6 More Stocks We Like
After reviewing our fair value estimates, we think these names are oversold.
|Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.|
COVID-19 has driven stores and theaters to close, restaurants to turn into takeout joints, and businesses to establish work-from-home procedures. As the pandemic continues to threaten economic growth, our analysts are re-evaluating the companies they cover. In doing so, they’re uncovering many opportunities. We’ve shared some of their ideas before, here and here. Today we suggest six additional stocks to consider.
Given the ongoing uncertainty in the market, these stocks may certainly fall further. Nevertheless, these names are trading at appealing entry points, given our long-term outlook for each.
Market Is Pricing In Sub-$50 Oil to Infinity for Continental Resources
We are restoring coverage of Continental Resources (CLR) with a fair value estimate of $19 per share. The decrease mainly reflects the depressed oil outlook following the collapse of the OPEC+ coalition and the continuing escalation of the global COVID-19 crisis.
Oil prices crashed March 6 after Russia surprised the market by refusing to agree to shoulder a portion of the production cuts proposed by OPEC for the wider OPEC+ partnership. The disagreement escalated when Saudi Arabia responded with wide discounts on its oil exports, kicking off a price war. That leaves individual OPEC members free to ramp up their production and is likely to result in heavily saturated oil markets for the next couple of years, materially reducing futures prices for crude. The fact that these events coincided with the worsening of the coronavirus outbreak makes things exponentially worse; essentially, it combines a supply shock with a demand shock.
Although the near-term outlook looks bleak, we think stock markets have overreacted. The marginal cost of supply is still around $55 a barrel for West Texas Intermediate--this is the price required to encourage development activity in the U.S. shale arena. Russia and Saudi Arabia do not have enough spare capacity to displace the 10 million-plus barrel/day U.S. shale industry, and we estimate the coronavirus impact on long-term demand will be modest, even if consumption plummets this year. Thus, further growth is required from U.S. producers in order for supply to keep up with demand after 2021, and that won't happen without higher prices.
Continental was more exposed to the downturn in prices than most exploration and production companies because management opted not to layer in hedges (this explains the magnitude of the cut to our fair value estimate, which was previously $45). But unlike most peers, the company can still live within cash flows through 2021, making it one of the best options for investors looking to capitalize on undervalued energy stocks.
Dave Meats, director
No Reason to Sell CenturyLink on COVID-Related Concerns
Recent selling induced by COVID-19 fears has brought CenturyLink’s (CTL) stock down to levels it hasn’t seen since the 1990s. We suspect concerns regarding the company's financial position have been as responsible as fear about business struggles amid the economic shutdown. We think financial concerns should be virtually nonexistent, and we expect business disruption to be modest. We are reducing our fair value estimate to $18 per share from $19 to account for the business headwinds that may arise, but the stock is still extremely undervalued, in our view.
We expect most of CenturyLink’s revenue base to see minimal impact from the current pandemic. More than 60% of revenue comes from supplying the network needs of large enterprises and governments. With workers and consumers confined to their homes in many parts of the world, we don’t expect this business to suffer as more Internet and private data traffic flows. The modest reduction in our revenue forecast comes mostly from a lower small and medium business contribution (13% of total revenue in 2019). As many of those businesses have temporarily shut down, and some may never come back, we expect a bigger contraction in 2020 and beyond than we did previously.
We also expect the societal impact from COVID-19 will slow CenturyLink’s margin expansion in 2020. Part of the expansion opportunity has come from bringing more buildings onto its network. Potential delays in that pace, given limits on nonessential business construction, along with the revenue headwinds led us to cut 30 basis points from the point of margin expansion we had been forecasting. We now project adjusted EBITDA of about $8.85 billion in 2020, rather than $9 billion, and revenue to fall 4%, down from a 3.3% decline. We’re not forecasting a substantial reduction in free cash flow (still about $3 billion), as we think reduced capital spending would result from the slower pace of construction, offsetting a decline in operating cash flow.
Matthew Dolgin, analyst
COVID-19 Only Muddies Near-Term Waters for Valvoline
With the COVID-19 pandemic leading commuters to stay home and skyrocketing unemployment pressuring premium demand, we are cutting our valuation for narrow-moat Valvoline (VVV) to $19.80 per share from $22.50. Despite our diminished outlook, the outbreak doesn't damp our enthusiasm for Valvoline’s future as demand for premium lubricant rises and the company's quick-lube operation expands. We still see mid-single-digit top-line growth against adjusted EBITDA margins of over 20% long term and suggest that the shares’ trading price implies undue focus on the near term at the expense of the long, creating a buying opportunity.
We believe Valvoline has ample liquidity to withstand the pandemic, especially as we suspect many of its stores will remain open to serve the needs of delivery drivers, healthcare workers, and other essential personnel. The firm drew on its credit facilities as a precaution ($525 million in total), leaving more than $750 million in available cash and no meaningful debt maturities until 2024. We expect leverage to return to precrisis levels as the pandemic eases.
Near-term demand will be challenging, highlighted by a midteens percentage dip in core North American segment revenue (and a high-single-digit percentage swoon in the international unit) as volume slumps alongside overall vehicular traffic and customers trade down to more price-competitive and lower-margin conventional oil. However, the premiumization trend that should allow Valvoline to capitalize on its strong brand is persistent, as newer vehicles require synthetic lubricant. Additionally, increasing vehicle complexity should continue to drive sales in the quick-lube unit once motorists return to the road, with the chain’s convenience (10-minute oil change without requiring the customer to leave the car) resonating with time-starved patrons. With a strong product brand and increasing quick-lube popularity, Valvoline should be poised to reward patient investors willing to endure near-term volatility.
Zain Akbari, analyst
Ingredion Offers Strong Free Cash Flow and Healthy Balance Sheet
After reviewing our 2020 assumptions for Ingredion (INGR) amid the COVID-19-related economic slowdown, we have slightly reduced our profit outlook. While we see no major changes to the majority of Ingredion's sales to the food and beverage industry, we expect slightly lower sales for the less than 20% revenue from industrial customers. We now forecast 2020 adjusted earnings per share to be near the bottom of management's range of $6.60-$7.20, down from our previous forecast around the midpoint. However, our long-term outlook is unchanged. Having updated our model to reflect these changes, we maintain our $125 fair value estimate as our slightly lower 2020 forecast is offset by time value of money effects since our last update. Our narrow moat rating is also unchanged.
We view Ingredion as materially undervalued, as the shares trade in 5-star territory. Even with a reduced 2020 profit outlook, we expect the company to generate solid free cash flow. Further, Ingredion's strong financial position makes the company well positioned to weather a prolonged economic slowdown. Net debt/adjusted EBITDA was a healthy 1.7 times at the end of 2019. Accordingly, we view the recent pullback in shares as a great entry point for long-term investors.
Ingredion derives more than 70% of its revenue from food and beverage customers that shouldn't be heavily affected by the COVID-19 outbreak. Additionally, as an ingredient producer, Ingredion should continue to be deemed essential and should see little disruption from government-mandated quarantines. We think the company's top-line results should remain steady as consumer food preferences have temporarily shifted toward packaged foods over dining out. For its exported products, the company could see a temporary timing impact due to logistics issues that could weigh on first-half results. However, we would expect these to reverse in the second half of the year, limiting the overall materiality of their impact.
Seth Goldstein, analyst
Despite Lower Expected Gross Margins, Hostess Is a Compelling Value
We are lowering our fair value estimate for Hostess (TWNK) to $15.80 per share from $17.60 after reassessing the impact the acquired Cloverhill business will have on the firm’s consolidated gross margin. When Hostess acquired Cloverhill in 2018, the asset reported a $14 million EBITDA loss, but management was confident in its plans to convert the business to a profitable enterprise that would generate $20 million-$25 million in incremental EBITDA by 2020, implying a 20% EBITDA margin. Recently, Hostess revealed that the turnaround was tracking a year ahead of schedule and the incremental profit was fully realized in 2019. It also said that the $20 million-$25 million includes the benefit from expanding the Hostess brand into Cloverhill’s established channels, such as club stores. As we previously assumed the profit target was fully from the stand-alone Cloverhill business, this indicates that the Cloverhill business will be less profitable that we initially assumed. As a result, we are lowering our five-year projected gross margin to 35.4% from 38.5%.
Even so, we view the shares as very compelling, trading 35% below our revised valuation. We still expect Hostess to continue its trend of consistent market share gains, given strong brand equity (which underpins our narrow moat rating); an advantaged distribution model that provides unique access to convenience, drug, and dollar stores; the ability to extract value from acquisitions by leveraging channel relationships (one factor supporting our Exemplary stewardship rating); and the expansion into the breakfast and cookie categories. Furthermore, we expect Hostess’ revenue to remain relatively stable throughout COVID-19-related disruption, as pantry-stocking benefits in channels representing 57% of the firm’s retail sales (grocery, mass, club, dollar, and drug stores) should offset potential weakness in the convenience store channel (43% of 2019 retail sales).
Rebecca Scheuneman, analyst
After the Recent Decline, Alphabet Has Become Attractive
Wide-moat Alphabet (GOOG)/(GOOGL) has become attractive in the recent COVID-19-driven downturn. Google's ad revenue will take a hit from the coronavirus in 2020, but the firm should maintain its dominance in the online advertising market, which should recover quickly after the pandemic eases and companies look to quickly regain consumers’ attention. In the short to medium term, any indication of a slowdown in the spread of COVID-19 could initiate a recovery in Alphabet stock and push it toward our $1,400 fair value estimate. Long-term catalysts include the return of strong subscription and ad revenue growth in YouTube and further traction gained by the firm in the cloud market. The Waymo and Verily call options represent additional upside to our fair value estimate. Verily's recent efforts to work with government agencies and create sites for coronavirus testing and screening may create commercialization opportunities in the long run.
As the pandemic continues to spread around the world, we believe it will further negatively affect ad spending. We expect total Alphabet revenue to increase only 1% this year as the decline in ad revenue is offset by further growth in cloud. We assume continuing growth in cloud and a recovery in advertising to push top-line growth to 27% in 2021.
Ali Mogharabi, senior analyst
Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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