February 10, 2023

This week, we comment on earnings from Adient (ADNT), Brookfield Re (BANR), Brookfield Asset Management (BAM), Goodyear Tire (GT), Mattel (MAT), Newell Brands (NWL) and Western Union (WU).

Next week, Toshiba (TOSYY), TreeHouse Foods (THS), Conduent (CNDT), Ironwood Pharmaceuticals (IRWD) and Organon (OGN) report earnings.

Earnings updates:

Adient (ADNT) – Adient, one of the world’s largest automobile seat makers, struggled due to weak leadership after its 2016 spin-off from Johnson Controls. We became interested in late 2018, after the shares fell sharply, due to the arrival of Doug Del Grosso as CEO. While we were a bit early on this name, Del Grosso’s highly capable leadership has produced an impressive turnaround so far.

Adient reported respectable fiscal first-quarter 2023 results that showed further recovery from its pandemic-related downturn. The operational turnaround appears to be mostly complete, but when compared to the margins at competitor Lear’s seating division, Adient is still lagging. The business environment (car production, input costs) continues to weigh on financial performance and thus obscures our visibility into the company’s underlying margin structure. Both the lackluster environment and the lack of visibility impede the shares from reaching our price target.

The company incrementally ticked up its full-year revenue guidance (to +6%) and ticked down its equity income guidance but maintained its guidance for key metrics like EBITDA ($850 million), capital spending ($300 million) and free cash flow ($200 million). Adient generated only $47 million in free cash flow in FY2022 and zero in FY 2021 – so we are encouraged that this key metric is moving in the right direction. The balance sheet is strong.

The shares have 22% upside to our $55 price target – a level reachable once the company demonstrates enough fundamental progress toward a full recovery. We believe this will happen in 2024, or perhaps sooner if Adient executes well later this year. No change to our rating.

In the quarter, revenues of $3.7 billion rose 6% and were about 2% above estimates. Adjusted earnings of $0.34/share compared favorably to a loss of $(0.38) and were 6% above estimates. Adjusted EBITDA of $212 million rose 45% and was 9% above estimates.

While the 6% increase in revenues was relatively modest, it was stronger than Adient’s end markets in all geographies except the European segment. The company expects long-term auto production there to be permanently lower than pre-Covid, so it is taking steps to reduce its overhead, physical footprint and capital spending to adjust. Americas car production is likely to remain reasonably healthy this year, and China is improving. Adient continues to win meaningful new mandates for vehicle seats.

Steel, plastics, oil/electricity and other input prices remain difficult but trending in a better direction.

Brookfield Asset Management (BAM) – Investors in our Buy-rated Brookfield Re (BNRE) received shares of Brookfield Asset Management in its December 2022 spin-off. BAM shares are “Unrated” as the company is not in a turnaround situation. We anticipate moving our rating to Sell in the near future. Our earnings review is therefore brief.

The company reported a strong quarter. Distributable earnings (a more relevant metric than earnings per share) were US$0.36/share, rising 6% from a year ago and beating the consensus estimate which called for flat earnings. As an asset management company, total assets under management drive profits – one major driver is the amount of new capital raised. Private equity firms like BAM bring in new assets from formalized fundraising for specific partnerships, unlike mutual fund companies which bring in new assets primarily through daily purchases in the open market and through client mandates. In 2022, the company raised $93 billion in new capital commitments – an enormous sum that reflects confidence in its ability to produce strong returns in its various partnerships.

All-in, a strong inaugural quarter as a public company, reflecting this company’s high quality. The shares remain Unrated, but, like when dining on a well-crafted meal, we’re not quite ready to push back from the table just yet.

Brookfield Reinsurance Ltd (BNRE) – Recently spun out of highly regarded Canadian investment management firm Brookfield Asset Management (now called Brookfield Corporation), BAM Re is a new investment company that acquires the assets of and future contributions to pension plans and life insurance books. It invests these assets with the expectation that the returns will be significantly greater than the build-up in the related payout obligations. Over time, excess returns can build up considerable value for shareholders.

The company reported an encouraging quarter, with distributable operating earnings increasing to $170 million from $21 million a year ago. There is currently no consensus estimate. The growth is driven by Brookfield Re’s growth in assets (now at $44 billion compared to $11 billion a year ago) as it acquires insurance companies and books of insurance and pension risks. Its strategy, started about a year ago from scratch, will take several years to fully develop. The company appears fully engaged and its build-out is progressing well.

Goodyear Tire & Rubber Company (GT) – An investment in Goodyear is an opportunistic purchase of an average company whose shares have fallen sharply out of favor for what look like short-term reasons. Investors aggressively sold the shares following the company’s disappointing outlook provided during its fourth-quarter earnings call. However, demand and pricing will likely remain robust, more than enough to offset rising input costs. And, the benefits from Goodyear’s acquisition of Cooper Tire provide additional value. The company’s balance sheet is sturdy.

Goodyear reported a mixed quarter as it continues to be plagued by uneven demand and ongoing cost increases. Despite the weak results, our thesis is unchanged, although its resolution is delayed.

In the quarter, revenues rose 6% and were 4% above estimates. Adjusted earnings of $0.07/share fell sharply from $0.57 a year ago and were well below the $0.12 consensus estimate.

Revenues were reasonably strong and would have been about +13% without the headwind from the strong dollar. Sales to car makers rose 11% as global vehicle production continues to improve, but sales of replacement tires slipped 6%. Goodyear’s sales growth was stronger than the industry in both categories. All of the sales increase came from higher prices as tire volumes fell 3% from a year ago.

Results in EMEA (Europe, Middle East and Africa) were the weakest, as pre-released by the company a few weeks ago. The region drove most of the total company’s volume decline, and regional profits swung from a $41 million profit a year ago to an $80 million loss this past quarter. Weak economic conditions as well as an inventory glut of winter tires (due to mild weather) are weighing on results. Goodyear is consolidating and closing plants and making other cost cuts to address what may be a structural over-capacity problem.

Price increases more than offset higher raw material costs but inflation and inefficiencies elsewhere pulled down profits. Synergies from the Cooper Tire acquisition were $40 million.

Goodyear’s balance sheet remains over-leveraged at 3.8x EBITDA, but cash flow is more than adequate to service it and the nearest maturity is in 2025, so the company has plenty of financial flexibility. We would like to see meaningful debt reduction, to perhaps the 2.5x level. We anticipate stronger free cash flow in 2023 as the company works down its excess inventory.

Mattel (MAT) – At our initial recommendation in 2015, Mattel was struggling with its failure to adjust to the realities of how young children spent their playtime. This failure had produced years of revenue decay. In addition, its cost structure became bloated, and its debt levels increased. However, led by its new CEO, Mattel now appears to be finding its way.

Mattel reported a surprisingly weak holiday-driven fourth quarter. Guidance for 2023 was uninspiring, calling for sales to be flat and earnings to fall about 8% – these were well below consensus estimates. Favorably, Mattel gained market share in the quarter, but the post-pandemic toy boom seems to have ended while inflation and other economic conditions are weighing on consumer demand. Financially, Mattel is strong – enough that it expects to resume share repurchases in 2023. But the turnaround has stalled while we wait for new company-driven initiatives to roll out (including movies) and some improvement in the macro environment as well as reductions of somewhat bloated inventories at retailers.

In the quarter, revenues fell 19% excluding currency changes and were 17% below estimates. Adjusted earnings of $0.18/share fell 66% and were 38% below estimates. Adjusted EBITDA of $158 million fell by half and was 31% below estimates.

Dissecting the revenue problem, we see that sales fell $393 million. Our math attributes more than half the decline to weaker volumes, with the balance due to weaker pricing. Both appear to be driven by Mattel’s over-production of toys and retailers’ over-buying of toy inventory.

To address this inventory problem, Mattel said that it used “inventory management efforts, including higher close-out sales and inventory obsolescence expenses” during the quarter. This essentially is discounting to move unwanted merchandise. The effects won’t fade quickly: while reasonably healthy, consumers’ appetite for toys is not boundless, so Mattel is cutting its production and retailers are cutting their orders. These knock-on effects account for the uninspiring 2023 revenue and profit outlook, backed by management’s comments that inventory reductions at retailers would weigh on sales by 3-4%.

Helpfully, operating expenses in the quarter fell 16% and partly offset the weaker gross profits. But, with gross profits falling $282 million and expenses falling only $103 million, operating profits were decimated.

Free cash flow for 2022 was low at $256 million. The company guided 2023 free cash flow to “>$400 million” which would be healthy, in our view. Debt fell nearly 10% from a year ago and is at a reasonable 2.4x EBITDA.

Despite the weak quarter and outlook, Mattel showed the strongest end-customer demand for a fourth quarter and a full year in over 8 years, suggesting that there is no structural issue with Mattel’s products. Profits compared to pre-pandemic and pre-turnaround 2019 have doubled.

Newell Brands (NWL) – The company has struggled, literally for decades, with weak strategic direction and expense control, epitomized by its over-reaching $16 billion acquisition of Jarden in 2016. Pressured by activist investors last year, and now led by a capable new CEO, Newell appears to be finally fixing its problems, yet the shares remain significantly undervalued relative to their post-turnaround potential.

Newell reported weak 4Q results that nevertheless beat estimates. But the company provided dismal guidance for 2023, sending its shares sharply lower in pre-market trading. Our growing concern with Newell is that, despite its many restructurings, it continues to struggle, and that it may have structural issues that are simply unfixable.

In the most recent effort to address its problems, Newell announced today that it is replacing its CEO with the current president, Chris Peterson. Peterson joined Newell as CFO in 2018 and was moved up to President last May in what probably was a planned but contested succession. This change is encouraging news, partly because Peterson seems capable but perhaps more because the board has recognized that the current plan and leadership aren’t making any progress. The announcement in January of a reshuffling of operating segments was a classic and disheartening plan to hide the shortcomings.

Also, the board is being partly overhauled. The board chair is being replaced by a 5-year board member, and Carl Icahn (8% ownership) is placing another of his lieutenants on the board, bringing his roster of board seats to three of the 12 seats. The changes in leadership helped trim the shares’ pre-market slide.

The change-over in leadership, plus the shares’ reasonable valuation, are keeping us interested. Otherwise, we would be inclined to move the shares to a Sell as the company seems to have chronic struggles.

In the quarter, revenues fell 9% excluding currency and divestitures but were 3% above estimates. Adjusted earnings of $0.16/share fell 62% from a year ago but were 45% above estimates.

Guidance for 2023 called for revenues to fall 7% from 2022 and come in 7% below current estimates and for earnings per share to slide 36% compared to 2022 and come in nearly 30% below estimates. The company blamed a weak economic environment and elevated inventory at retailers for its problems. Our view is that management hasn’t gotten the job done and we are relieved that new leadership is arriving. However, we need to see clear evidence of meaningful internal changes starting relatively soon to stay engaged with the Newell recommendation.

If the company is able to rebuild its revenue stream and restore EBITDA margins to around 15%, its current valuation would be about 7.9x EBITDA – cheap enough for us to wait, for now.

The Western Union Company (WU) – This widely recognized money transfer company is facing secular headwinds from the transition to digital money. Prior efforts to diversify away from the core retail business using the company’s sizeable cash flows were unsuccessful, but a new CEO with impressive fintech experience brings the real possibility of a meaningful improvement in both execution and strategy as it makes its transition to the digital world. Investors have aggressively sold WU shares, ignoring the company’s relatively stable revenues, sizeable free cash flow and valuable intangible assets as well as its generous dividend yield.

The company reported a mildly concerning quarter. Revenue, customer activity and profit metrics continued to slide, which suggests that the secular headwinds are not weakening – if anything, they are becoming stronger. This raises the risk that the new leadership won’t be able to successfully execute a turnaround, and it shrinks the time window available to do so. The company still generates decent free cash flow, at about $380 million last year – enough to cover the $364 million in dividends – but there is little margin of safety. Western’s large share repurchases and debt paydown last year were funded by proceeds from its major divestiture. The company has not “turned the corner” yet so we will remain patient, understanding that this complicated project will take some time. Western Union’s board approved the quarterly dividend which produces a 6.7% yield. Given the results, we cannot say that the dividend is rock solid.

The company’s 2023 outlook calls for organic revenues to decline 2-4%, profit margins to stay flat or incrementally improve to 19% to 21% (compared to 20.4% this past year) and for adjusted earnings per share of $1.48-$1.58 (in line/incrementally above current estimates).

Western Union is still in the early stages of building out its new strategy of boosting use from new and repeat customers, accelerating the digitization of its products, expanding into retail digital banking and improving its operating efficiency. All of these make sense and, to no small degree, are projects necessary to bring Western Union into the 2020s in terms of its technology, customer interface, marketing and product array. Much of the pressure on profit margins is due to spending on these strategic initiatives.

In the quarter, revenues, adjusted for divestitures and currency changes, fell 6%. Removing the effects of the suspension of operations in Russia and Belarus, revenues would have declined 3%. Revenues were about 2% above estimates. Adjusted earnings of $0.32/share fell 50% from a year ago and were 9% below estimates.

Friday, February 10, 2023, Subscribers-Only Podcast:

Covering recent news and analysis for our portfolio companies and other topics relevant to value/contrarian investors.

Today’s podcast is about 13½ minutes and covers:

• Earnings reports
• Comments on other recommended companies:
  
  • Wells Fargo (WFC) – paying $300 million to settle legal issues.
  • Toshiba (TOSYY) – Japan Industrial Partners moves a step closer to having the financing for a buyout.
  • Volkswagen AG (VWAGY) – preliminary results were mixed.
  • Brookfield Re (BNRE) – buying Argo Group.
  • Warner Bros Discovery (WBD) – will keep the HBO Max and Discovery+ streaming apps separate for now.
• Elsewhere in the markets
  
  • Nasdaq marks its 52^nd anniversary.
• Final note
  
  • Super Bowl and the Kelce brothers’ appetites.

Disclosure: The chief analyst of the Cabot Turnaround Letter personally holds shares of every Rated recommendation. The chief analyst may purchase securities discussed in the “Purchase Recommendation” section or sell securities discussed in the “Sell Recommendation” section but not before the fourth day after the recommendation has been emailed to subscribers. However, the chief analyst may purchase or sell securities mentioned in other parts of the Cabot Turnaround Letter at any time.Please feel free to share your ideas and suggestions for the podcast and the letter with an email to either me at bruce@cabotwealth.com or to our friendly customer support team at support@cabotwealth.com. Due to the time and space limits we may not be able to cover every topic, but we will work to cover as much as possible or respond by email.