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With 2022’s inflation scare and subsequent interest rate shock, most sectors faced synchronous declines last year. It was a terrible year even for seemingly “safe” assets such as Treasury bonds and investment-grade corporate bonds, which logged their biggest annual declines in modern history!
With across-the-board declines like that, there are bound to be some high-quality gems that have been thrown out with the bathwater. Look for these three competitively advantaged companies to bounce back in a big way in 2023 and beyond.
One must admit this year’s memory downturn has been worse than even the pessimists could have imagined. In fact, leading memory chip manufacturer Micron (MU -1.10%) has continually revised its targets down, reporting uglier and uglier numbers since the memory slump began last June. And yet, Micron’s share price remains around the same levels as the June slump — just above its tangible book value.
When a stock doesn’t plummet on terrible news, that could indicate a bottom may be forming. Furthermore, Micron has some unique competitive advantages. First, it operates in a market with few competitors, as one of only three major DRAM manufacturers and one of only six major NAND flash players. The NAND market may actually consolidate further to four if one counts the Western Digital and Kioxia NAND joint venture as one company and if U.S. sanctions on Chinese upstart Yangtze Memory Technologies (YMTC) weakens or takes this player out of the market.
Meanwhile, under CEO Sanjay Mehrotra, Micron has leaped ahead of competitors in terms of leading-edge technology this year. Whereas Micron used to be a laggard in memory node transitions, it was the first to manufacture and ship advanced 1-beta DRAM in November, following its achievement of becoming the first to manufacture and ship 232-layer NAND flash last July.
With its new industry leadership well in hand, Micron just announced big cuts to its capital expenditures in 2023 in a salvo to balance the market. Moreover, the company even made the unusual move of providing 2024 capital spending guidance, in which Micron now sees an even further decline in its front-end equipment investment.
As has been seen in the oil industry, industrywide consolidation and control of supply can lead to big profits and cash flows. With its valuation near trough levels, the potential for decreasing supply growth, and a demand recovery forecast for late 2023, it’s a good setup for a big recovery in Micron’s stock this year.
While Micron is cutting back on supply growth, cable and broadband leader Charter Communications (CHTR 0.05%) recently sold off due to its plan to increase capital spending, which scared off short-term investors.
But that may be appropriate, as Charter’s utility-like broadband, cable, and mobile subscriptions are much steadier than the commodity-like memory chip industry. That makes Charter stock’s 49% decline in 2022 and 60% decline from all-time highs all the more remarkable.
Chalk up Charter’s decline to a bad combination of slowing growth, high debt, and its new CEO’s plan to increase spending next year to augment Charter’s reach and upgrade its network. The cable stock has now fallen to a valuation of just 10 times earnings and 7 times its trailing free cash flow.
However, Charter’s capital allocation policy should enable it to continue repurchasing its stock at these bargain-basement levels, even as it spends on upgrading and expanding its network.
It’s also not as if Charter isn’t growing at all. The broadband industry is fairly low-churn, but the lack of people moving and forming households after the pandemic ended and interest rates spiked has eroded gross additions across the industry. Yet while many high-debt companies may have reasons for concern in a new rate environment, Charter makes very high adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margins of around 40%, which should allow it to cover its interest payments handily.
It wouldn’t be hard to envision a scenario a year from now in which Charter is well into its upgrade cycle, cash-conscious customers have increasingly adopted Charter’s attractive low-cost broadband and mobile bundles, and interest rates have stabilized or come down, making investors less scared of Charter’s debt load. In that scenario, Charter’s bargain-priced stock could appreciate a lot from these depressed levels.
If the tech sector has been terrible this year, the fintech sector has been downright horrific. Newer, high-growth, but unprofitable businesses predicated on low interest rates are now in serious trouble, as rates have risen and funding has dried up. Many lending “platforms” such as Upstart have gone from growth darlings to having serious questions about their viability.
And yet, personal loan leader LendingClub (LC 2.09%), founded in 2007 and public since late 2014, is much more mature than these newer competitors. Most importantly, it is profitable and has a much better funding structure than other fintechs since the company acquired Radius Bank in early 2021.
Because LendingClub now has a banking license with access to low-cost deposits, it has a nice hybrid model in which it can either sell its loans to third parties or hold more loans on its balance sheet. And because of that optionality, it can market to a wider range of borrowers, increasing its marketing efficiency over its peers.
While LendingClub rocketed higher in 2021 on that surge in growth and profitability, the stock has been decimated in 2022, down 65% on the year. It’s a bit of a head-scratcher, but the likely explanation is that LendingClub has been grouped in with other newer unprofitable fintech stocks dependent on third-party funding.
After this sell-off, LendingClub trades at just 5 times 2023 earnings estimates and 0.8 times book value — and keep in mind, this is still a growth company, too. While there are very valid concerns about a recession next year, LendingClub has pivoted in recent years to higher-quality borrowers, largely with FICO scores above 700 and salaries over $100,000 per year. LendingClub also chooses to generally put the highest-quality 20% to 30% of loans on its own balance sheet, mitigating risk even further.
As weaker competitors fall away in this difficult environment, stronger legacy players may only come out stronger on the other end. It’s possible by the end of 2023, LendingClub’s stock will be substantially higher than its current depressed levels.
Billy Duberstein has positions in Charter Communications, LendingClub, and Micron Technology and has the following options: short January 2023 $160 calls on Micron Technology and short January 2023 $40 puts on Micron Technology. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends Upstart. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
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