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IMF October Buys: The 15 Stocks Added To My Fund

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Includes: AVLR, AYX, CAAP, CBOE, CCU, EL, HRL, KOF, ROP, TAP, WFC
by: Ian Bezek
Summary

I added to 15 stocks in the IMF portfolio for October.

That included additional capital into 14 holdings and a new position: Estee Lauder.

Tech, banks, and a few foreign stocks have my attention this month. Here's why.

Ian's Million Fund "IMF" is a real-money portfolio that I've written about monthly since January 2016 here at Seeking Alpha. The portfolio is a largely buy-and-hold group of ~130 stocks. Each month, I buy 10-30 of the most compelling stocks available at then-current prices, deploying $1,000 of my capital plus accumulated dividends. If things go according to plan, this portfolio, began when I was 27, will hit one million dollars in equity in 2041 at age 52. I intend it to serve as a model for other younger investors.

I made the portfolio's October buys a week ago Tuesday. October may be the most frightful month of the year for investors, but it brought no significant pullbacks to buy into this time around. Regardless, there was still some decent value to be had in this month's selections. There were no portfolio sales in October, so the fund had its usual $1,000 monthly capital addition to work with plus $231 of dividends received in September. Here's what I bought:

First things first, I reinvested dividends for the month into Hormel Foods (HRL). With that purchase, Hormel became the second-largest holding in the overall portfolio, and it was all paid for with dividends received from various companies over the years, rather than any of my own earned capital.

In any case, I see Hormel as the compelling high-quality consumer staple play at a fine price in a field where many of the others have already run up:

Chart

Data by YCharts

I'd argue that Hormel has diverged from its peers since early 2019 because of fears around the African swine fever. So far these haven't had a major impact on Hormel's operations, and the company offered upbeat guidance recently. Regardless, Hormel stock has stalled out for the time being while it continues its long-term trajectory of compounded 5% annual revenue growth and 10% annual earnings growth.

With the fantastic debt-free balance sheet, the Dividend Aristocrat-seeking investors will come back to Hormel stock soon enough as swine fever fears fade. There's a clear path to ~30% upside over the next year as that happens.

In the meantime, Hormel, with its 50+ year track record of annual dividend hikes, is offering a highly attractive yield compared to its historical average:

Chart

Data by YCharts

When Hormel returns to yielding 1.5%, as it did for most of 2014-16, the stock price will be $56 share (it's at $41 now) assuming no additional dividend hikes between now and then. Don't forget that Hormel's dividend and share price have both quadrupled over the past decade so while the current yield may look modest, the yield-on-cost becomes large rather quickly.

Also in consumer staples, I added to the position in Molson Coors (TAP). Here's what I wrote about TAP stock in the Ian's Insider Corner Member chat in response to the most recent quarterly numbers. To be clear, the earnings report hasn't changed my fundamental view:

Management certainly hasn't done much to earn the market's confidence. That said, alcohol is such a great business that you can keep putting up lousy numbers and the stock just goes sideways. They're generating tons of cash flow and paying down debt. Hard to lose money with a high profit margin/cash flow business at 12x earnings as long as management doesn't blow up your balance sheet. I worry about them doing something stupid like buying a marijuana company but unless they do that, collect the dividend and eventually it goes back to 18x earnings $80-$90 when they report a couple of good quarters.

I'm reminded of late 2016 when people were downgrading Diageo (DEO) on Brexit fears, claims that the CEO was not competent, and that there was emerging market weakness. If you consider that comparison too optimistic, I find Robert Mondavi wine an instructive case. Their stock was public for 11 years and Constellation acquired it in 2004 for 4x its IPO price despite being terribly run for most of that time and having the controlling family war with each other and actively undermine the firm's operations. Again, as long as the balance sheet is okay, it's really hard to lose money long-term buying an alcohol business at 12x earnings (8% earnings yield).

Also on the topic of beer, I added to the position in Compañia Cervecerias Unidas (CCU), the Chilean brewer. It's been hammered (down 30%) on the combination of the political change in Argentina and protests in Chile, its #2 and #1 markets, respectively. Regardless, CCU sells beer, wine, and Pepsi (PEP) bottled products - we're not talking about economically sensitive goods here. I think it's fair to say that much of the selling in CCU stock is due to it being part of index funds that people are dumping due to political worries. If you want to sell a Chile ETF, that will cause CCU stock to get dumped as part of the basket. Regardless, CCU is now down to 15-16x forward earnings and offering its highest dividend yield (3.5%) in years. That's fantastic for a high profit-margin monopoly (more than half of Chilean beer market share) firm.

And in beverages, I also added to Mexican Coca-Cola (KO) bottler Coca-Cola Femsa (KOF) which has hit multi-year lows, presumably on Latin American weakness in general. While the firm is based in Mexico, it also has business in various South American countries. I've been stashing KOF stock for awhile as my favorite change of government play for Venezuela, as Coca-Cola Femsa used to earn large profits there and that has gone away for the time being.

Source: Corporate Website

The company is massively under-earning because of this, and it's not like Mexico's stock market or economy has been booming lately either. Femsa also operates in Argentina, so that's another reason for people to be dumping the stock at the moment.

Regardless, KOF stock is trading at 15x trough earnings and is down two-thirds from its 2013 high when LatAm was last enjoying a speculative boom. I'm happy to park money here, collect the greater than 3% dividend and enjoy the reversal when Latin American sentiment picks up again and the Venezuelan market reopens for business.

Chart

Data by YCharts

As you can see, KOF stock has a long track record of shareholder value creation (it's still up more than 5x from the mid-1990s) and this has been an extended down-cycle. There should be plenty of energy to the upside once the trend finally switches.

Why am I buying now in particular? For one, shares are down 20% since spring in an otherwise rising market. Two, there are protests in a whole bunch of different Latin American countries at the moment, and if they end up being contagious, things could get interesting quickly in Venezuela. You already had a near regime change there earlier this year, and economic conditions continue to worsen, so popular discontent should be building. KOF stock will take off like a bottle rocket once decisive action occurs.

Picking Up More Tech Stocks

I laid out the full case for Avalara (AVLR) recently. The company, for those unfamiliar, provides software to help small businesses collect and handle accounting for sales tax on online purchases.

I'll just add that Tuesday's earnings numbers were solid, with revenue growth continuing to run at 40% annually, and both the top and bottom line coming in way ahead of expectations. As of mid-day Wednesday trading, AVLR stock was only up a couple of percent, but it's been a rough environment for SaaS stocks this earnings season. Avalara should get on a roll in coming weeks as folks react to the earnings number.

Data analytics software provider Alteryx (AYX) also posted strong earnings, yet the stock has had a mixed reaction since reporting them. If you aren't posting blow-out numbers, the market simply doesn't want to buy SaaS right now. That, of course, means I'm interested in picking up names in the sector during this downturn.

AYX stock has gotten absolutely slammed off its previous highs. If my theory is right about tech leading the next leg of the run-up in the stock market, Alteryx should be in the sweet spot. The S&P 500 has now clearly broken out to all-time highs, so let's see if these SaaS names can get some traction:

Source: Finviz

If you were waiting for a pullback in SaaS stocks, there's plenty of charts like Alteryx out there now. If August wasn't the top for the whole space (and I don't think it was), this will be a most profitable dip to buy. Sticking with that theme, I added to the position in IT operations management software provider Datadog (DDOG) as well. The company, which now provides services to nearly 9,000 customers, recently IPOed after rebuffing a reported takeover offer from Cisco (CSCO). With DDOG stock fairly soft since the IPO, we can buy at a price not that far removed from what Cisco was willing to offer. Fellow contributor Yves Sukhu had an exhaustive article looking at Datadog's pros and cons recently.

Finally in the tech category, I added to the position in Roper (ROP). The company just announced an in-line earnings result. Revenues were up just 3%, which is slow for the firm, but profit margins grew nicely, leading to significantly larger gains in earnings and EBITDA. They also reiterated in-line guidance for the year. Regardless, the market wasn't particularly thrilled and ROP stock is still down 10% from its recent high.

October's New Holding: Estee Lauder

Photo Credit

I'm not going to get any timing points for this next pick. Estee Lauder (EL) is selling at 30x forward earnings, and the stock chart has been nearly straight up for a decade. EL stock recently pulled back from $207 to $186 in time for this month's purchase, but that's barely a dip in the grand scheme of things; it was at $90 in 2017.

However, I've been studying this company recently and it's simply a phenomenal business. Not only is it great in terms of having huge profit margins and cash flow generation, it's also enjoying a wave of growth from emerging markets as more consumers finally earn enough money to buy top-notch cosmetics products. On top of that, internet marketing has been an absolute boom for firms like Estee Lauder and L'oreal (OTCPK:LRLCY). Instagram influencer marketing and targeted online campaigns were pretty much invented to sell these sorts of products.

Estee Lauder's profits and margins have both soared as the company has developed its online sales channel which comes with far better economies than selling products through department stores and other traditional channels. Estee Lauder is also enjoying a huge sales boom for airport retail - and with international air travel positively exploding (again, particularly in emerging markets), there's a huge tailwind here as well.

Overall, over the past 10 years, Estee Lauder has grown net income by 18% per year compounded, and earnings per share by 24%/year. Those are jaw-dropping numbers for a defensive firm selling branded consumer goods. Coca-Cola, by contrast, has grown net income at 2%/year and EPS at 3%/year over the past 10 years.

So go ahead and say EL stock is too expensive at 30x forward earnings. It's certainly a steep price, I won't dispute that. But if 30x earnings is too expensive for something with high teens annual earnings growth, how can somebody justify paying 26x forward earnings for Coca-Cola stock with low single digits earnings growth?

Estee Lauder may trade down in coming months. The U.S. cosmetics market has slowed down this year, which caused a massive dump in rival Ulta's (ULTA) stock recently. Estee Lauder has more international exposure, so I doubt they'll follow that path, but it's something to keep in mind. Regardless, I'll be adding to this position at any halfway decent price. Estee Lauder was a major error by omission on my part for not doing a deep dive on it sooner, and I'll take advantage of any weakness to build out a meaningful position. There's so many favorable trends here - direct-to-consumer marketing, the Instagram/selfie trend among young people, emerging market consumer growth, and the rise of airport retail that Estee Lauder is perfectly positioned for long-term rapid growth in an extremely attractive business sector.

Energy, Banks, And More

Moving to a decidedly less glamorous topic, on the energy stocks, I continue adding to ExxonMobil (XOM), Canadian Natural (CNQ), and Suncor (SU) for the reasons I discussed last month. Very little has changed with the story on those. I'd note with all the lower-yielding names coming into the portfolio lately, energy is a nice way to balance that out and add some starting 4-5% dividend yielders to the mix.

In financials, I only picked up two, which must be the lowest monthly total in quite awhile. The whole sector has rallied quite a bit over the past quarter, with many of my favorites like State Street (STT) and TFS Financial (TFSL) making fairly big jumps. So I passed on those. Banks are also the largest industry holding in the IMF portfolio already, so I feel less urgency to add to positions today.

That said, Wells Fargo (WFC) remains way too cheap. With the new CEO in place and a massive share buyback, it's hard to see meaningful downside from $50, meanwhile, WFC stock could easily hit $70-$80 over the next couple of years if the bearish narrative around the economy and yield curve fails to materialize.

I'm also adding again to CBOE Holdings (CBOE). Stock exchanges are a fantastic business inherently, with low capital costs, high network effect, and huge scale. CBOE in particular is interesting since it has the VIX trade, and thus offers a natural hedge; when the stock market invariably corrects, VIX trading will pick up and give CBOE's earnings a boost. 22x forward earnings for a high quality business with consistent double-digit earnings growth is a reasonable deal.

Corporacion America Airports (CAAP), this one I should write a full report about as it's been most volatile recently. In any case, Corporacion America Airports develops and operates dozens of airports around the world. It's home base in Argentina, but it has substantial operations in Brazil, Italy, and Ecuador among other countries.

Given the political developments in Argentina, CAAP stock has continued to decline, and it's now down 75% from its IPO price in 2018. It's not hard to make the case that this is an overreaction, particularly since 40% of the company's revenues come from countries other than Argentina. A lot of people seem to be pricing in Argentina nationalizing the airports - which seems like a rather negative assumption - CAAP held these leases through the last Kirchner government without them being taken away, so why expect worse now than what actually happened last time she was in power?

That said, even if you assume the worst and Argentina is a big zero, CAAP stock still looks viable. The company is producing roughly $300 million a year in operating income and only has $70 million in interest expenses. Those figures are in dollars and are subject to substantial variation given currency fluctuations, however, as CAAP has significant dollar and euro revenue streams and much of its debt is denominated in emerging market currency, Peso devaluation isn't nearly as significant a risk to cash flow as you might guess. I think folks are looking at the financial expenses line of the income statement and not realizing that the much larger figure there includes a lot of non-cash items that aren't relevant in factoring CAAP's creditworthiness.

Long story short, CAAP's debtload looks okay, and even if Argentina tried to nationalize the airports there (which is unlikely), they could still cover their debt and have cash flow left over.

Meanwhile, if CAAP stock trades back to anything close to a decent EV/EBITDA multiple, the stock price would be at least $15/share, with it moving into the low $20s to match the Mexican airport operators on valuation.

Chart Data by YCharts

Is $20/share going to happen anytime soon? Probably not. You'd need Argentina to move back to the right politically, and the earliest things could really start to swing is with legislative voting in 2021. That said, the stock could easily get back toward $6-$8 (50-100% upside) simply as people realize that the new government isn't going to seize the Argentine airports; the underlying business itself has desirable economics and will compound shareholder value as well. CAAP stock is highly risky as far as individual IMF holdings go, however the potential reward justifies the risk.

Disclosure: I am/we are long ALL THE STOCKS IN THE TABLE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.