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Turnaround Letter
Out-of-Favor Stocks with Real Value

July 2020

Like many consumer goods producers, companies that make apparel and related products have experienced sharply lower sales and profits with the stay-at-home restrictions during the pandemic. But, for companies that make everyday apparel, particularly those with enduring brands or an outdoor/active lifestyle focus, demand should eventually return to healthy levels.

In this issue, we list seven companies that we believe offer interesting recovery potential.

Cabot Turnaround Letter 720


In this Issue:
Specialty Apparel Stocks: Enduring Values Currently in the Bargain Bin
Mid-Year Bankruptcy Update
Mid-Year Stock Market Update

Buy: GCP Applied Technologies (GCP)
Price Targets Changes and Sells

Like many consumer goods producers, companies that make apparel and related products have experienced sharply lower sales and profits with the stay-at-home restrictions during the pandemic. Unable to go shopping, along with a seasonally lower need (right after the holidays) to buy, consumers not surprisingly have tamped down much of their spending on clothing. This exacerbates the multi-year trend of declining sales at most brick-and-mortar retailers.

But, for companies that make everyday apparel, particularly those with enduring brands or an outdoor/active lifestyle focus, demand should eventually return to healthy levels. Consumers generate a relatively steady replacement demand for these goods, and growing new demand from lifestyle changes and new innovations should bolster sales. And, the everyday orientation reduces the volatility and risks that fashion-oriented or seasonal products carry, while also lessening the need for costly markdowns to unload time-sensitive inventory.

In complicated times like these, consumers generally migrate to the familiarity and assurances of a quality brand – a fact that also puts the producers of these brands in a stronger bargaining position with retailers. Too, work-from-home brings a step-down from business casual, helping shift demand toward more casual but quality apparel. Another emerging trend is that consumers are spending more time outdoors, raising demand for the clothing and gear that accompanies these activities.

Like all industry groups, some specialty apparel companies are better-positioned than others. In addition to having the right brand quality and product types, those less-reliant on sales through department stores or weaker malls, for example, will likely be more resilient. Also, some stocks are more appealing bargains than others. Shares of exceptional companies like Nike (NKE) have returned to near-record highs, while those of others in the sector may continue to struggle due to weak competitive positions. Listed below are seven companies that we believe offer interesting recovery potential.

Columbia Sportswear (COLM) – With over $3 billion in revenues generated from 90 countries, this company produces the highly-recognizable Columbia brand of outdoor and active lifestyle apparel and accessories, as well as SOREL, Mountain Hardware, and prAna products. For decades, the company was successfully led by the one-of-a-kind Gert Boyle, who passed away late last year. The Boyle family retains a 36% ownership stake and Gert’s son Timothy Boyle remains at the helm. First quarter sales fell 13% from a year ago, as a high 64% of sales come from the U.S., where Columbia’s reliance on wholesale distribution, and the longer lock-down periods relative to other countries, hurt results. However, the company is rapidly improving its on-line operations, both through its own websites and through third-party online retailers, which combined generate over 20% of sales. Columbia’s balance sheet remains solid, with $707 million in cash and only $174 million in debt. The company is likely to remain healthy as consumers seek its highly-relevant products.

Hanes Brands (HBI) – Hanes produces active wear and innerwear under the popular Hanes, Champion, Bali and Maidenform labels, which often are the #1 or #2 global brands in their categories. Michael Jordan, perhaps the most recognizable sports figure in the world, is a marketing partner. Hanes is one of many spin-offs (in 2006) from the former Sara Lee Corporation. While in normal times it generates considerable free cash flow, Hanes currently is struggling from its reliance on department stores and lower-margin mass merchandisers. However, the company recently hired Walmart’s head of merchandising (Hanes’ largest customer, at 14% of its sales) as its new CEO. His insight and drive could re-energize the company’s longer-term fortunes. An upcoming CFO appointment should reinforce the new leadership. Hanes’ balance sheet carries a modestly elevated amount of debt, but the company is confident enough in its finances to continue to pay its generous $.15/share quarterly dividend.

Kontoor Brands (KTB) – Spun off from VF Corporation in May 2019, Kontoor houses the well-known Wrangler and Lee brands of jeans as well as VF’s Outlet operations. After years of underinvestment as part of VF, Kontoor is rebuilding its business. New initiatives include its rollout of Lee jeans into 2,000 new U.S. mass retailer locations, Wrangler’s expansion into China and 400 new stores in Europe and an updated e-commerce platform. Kontoor’s reliance on mass merchandisers such as Walmart and Target (which, along with Amazon, produce 70% of sales) that remained open during the lockdowns allowed first quarter sales to decline an acceptable 22%. This reliance, however, this is a double-edged sword, as the channel’s lower margins, combined with Wrangler’s and Lee’s lower brand value relative to Levi’s, puts Kontoor Brands in a somewhat weak position. Also, the company’s elevated debt will constrain its near-term flexibility. Yet as it flexes its newly-independent muscles, and as its shares sell at a considerable discount, Kontoor Brands has noticeable potential.

Levi Strauss (LEVI) – This company, with one of the most highly-regarded brands in the world, sells its iconic blue jeans in over 50,000 retail locations in 110 countries. Over 70% of its inventory is evergreen, with little fashion or seasonality risk. After an initial surge to over $22 in its March 2019 initial public offering, its shares are now 28% below their $17 IPO price. Investors worry about Levi’s high reliance on department store and mall stores, which will likely drive sharply weaker (down as much as 50%) second quarter revenues, to be reported on July 7th. However, its balance sheet has cash that mostly offsets its debt, and it readily raised new debt to help it endure the downturn. Levi’s capable management is proactively adjusting the business model. While the near-term outlook is humbling, the company and its shares should prosper in the long-term.

PVH Corporation (PVH) – PVH has evolved from the Van Heusen dress shirt business into a $10 billion (revenues) giant that owns the Tommy Hilfiger, Calvin Klein, Geoffrey Beene, Izod and other labels. Its shares have fallen sharply, as its brands have lost much of their cachet in the U.S. and the company has a higher dependence on department stores. These traits, along with its leveraged balance sheet, make PVH’s prospects riskier than many of its peers. This risk was realized in its startling $(3.03)/share adjusted loss in the most recent quarter. However, the company has an intriguing catalyst. In May 2019, PVH hired highly-regarded brand turnaround executive Stefan Larsson as president. Larsson could help PVH’s brands improve their value and migrate to higher-value sales channels including e-commerce. Supporting Larsson’s efforts: the company’s brands carry heightened value outside of the U.S. where it generates nearly 80% of its normal operating profits. To bolster its cash balances, the company sold its Speedo North America business in April for $169 million and is slashing its spending. While higher risk, PVH’s turnaround could produce higher returns than its peers.

Ralph Lauren (RL) – Shares of this iconic company remain near their year-to-date lows, and, remarkably, trade at the same level they did in 2006. Some of the investor concern is driven by the company’s weak U.S. outlook, which could push first quarter revenues down 50% or more. But the company’s enduring value and longer-term outlook offer solid reasons for optimism. The company would still likely earn as much as $2.00/share this year even if full-year sales fell by the consensus 20% estimate. Better management is revitalizing Ralph Lauren’s prospects: its relatively new CEO (joined in 2017) has restored much of its former luster (and boosted its profit margins) by shifting away from department stores and mass retailers, emphasizing instead its own prestigious stores. The company is leveraging the pandemic to accelerate this shift, as it will focus its U.S. stores on the top 30 cities, expand into Asia and Europe, and elevate its game on its e-commerce platform. Ralph Lauren’s balance sheet is flush with $2.1 billion cash, against $950 million in debt. The Lauren Family retains a controlling 34% stake. Selling at a modest 5x estimated FY2022 EBITDA, shares of this conservatively funded, well-run company, with its high-value brand, look meaningfully undervalued.

VF Corporation (VFC) – VF’s apparel portfolio is anchored by the highly valuable Vans, The North Face and Timberland brands. The company has been trimming its portfolio, starting with the May 2019 spin-off of Kontoor Brands (KTB) which held its Wrangler and Lee jeans business and its VF Outlet operations, and will divest its Occupational Workwear business, although it will retain its well-known Dickies brand. The resulting VF will have stronger growth prospects (the company targets 7-8% revenue growth), a higher international and e-commerce mix, and simpler and more efficient operations. Also, the company is shifting away from wholesale distribution, even as its U.S. wholesale exposure to mid-tier mass merchandisers and department stores is only about 5% of sales. Revenues fell a relatively modest 11% in the most recent quarter, and management reiterated its commitment to its full dividend. VF’s balance sheet, with reasonable debt net of cash, should be bolstered by ongoing free cash flow and the proceeds from its workwear divestiture in the next few quarters.


While we wrote in our January 2020 Bankruptcy Review and Outlook that the quantity of debt needing to be restructured over the next few years would likely increase, we certainly didn’t anticipate that a pandemic would drive bankruptcies to surge to decade-high levels. So far this year, 58 publicly-traded companies have filed for bankruptcy, which is 76% above last year’s mid-year number (33) and on a pace to exceed the highest years since 2009. The year-to-date value of assets going into bankruptcy, at $173 billion, is 68% higher than last year’s mid-year value ($103 billion). While 2020’s mid-year total already eclipses the full-year 2019 total, it is actually more impressive as the gargantuan $71 billion filing by California utility PG&E Corp. distorted last year’s numbers.

Bankruptcies so far this year include many large companies: 29 filing companies had over $1 billion in assets, compared to a modest nine at this time a year ago and 19 for all of 2019. Perhaps not surprisingly, energy companies comprise the largest industry group, with $52 billion in assets or about 30% of the total. Telecom industry bankruptcies had the second largest total ($29 billion), closely followed by the airline ($28 billion) and retail ($22 billion) industries. Unlike last year, in which many obscure names filed, this year’s roster includes iconic consumer brands like Hertz, J.C. Penney, Neiman Marcus and Chuck-E-Cheese. Shares of Hertz provided an unusual case where the stock surged briefly in the weeks following its bankruptcy – even though the shares are very likely to end up completely worthless.

We expect bankruptcy activity to remain robust. Many companies have raised vast new sums of debt to fund their upcoming cash flow shortfalls. June’s high yield issuances of over $50 billion is a monthly record, and the year-to-date total of $205 billion is 70% above this time a year ago. But lower revenues and earnings have reduced these companies’ ability to service their existing debt, much less the new debt. And, the proceeds aren’t generally being used to fund profit-generating initiatives but rather merely to keep the lights on. This heightened default risk isn’t necessarily priced into high yield bonds. Investor optimism over the economy’s re-opening, along with explicit verbal support (albeit little actual high yield bond-buying) by the Federal Reserve, has driven aggressive buying, which has narrowed the spreads over investment grade bonds. We encourage investors to remain wary of the junk bond sector.


In one sense, our Market Outlook from last December was spot-on, with our comments about “… investors will be evaluating conditions that are not predictable today.” Our point was that it is exceptionally difficult to make accurate predictions. The Covid pandemic has clearly proven this. As for our expectation for an 8% return for the S&P500: while there are a full six months left in the year, with an unknowable outcome, we currently are well off the mark, given the ?6.0% return year-to-date. Investors frequently ask how the S&P500 can be down only modestly given the Depression-like broad economic statistics.

The answer clearly is the buoyant effect of mega-cap stocks like Amazon (+46% YTD), Apple (+20%) and Microsoft (+24%), which benefit from the pandemic environment. On an equal-weighted basis, the S&P500 is down 13.8% year-to-date. Likewise, Growth stocks, which include the tech giants, have gained +6.6%, far ahead of the dismal 18.8% loss for Value stocks. Similarly, small cap stocks have produced a 16.8% loss. The international picture is little different: developed country stocks have fallen 12.6%, while emerging market stocks have declined 10.4%, helped by modest gains in Chinese stocks. What do we see for the remainder of 2020? If the “Vaccine by Halloween” concept holds true, in which an effective and widely available vaccine or treatment arrives soon, we expect the markets to surge well-past our full-year expectations. Without such a remarkable but highly unlikely achievement, we anticipate that the markets, and economy, will muddle along yet gradually improve as more efficient methods of controlling transmission, and more effective detection and treatment for those with the illness, ease re-opening concerns.

Second quarter GDP is projected to decline at a startling 40% annualized rate, but this “Flash Depression” is likely to be followed by a sharp but only partial rebound in the third quarter. Globally, we see an unsynchronized recovery among countries – unlike the downturn which was highly synchronized.Unpredictability is heightened by many other issues: immense and rising federal budget deficits, growing Federal Reserve bond market influence, the presidential election, social unrest, global trade tensions, and the potential for negative interest rates in the United States. Any of these, or some new black swan, could lead to a wide range of possible outcomes. The steadily rising price of gold, now at $1,778/ounce and approaching an all-time high, reflects the weight of these concerns. Despite the near-term uncertainty, it is important to remember that the world, and markets, have historically produced growth and prosperity. You should focus on company fundamentals, rather than try to predict the direction of the market or the pandemic. As Buffett said in his 1987 letter to shareholders, Mr. Market is there to serve you, not to guide you.” He urged investors to take advantage of the market’s dour moods by buying and its exuberant moods by selling, rather than following the momentum in either direction.

And, remember that past calamities have led to future innovations. Much as World War II led to the accelerated development of passenger jets, telecommunications, medicine and other advances that otherwise would have taken decades, so too will the all-out effort to find a vaccine and treatment for the coronavirus accelerate our collective understanding of human immunology. We continue to be highly optimistic in our long-term outlook.


Purchase Recommendation

GCP Applied Technologies is a global construction materials company. Its largest segment, Specialty Construction Chemicals (about 57% of revenues), produces additives for concrete and cement that improve their performance. The Specialty Building Materials segment (about 43% of revenues) produces waterproofing membranes, roofing under-layments and a range of other materials for new construction and renovations that protect buildings from water, vapor, fire and other types of damage. About half of GCP’s revenues are generated from outside of the United States. Based in Cambridge, Massachusetts, GCP was formed within W. R. Grace & Company in 2015 and spun off to shareholders in February 2016. The company’s stock price rose steadily after the spin-off, more than doubling to over $33 by March 2018, due to GCP’s bright prospects, undervaluation, and potential for a breakup. Reflecting this sentiment, when GCP agreed to sell its Darex Packaging Technologies business to German company Henkel for $1.1 billion in March 2017, the shares jumped 25%.

However, the company’s remaining operations went on to produce disappointing results, with quarterly revenues and earnings regularly missing analysts’ estimates. At this point, GCP appears to be poorly managed: revenue growth has lagged the industry, expenses remain bloated, a steady stream of restructuring plans have produced no lasting improvements, and the board of directors has been plagued by problematic interlocking relationships that curbed its accountability and led to excessive compensation and other governance issues. One indication of investor frustration: GCP shares jumped 13% in early 2019 when the company announced a strategic review along with respected and successful activist investor Starboard Value’s initial plans to nominate board members, only to fall sharply when the company later announced that the review would not result in a sale. GCP shares now trade at $17.96, not much higher than the roughly $16 price at the 2016 spinoff.

The GCP situation has the ingredients of an impressive turnaround. First, it has stable revenues in a relevant industry. Its organic sales growth has been flat since 2017, while its products (at least previously) held the #1 or #2 market shares in critical segments within the growing and steadily relevant global construction industry. Second, it has a capable new board of directors with a credible strategy to improve the company’s operations. Starboard Value, which holds a 9% stake, led a successful proxy campaign in which shareholders elected its slate of well-qualified directors to replace eight of GCP’s ten directors earlier in June. GCP has a relatively new CEO (Randy Dearth) who joined as president in July 2019 – we anticipate that he will either become more effective or be replaced. The company’s plan going forward includes detailed steps to boost organic revenue growth, expand margins by up to six percentage points, and rebuild product innovation effectiveness. Another possible outcome is a breakup and sale of the company. We note that industrial firm Standard Industries holds a 17% stake – perhaps because they would like to acquire the membranes business to add to theirs. Additionally, although the company is operating well below par, it remains profitable and generates free cash flow. The balance sheet has only a modest $348 million in debt, almost fully offset by $320 million in cash. Lastly, GCP shares are significantly undervalued. In a turnaround or sale, we believe the company is worth at least $28, providing investors with an attractive potential return.

We recommend the purchase of GCP Applied Technologies (GCP) shares with a $28 price target.

Sell Recommendations

Shares of recreational vehicle maker Thor Industries surged to over $109 as the company has reduced its excess inventory and the pandemic is boosting demand for RVs. The shares are fully valued on optimistic 2022 earnings. We moved THO shares to a SELL on June 25 for a 64% total return since our Buy recommendation in November at $67.60.

We are moving global energy company BP to a SELL. Its turnaround has concluded. With low energy prices, its diminished cash flow has forced it to slash its exploration spending and likely sharply reduce its high dividend. BP’s deal to sell its petrochemicals business for $5 billion buys the company time, but does little to resolve its structural cash flow problem. BP’s prospects no longer warrant a position on our turnaround roster, so we are closing it out with a -5% total return since inception.

While Janus Henderson Group remains profitable, has a sturdy balance sheet and a well-covered 6.9% dividend yield, we see little potential for a turnaround due to secular pressure on asset flows and profit margins. Its relatively small size may lead to its acquisition, but this could be years away and isn’t a sufficient rationale for keeping our position. While the shares may be suitable for dividend-oriented investors, we no longer consider Janus Henderson Group a turnaround and therefore are moving JHG to a SELL.