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Turnaround Letter
Out-of-Favor Stocks with Real Value

February 2019

Investment management companies, which manage mutual funds and other investments on behalf of individuals, pensions and other clients, have fallen sharply out of favor. As contrarians, we think there is still good value in these companies.

In this issue, we cover eight managers whose weak shares offer attractive valuations and dividend yields.

Cabot Turnaround Letter 219

In This Issue:

Investment Manager Stocks

High-Yield Bonds Volatile Markets


Buy: Barrick Gold

News Notes


Investment Manager Stocks-Eight Attractive Stocks

Investment management companies, which manage mutual funds and other investments on behalf of individuals, pensions and other clients, have fallen sharply out of favor. Historically, their shares would loosely track the broad stock market. But since 2014, they have diverged sharply. In just the past year, shares of many of these companies are down by 20%-50%. What’s going on? First, and most important, the relentless shift toward index-based ETFs has drawn assets away from traditional managers. ETFs now account for $5 trillion in assets, much of which otherwise would be held by the traditional managers. Weak fund performance at many firms hasn’t helped, either. Competition from ETFs has led to lower management fees, further pressuring managers’ revenues.

The steep market decline late last year not only reduced assets under management, but exacerbated investor worries about a recession and a subsequent stock market decline, especially after 10 years of prosperity. That caused more investors to step away from the investment managers’ stocks. As contrarians, we think there is still good value in these companies. Many of their balance sheets are cash-laden, and cost-cutting has tempered the effects of weaker revenues. Some of the smaller firms might make enticing acquisition targets. Listed below are eight managers whose weak shares offer attractive valuations and dividend yields.

Investment Manager Stocks - Eight Attractive Stocks AFFILIATED MANAGERS GROUP (AMG) – AMG’s affiliate model allows it to take majority ownership of some of the industry’s top investment firms. The company’s capable leadership team oversees a diversified stable of managers of public and private equities, fixed income (bond) and alternative investments, while also providing global marketing support. Its revenue-sharing structure adds a stabilizer to AMG profits in weaker markets while keeping its managers motivated to produce strong returns. Its sturdy balance sheet and healthy cash flows offer opportunities for growth by further acquisitions.

FRANKLIN RESOURCES (BEN) – With $650 billion in assets under management, including the venerable Templeton funds family, Franklin Resources is one of the largest publicly traded investment managers. The firm is well known for its deep research into local markets, illustrated by its 42 research offices around the world. While recent underperformance by many of its funds has hurt asset retention, Franklin Resources is buttressed by its large $5.9 billion (about $11/share) cash balance. The 40% stake held by the Johnson family likely precludes its sale, but shareholders are occasionally rewarded with sizable special dividends like the $3/share payout last February.

HENNESSY ADVISORS (HNNA) – This micro-cap company, led by founder Neil Hennessy, has accumulated $5.1 billion in assets by acquiring funds discarded by other management firms. Recently, it acquired two funds that were previously owned by noted oilman T. Boone Pickens. The company is well managed, with tight expense control, a conservative balance sheet and a sustainable 3.8% dividend. Their 1 million-share repurchase (17% of then outstanding shares) at $25/share, in September 2015, could have been better timed. Nevertheless, this interesting niche company’s shares trade at a heavily discounted 3.6x EBITDA and offer an appealing bargain.

JANUS HENDERSON GROUP (JHG) – While Janus’ 2017 merger of equals didn’t go as smoothly as expected, Dick Weil, who led Janus’ prior turnaround, is now the sole CEO. He is likely to bring considerable improvements to the combined company. One particular strength is Janus’ commitment to generate cash and return it to investors. Since its merger, the company has returned over $770 million to investors, with promises of more in the future. Janus shares are quite compelling: it has $750 million more in cash than debt, its valuation is modest at 4.5x EBITDA and pays a sustainable 6.4% dividend yield.

LEGG MASON (LM) – Legg Mason operates as a group of nine independent, specialized investment managers across a range of fixed income, public and private equity and real estate strategies. Founded in 1899, the firm has $755 billion in assets under management with a sizable international component. The substantial fixed income business, at about 40% of revenues, provides stability against its more volatile equity products, while its expanding ETF offerings should help generate some growth. Part of Legg Mason’s lackluster share price is offset by the $500 million a year it has returned to shareholders, including its recently increased dividend.

OAKTREE CAPITAL MANAGEMENT (OAK) – Led by highly regarded Howard Marks, Oaktree specializes in distressed credit and other non-traditional investments. Its contrarian approach coupled with disciplined risk control has proven itself over the years. Oaktree’s profit stream can be bumpy, largely due to the timing of gains from its illiquid and complicated investments, but is tempered by a steady stream of fee income. When the currently buoyant credit cycle turns downward, and investors rush to sell unwanted bonds, Oaktree should be well positioned to scoop up bargains. OAK investors will want to be aware of the shares’ tax status as a publicly traded partnership.

WADDELL & REED (WDR) – Since its founding in 1937, Waddell & Reed has focused on selling its mutual funds through its network of company affiliated advisors. That business model has been losing traction, causing the company’s asset base and EBITDA to shrink 36% and 49% respectively, over the past four years. However, recently improved investment returns along with stable revenues and lower costs have produced better operating profits. The company has nearly $9/share in net cash on the balance sheet. Trading at only 2.4x EBITDA and paying a 5.7% dividend, WDR shares could be an acquisition candidate or see a rebound if its profits continue to stabilize.

WESTWOOD HOLDINGS GROUP (WHG) – Founded in 1983 by secretary turned investment manager Susan Byrne, Westwood Holdings oversees $21 billion in assets. The company’s steady record of asset growth was interrupted last year, but remains poised to stabilize and potentially recover as its funds’ performance has rebounded lately. Cost-cutting has softened the weaker revenue trends. The debt free balance sheet holds nearly $14/share in cash. Its generous 7.7% dividend yield is not quite covered by earnings, but the dividend recently was increased, indicating some confidence by the company that it won’t need to be cut anytime soon.


With investors’ faith in the long-running economic expansion and bull market being tested, we thought some comments on high yield bonds would be of interest to turnaround investors. Companies with these bonds, sometimes referred to as “junk bonds,” often are, or probably should be, in turnaround mode. And, if the companies eventually file for Chapter 11 bankruptcy, they can provide appealing distressed bond or post-bankruptcy stock opportunities. Given their riskier nature, high yield bonds tend to behave more like stocks than other, higher quality bonds.

Over long periods of time, high yield bonds have produced attractive returns. The 10-year annualized return of the S&P U.S. High Yield Corporate Bond Index, at 10.6%, has nearly kept pace with the S&P500 Index (at 13.1%). Yet, returns tend to be cyclical, and when these cycles end, they usually end poorly.

In the current cycle, U.S. corporate debt has reached nearly 46% of GDP, a record. As the graph on the next page shows, a staggering amount of high yield debt has been issued over the last nine years. And as the graph also shows, periods of strong high yield issuance have historically been followed by periods of high levels of default and bankruptcy. If defaults do pick up, as the graph suggests, returns on high yield debt will be poor for a while.

Another indicator of whether high yield bonds are attractive is their yield relative to risk-free U.S. Treasury bonds. The wider this “yield spread,” the more investors get paid to take on the extra risk. During calm and prosperous periods, high yield spreads can be below 4 percentage points. Yet, when defaults increase, these spreads can widen into double digits. How do spreads widen? Bond prices fall. With spreads currently at about 4.4 points, the upside in these riskier bonds is limited, while the downside could be sizeable

For turnaround investors looking at high yield bonds, this is a time to be cautious. Companies with credible business plans and reasonably good prospects may have appealing bonds. But, in general, the high yield sector looks unlikely to continue its strong performance and now carries increased risk. Investors should wait for the cycle to turn downward, then look for bargain prices in distressed bonds and newly emerged post-bankruptcy stocks.



As the stock market was selling off late last year, many of our Recommended stocks tumbled sharply. Companies undergoing turnarounds tend to have less-certain near-term prospects, and so when investors worry about the economy and stocks in general, our long-term oriented recommendations are some of the first to be sold.

However, once the calendar turned, these worries faded a bit. Several of our Recommended stocks surged by more than 30%, and on average these stocks have rebounded by about 16%, nearly ten percentage points greater than the S&P 500 returns so far this year.

We anticipate that the markets will continue to show higher volatility than in the past several years. Near-term sentiment regarding the economy, corporate earnings, interest rates and the already-started 2020 presidential election cycle, not to mention some unpredictable events, could easily produce rapid changes in share prices. No one, certainly not us, has the ability to predict sentiment changes or has any control over the resulting market gyrations. Turnaround investors are well-served by ignoring this sentiment and focusing instead on each company’s particular turnaround. Trying to react to the short-term sentiment shifts will only cause poor investment results and heartburn.

Purchase Recommendation: Barrick Gold Corporation


Background: Barrick Gold is the world’s largest gold mining company. With its recent acquisition of Randgold, it will produce as much as 5.8 million ounces of gold a year. About 91% of its expected $8.7 billion in 2019 revenues will be from gold sales with the balance from copper. Based in Toronto, the company was founded in 1983 by Peter Munk, who fled war-torn Hungary and arrived in Canada in 1948 at age 20 with only a suitcase. The company grew by acquisition, including the hugely -successful Goldstrike mine deal in 1986, Homestake Mining in 2001 for $2.3 billion, and the $10.4 billion acquisition of Placer Dome in 2006. Then-named Barrick Resources completed its initial public offering in 1983 on the Toronto Stock Exchange, adding a NYSE listing in 1987.

Following the sharp gold price decline in 2013, Barrick moved board member John Thornton into the executive chairman role, succeeding Peter Munk. As a former Goldman Sachs president, Thornton brought much-needed financial discipline to Barrick, slashing its weighty $13 billion in debt to its recent $5.7 billion. However, as this reduction was largely funded by mine sales and cuts in capital spending, Barrick’s gold production and reserves fell nearly 40% by 2018. Investors worried about the company’s long-term viability under this financially-driven strategy. Barrick’s shares have declined nearly 50% since mid-2016, badly lagging gold mining peer Newmont Mining.

Analysis: Barrick’s outlook turned much brighter with its just-completed $6 billion allstock acquisition of Randgold, an Africafocused gold mining company. Not only does this add Randgold’s debt-free balance sheet and numerous valuable mines to Barrick, the deal brings its CEO Mark Bristow, a South African-born executive widely regarded as one of the gold industry’s best managers. The Randgold founder delivered nearly 100x returns for his shareholders since its 1995 inception. The combined company holds five of the world’s top ten “Tier One” mines, located in the United States, Democratic Republic of the Congo, Mali and the Dominican Republic.

Change has started at Barrick – it has already reined in its unsuccessful technology initiatives and laid off half of its nearly 200 headquarters staff. Board member Anthony Munk, son of Barrick’s founder, is resigning, as is Barrick’s head of U.S. operations. Bristow’s approach will push accountability closer to the operations, which should improve efficiency and boost production at laggard mines. He will also re-focus Barrick by selling lower priority mines. A likely source of cash is from reducing Barrick’s outsized working capital position. On February 13th, the company will outline in more detail its plans and goals for the postmerger business.

Like all mergers, this one carries risks, particularly those related to integrating the two companies. Also, much of its production is in countries where governments yearn for access to Barrick’s highly valuable assets. In addition, its short-term share price will fluctuate with the price of gold.

Longer term, the changes at Barrick should meaningfully boost its earnings power and valuation. The company’s positive cash flow, combined with its investment grade balance sheet that has almost no debt due for nearly 14 years, provides Barrick the time needed for a turnaround. Our thesis assumes no change in the price of gold, although the dwindling supply of attractive new gold resources, along with an industry-wide decline in reserves, should be at least supportive of the current price level.

With its new leadership and strong earnings improvement potential, backed by its healthy balance sheet, Barrick’s shares look ready to shine.

We recommend the PURCHASE of shares of Barrick Gold (GOLD) up to 20.


Recommendation change: Civeo’s shares have rebounded sharply yet remain meaningfully undervalued. On January 16th, we raised our Buy limit to 2.50.

Earnings updates: Ford reported mixed 4th quarter earnings, with strong results in North America and Ford Credit yet large losses in the rest of the world. Under new CEO Jim Hackett, the company’s turnaround is making progress, but the pace of improvements is slow. We would like to see more aggressive changes as we retain our Buy rating on Ford shares.

Ally Financial reported 4th quarter earnings that were 11% above consensus estimates. Underlying profitability remains healthy, and Ally continues to return cash to shareholders through dividends and share repurchases. Trading at a 12% discount to its adjusted tangible book value, Ally shares remain attractive.


The tables below and on the next page show the performance of all of our currently active recommendations, plus recently closed out recommendations.