Librarian Capital's Monthly Top Buys And Price Moves - January 2022
Summary
- Tobacco stocks remain strong buys after the defeat of the U.S. "nicotine tax" proposal and a reassuring update from British American Tobacco.
- In Payment, Mastercard and Visa each rebounded by more than 10%; U.S. holiday retail sales were strong and credit cards kept growing.
- U.S. Cable stocks fell after outlooks were cut again in early December, but recovered by month-end. We like Charter and Comcast.
- Industrial stocks like Kone, Otis, and Raytheon offer solid returns with little technology and regulatory risk. Fears on Omicron are receding.
- Zoetis shares gained another 10% in December, which we believe further limits future investor returns.
hanakaz/iStock via Getty Images
Introduction
In this monthly newsletter, we try to identify the most attractive opportunities in our research coverage by reviewing price moves and key news by sector.
December 2021 saw a significant rebound in equity markets, and nearly all the stocks (38 out of 43) in our coverage achieved gains. While this means none of the companies have become more attractive as a result of price moves, many of them have seen positive news supporting their investment cases.
Current Buy-Rated Stocks Ranked
The forecasted annualized returns of key companies in our coverage, along with their current and assumed exit P/E multiples, are shown below:
| Illustrative Annualized Returns vs. Current & Exit P/E Multiples
NB. Annualized returns are for the end of 2024 (or, where applicable, a company's FY25). Companies pending results reviews are marked with an asterisk (*). Multiples for Charter and Comcast are based on FCF. Estée Lauder P/E is based on CY19. Source: Librarian Capital estimates; market data as of 31-Dec-21. |
While the stocks above have been ranked by forecasted returns, the return figures are those for our base case scenarios and not probability-weighted, so a higher-ranked stock does not necessarily offer a better risk/reward.
Tobacco, Payments and Communications have continued to present many of our highest-ranked stocks, including 8 of our top 10. Compared to last month, Comcast (CMCSA) and Verizon (VZ) have entered the top 10, while Mastercard (MA) and Admiral Group (OTCPK:AMIGY) have dropped out.
Key Stocks By Sector
We discuss the most notable stocks by sector below.
Tobacco: U.S. "Nicotine Tax" Threat Receded
In the Tobacco sector, Swedish Match (OTC:SWMAY), Altria (MO) and British American Tobacco (BTI) (referred here as "BAT") are ranked at #5, #6 and #7 in our Buy list respectively, while Philip Morris (PM) is at #19:
The "nicotine tax" proposal being abandoned in the U.S. Senate was the key news for the sector last month. This was first reported by the press on December 9, and later officially confirmed by Senate Finance Committee chairman Ron Wyden. As we explained in previous articles, the proposal would have meant double- or even triple-digit increases in the prices of vaping and nicotine pouch products in the U.S., while leaving the tax on cigarettes unchanged. As we expected, the proposal was ultimately defeated by the firm opposition of three Democratic Senators.
Without a "nicotine tax", we expect existing trends in the U.S. nicotine market to continue, with a measured decline continuing in cigarette volumes, moderate growth in vaping volumes, and rapid growth in the (small) nicotine pouch category (where Swedish Match's market share exceeds 60%):
| U.S. Nicotine Pouches Volume & Market Share (Since Q2 2019)
|
British American Tobacco's H2 2021 "pre-close" trading update on December 9 also helped Tobacco stocks. BAT reaffirmed its overall full-year outlook, with revenue growth to exceed 5% and EPS growth to be mid-single-digits on constant currency. Just as importantly, BAT revised its 2021 global cigarette industry volume outlook upwards from an 1.5% decline to flat (but, for its P&L, offset by excise-related profit declines in Australia and New Zealand), referred to a strong U.S. cigarette market with little downtrading, and reported only mixed progress in its New Categories:
| Vapour | Heated Tobacco | Modern Oral | |
| BAT Brand | Vuse | glo | Velo |
| Market | Top 5 Markets | Top 9 Markets | Top 5 Markets |
| 2020 Revenue | £611m | £634m | £198m |
| Share Metric | Value | Volume | Volume |
| FY 2020 | 27.2% | 13.2% | 36.7% |
| May YTD 2021 | 31.6% | 16.5% | 39.5% |
| Sep YTD 2021 | 34.1% | 17.7% | 36.1% |
This is in line with our medium-term view for the tobacco sector, which is for broadly stable cigarette declines, except in markets disrupted by Philip Morris' IQOS Heat Not Burn product (primarily Japan, Eastern Europe and the European Union) and Swedish Match's ZYN nicotine pouches (the U.S.).
We continue to view Philip Morris as the most balanced overall risk/reward, with an expected annualized return (or "IRR") of 13.3% and a Dividend Yield of 5.3%. Swedish Match is our second preference, potentially higher-risk but also higher-return. Altria and BAT are "value" plays, both trading at low P/E and each offering a high-single-digit Dividend Yield:
| Current P/E | Expected P/E | Expected IRR | Dividend Yield | |
| Swedish Match | 22.4x | 23.4x | 21.3% | 2.1% |
| Altria | 10.9x | 12.0x | 21.1% | 7.3% |
| BAT | 8.2x | 10.0x | 20.5% | 7.9% |
| Philip Morris | 18.4x | 16.0x | 13.3% | 5.3% |
Payments: 10%+ Rebounds in Mastercard and Visa
From the Payments sector, PayPal (PYPL) is currently ranked #1 by forecasted return, while Visa (V) and Mastercard are ranked #10 and #11 respectively:
Mastercard and Visa shares gained 13.9% and 11.9% respectively during December. As we explained in our recent article on Mastercard, we believe share price declines in the two payment networks in the preceding months were driven by investor fears that were largely unfounded; conversely the rebound last month could not be easily attributed to any tangible news, though Buy Now Pay Later competitors were facing more headwinds.
U.S. retail sales were robust during the holiday season. Mastercard's SpendingPulse (which includes all forms of payments) reported total U.S. holiday sales growth of 8.5% year-on-year, with growth of 8.1% for in-store sales and 11.0% for e-commerce. This means e-commerce sales have grown by 61.4% since 2019, a significant tailwind for both Mastercard and Visa:
| U.S. Holiday Retail Sales (2021 vs. Prior Years)
Source: Mastercard SpendingPulse (26-Dec-21). |
Comments by executives from U.S. banks at a Goldman Sachs (GS) conference in early December pointed to good growth in credit cards, notwithstanding supposed disintermediation by Buy Now Pay Later:
"The numbers of credit cards are back at where they were (before the pandemic) and growing beyond that."
Brian Moynihan, Bank of America (BAC) CEO (07-Dec-21)
"If we talk about credit cards revolving balances ... they have been growing alongside the level of growth that we saw been in 2019".
PayPal shares gained a relatively modest 2.0% during December, and there were little company-specific news. CEO Dan Schulman also appeared at the same conference, and was bullish about his company's prospects. Our Upside Case for PayPal sees its EPS growing with a CAGR of more than 20% during 2021-24 and its P/E multiple returning to 55x (from 48.6x now), which together should generate an annualized return of close to 35%.
Communications: Broadband Net Adds Still Volatile
In the Communications sector, Charter (CHTR) continues to be #2 in our list, while Comcast has risen to #8 (from #13) and Verizon to #9 (from #11):
Charter and Comcast share prices both finished December higher, but only after recovering from significant corrections in the week of December 6-10, when they fell by 10.0% and 6.4% respectively. The correction was caused by another set of downward guidance revisions by U.S. Cable executives at an investor conference, with Comcast cutting its full-year broadband subscriber net add outlook from 1.4m to 1.3m, and Altice USA (ATUS) cutting its from "slightly positive" to a negative 5-10k. (Charter left its outlook unchanged.)
We remain positive on both Charter and Comcast shares. As we explained in our article on December 10, we believe the deceleration in their broadband net adds is primarily due to a natural normalization after the COVID-related boost in late 2020. Rival wireline offerings from telcos like Verizon and AT&T (T) have continued to see barely positive net adds, and rival fixed wireless offerings (including from T-Mobile (TMUS)) had only a marginal impact in Q3 2021:
| Wireline & Fixed Wireless Broadband Net Adds - Key Players (Since 2018)  NB. Verizon and T-Mobile fixed wireless net adds not disclosed before Q3 2021, but were likely to be minimal. Source: Company filings. |
Altice USA shares also corrected in the same week and recovered subsequently, though comments by their CEO revealed additional problems that we believe to be significant, including clear market share losses to Verizon's Fios fiber network, a likely decline in both revenues and EBITDA in 2022, and a continuing pause in buybacks.
Industrials: Solid Returns with Different Risks
In Industrials, we have Kone (OTCPK:KNYJY), Raytheon (RTX) and Otis (OTIS) being ranked at #15, #17 and #18 respectively, even after having each made a high-single-digit gain in December:
While the three stocks have forecasted annualized returns that are "only" around the mid-teens, they tend not to have the same technological and regulatory risks that higher-ranked names in our list have to contend with. (The elevator companies, however, are more exposed to China.) Their investment cases also tend to involve lower exit multiples (P/E multiples in the 30s for Kone and Otis, and a FCF Multiple of 18.2x for Raytheon).
Raytheon's share price has been volatile through December, falling and rising as investors' views on the new Omicron strain of COVID-19 shift. (As we discussed in last month's edition of this newsletter, Omicron is a strictly short-term factor that does not alter long-term fundamentals.) Scientific consensus has been converging on the view that Omicron is far more infectious (as it multiples faster in the airways) but induces less severe symptoms (as it multiples much less in the lungs).
| Sample News Headlines on Omicron Variant
Source: CNBC (16-Dec-21). |
|
More transmissible but less severe variants could still produce a large number of hospitalizations in the short term and overwhelm public health systems. However, they could mean fewer hospitalizations over time, or even a quicker achievement of "herd immunity" (especially when combined with accelerated vaccination efforts), and an end to disruptive COVID restrictions. We believe our Raytheon investment case has been strengthened.
We reviewed our Otis investment case in December, and was reassured by its strong Q3 2021 results. 2021 EPS growth is now expected to be 17%, the Chinese market is expected to be flat in 2022 but recover thereafter, and the buyout of Otis' Spanish subsidiary should add a mid-single-digit percentage to 2023 EPS. We expect an annualized return of 14% by the end of 2024.
Animal Health: Zoetis Now Even More Expensive
Zoetis (ZTS) shares gained another 10.0% during December, taking its total gain since our July downgrade to 23.6%. We reviewed our Neutral rating in December and, despite revising our forecasts upwards to reflect strong growth, continue to see little upside for investors. The core issue is high valuation - shares trade at over 50x 2021 guided EPS, compared to the 38.5x that we view as fair. The implied de-rating that will offset nearly all of the benefit of EPS growth in the next few years. (ZTS stock fell 4.1% on the first trading day of 2022, and was down another 1.3% in aftermarket trading.)
Other Sectors
The rest of the sectors in our coverage is below:
Closing Comments
After a difficult November, December was a welcome return to normality, with significant gains in many of our Buy-rated stocks.
Our Buy-rated stocks had a good year in 2021, with key winners such as Intuit (INTU) (up 69.5%), Microsoft (MSFT) (up 52.2%) and Bank of America (up 47.9%). Gains across all stocks that were Buy-rated through the whole year, unweighted and in local currencies, averaged 16.0%.
Our long-only portfolio, constructed based on our research, gained 23.2% (in GBP) in 2021, taking our total gain since the start of 2019 to 81.0%.
We expect to see a strong economy in 2022, helped by pent-up consumer demand and a further normalization from COVID-19 disruptions. Markets are harder to predict, given the level of excess liquidity and irrational behavior since the start of the pandemic, but we are confident that the high-quality, enduring franchises in our Buy-rated coverage will do well over time.
This article was written by
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