. Bhansali, of Ariel Investments; Scott Black, of Delphi Management; Mario Gabelli, the boss at Gamco Investors ; and Sonal Desai, chief investment officer of Franklin Templeton Fixed Income. Their picks range from the familiar—like Microsoft (ticker: MSFT) and Northrop Grumman (NOC)—to the obscure— Hyster-Yale Materials Handling (HY), anyone? But all of them share several characteristics: They trade at relatively cheap valuations, and could be worth more, maybe much more, as operations and business conditions improve. That many sport tantalizing yields only makes them more inviting.
When this year’s Roundtable met on Jan. 11 and Jan. 12 on Zoom, our 10 panelists forecast a snappy rebound for the U.S. economy after last year’s grim, pandemic-fueled recession. But the group, whose big-picture views were featured in last week’s issue, predicted merely muted gains for the broad market, not to mention bonds, given 2020’s exuberant rally and the past 11 years’ cumulative gains. (Could that explain the profusion of tulips on Mario’s desk?)
Read on for an edited version of the stock- and bond-picking conversation. In next week’s final Roundtable package, you’ll hear from the rest of our savvy crew.
Barron’s: Rupal, what investment ideas have you brought us today?
Rupal Bhansali: Given my negative market outlook, I believe we need to be much more defensive in our investment exposure this year. Dividend yields will become a bigger source of total returns in the stock market, especially given the low level of interest rates and bond yields. You can find stocks today that yield more than high-yield bonds—and dividend yields can grow, whereas fixed-income yields can’t.
I have five picks. All are uncorrelated with the broad stock market. Nor do I want a single theme cascading through my holdings, because then it becomes a binary bet.
I mentioned the attractiveness of European stocks this morning. My first pick is Snam [SRG.Italy], a utility that isn’t well known in the U.S. Utility stocks have done well here as income proxies. That isn’t the case internationally. Snam is a regulated gas-transmission utility based in Italy, which is increasingly becoming the gas-storage and transmission hub of Europe. Historically, Europe has procured most of its gas from Russia, but its dependence on Russia has been a source of concern. Snam is the solution. Snam needs to invest billions of euros to create a gas-pipeline infrastructure, so a low-single digit rate of revenue growth is assured. Returns on this investment spend are also guaranteed, because it is a regulated utility. Despite these attributes, there is a growing concern that the business of transporting gas is going to be upended by renewable energy. I believe this overhang is unwarranted.
Renewable energy is an incremental source of energy, but it won’t replace gas-fired power plants anytime soon. Could gas transmission become a stranded asset 25 years from now? Possibly, but it is premature to think about pricing that in now. In fact, gas pipelines are being constructed in a way that will enable them to be retrofitted to transport hydrogen, the next-generation renewable energy source.
What does Snam trade for?
Bhansali: The stock has been trading around 4.60 euros. [Snam also trades in the U.S. under the ticker SNMRY.] It has a price/earnings multiple in the low teens, with a dividend yield of 5.5%. The company has a higher level of debt compared to my other picks, but because it is a regulated utility, its debt is highly rated. I see the stock as more of a single or double than a home run. It provides ballast in turbulent times and offers steady income with steady growth.
Rupal J. Bhansali’s Picks
I like companies with strong balance sheets and an outlook determined more by self-help than quantitative easing, stimulus spending, tax rates, or other macroeconomic trends, or the coming of a Covid vaccine. I want to have a portfolio that will perform, no matter what. My second idea in Europe is Munich Re [MUV2.Germany], one of the world’s leading reinsurance companies. It is well capitalized, with a solvency ratio of 200%. One thing people haven’t realized is that the reinsurance industry is a big beneficiary of climate change. One of the biggest adverse impacts of climate change is the increase in natural catastrophes, which reinsurance companies tend to reinsure. In the first 50 years of the 20th century, the world had, on average, about 20 natural catastrophes a year. In the past 10 to 20 years, we’ve been averaging about 300 to 350 natural catastrophes a year. Not only is the frequency rising, but the severity is far greater.
The reinsurance market is oligopolistic, with few players. From time to time, new entrants dabble in the market via sidecars, thinking it is a low- to no-risk investment, but last year, they lost their shirts as unexpected losses mounted. That will reduce the appetite for new entrants, so the incumbents are likely to be writing most of the business.
Munich Re is one of the most prudent, conservative underwriters in the world. It tends to have good loss-reserve ratios. Investors get exposure to an industry with both secular and cyclical tailwinds, as the market typically hardens [premiums rise as reinsurance demand exceeds supply] after a big loss year like 2020. Should interest rates go up—and I’m not predicting they will, but that looks to be the tendency—that is an added bonus for the company’s investment returns. Munich Re has a 4% dividend yield, lower than some of my other ideas. If the market has a 10% to 20% pullback, I would look to average down [buy more at lower prices]. At a recent price of €242, the stock is a good value. And, it is uncorrelated with my other stock picks.
What is your next idea?
Bhansali: Telecom is one of my favorite sectors. Perhaps you’ve heard me call telecom companies the new consumer staples. I was intrigued by Bill Priest’s T-Mobile US [TMUS] recommendation [in 2021’s first Roundtable installment], but T-Mobile’s balance sheet scares me. The company has a lot of debt. I am recommending a different telecom—one with a far stronger balance sheet, in a country that has also seen consolidation of its telecom market. The country is Brazil, and the company is Telefônica Brasil [VIV], the leading player in Brazil’s wireless market, with 77 million subscribers and about a 32% market share. Brazil’s telecom sector is going through an in-market consolidation, which is beneficial in any industry with high fixed costs, where scale is an advantage.
More important, Brazil’s regulatory framework is improving. Regulators have taken an enlightened view: If you create too much competition and don’t allow incumbents to make money, it prevents them from investing. Through a merger, four players will be reduced to three. Regulators also have allowed the top two players—TIM Brasil, a subsidiary of Telecom Italia [TIT.Italy], and Vivo, Telefônica Brasil’s wireless unit—to share networks, which enables them to reduce capital spending.
Telefônica Brasil has an AAA-rated balance sheet, remarkable in a world where companies are gorging on debt. The headline dividend yield screens at only 1% to 2%, but Brasil confers a tax advantage on what it calls a return on capital, which is a dividend, as we would understand it. As a consequence, the effective yield is 7.5%.
Finally, in my view, the Brazilian real is undervalued. As I said this morning, the dollar is more likely to depreciate, and international currencies are more likely to appreciate. For a dollar-based investor, owning a nondollar-denominated asset like Telefônica Brasil could enable you to make money in two ways: capital appreciation and currency appreciation.
Bill, are you worried about T-Mobile’s debt?
William Priest: T-Mobile has a lot of debt stemming from its acquisition of Sprint. But significant cost savings will come out of this merger. T-Mobile also has a pricing advantage as we get into the deployment of 5G opportunities. The debt is high, but I don’t expect that paying it down will be a problem.
Bhansali: My next stock is controversial and may not play well from a headline basis, but is an example of an investment opportunity that could provide idiosyncratic alpha [excess return, relative to the broad stock market]. The stock is Philip Morris International [PM], the international arm of the old Philip Morris, which split into the U.S. arm, Altria Group [MO], and Philip Morris International, run out of Switzerland.
Everyone views nicotine as harmful, but it isn’t harmful in and of itself. It causes harm when you burn it—that is, light a cigarette. I am not condoning smoking, but there are more than one billion chain smokers in the world today, and they need help in reducing the adverse effects on their health from smoking.
In years past, pharmaceutical companies came up with nicotine patches and gum to help such smokers stop smoking. These products were even approved by the Food and Drug Administration, but failed to gain market acceptance because they didn’t deliver a similar experience to smoking. Philip Morris International has come up with a product called IQOS—an electronic device that heats tobacco just enough to release nicotine vapors, but not enough to burn the tobacco. The letters are thought to stand for I quit original smoking.
Philip Morris has converted about 10 million smokers to IQOS. The company spent more than $6 billion on research and development and clinical trials for the product, and leading health-care bodies around the world have approved it as lowering the risk of consuming nicotine. In fact, clinical data show a dramatic reduction of risk of 90%-plus, a game changer for chain smokers.
Sales fell last year because of Covid, but we expect them to pick up again. By 2025, Philip Morris hopes to generate 40% of its revenue from IQOS. We expect the company to earn $10 billion to $11 billion this year, and it will distribute the majority of its earnings in dividends. The stock yields about 5.5%, and the P/E multiple is around 15. Admittedly, this isn’t a mainstream investment idea, as tobacco stocks are considered sin stocks, but I believe we’re better off encouraging companies to invent a product that significantly lowers the risk of consuming nicotine and secondhand smoke.
Can Philip Morris sell IQOS directly in the U.S., or must it sell the product through Altria?
Bhansali: It has a distribution arrangement in the U.S. with Altria, but the vast majority of the opportunity is in international markets, where it sells directly. Japan is one of its biggest and most successful markets for IQOS.
Priest: China has always had an issue with foreign-based tobacco companies. Is that a problem for IQOS? Secondly, what do people who use IQOS like about the product, other than the fact that it’s healthier than smoking?
Bhansali: China’s tobacco market is a national monopoly. The government owns it, so the market isn’t open for private companies. But there is a large opportunity outside China. As for IQOS users, unlike nicotine patches or gums, this product gives them an approximate sensation of smoking. That is why adoption has been high.
I try to discuss stocks that readers might not know. Meanwhile, Microsoft has been sitting right under my nose. We have owned the stock for almost a decade. It is the poster child for everything right with technology companies, whether it’s SaaS [software as a service] business models or productivity enhancement. You might wonder what is left to squeeze out of this name after a near-tenfold increase in market value in the past nine years. A number of things aren’t yet fully priced into the stock.
“ Microsoft owns Xbox, which has overtaken Sony’s PlayStation in popularity. Now, Microsoft is on its way to becoming the Netflix of gaming. Just as we stream media content, Microsoft‘s xCloud will stream videogames. ”
Microsoft is trading for roughly 25 times June 2023 earnings. The company nets more than $50 billion of profit every year, and earnings can grow by double digits in coming years. The biggest opportunity is Azure, Microsoft’s hybrid public/private cloud service. Amazon Web Services, in contrast, operates only a public cloud. For most large companies, particularly in financial services and health care, data privacy is very important, and it is going to become even more so. In order to have control over data, sometimes even physical control in a particular jurisdiction, you need to have a private cloud. Microsoft’s Azure is the only scaled player that offers a private and a public cloud. While Azure has done extremely well, it is probably in the third inning of a nine-inning story.
What else isn’t priced in?
Bhansali: Another vector of opportunity is videogaming. Microsoft owns Xbox, which has overtaken Sony’s [SNE] PlayStation in popularity. Now, Microsoft is on its way to becoming the Netflix [NFLX] of gaming. Just as we stream media content, Microsoft‘s xCloud will stream videogames. The next generation of games won’t require consoles. Gamers want subscription-based streaming models because games are quite expensive. Microsoft has a library of games and produces its own content. What’s more, Nintendo [NTDOY] and PlayStation have agreed to let their games be hosted on Microsoft’s xCloud, so it is likely to become the dominant platform for consumers.
Microsoft 365 (which includes Office 365 and Windows 10) is yet another growth vector. Office 365 has a lot of traction, as we all use Outlook, PowerPoint, Word, and Excel. But Windows, the underlying operating system, hasn’t yet seen the same traction and growth rate. Again, the best is yet to come.
So far, Salesforce.com [CRM] has been the unchallenged leader in customer-relationship management software. But Microsoft is beefing up its own CRM business, Microsoft Dynamics 365. In most businesses, Microsoft hasn’t been first to the party, but it catches up rapidly. I expect that to happen in the CRM space. Dynamics 365 is a plug-and-play module that works much faster and seamlessly out of the gate than alternatives. It is another opportunity that isn’t well understood.
Finally, [Microsoft’s] LinkedIn is the only B2B [business to business] social network, and that means advertisers can do microtargeting, which is extremely valuable. While the user engagement might not seem like much, LinkedIn is coming up on a billion users. Today, graduating students from any walk of life make sure their profile goes on LinkedIn. This marks an inflection point, and speaks to the power of the platform in the professional world.
Priest: We have a large holding in Microsoft, but three things concern me. They have a latency problem with their cloud. AWS has a faster cloud. In the gaming world, Fortnite is going to dominate. And, Salesforce.com recently purchased Slack and plans to establish its own rival to Microsoft Teams. It seems some things are moving away from Microsoft.
Bhansali: The public cloud is faster because it doesn’t have the same security firewalls as the private cloud. More controls mean that it will take slightly longer to access data. Regarding Teams, it’s the incumbent tool, so Salesforce is unlikely to upend it. And, yes, Fortnite is a spectacular success story, but it was played on the Xbox and will be played on Microsoft’s streaming platform.
Microsoft is a $1.7 trillion-in-market-cap company. Can videogames really move the needle at this point?
Bhansali: I gave you several growth drivers, not just one. Sometimes, we think of trillion-dollar companies as being mature and devoid of opportunities. All of these are blockbuster opportunities. And, unlike the Teslas [TSLA] of the market, Microsoft sells for a relatively modest multiple of future earnings, and has net cash on its balance sheet and recurring revenue streams. We spent a lot of time this morning discussing the economic outlook for increased productivity. Microsoft’s goal is to improve the productivity of enterprises and their employees.
You recommended China Mobile [CHL] at several past Roundtables. The Trump administration put the company on its sanctions list because of its ties to China’s military. What should investors do now?
Bhansali: My fundamental bullish view on China Mobile’s business prospects and undervalued stock hasn’t changed, but it’s an academic question now that the U.S. government has issued an executive order that prevents U.S. persons from buying the stock after Jan. 11, 2021, and compels them to sell any existing holdings by Nov. 11, 2021. Obviously, we will abide by the law.
Thank you, Rupal. Scott, you’re next.
Scott Black: We look for companies likely to have rising sales and earnings this year, strong balance sheets, and sustainable cash positions, and that generate free cash flow. As value investors, we like low P/E ratios. I build my own earnings models.
My first pick is AdvanSix [ASIX], a chemical company spun out of Honeywell International [HON] in October 2016. It has three manufacturing sites in the U.S. AdvanSix makes an array of chemicals and ammonium sulfate fertilizer. It could generate about $1.23 billion of revenue this year, up 11%. Pretax income will be about $81 million. Taxed at 25%, that’s $60.8 million in net income, or $2.16 a share. The stock trades for $22.11, or 10.2 times expected earnings and 1.47 times book value. The market cap is only $621 million. There is no dividend. Return on equity is about 13%; return on total capital, 9%.
We estimate that AdvanSix will generate free cash flow of about $46 million this year. It has roughly $313 million of debt, and another $112 million in lines of credit. Net debt to Ebitda [earnings before interest, taxes, depreciation, and amortization] is 3.1 times, but they are targeting a 2.5 ratio.
AdvanSix’s main addressable market is building and construction. The next-biggest market is fertilizer, and the third is acetone, used in paints and adhesives in the auto industry. The company has strong internal cost controls, and creates a formal five-year strategic plan to address strengths, weaknesses, opportunities, and threats. This isn’t a glamorous industry. The company isn’t a disruptor. But it has rising earnings and a cheap stock.
We can’t argue with that.
Black: We own a lot of technology companies, but many stocks have gone up sharply. Kimball Electronics [KE] is under the radar. The stock is $17.11, and the market cap is $433 million, with no dividend. Kimball is a global provider of electronic manufacturing services. It offers engineering and supply-chain support for the automotive, medical, industrial, and public-safety markets. It also makes nonelectrical components. The company has a June fiscal year. We expect revenue to grow 8% this year, to $1.3 billion, yielding operating income of $58 million to $61 million. Interest expense is only $3.3 million. We see pretax income of $54.8 million to $57.8 million, and $1.77 to $1.87 in earnings per share, with the midpoint at $1.82. On a calendar-year basis, Kimball could earn $1.95, giving the stock an 8.8 P/E multiple, and a multiple of 1.08 times book value. The company will earn an 11.5% return on equity, and has almost no debt. Free cash flow could total $35 million this year.
Scott Black’s Picks
The revenue mix is about 38% automobiles, 33% medical, 23% industrial, and 6% other. Philips [PHG] accounts for 16% of revenue, and Michigan-based Nexteer Automotive Group [1316.Hong Kong], 14%. The business is sticky; 30 customers account for almost 80% of revenue, and have been customers for more than 10 years. Kimball has 11 manufacturing facilities around the world.
Next, Westlake Chemical Partners [WLKP] will appeal to investors looking for yield. It was spun out of Westlake Chemical [WLK] in 2014. It trades for $21.99, and the market cap is $774 million. Westlake is a limited partnership. It pays an annual dividend of $1.89, for an 8.6% yield. The company has production capacity of 3.72 million pounds of ethylene. It provides ethylene to Westlake Chemical. It is guaranteed a certain price, regardless of the price of its feedstock or the market price for the chemical.
We expect Westlake to have $1.25 billion in revenue this year, and operating income of $347 million. Interest expense will be $10 million; the debt is owed to the parent company, which still owns 77.2% of the partnership. Earnings available to other shareholders, like me, will total $77 million, or $2.19 a share, up from $1.97 for 2020. Return on equity is an impressive 27%. Westlake Chemical Partners is trading for 10 times expected earnings. Investors needn’t worry about the solvency of Westlake Chemical, which takes 100% of the partnership’s output. It will have about $8.2 billion of revenue this year, and $3.25 a share in earnings. It has a low net debt-to-equity ratio of 0.37. To summarize, Westlake Chemical Partners offers a rich yield. It has a strong balance sheet and a deep-pocketed parent, and the potential for capital appreciation.
Do you expect small-caps, in general, to rebound this year? Last year was great for large-caps.
Black: Contrary to what people thought, small- and mid-cap growth stocks outperformed the S&P 500 last year. The Russell 2000 Growth index returned 34.6%; the Russell 2500 Growth index returned 40.5%. That compares with the S&P’s total return of 18.4%. The multiples on the growth indexes are astronomical: The Russell 2000 Growth trades for 34 times forward earnings and 2500 Growth is at 38.5 times forward earnings. The S&P 500 has a P/E of 23.
My next pick, home builder D.R. Horton [DHI], has a market capitalization of $24.4 billion. The stock closed on Friday [Jan. 8] at $66.96. Horton pays an annual dividend of 80 cents a share and yields 1.2%. The company is based in Arlington, Texas, and is the largest home builder in the U.S. In fiscal 2020, it delivered 65,388 new homes, and has guided for 77,000 to 80,000 this year. My earnings model is based on the midpoint: 78,500. Their average home price last year was $299,100. Assuming 3% price inflation, we see $24.19 billion of home-building revenue this fiscal year, ending in September. With financial services, total revenue will come to nearly $25 billion. We calculate pretax profit at $3.8 billion, up from $3 billion last year, based on more homes built, operating leverage, and higher gross margins. Horton could net $2.92 billion, or $8.01 a share. Return on equity should be about 22.4%. Net debt to equity is only 10%. Horton generated $1.13 billion in free cash last fiscal year.
With mortgage rates as low as 2.87%, Horton has the wind at its back. The Horton brand, designed for move-up buyers, accounts for 66% of revenue. Express, for entry-level buyers, contributes 28%. Emerald, for high-end buyers, is 3%, as is Freedom, which targets downsizers. Horton operates in 88 markets in 29 states, and is No. 1, 2, or 3 in most of its markets. The company knows, down to the individual house, how profitable it is. It wants to grow revenue by 10% to 15% per annum for the next three to five years, with earnings growing at an even faster rate. You’re paying 8.4
times earnings for a company that earns well over 20% on book value. Horton has a five-year inventory of lots; it owns 30% outright and has a call option on the other 70%.
Have you another pick, Scott?
Black: Magna International [MGA] trades for $75.85. It has a $23.7 billion market cap and pays a dividend of $1.60 a share, yielding 2.1%. It is the third-largest auto original equipment manufacturer, or OEM, in the world. It has four divisions: Body exteriors and structures accounts for 42% of revenue, power and vision is 29%, seating is 14%, and complete vehicles is the rest. I estimate revenue of $38 billion this year, and Ebit [earnings before interest and taxes] of $2.85 billion. We get pretax profits of $2.75 billion, and net income of $2.02 billion, or $6.75 a share. Return on equity is 18%, and the P/E is 11.2. We expect Magna to generate $1.5 billion to $2 billion of free cash flow this year.
Magna doesn’t see the growth of electric vehicles as a big threat to its business because the power-train portion of traditional vehicles is under 10% of revenue. The company works with EV companies, although not with Tesla. Its customer roster has been steady in recent years, with General Motors [GM] contributing 15% of revenue; Ford Motor [F], 13%; and BMW [BMW.Germany], 14%.
Auto companies expect OEMs to cut their prices by 1% to 3% a year, and Magna complies, but has to improve its manufacturing efficiencies to compensate.
Bhansali: If Apple [AAPL] moves into the EV industry, as seems likely, this could be an opportunity for Magna.
Black: I agree. So far, it appears that Apple will team up with Hyundai Motor [005380.Korea].
My last recommendation is Northrop Grumman. The stock is trading for $288.33, and the market cap is $48 billion—big for Delphi. The company pays a $5.80 dividend, for a yield of 2%. Northrop is a major aerospace and defense manufacturer, based in Falls Church, Va. Its core competencies are strategic deterrence, stealth, and cyber. The company has four divisions: Aeronautics is 32% of revenue; defense systems, 20%; mission systems, 28%; and space, 24%. Among their major programs is Skyborg, which combines AI integration with UAV [unmanned aerial vehicle] combat systems, and the ground-based strategic deterrent, which will replace the Minuteman III program, an intercontinental ballistic missile system.
For last year, Northrop should post $35.85 billion of revenue. That’s after the planned sale of its federal IT and mission-support services business for $3.4 billion. After deducting interest expense of $590 million and adjusting for other items, we get pretax profits of $4.69 billion to $4.83 billion. Taxed at 16.5%, that’s net income of $3.92 billion to $4.03 billion, or about $24.50 a share. Return on equity is 33.4%, and return on total capital, about 18.5%. At 11.8 times expected earnings, this stock is dirt cheap. Northrop generates more than $2.5 billion of free cash flow, year after year, and this year it could exceed $3 billion.
The U.S. government accounts for 83% of revenue, and sales to non-U.S. military services are 15%. The company has an $81.3 billion backlog, which represents more than two years of future revenue. In the most recent quarter, the book-to-bill ratio was 2.2. Northrop offers stability and earnings growth, and it is focused on areas that are a priority of the U.S. Department of Defense.
Thanks, Scott. Mario, are you ready to share your ideas?
Mario Gabelli: Yes. I’m going to talk about clusters of stocks. One theme is “love our planet,” or companies focused on climate change and sustainability. I’ll echo Bill’s recommendation [in the first Roundtable installment] of NextEra Energy Partners [NEP]. James Robo [the chairman and CEO] has done a fabulous job of creating that investment vehicle, or “yieldco,” which develops, owns, and manages onshore wind and solar projects. The stock trades for $80; there are 175 million shares, including 60% owned by NextEra Energy [NEE]. The entire environmental ecosystem is going to get enormous attention from investors. NEP is expected to grow its $2.38-per-share annual distribution to $4.15 by year-end 2024.
Avangrid [AGR], an energy and utility company, is another love-the-planet play. It trades for $47, and has 309 million shares; Iberdrola [IBE.Spain], the Spanish utility and another of my favorite stocks, owns 260 million shares. Avangrid announced in October that it plans to acquire PNM Resources [PNM], which we also own. Iberdrola understands the renewables world and is well positioned in the U.S. I have suggested that the company spin out a portion of Avangrid’s renewables business as a yieldco, similar to NextEra Energy’s spinout of NextEra Energy Partners, and thereby create a higher valuation. The PNM deal will add significantly to Avangrid’s revenue and Ebitda, and you’ll get a decent dividend. Avangrid’s current return is 3.85%.
Our revenue estimate for 2022, including PNM, is $8.9 billion, and our earnings-per-share estimate is $2.60, after allowing for the sale of shares to finance the PNM acquisition.
What else do you like?
Gabelli: GCP Applied Technologies’ [GCP] main product lines are cement and concrete additives. They also have a smaller waterproofing-membrane business, which makes products used in residential roofing. The company should benefit from infrastructure spending on roads, bridges, and inland waterways. The stock sells for $25; there are 73 million shares, and the market capitalization is $1.8 billion. The company has about $120 million in net cash. GCP will earn $1 a share on $975 million in revenue in 2022, with chemicals about $555 million and building products, $420 million. Activist Starboard Value has added directors and controls the board.
Infrastructure spending should bolster demand for forklift trucks. Hyster-Yale Materials Handling, based in Cleveland, sells forklifts and aftermarket parts. The stock sells for $66, and there are around 16.8 million shares, of which 13 million are common shares, and 3.9 million are Class B shares with 10 votes per share. The CEO and his family own 3.3 million, or 85% of the Class B voting shares.
Hyster-Yale will earn $6.10 a share in two years, up from $2.10 this year. Aside from earnings increases, I am interested in Hyster-Yale, as it has spent $200 million over the past five or six years to develop its own hydrogen fuel-cell technology. At the last Hyster-Yale investor meeting, I asked, “Why not monetize your hydrogen-cell operation?” Since then, Plug Power [PLUG] shares rose from $4 to more than $60 in the past year because investors are viewing hydrogen as an alternative energy source. Plug sold $1.5 billion of shares to South Korea–based SK Group, and that stock now has a market cap of $25 billion. Hyster-Yale is having its next investor day in May. The stock could double in the next two years, assuming that Nuvera, the hydrogen business, becomes profitable.
What else appeals to you?
Gabelli: Deutsche Telekom [DTE.Germany] is trading for €15. If you back out the company’s stake in T-Mobile US, and associated debt, you’re getting the German and European telecom companies for €3. The operating company, ex-TMUS, could earn 65 euro cents in 2021, going to 95 euro cents in 2022. In addition, Deutsche Telekom has the option of buying an additional 101.5 million shares—an additional 8.2% stake—in T-Mobile US from SoftBank Group [9984.Japan]. It is an interesting way to play the postpandemic recovery story in Germany and continued momentum of T-Mobile US, and you might get the benefit of an appreciating euro. The stock pays 60 euro cents, for a 3.9% current return.
Switching gears, about 40 million used cars are sold in the U.S. every year. Genuine Parts [GPC] sells automotive replacement parts under the NAPA brand for the more than one-quarter billion vehicles on the road in the U.S. and over one billion worldwide. The stock is trading around $100, the market cap is $15 billion, and the company has $2 billion of debt. In the U.S., about 80% of auto-parts sales are for do-it-yourself repairs, and 20% are do-it-for-me. Business was sluggish in 2020 because of the absence of do-it-for-me work. Also, the company’s international operations have suffered from Covid-related lockdowns. When lockdowns end in Europe, and there is renewed growth in the company’s Australia/New Zealand operations, demand could surge for auto parts and repairs.
“ Madison Square Garden Sports owns the New York Knicks and the New York Rangers. At some point, Jimmy [Dolan, MSGS’ executive chairman] has to figure out what he wants to do with MSGS. We believe there would be (and are) buyers for the New York Knicks. ”
Genuine Parts should have $18 billion in revenue this year, with $6 billion coming from Motion Industries, its industrial-parts distribution business. In the next four years, there will be a surge in cars in the four- to eight-year-old bracket and a cyclical recovery at Motion. The company could earn close to $7 a share by 2023, with earnings growing about 9% a year thereafter. Unfortunately, they pay a big dividend [$3.16 a share], which I don’t like, because taxes on dividends are likely to rise.
How will growing sales of electric vehicles affect Genuine Parts?
Gabelli: Battery and hybrid electric vehicles should account for about 170 million cars in the world by 2030. At that time, the automotive population should be around 1.4 billion vehicles. They will consume fewer engine parts per car, but the existing base will remain quite fertile for the sale of replacement parts.
Finally, I want to put down a lot of bets on the gaming business. I can play it by owning sports teams, media companies, and companies that supply the iGaming infrastructure. Sports teams will get fees from online gambling, which is growing. Madison Square Garden Sports [MSGS] sells for about $180 a share. There are 24 million shares; 20 million are nonvoting. The Dolan family owns the four million shares of voting stock. MSGS owns the New York Knicks and the New York Rangers. At some point, Jimmy [Dolan, MSGS’ executive chairman] has to figure out what he wants to do with MSGS. We believe there would be (and are) buyers for the New York Knicks.
I also like Liberty Braves Group [BATRA]. The stock is $25, and there are 60 million shares outstanding. Liberty Braves, better known as the Atlanta Braves, is controlled by John Malone’s Liberty Media through another Liberty entity, Formula One Group [FWONK]. At some point, Liberty Braves, which is a tracking stock, will be sold. We estimate that it will go for $45 a share.
Next, Fox [FOX] is $30 a share. [Fox and Barron’s parent News Corp (NWS) share common ownership.] FOX Bet has a valuable partnership with Flutter Entertainment [FLTR.UK], which controls FanDuel, a gaming company. Fox also has a sports network, and owns Fox News. Advertising spending on TV will pick up with a consumer-led economic recovery, and Fox will benefit. Contracts with the NFL and other sports leagues will be renewed, but at a higher cost. Fox has about 600 million shares, including 257 million voting shares. I recommend buying the voting stock, as it sells for about the same price as the nonvoting shares. Buy the shares based on the benefits of online sports betting, coupled with a good sports and local business. I estimate revenue for the fiscal year ending on June 30 of $12.4 billion, going to $13 billion in fiscal 2022, and earnings per share of $2.45, climbing to $2.65 in fiscal 2022.
Sinclair Broadcast Group [SBGI] is also attractive. Sinclair is selling the naming rights to its regional sports networks, or RSNs, to Bally’s [BALY], the gaming company. Sinclair has 75 million shares, trading at $32, for a market cap of $2.5 billion. While debt looks significant at $12.5 billion, $8 billion is nonrecourse and tied to the RSN business. Meanwhile, the RSN business will bounce back, with revenue growth from the recovery in the sports-related ecosystem, and they are going to enjoy significant cash from broadcasting. Sinclair has warrants to buy a significant piece of Bally’s at nominal prices, and the online sports-betting business at Bally’s is doing well.
I estimate revenue for calendar 2020 from broadcasting at around $3.3 billion, dropping to $3 billion this year, but rising to $3.5 billion in 2022, with Ebitda of $1 billion rising to $1.2 billion in 2022.
Barry Diller’s IAC/InterActiveCorp [IAC] is the largest holder of MGM Resorts International [MGM], which is pursuing a bid for Entain [ENT.UK], the owner of Ladbrokes. [On Jan. 19, MGM withdrew its preliminary offer to merge with Entain.] We like GAN [GAN], a B2B provider of iGaming and sports-betting infrastructure and services to sports books like FanDuel and WynnBET. The company came public last May and is trading for $20. There are 38 million shares. GAN earns a percentage of the gaming revenue that its sports-book customers generate, so its revenue grows with theirs. We expect GAN to continue signing new client engagements as more states legalize sports betting and iGaming. Eventually, we believe GAN will be acquired at a significant premium to its current price.
Thank you, Mario. Sonal, the floor is yours.
Sonal Desai: I’ll start with the Matthews Asia Growth fund [MPACX]. Asia has done a much better job on the virus front than the rest of the world, so this is a way to capture that recovery. China was the sole major global economy to post positive growth in 2020, and has experienced a largely V-shape rebound in manufacturing and consumption. Other Asian countries, such as Japan and South Korea, are also recovering steadily, and are beneficiaries of structural growth in new technologies and the diversification of global technology supply chains. Many Asian companies have successfully executed during the pandemic and should emerge from the crisis in stronger competitive positions. Weakness in the U.S. dollar will also likely continue to help Asian equities in the year ahead.
Matthews Asia has almost a third of its holdings invested in Japan. Last year, I recommended the Japanese yen. This year, I’d rather invest in Asian stocks.
I still think gold is good to hold, so I’m going to recommend the SPDR Gold Shares exchange-traded fund [GLD], which I also recommended last year. This reflects my strong view that commodity prices will do well, inflation is picking up, and the dollar will remain weak. Given these three elements, it is worth holding gold for a while longer.
Gold has been trading around $1,900 an ounce. How high do you see the gold price going?
Desai: I’m not a gold specialist, but I think gold could easily go up to $2,200. I’m not saying it will happen in the next month or two, but production of gold is quite low right now. I prefer gold to Bitcoin. Gold is a time-honored store of value.
I also like emerging markets, but you have to be very careful—not all emerging markets look attractive. I will stick with my pick from last year: the Payden Emerging Markets Bond fund [PYEWX]. I like the team managing it, and it has an optimal mix of approximately 70% U.S. dollar-denominated debt and 30% local-currency debt. Emerging markets are giving us yield at a time when yield is needed. [The Payden fund yields 4.42%.] Spread levels over developed-market government bonds should continue to attract inflows, and investors remain structurally underweight emerging market debt. Not all emerging markets have handled the pandemic well, but in some cases—such as India, with its vaccine rollout—they are doing surprisingly well. And many benefit from younger populations, with many no longer imposing lockdown restrictions.
What else should income investors consider?
Desai: There is very little income to be had within the fixed-income universe, and there is even $17 trillion in negative-yielding global debt. So high-yield debt should look good to investors, even if valuations aren’t cheap. We believe the potential for further spread tightening, combined with lower duration exposure and the relative yield pickup, will continue to make high-yield assets attractive in 2021.
“ I’m not a gold specialist, but I think gold could easily go up to $2,200 [an ounce]. I’m not saying it will happen in the next month or two, but production of gold is quite low right now. I prefer gold to Bitcoin. Gold is a time-honored store of value. ”
The Franklin High Income fund [FVHIX; managed by Franklin Templeton] yields 5.3%. Investors need to recognize that they have to take additional risk if they want that yield, but with vaccines now available and the economic recovery as our base case, that’s a supportive backdrop. The default rate should be manageable, and other issues are further down the road.
The other reason I like high yield is that it is lower duration. I see Treasury yields increasing in the second half of the year, so I prefer to stay with lower duration. In the rest of the world, especially Europe and Japan, you aren’t likely to see yields rise the way they will in the U.S.
Is there any reason to own a 10-year Treasury note or other long-dated bonds now?
Desai: I would not be extending duration anywhere. But some fixed-income investors are obliged to hold a certain amount of Treasuries. To generate an attractive return, investors must increase their level of risk, and they need to reduce duration—thus, high-yield bonds. Last year, I recommended investment-grade credits. I can’t recommend investment-grade at this stage.
The next stimulus bill in the U.S. could include aid to state and local governments. Do you see opportunities in municipal bonds?
Desai: Within my top picks are two municipal bond funds: Franklin Federal Tax-Free Income [FAFTX] and Franklin High Yield Tax Free Income [FHYVX]. Tax-free munis don’t look particularly attractive, unless you think tax rates are going to go up. I see that happening later in the year. High-yield munis could do well this year. There is going to be a lot of fiscal stimulus. Investment-grade munis are safer than high-yield, but offer less yield. I would recommend both funds to capture the tax-free benefits, plus the federal fiscal support. It seems pretty clear the Biden administration will give assistance to municipal governments, and I think it will be sizable.
Todd Ahlsten: Sonal, I know you expect inflation to pick up this year. But are you thinking about the possibility of a deflationary spiral a few years down the road?
Desai: It’s a great question. I don’t think it will happen next year or in the next several years. Everyone points to the parallels with Japan, but the U.S. isn’t Japan. U.S. demographics don’t even begin to approximate Japan’s. Consider Korea, China, Germany, Italy—a whole host of other countries whose demographics are an order of magnitude worse than U.S. demographics. None of them is seeing deflation. Demographics in the U.S. don’t suggest a deflationary spiral.
Creative destruction is very real in the U.S. Firms go bankrupt. You don’t have zombie companies, as Japan did for a long time, until productivity growth turned things around. So, I’m not too worried about the Japanification of the U.S. The assumption that productivity growth is permanently behind us—that somehow every technological advance that was ever going to happen has happened and is in our past—is hugely, vastly arrogant.
Abby Joseph Cohen: In Japan, the most important zombie companies were the banks. Poorly performing assets were kept on bank balance sheets indefinitely, limiting the ability to lend. In contrast, the U.S. responded quickly during the global financial crisis, benefiting from more stringent accounting and regulation for banks. Bad assets were written down, often dramatically. This was hugely important in putting the financial system right and getting the economy moving again.
Desai: It’s enormous. It is an additional reason why the recovery from the current crisis is going to be significantly different than from the financial crisis.
Thank you, Sonal.
Additional editing by Nicholas Jasinski
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