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Turnaround Letter
Out-of-Favor Stocks with Real Value

October 2019

Texas is booming and has the nation’s second-largest economy behind California would be the world’s tenth largest if it were a stand-alone country. Yet not every company in the Lone Star State is doing well.

In this issue, we cover seven companies there that we believe have appealing turnaround potential.

Cabot Turnaround Letter 1019


In This Issue:
Texas Turnarounds
Value Rebounders
Buy: Signet Jewelers
Other Ratings Changes
News Notes & Performance

The Lone Star State is booming, with incomes growing 7.5% in the most recent quarter – the fastest in the country. Texas has the nation’s second-largest economy behind California and would be the world’s tenth largest if it were a stand-alone country. Helped by but no longer reliant upon the oil and gas industry, the state has become a home for technology, aerospace, medical and other rapidly growing industries.

Yet not every company in Texas is doing well. Like all economies, the state has a range of companies that are struggling. Some have been hampered by weak conditions in their particular industries, while others have lost their way due to management missteps.

Listed below are seven companies that we believe have appealing turnaround potential. Our selection draws from a wide range of industries, including the energy sector, even as most energy company shares are out-of-favor. We would of course also include our Texas-based Turnaround Letter-recommended stocks like last month’s Trinity Industries.

American Airlines (AAL) – Shares of American Airlines have fallen by more than half since their 2018 peak at over $58, and now are approaching their post-Chapter 11 exit lows. Higher costs due to the Boeing 737 MAX grounding and disruptions surrounding the mechanics’ labor union contract have delayed its hoped-for efficiency gains. Also, concerns over higher fuel costs and an uncertain demand and pricing environment weigh on the shares. The company, however, is pressing forward with revenue-enhancing and cost-cutting efforts. And, second quarter passenger revenues, pricing and capacity utilization were all strong. Assuming the domestic and global economies remain reasonably healthy, American Airlines should start to boost its free cash flow as a major capital spending cycle winds down.

AT&T (T)Proving that no company is too large to avoid an activist campaign, AT&T is under siege by the influential Elliott Management, which recently took a $3.2 billion stake in the company. Elliott is critical of the shares’ long-term underperformance due to the DirecTV and Time-Warner acquisitions, weak operating performance and high leadership turnover. While AT&T’s management has so far rebuffed the activist, it seems likely that the criticism and detailed plan will lead to at least some changes in AT&T’s strategy. In some ways, shareholders are in a win-win position: they win if the stock does well, and if the stock does poorly it exerts more pressure on management to make more of the aggressive changes that Elliott is proposing. In their 23-page letter (worthy of a read), the activist makes their case for AT&T shares trading up to $60.

Civeo (CVEO) – The share price of this two-time former Turnaround Letter recommended stock (both times generating over 110% gains) has returned to near its lows. Spun-off from Oil States International in 2014, Civeo provides housing to workers in remote regions, primarily in the Canadian oil sands, LNG and Australian coal mining regions. Despite investor concerns over the slow recovery in its markets, profits and cash flows remain healthy. Management is working to pay down and extend the maturity of its 2020 debts, which we believe is likely and could be an important catalyst. This misunderstood and volatile stock is worth another look.


Fluor Corp (FLR) – Irving-based Fluor is one of the world’s largest engineering and construction firms, generating $19 billion in revenues last year from a diverse span of major energy, biotech and transportation infrastructure projects. Much of its business is based on fixed-price contracts, leaving Fluor to cover cost over-runs, which can be both frequent and large. This past quarter alone, the company wrote off over $700 million from these contracts and other problems. The steady stream of bad news has left Fluor’s shares nearly 70% below their year-ago price, which now trade at 16-year lows. Worried about its future, the company has taken aggressive action, including replacing its CEO and most of its senior management and several board members. Last week, Fluor unveiled the results of its strategic review: it will sell its government services and construction equipment rental businesses, divest its surplus real estate and non-core investments, cut its dividend by 52% and implement a $100 million cost savings program. Strategically, it hopes to sharply reduce its business risk by tightening its project bidding and acceptance criteria as well as instilling discipline in its culture. If the turnaround is successful, Fluor’s shares have plenty of upside.

Halliburton (HAL) –Shares of Houston-based Halliburton, one of the key suppliers to the global energy industry, are unchanged from their price 20 years ago. But it has been a wild up and down ride. Not many well-managed companies with a 100-year history, reasonable debt (2.4x EBITDA), steady revenues and profits, and solid long-term prospects in an industry that is critical to the global economy are as out-of-favor as Halliburton. While more than a little patience could be required, the shares’ suppressed 7.1x EBITDA valuation combined with the company’s strong operating leverage offers investors impressive upside from any sustained industry upturn, and pays an attractive and likely sustainable 3.7% dividend yield during the wait.

Luby’s (LUB) – Although this micro-cap company has strategically drifted in recent years, with flagging operating results, it appears to be reinvigorating itself with new leadership and board members. While its shares have nearly doubled from their lows, they have a lot further to go if this formerly iconic company’s turnaround remains on track.

The Michaels Companies (MIK) – The Michaels Companies’ shares have fallen 43% since the firm went public in a 2014 IPO after having been privately held by Blackstone Group and Bain Capital for eight years. As a retailer that focuses on arts and crafts, this company would appear to be on the wrong side of the rapid growth in on-line shopping. While to some extent this is true – revenues have drifted downward in recent years – much of the company’s struggles relate to its high mix of China-sourced goods which now are subject to margin-eroding tariffs. Yet, Michaels’ outlook may be improving. Same store sales growth and gross margin both turned upwards in the most recent quarter as management works to improve the business. Free cash flow remains strong, allowing more share buybacks. While leverage is a bit high at 3.3x EBITDA, the company’s nearest debt maturity is not until 2023.

Value Stocks With Rebound Potential

It’s been a long, disappointing decade for the value style of investing. Through August 30, the rate of return for the Russell 1000 Value Index has lagged that of the Russell 1000 Growth Index by four percentage points a year. Over the decade, this translates into a 41% higher cumulative return for growth stocks over value stocks. For shorter periods, the spread is even wider: over the past three and five years, the growth index’s rate of return has been double that of the value index. However, the tables turned sharply in September. In the month so far, the value style has gained 3.8%, swamping the 0.4% growth style’s return. This by no means offsets the value style’s long-term underperformance, nor does it necessarily signal that value will become the style of choice going forward. It does, however, provide some encouragement for investors who look for stocks other than large momentum-driven names that seem to relentlessly march upward regardless of their high valuations. Although the precise reason for the value surge is impossible to determine, it seems likely that rising competition and the maturing of previously open-ended growth prospects of cloud-computing, smartphones and streaming services have begun to weigh on the appeal of “one-decision” mega-cap tech stocks. The rush of rapidly-growing but money-losing initial public offerings probably contributes to investor wariness. Meanwhile, perhaps the market has recognized that most traditional or lower-tech companies won’t be going away anytime soon. As an example, utility stocks, often dismissed as the dullest of value stocks, have surged 25.1% this year, well ahead of the 20.9% return of the S&P 500. Compared to near-zero interest rates, the higher yields of utility stocks, along with their immunity to any Amazon effects or tariff impact, have offered considerable appeal. Listed below are five value stocks that have suffered heavily this year, with sharply negative returns while the broad market has posted strong gains. They all have interesting turnaround or rebound possibilities, with some carrying higher risks and offering commensurate reward potential.

Centennial Resource Development (CDEV)Led by Mark Papa, who built EOG Resources into a large and highly profitable company, Centennial concentrates on the prolific Permian Basin in West Texas. Nearly 60% of its production is oil, high for an independent company, so its shares are highly sensitive to West Texas Intermediate prices. As investors lose faith in its ability to produce free cash flow, as natural gas prices remainlow, and as its financial leverage is elevated, Centennial’s shares have fallen 80% in the past twelve months. Like the many other energy companies with beaten down shares, CDEV shares would likely rebound sharply if Middle East or other oil supplies were further threatened or if other forces drive up energy prices.

Chemours (CC) – Chemours shareholders have endured a volatile ride to nowhere since the company’s mid-2015 spin-off from DuPont. Its shares promptly dropped 75%, then surged 16-fold, only to plummet 75% again, returning to their spin-off-date price. Weak hydrofluorocarbon sales in Europe and slowing sales of titanium dioxide, among other headwinds, have weighed on the shares. Another issue is Chemours’ potentially large liability for environmental damage, for which the company is suing its former parent. Chemours asserts that DuPont grossly underestimated this liability and seeks either indemnification or the return of the $4 billion it paid to DuPont via a dividend. While the debt and other risks appear high, Chemours generates sizeable free cash flow and pays a 6.9% dividend to help compensate. The board recognizes its issues, and has replaced the CFO and chief operating officer, and added a new board member, to help right the company.


Owens-Illinois (OI)This company is the world’s largest maker of glass packaging, typically used for food and beverage containers, with a 25% market share. Glass manufacturing is generally a stable business, with recession-resistant demand, healthy pricing power and wide profit margins. OI shares fell 40% recently, to 15-year lows, following disappointing second quarter results and a weaker full-year outlook. The company is struggling with lower volumes and higher currency headwinds, along with higher operating costs and taxes. Free cash flow after hefty asbestos obligation payments and other costs will likely be thin this year. Yet, much of the difficulties appear temporary in nature, and management may be taking more aggressive steps to reduce Owens-Illinois’ high debt under pressure from activist investor Atlantic Investment Management. The valuation is unchallenging and the newly-initiated dividend provides a 2% yield.

Tapestry (TPR) – This company owns the highly-regarded Coach, Kate Spade New York and Stuart Weitzman luxury brands. Efforts to expand from its core Coach brand, which itself was resuscitated years ago, have been largely unsuccessful. Tapestry’s shares have fallen by 50% from a year ago as it struggles with declining same store sales from the Kate Spade line, while Stuart Weitzman remains unprofitable after over four years of ownership. Looking for new ideas and a change in direction, the company has brought in a new chief operating officer, chief digital officer and new CFO, and installed board chairman Jide Zeitlin as the new CEO a few weeks ago. While import tariffs and exposure to outlet malls add to its problems, the company has many levers to pull to boost its value to shareholders. Tapestry has only modest debt and generates considerable free cash flow, buying it time to execute its turnaround.

U.S. Steel (X) – This company ranks as one of the most out of favor among major companies. Not only is its stock at one-fourth its price of only 18 months ago, the narrative is depressing: slowing demand from almost all customer groups, steady industry capacity increases, an environmentally unfriendly product, high debt and pension liabilities and a potential cash flow squeeze. While the risks involved with an investment in U.S. Steel’s equity are clearly high, even a small improvement in fundamentals and sentiment could produce a sharp rebound.

Purchase Recommendation: Signet Jewelers Limited


Background: Signet Jewelers is the world’s largest diamond jewelry retailer, with 3,284 stores and kiosks in the United States, Canada, United Kingdom and Ireland. Major brands include Kay, Zales, Jared, James Allen and H. Samuel. Founded in 1949 in England, then-named Ratners expanded throughout the U.K., entering the United States in 1987 with the acquisition of two Ohio-based companies. Following a public relations gaff, the company was renamed Signet Group in 1993 and eventually transitioned into a primarily United States business. Today, about 90% of the company’s revenues come from the U.S. Although it is domiciled in Bermuda, Signet’s operational headquarters is in Akron, Ohio. For years, Signet was managed as a growth company. Sales nearly doubled from 2011 to 2015, driven by healthy same store sales, new stores, and acquisitions including the $1.5 billion purchase of Zales in 2014. However, easy financing terms from its in-house credit operations fueled much of this growth while masking problems in the neglected core retail business. The sparkle wore off when same store sales turned negative, credit losses mounted and the leadership faced accusations of widespread discrimination against its female employees. Efforts to outsource the credit operations only seemed to make matters worse. Eager to resolve its problems, the company replaced its CEO in August 2017 with board member Virginia Drosos, a highly-regarded executive. Her three-year turnaround plan, unveiled in March 2018, concentrates on improving Signet’s merchandising and marketing, rationalizing the store base and expense structure, and completing the outsourcing of the credit operations. Currently about halfway through the plan, the company has made impressive progress but investors remain skeptical. Worries about gross margins and still-negative same store sales (-1.5% in the most recent quarter) driven by on-line competition and Signet’s exposure to weaker malls, as well as Brexit, weigh heavily on investor sentiment. Signet’s shares remain nearly 90% below their late 2015 peak of $150.

Analysis: Signet’s turnaround plan includes all the right steps and appears likely to succeed. After years of neglect, the company’s reinvigorated product line along with its clearing-out of dated inventory and better digital marketing should improve sales and margin performance. Its e-commerce initiatives have already doubled sales in the past two years to 11.5% of revenues. Signet is pruning its exposure to weaker regional malls and plans to close 150 stores (about 4.5% of its store-base) this year. It remains on-track to cut as much as $225 million (net) in costs. The leadership team has been replaced and the board has been overhauled with new members, including a representative of respected private equity firm Leonard Green, all helping to ensure that the turnaround remains top-of-mind. Signet’s balance sheet carries only a modest $682 million in debt, about 1.6x EBITDA, nearly all of which will be refinanced with a new five-year credit facility that extends its maturities and provides increased liquidity. Additional liquidity comes from the $272 million in cash on hand. Respectable Q2 results, an increase in full-year guidance to about $270 million in adjusted operating income despite higher costs from import tariffs, and a shift in investor sentiment, led to a recent bounce from the stock’s lows. Signet shares trade at a modest 4.4x EBITDA. The recently-affirmed dividend offers an appealing 8.7% yield. However, investors shouldn’t count on this as being sacrosanct and any cut would likely pressure the shares.While the upcoming holiday season, which typically produces close to 40% of annual revenues and 100% of operating profits, will be a major test, we think Signet’s turnaround will restore the luster of this tarnished company. We recommend the PURCHASE of shares of Signet Jewelers (SIG) with a $29 price target.

Other Ratings/Price Target Changes

We are raising our price target on Hovnanian Enterprises (HOV) shares from $16 to $19.50, as the company continues to make progress with its turnaround and as industry conditions that appear to be improving. With the recent flurry of news regarding McDermott’s (MDR) hiring of advisors, potential sale of its technology division, pursuit of a bridge loan and other news, all of which point to a heightened risk of a bankruptcy filing, we added “Speculative” to our Buy rating for MDR shares. Investors who are unwilling or unable to accept the risk of a bankruptcy filing, which would likely result in a total loss of equity value, should sell their shares. For those willing to accept this risk, we continue to see considerable upside potential should the company successfully work its way through its near-term difficulties. We provide further analysis in our most recent podcast.

News Notes & Performance


Brookdale Senior Living’s annual shareholder meeting, scheduled for October 29, could be contentious. Activist investor Land & Buildings has proposed adding its own representatives to the board, but this appears unlikely to succeed. Brookdale secured a valuable endorsement for two new board candidates, Victoria Freed and Guy Sansone, by activist investor Glenview Capital, which holds a 9.5% stake. Either way, investor pressure on the company should lead to better operating performance and increase the chance of strategic changes. Credit markets may be tightening, potentially increasing the difficulty that higher risk companies may have in securing funding. These companies may turn to cutting their dividends to preserve cash. We think Washington Prime Group is likely to sharply cut their dividend starting next year. While this would improve the company’s immediate and long-term financial viability, investors holding the shares primarily to capture the very high 24% yield would likely sell, pressuring the stock price. However, the high yield already implies considerable market skepticism about the dividend’s sustainability, so a price drop may only be temporary. While the dividend payouts of other high-yield stocks, including Kraft Heinz Group, AMC Entertainment Holdings, Ford Motor and Macy’s, appear sustainable, shareholders may want to factor the risk of a cut into their views.


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