December 1, 2021

Thank you for subscribing to the Cabot Turnaround Letter. We hope you enjoy reading the December 2021 issue.

For most of the year, we have an intense focus on long-term business fundamentals and underlying valuations. However, as year-end approaches, artificial selling pressure can create large enough short-term bargains that even we find worthwhile. We discuss several sources of selling pressure that can turn others’ losses into your gains, and list six stocks that look most promising.

Please feel free to send me your questions and comments. This newsletter is written for you. A great way to get more out of your letter is to let me know what you are looking for.

I’m best reachable at Bruce@CabotWealth.com. I’ll do my best to respond as quickly as possible.

Attractive Turnaround Stocks

Interesting Turnarounds in the “Dull” Transportation Industry
Most investors, and the general public, seem to regard the transportation industry as somewhat dull. No doubt, there is little inspiration that comes from waiting at airports, driving in city traffic, or watching delivery trucks start-n-stop their way through neighborhoods.

But transportation is a fundamental component of human existence, and like all industries, innovations that improve relevance while reducing costs mean the difference between prosperity and oblivion. And, with more calls for low carbon emissions, the industry is on the cusp of a secular shift in its fuel sources. Perhaps there is more excitement in the industry than its tiny 3.9% weight in the S&P 500 index might imply.

Listed below are five transportation companies that are updating their strategic playbooks to boost their prospects, in several cases under new leadership. To this list we would add Cabot Turnaround Letter Buy-recommended General Motors (GM).

Daseke, Inc (DSKE) – Based near Dallas, Texas, Daseke is the largest flatbed and specialized transportation and logistics company in North America, with a fleet of nearly 4,500 tractors and 11,000 flatbed and specialized trailers and over a million square feet of warehouse space. Founded in 2009, Daseke grew quickly with 20 acquisitions, funded partly through its 2017 go-public debut via a SPAC. However, several of these acquisitions performed poorly, leading to weak results and a bloated balance sheet, which pushed its share price to below $2 by late 2019. Today, Daseke’s outlook is much healthier – the primary driver has been the company’s top-down overhaul, although the pandemic has also helped lift shipping volumes and pricing. The founding CEO has stepped down, replaced by capable executives and board members, with some effective pressure from activist investor Lyons Capital. Improved sales and marketing efforts, tighter operational controls and divestitures of some underperforming segments are leading to record profits and margins. The stronger free cash flow, plus better lending terms, has trimmed debt to only 2.4x EBITDA. Daseke trades at 5.1x estimated 2022 EBITDA, roughly in line with peers but this appears to underestimate the fundamental improvements underway.

Ford Motor Company (F) – The company’s bold move to literally pledge its treasured Ford badge as loan collateral during the global financial crisis helped it avoid bankruptcy while General Motors and Chrysler succumbed. Disappointingly, the Ford Motor Company has struggled ever since. After a succession of ineffective CEOs, the company is now finding its way under newly-appointed (October 2020) chief Jim Farley. Farley is known as a true “car guy” and is driving Ford firmly into the EV era. Previously Ford’s chief operating officer, he oversaw the development of many of the new vehicles that are now coming to market, including the all-electric F-150 Lighting Truck, Mustang Mach-E and the new Ford Bronco. Critical to the turnaround, Farley is making long-needed strategic changes like its recently-announced exits from vehicle production in India and Brazil. The company has much work ahead to expand its narrow profit margin and bolster its balance sheet, as well as overcome the chip shortage and other industry-wide issues, but it appears to be finally moving in the right direction.

Frontier Airlines (ULCC) – Frontier is an ultra-low-cost carrier, hence its “ULCC” ticker, specializing in highly-discounted flights to over 120 destinations in the United States, Caribbean, Mexico and Central American. Among its strategies to keep its costs at industry-low levels, the company uses a fleet of 109 specially-configured A320 jets, which significantly reduces fuel and maintenance costs. It also emphasizes an asset-light model by leasing (rather than owning) its aircraft and outsourcing non-core functions. An additional edge is Frontier’s balance sheet, which holds more cash than debt and allows it to spend the equivalent of only $1/passenger in pandemic-related principal and interest payments, compared to an average of $21 at its competitors. Second-quarter results were strong. But the Delta variant is dampening the near-term outlook, sending the shares down by nearly a third since the summer and they remain 17% below their March 2021 initial public offering price of 19. Confident in its future, Frontier has 157 new aircraft on order. Once the pandemic headwinds abate, Frontier should be well-positioned to benefit as budget-minded travelers return to their favorite destinations.

Closing prices on September 24, 2021.
* EV/EBITDA is Enterprise value to Earnings before interest, taxes, depreciation and amortization. This metric is a proxy for cash operating earnings. Valuation based on consensus 2022 estimate.
Sources: Company releases, Sentieo, S&P Capital IQ and Cabot Turnaround Letter analysis.

Hertz Global Holdings (HTZZ) – After struggling for years with an unwieldy debt burden, Hertz (which also owns the Dollar, Thrifty and Firefly brands) slipped into bankruptcy in May 2020 when the pandemic crushed demand for rental cars. When it emerged in July 2021, its creditors were paid in full and shareholders received a cash payment and other securities – a remarkable outcome as most stocks in bankruptcy become worthless. Helping the emergence was $5.9 billion in new equity, cash proceeds from the sale of a sizeable portion of its fleet into a very strong used car market, the sale of its Donlen business, aggressive changes to its operations, and much cheaper borrowing costs. In the second quarter, strong rental car prices and high fleet utilization helped generate adjusted EBITDA of $639 million, an impressive feat for a company with an enterprise value of $19 billion. The company is reportedly looking for a new CEO to lead its next phase, and is planning an investor roadshow and re-listing on a major exchange by year-end. Valuation is at about 15x estimated 2022 EBITDA, a 20% discount to peer Avis Budget Group (CAR).

Workhouse Group (WKHS) – Based in Cincinnati, Ohio, Workhorse Group specializes in all-electric last-mile delivery vans. Optimism about its prospects drove its shares from around 4 to over 40, but its failure to secure a coveted U.S. Postal Service contract sent its shares plummeting nearly 50% in a day. Doubts about its production capabilities and other issues, along with its recent decision to recall 41 vehicles and suspend new deliveries, continue to weigh on its shares.

Yet, Workhorse makes an intriguing turnaround story. Last-mile delivery is arguably the most attractive category for EV adoption, with its short, circular routes (ideal for centralized charging), considerable lifetime maintenance cost savings, favorable tax treatment, and appeal to image-conscious companies that want to buff their low-carbon emissions credentials. While still an early-stage company, Workhorse is generating revenue. Its vehicles are proving their value on the road: it currently has 381 vehicles in operation at FedEx, Ryder and UPS, and have logged over 8 million miles of use. And, not only is its production up-and-running, it also has visibility supported by a strong (and apparently legitimate) backlog of 8,000 vehicles, led by orders for its next-generation C-Series Vans. Its balance sheet carries over $200 million in cash against its $200 million in debt.

The key to the turnaround is newly-hired CEO Richard Dauch. He is a highly-regarded auto industry CEO who previously led Delphi Technologies, Accuride, and Acument, and brings deep engineering, operational and strategic experience to Workhorse. His task is to transition the company from its “tech start-up” phase to a serious production company – no small feat but one that he appears fully capable of accomplishing. He recently gave a brief presentation to investors titled, “Not Wasting Any Time - My First Week,” which has become an instant classic for its direct, results-oriented stance. The decision to recall vans and halt production makes a lot of sense – Workhorse needs to tighten up its operations first, then move to expand, even if it means a temporary setback in its near-term pace. The company promised a detailed update to investors in November. While Workhorse has a difficult road ahead, and its 2019 transaction with Lordstown Motors adds complexity and risk, as well as opportunity, it is now in a much better position to prosper. Its washed-out shares and 35% short position help boost its appeal to contrarians.

Turnarounds Under $11
One of our go-to methods for finding interesting turnaround ideas is to look through the roster of stocks with low prices. We generally define this group as having share prices below $10 or $11 or so. Most investors tend to dismiss stocks with basement-level prices, on the assumption that these companies are struggling, on their way to failure, or perhaps not “real” companies. While there certainly are plenty of these, we have also found some hidden gems of neglected value over the years. Currently, three Cabot Turnaround Letter stocks, Gannett (GCI), Nokia (NOK) and Conduent (CNDT), are among this group of attractive stocks.

In considering low-priced stocks, we remember a lesson learned long ago. It may seem logical to justify buying low-priced stocks by thinking, “You can’t lose much if the price is so low.” Yet, while a $3 decline in Procter & Gamble shares ($143 share price) may not hurt much, a $3 decline in a $3 stock means a 100% loss.

Listed below are five companies that look appealing. They each have real businesses with substantial operating assets, capable managements, and reasonably solid balance sheets. These companies also have appealing fundamental changes underway that could lead to much higher share prices. Several additional interesting sub-$11 stocks have been mentioned in recent Cabot Turnaround Letter articles, but we omit them here to avoid redundancy.

Arcos Dorados (ARCO) – Spanish for “golden arches,” Arcos Dorados is the world’s largest independent McDonald’s franchisee. Based in stable Uruguay and listed on the NYSE, the company holds exclusive rights to McDonald’s operations in 20 countries, including nearly all of Central and South America and much of the Caribbean region. About 72% of its revenues are produced in Brazil, Mexico, Argentina and Chile. Arcos’ shares remain 35% below their year-end 2019 level, as the pandemic has hit its markets hard and remains a lingering problem. Recent concerns about the political direction of Brazil and Peru have also weighed on the shares. And since the company translates its profits into U.S. dollars, any weakening of domestic currencies risks diluting Arcos’ value. However, vaccination rates are improving quickly, allowing the company’s restaurants to approach a full re-opening and boosting store traffic as workers return to nearby offices and workplaces. Arcos’ leadership looks highly capable, led by the founder/chairman who owns a 38% stake. Debt is reasonable relative to post-recovery earnings. Second-quarter results were encouraging, with systemwide same-store sales nearly equal to the two-year-ago period, despite many of its restaurants still under government capacity and operating hours restrictions. Arcos should return to its previous level of profits, likely lifting the shares significantly.

Centennial Resource Development (CDEV) – Shares of many oil and gas exploration and production (E&P) companies sell at below-$11 prices, as investors shun carbon-intensive, capital-wasting industries and worry about a return to low commodity prices. Setting aside the carbon issue, it appears that energy prices will head upward before they slide backwards, as the world’s demand for traditional fuels is overwhelming the supply. Centennial is a disciplined primarily-oil producer that was founded by E&P icon Mark G. Papa, who stepped aside in 2020. Now led by a new team, the company retrenched in the downturn and remains focused on generating free cash flow and reducing its already-manageable debt. Improved operating efficiency as well as higher new well quality is helping Centennial mitigate its fast production decline-rate problem. Conservative management led the company to hedge much of its 2021 production, yet it will still participate in strong oil prices, especially as most of 2022 production remains unhedged. The shares trade at 4.9x estimated 2021 EBITDAX and an 11% free cash flow yield, both of which will look much cheaper if commodity prices remain elevated.

Closing prices on September 24, 2021.
* EV/EBITDA is Enterprise value to Earnings before interest, taxes, depreciation and amortization. This is a proxy for cash operating earnings. For Centennial Development, we use EBITDAX which also removes exploration expenses. Valuation based on calendar 2022 estimates, except for The Container Store which is for fiscal year ending March 2022.
Sources: Company releases, Sentieo, S&P Capital IQ and Cabot Turnaround Letter analysis.

Cresco Labs (CFLBF) – The market has turned away from companies involved in the legalized cannabis/marijuana industry. For starters, the investment constituency is currently small, as many investors, including private individuals as well as institutional mutual funds, pension funds and others, prefer to avoid these companies for ethical and policy reasons. Also, the industry is still in its early stages, with a complicated legal and financing environment making its development more difficult. Yet, from a pure investment perspective, the group has considerable appeal. First, the shares of most companies have fallen sharply from their previously over-hyped prices. Fundamentally, the industry is growing rapidly in the United States, in no small part due to cannabis’ medicinal properties that can be separated from its recreational uses. Many companies produce wide profit and cash flow margins, backed up by sturdy balance sheets. Management and board leadership is often of impressive quality and pedigree.

One company that looks interesting is Chicago-based Cresco, a vertically-integrated producer and distributor of branded cannabis products. Cresco uses a consumer packaged goods approach to market its nine brands, generates nearly $1 billion in revenues, produces $250 million of EBITDA and could produce a positive net income this year. Its debt is essentially fully offset by cash. The CEO is an attorney who also is an adjunct law professor at the prestigious Northwestern University law school. The board chairman, Tom Manning, previously was chairman and CEO of Dun & Bradstreet, previously a long-serving top executive at the highly regarded Cerberus private equity firm as well as a former CEO of Ernst & Young’s Asia operations, and is a Stanford MBA graduate. Other board members and senior executives have impressive, mainstream professional backgrounds as well. Cresco sells at about 9x estimated 2022 EBITDA. Many other cannabis majors have similar traits, which we will explore as we ramp up our understanding of this nascent industry.

Kinross Gold Corporation (KGC) – Based in Toronto, Kinross is a large and respected gold mining company. About 55% of its production is in the United States and Brazil, with the balance in Russia and western Africa. Recent but temporary difficulties with production at two sites, and investor concerns about the direction of gold prices, have pulled Kinross’ shares down by nearly half from their late 2020 price. But, the company’s long-term production outlook remains sturdy, as the company is well-managed and has good mines that it continues to develop. Following a recent agreement with the Mauritanian government, Kinross’ Tasiast mine should see improved production growth. The company is working to reduce its modestly elevated mining costs. Kinross carries an investment grade balance sheet, pays a respectable 2.3% dividend yield, and has been repurchasing its shares. Kinross shares offer internally-generated value creation potential and the ability to participate in rising gold prices should the global central bank easing cycle and other assumed macro glide-paths turn out to be not as docile as assumed in the market’s current narrative.

The Container Store (TCS) – After a strong start following its November 2013 initial public offering at $18, The Container Store’s shares plummeted to nearly $4 by early 2016 as weak results and strong competition dragged on its profits. Over the next four years, efforts to improve its fundamentals were largely unsuccessful. However, during the pandemic, with many people stuck in their often-disorganized homes, the company’s sales and profits surged, driving its shares to over 19. Now, with the pandemic tailwind fading, the shares have dropped by nearly half. We think this offers an interesting opportunity. For starters, at 5.2x EBITDA, the shares have a low valuation. The company is generating good profits and cash flow, and the balance sheet is sturdy, with net debt at only 1.2x EBITDA. New marketing initiatives, including partnerships with Marie Kondo and the Netflix show The Home Edit, as well as new, upscale brands, offer the opportunity for continued growth. Helpfully, the company’s store base, at 94, has grown only modestly, leaving plenty of opportunities for new locations while limiting the burden of unproductive stores. And, its e-commerce business is thriving, recently reaching 38% of total sales, as is its loyalty program, with 10 million members. A new CEO was hired this past February, which creates both opportunity for new ideas yet also some risk. If America continues to declutter, The Container Store looks well-positioned to benefit.

New Recommendation, Updates and Performance

Recommendation

Purchase Recommendation: TreeHouse Foods, Inc. (THS)

TreeHouse Foods, Inc. (THS) 2021 Spring Road Suite 600 Oak Brook, IL 60523 (708) 483-1300 treehousefoods.com

Symbol: THS Market Cap: $2.2 Billion Category: Mid Cap Business: Packaged Foods Revenues (2021e): $4.3 Billion Earnings (2021e): $123 Million 9/24/21 Price: 39.43 52-Week Range: 34.33-55.50 Dividend Yield: 0% Price target: 60

Background
TreeHouse Foods is one of the nation’s largest independent private label food manufacturers. Based near Chicago, TreeHouse was created as the specialty foods division within Dean Foods and spun off in 2005. Over the subsequent decade, an aggressive acquisition pace took the company from a pickles and non-dairy creamer business with $700 million in revenue to a $6.3 billion broad-based manufacturer with a sizeable presence in dozens of categories. Today, the company generates about $4.3 billion in revenue across 29 types of snacks, beverages and meal preparation products. More than 90% of its sales are produced in the United States.

While the private label category continued to grow, TreeHouse’s results continued to sag. A major source of problems was its acquisition spree, which added underperforming businesses and considerable debt. Efforts starting in 2016 to improve its inefficient operations, including divestitures and the replacement of the original CEO in March 2018, have proven only modestly effective.

Competition is keen in the private label business, especially as TreeHouse sells into a concentrated grocery industry. Walmart, for example, is a 25% customer for TreeHouse. The challenge for the company is to leverage its huge scale to provide high-volume, high-quality and low-cost production, with strong service levels, all of which make it valuable to its customers and somewhat unmatchable by its competitors. To accomplish this, TreeHouse needs strategic coordination, production and logistics expertise, skilled procurement, and talented sales efforts to help fill its factories. While the management team brings industry experience, and has offloaded several poorly-performing product groups, it hasn’t yet produced satisfactory improvements.

TreeHouse’s share price has declined 60% from its 2016 peak at over 100, and now trade only modestly above its 2005 spin-off price.

Analysis
Our interest in TreeHouse relies heavily upon the presence of JANA Partners, one of the most effective activist investment firms. But for their involvement, we would have little interest in TreeHouse. We believe JANA is committed to making significant changes at the company – it took an initial 3.6% stake in late 2020, signed a standstill agreement in March 2021, and has steadily raised its holdings to a 9.2% stake that is now JANA’s second largest investment. With the agreement, JANA received two board seats, allowing it to take a better informed behind-the-scenes role. The agreement expires on December 15 of this year. We anticipate JANA will then become much more assertive in its efforts to raise TreeHouse’s share price.

Despite its struggles, TreeHouse generates reasonably stable revenues and profits. The $482 million midpoint of its full-year adjusted EBITDA guidance (the range is $460 million to $505 million) implies only a 1% decline from its trailing two-year average. The company has guided to full-year free cash flow of between $250 million and $300 million. Even if TreeHouse were to report results that were disappointing relative to its guidance, it would still generate more than enough free cash flow to service its elevated $2 billion in debt and maintain its financial flexibility.

Near-term results, to be reported in November, could be disappointing. The company could see revenue pressure as stimulus-buoyed consumers trade up to branded products, while rising commodity, labor and transportation costs could squeeze its margins.

TreeHouse shares are inexpensive, trading at 9.3x estimated 2021 EBITDA. The increase in value to our 60 price target comes from a higher multiple and higher earnings, resulting from better operations, better leadership and possibly many divestitures or a sale of the company, prompted by pressure from JANA.

We suggest that investors take a starter position now, and add on weakness that may follow the November earnings report or the emergence of other issues. With JANA’s involvement, we believe patient contrarian investors could see a solid return from TreeHouse shares.

We recommend the purchase of TreeHouse Foods shares (THS) with a 60 price target.

Price Target and Ratings Changes
We are raising our price target on Signet Jewelers (SIG) from 80 to 94. The company continues its impressive progress with improving its relevance to customers, expanding its profit margins and rebuilding its balance sheet. Even though the share price has risen sharply, the valuation remains low as the higher price reflects higher earnings and cash build-up, not multiple expansion. Our price target increase mostly incorporates updated estimates as we are not changing our target valuation multiple.

Wells Fargo & Company (WFC) shares remain just below our 49 price target. As such, we will likely wait until it reaches or exceeds this target before making a ratings change.

Shares of Meredith Corp (MDP) have surged above our 52 price target on news that it is in discussions to be acquired by IAC/Interactive Corporation (IAC). We believe the shares are worth more to this bidder than the current price implies, and will await news on a definitive agreement.

Disclosure: The chief analyst of the Cabot Turnaround Letter personally holds shares of every “Buy” 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.

Performance

The following tables show the performance of all our currently active recommendations, plus recently closed out recommendations. For additional details, please visit cabotwealth.com.

Large Cap¹ (over $10 billion) Current Recommendations

Mid Cap¹ ($1 billion - $10 billion) Current Recommendations

Small Cap¹ (under $1 billion) Current Recommendations

Most Recent Closed-Out Recommendations

Notes to ratings:
1. Based on market capitalization on the Recommendation date.
2. Price target in parentheses.
3. Total return includes price changes and dividends, with adjustments as necessary for stock splits and mergers.
4. SP - Given the higher risk, we consider these shares to be speculative.
5. * - Indicates mid-month change in Recommendation rating. For Sells, price and returns are as-of the Sell date.

The next Cabot Turnaround Letter will be published on October 27, 2021.