Susan Dziubinski: I am Susan Dziubinski with Morningstar. Every Monday morning, I sit down with Morningstar Research Services’ chief U.S. market strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead.
So, on your radar this week, Dave, are earnings from some key retailers. First, in broad terms, what will you want to hear about from the retailers?
Dave Sekera: Good morning, Susan. Good to see you again. Consumer spending, as you know, has really kept the economy running a lot faster. In fact, faster than what we originally expected coming into this year. But we do think that may be coming to an end very soon, and there’s a number of different reasons why. Some of the catalysts just being the ongoing impact of inflation. Just as higher interest rates start flowing through the system, we’ll see an increased costs on people’s credit card balances. New auto loans are certainly much more expensive than they’ve been, and mortgage rates are some of the highest levels, I think, we’ve seen in decades. We also have the resumption in student loan payments. The excess savings built up during the pandemic, I think, for the most part, those are depleted.
So really, I’m going to just be listening for any commentary from the retailers as far as how much they expect overall spending to slow. But even more specifically than that, I want to listen to see how they think that consumer spending may be shifting as it slows, and I think there’ll be several different implications from that, not just necessarily how it impacts the retailers themselves, but how that also then may impact those companies that supply the retailers.
Dziubinski: Now, drop some names, Dave. Who’s reporting this week, and what do we think of the stocks heading into earnings?
Sekera: First off, it looks like we have Home Depot. Now, Home Depot’s stock is down 8% year to date, and that brings that stock down into fair value territory. So it’s now rated 3 stars. In fact, if you look at that stock, it’s trading near the same level as it had all the way back in mid-2020. That stock had risen all the way up into 1-star territory in late 2021. I’m going to listen how demand is holding up. Now, part of our thesis as far as why we thought that stock had become as overvalued as it did in 2021 was that, during the pandemic, so many people were at home. They were remodeling their houses, doing a lot of at-home projects, that I think that that pulled a lot of future demand forward back then.
Next up is going to be Target. That stock is down 27% year to date. It’s also now trading at the same level as before the pandemic. Now, also that stock was a 1-star-rated stock during much of 2021. What we saw back then is that consumers had shifted their spending into goods away from services during the pandemic. But I think the market just way overestimated how long those excess sales were going to last. I’d also note with Target, too, we do not rate the company with an economic moat. We do not think that Target has long-term, durable competitive advantages.
And then rounding out these retailers here is Walmart. Now, unlike Home Depot or Target, Walmart stock, it was a 4-star stock in mid-2022. It rose into that 3-star territory beginning of this year. Also, unlike Target, Walmart is rated with a wide economic moat, yet looking at that stock performance thus far this year, it’s up 17%. That now puts it into overvalued territory. It’s currently rated 2 stars, trades at a 15% premium, company pays a 1.4% dividend yield.
Dziubinski: Any other earnings reports you’ll be watching for this week?
Sekera: Yeah. Really, two others, and they’re going to be in the tech sector that I’m going to be focused on. First is going to be Applied Materials. Now, that stock is up 60% over the past 52 weeks. It’s now rated 3 stars, trades almost right on top of our fair value estimate, and the company only pays a little under a 1% dividend yield. Now, that stock was in 4-star—and actually deep into 4-star—territory last October. What the company does is it’s the largest producer of semiconductor wafer fab equipment. We do rate the company with a wide moat. So here I’m going to be just listening for the commentary they have on the semiconductor industry. What we’ve seen over the past 12 to 18 months is that the performance has been very bifurcated among semis, those commodity-oriented semis. A lot of the memory chips have been under pressure for a while. I think we had seen a lot of excess inventory had gotten built up, so a lot of that has been sold down. I just want to hear: Are we near the point where those inventories have been cleared out? And then, on the specialty side, those semis have done extremely well. In fact, anything to do with artificial intelligence has been spiking for the past couple of quarters. I just want to hear what the outlook is for demand there.
Then the other one is Palo Alto. Now, that stock is up 82% year to date. I just note that’s one of those cybersecurity stocks that we highlighted back in June of 2022. We did publish an article on cybersecurity. We outlined why we thought that industry really had some of the most attractive long-term secular growth behind it. It was one of the best stories we thought at that point in time. But yet, with as much as that stock is up, I think that’s all priced in. It’s now a 3-star-rated stock, trades at fair value, has a 3% dividend yield, and as a company, we do rate with a wide economic moat.
Dziubinski: We also have a couple of inflation-related reports coming out over the next several days. What are they, and what are the implications, Dave?
Sekera: We have both CPI and PPI—the Consumer Price Index and the Producer Price Index. I’ll be focused mostly on CPI. Now, that’s projected to be up 3.3% year over year. So a slower rate of increase than last month, when it was up 3.7%. But of course, a lot of people would be very focused on core CPI. That’s expected to be up 4.1% year over year, and that would be essentially unchanged from the rate that it went up last month.
Either way, I really don’t expect these to deviate all that much from consensus. However, if, for some reason, they do come in hotter than what the market is expecting, I do think the market could get hit pretty hard. I think that would call into question the current market assumption that the Fed is done hiking interest rates at this point in time. And so if those numbers do come in hot, people might start pricing in another Fed hike in order to fight inflation.
Dziubinski: Let’s move on to some new research from Morningstar. We’re going to start out with our analysts’ takes on a few companies that reported last week. Let’s kick things off with the name that we’ve talked about a lot on the show this year, and that’s International Flavors & Fragrances.
Sekera: Yeah. And I’m just going to have to admit, IFF, that’s a stock for the last year, I think, we’ve just been long and wrong. That stock has fallen 22% over the past 52 weeks. Now, we’ve also cut our fair value a little bit but not anywhere near to the same degree that the market has sold off. Company’s results, they have been weak. We do continue to forecast, though, that the company should recover from inventory destocking and the cost inflation, both of which have really been pressuring the company over the past 12 to 18 months.
Our thesis here for this stock is that, over time, as inventories do normalize and prices continue to keep increasing, that should bring operating margins back up in line with historical averages. Currently, that stock is rated 5 stars, trades at a 45% discount to our fair value, and in the meantime, it pays a 4.5% dividend yield.
Dziubinski: Well, you get paid to wait on that one, I guess.
Sekera: Little bit.
Dziubinski: Next up are a couple of drugmakers, Gilead and AstraZeneca. Gilead stock was down after the company reported earnings, but we stood by our fair value estimate of $97, and the stock’s trading at an attractive discount. So what does Morningstar think the market’s missing here, Dave?
Sekera: Well, just really the short synopsis here is we just think the investors are underappreciating the stability of their HIV business. And we also see a lot more growth potential in their oncology portfolio, and in that pipeline, than I think what the market is pricing in. So it is a 4-star-rated stock, trades at a 22% discount to our fair value, and has a 4% dividend yield.
Dziubinski: Now, same industry, but different market response to earnings. AstraZeneca’s stock was up after earnings, and here, too, we stood by our fair value estimate of $78. Does the stock still have room to run?
Sekera: We do think it still has some upside potential from here. Again, we think the market is just underappreciating the pipeline and the overall growth potential. So it’s rated 4 stars, trades at about a 19% discount to our fair value, and has a 2.3% dividend yield.
Dziubinski: And Emerson Electric was down quite a bit after earnings, yet Morningstar raised its fair value estimate on the stock a little bit. Why did the stock pull back, and why did Morningstar tick up that fair value?
Sekera: Yeah. And I’d just first note that we did increase our fair value, but that fair value increase was a little bit under 4%. So it’s not very much of an increase. And the reason for that was really just a combination of a couple of minor changes in our model. We also incorporated National Instruments. NI is a company that EMR recently acquired. I think what happened here is the market is probably overly focused on sales being a little bit softer in their discreet automation business.
I talked to Josh, who’s our analyst that covers that name, and in his view, he just really didn’t think that shouldn’t have been a surprise to the market as it is a shorter business cycle business. So with the economy softening, it wasn’t a surprise to him. So overall, I would just say there’s really no change in our long-term thesis here for the most part. It’s a 4-star-rated stock, trades at a 21% discount, 2.4% dividend yield, and is a company that we rate with a wide economic moat.
Dziubinski: Let’s pivot over to some industry-related research from Morningstar about lithium stocks. Now, lithium stocks have been hammered over the past couple of weeks. Why?
Sekera: Lithium has just been extremely volatile over the past couple of years. Lithium skyrocketed in 2022. In fact, I think prices almost quadrupled that year. It hit a price that was double what is essentially our long-term forecast for lithium. And then here in 2023, lithium prices have now been dropping back down to earth. In fact, they’re back to essentially where they were in September of 2021. What’s happened here is over the past couple months, after it’s fallen as much as it has, we’ve seen several different brokerage research firms out there put out negative notes on the lithium sector and the miners.
I think the most recent note that we saw was predicated on lithium falling all the way down to $15,000 per ton in 2026. Now, that price actually would be 25% below what we model out to be the marginal cost of production, which we view as $20,000. In our view, that price would be just way too low at that point. With the marginal cost being higher, you’d certainly see people start curtailing production instead. We’re actually looking for lithium prices to stabilize and rebound a little bit, getting up to $24,000 a ton here in 2024.
Dziubinski: What’s our take today on lithium and lithium stocks, Dave?
Sekera: According to our research, really nothing has changed in our long-term forecasts. And when we look at those forecasts, they’re going to be based on how much lithium is currently supplied in the marketplace, how much is being mined today. We then add to that over the next decade how much we project to come online based on the projects that are out there and in development. And then we compare that to our forecast for the number of electric vehicles, the number that we expect to be produced every year over the course of the next decade. Then we add in some of the other demand out there for batteries, for lithium as well. Based on that supply/demand analysis, we think that lithium will actually be undersupplied over the course of the next decade. And of course, if it’s undersupplied, that will keep prices well above the marginal cost of production.
Dziubinski: Let’s move on to the stock picks portion of our program. Your picks this week are five lithium stocks that Morningstar covers that look undervalued today. Let’s parse through that list, starting with SQM. Now, SQM isn’t a pure play on lithium. Its asset portfolio includes other commodities, and it’s also the largest company among your picks this week. Tell us about it.
Sekera: I have to admit, my daughter tried teaching me how to pronounce the name of this company over the course of the weekend, and I just can’t do it. I’m not going to offend anybody’s ears that actually knows how to speak Spanish, so I’m just going to call it SQM. Now, that stock is down 55% over the past year. It’s a 4-star-rated stock, trades at about half of our fair value. Now, for dividend investors here, I would note that they do have a variable dividend policy, and it’s going to be set at a range based on the company’s net income. And then they’ve got several different balance sheet metrics. When you’re investing in this one for the dividend, I’d be very cautious because I think you could see some pretty big swings in what that dividend payment is going to be.
Now, the company is one of the three largest producers of lithium in the world. We do rate the company with a narrow economic moat based on its cost advantages, and it is a stock with a Very High Uncertainty Rating. Essentially, you have a lot of political risk in Chile, where a lot of its assets are located. The Chilean president, I think, a couple of months ago made mention that he wanted to nationalize the lithium industry such that the Chilean government would own a majority stake in all of those projects there. So if that were to occur, the company could be forced to sell a 51% stake in its assets to the Chilean government, and that sale could be as low as book value in order to be able to extend the lease beyond 2030. So that’s really the downside in the stock, but again, trading at a very large margin of safety.
Dziubinski: Albemarle is your next pick. It’s the world’s largest producer of lithium, but it isn’t exclusively a lithium producer. Tell us about it.
Sekera: That stock is rated 5 stars, trades at a 60% discount, and they do have a dividend, which is currently yielding about 1.4%. Again, it’s another one we do rate with a narrow economic moat based on being a low-cost supplier of lithium. Now, I do think this is one that, within the lithium industry, we do consider this to be a slightly less risky play than some of the other plays. Its uncertainty rating is High as opposed to the others, which are Very High. In addition to lithium, they do produce bromine. They’re the world’s second-largest producer of that. That’s a chemical that’s used in flame retardants. They’re also a top producer of catalysts used in oil refining and production of some petrochemicals. But essentially, I still think the bulk of the growth here is going to come from lithium, and really, I just think of this really as a play on lithium as well.
Dziubinski: The next two picks are Lithium Americas and recently spun out Lithium Argentina. So what’s the difference between these two names, and why might an investor prefer one over the other and over your other picks this week?
Sekera: Just to be clear, there are two different tickers that these companies trade under. We have LAC, that’s Lithium Americas. And now, we also have LAAC, and that’s Lithium Argentina. The company split into a company with just the North American assets and then the other company with the Argentinian assets, and I think that’s to be able to help investors be able to better value each set of assets individually. I think when they were combined, it was very hard to understand the value of one versus the other. So the company wasn’t all-in getting as high of a valuation that it thought it deserved.
Now, let’s talk about these individually.
The Americas business is still in preproduction stage. It only has one location, and that’s in northwest Nevada. Now, we do think that location is one of the largest known lithium resources in the world. Americas recently began construction. They are expected to begin production in the mid-2020s. So as a preproduction, of course, as you’d expect, we do not rate it with an economic moat, but we do think that once it is up and running, it will be in the lower half of costs out there.
Now, Argentina did start production this year. It is in the course of ramping up production at this point. It also does have a second project that is also in development as well. This is one that we do rate with a narrow economic moat based on being a low-cost provider.
Now, both of these stocks are rated 5 stars. Americas is trading at a 60% discount to our fair value, whereas the Argentinian business is trading at a 77% discount to our fair value. Both of these companies have Very High Uncertainty Ratings. And in my view, I think that if you are investing in these stocks, it really should only be held by investors that have very high risk tolerance levels, and make sure that any investment here would be properly sized within proportion to your other assets.
Dziubinski: And lastly, there’s Livent. Livent is a pure-play lithium producer, albeit a smaller producer of lithium by comparison, but Livent will be merging with another pure play lithium producer soon. Tell us about that and how this name compares to the others.
Sekera: The stock is currently rated 5 stars, trades at a 64% discount, but they don’t pay a dividend at this point. We do rate them with a narrow economic moat based on being a low-cost supplier, but it is another one of these companies that we do rate with a Very High Uncertainty Rating. The lithium production in Argentina is some of the world’s lowest-cost lithium sources. The company is undergoing a merger with Allkem. That’s going to be an all-stock deal. We do expect that transaction to close by year-end. We do think it will be value-accretive at the end of the day, but as you mentioned, the company is on the smaller side. However, we do think that this deal, when it does go through, has the ability to transform the company into one of the larger and a major lithium producer.
Dziubinski: Thanks for your time this morning, Dave. Viewers interested in researching any of the stocks that Dave talked about today can visit morningstar.com for more analysis. Dave and I will be back live next Monday at 9:00 a.m. Eastern, 8:00 a.m. Central. In the meantime, please like this video, and subscribe to Morningstar’s channel. Have a great week.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.