January 5, 2024

In today’s note, we discuss the recent earnings reports from Walgreens Boots Alliance (WBA). Our note also includes the monthly Catalyst Report and a summary of the January edition of the Cabot Turnaround Letter, which was published a week ago Wednesday.

We encourage you to look through the Catalyst Report. This report is a listing of all of the companies that have reported a catalyst in the past month. These catalysts include new CEOs, activist activity, spin-offs and other possible game-changers. We source many of our feature recommendations from this list. You will find it nowhere else on Wall Street.

In this month’s edition of the Cabot Turnaround Letter, we discuss our Top Five Stocks for 2024. This year’s list emphasizes companies with deep fundamental turnarounds underway. Goodyear Tire (GT) is a repeat selection as we believe the changes have only started. Advance Auto Parts (AAP), Kohl’s (KSS), Kopin (KOPN) and Newell Brands (NWL) all feature new leadership that are undertaking root-and-branch overhauls of their respective companies even as their share prices remain highly out of favor.

We also dissect and review what happened in the capital markets in 2023 and offer our outlook for the coming year: a “typical” 10% market gain, reasonable 3% GDP growth and stubborn 3% inflation. Please keep in mind two of our favorite quotes about forecasts. The first, spoken by the linguistically creative baseball legend Yogi Berra, is that “predictions are difficult, especially about the future.” The second, from Warren Buffett, is that “… the only use for stock forecasters is to make fortune tellers look good.”

This month’s Buy recommendation, Mohawk Industries (MHK), is a major global flooring manufacturer whose shares are deeply out of favor. We discuss three key questions when considering an investment in a cyclical company and describe how Mohawk passes all three with flying colors.

Comments on Earnings

Walgreens Boots Alliance (WBA) – Once a retail pharmacy powerhouse, Walgreens faces secular challenges from an overbuilt, mature and poorly-run store base facing plenty of competition along with enduring pricing pressure in its pharmacy operations. The poorly chosen first-round turnaround CEO was fired in September 2023. We anticipate that the second-round CEO, Tim Wentworth, who joined in October 2023, will restore confidence in the company’s prospects.

Walgreens reported another mixed quarter, cut their dividend by 48% and maintained its full-year earnings guidance. The dividend cut, to $0.25/share/quarter, was widely expected and saves Walgreens about $850 million/year in cash – a critical issue given the $788 million cash outflow in the quarter. The new yield of about 4.2% is still respectable. The new leadership has been in place only for a few months – too little time to have any effect on results but clearly the sense of urgency to generate free cash flow is now much higher. Also, the focus on ground-level execution in the domestic stores is a clear improvement from the prior leadership’s focus on slashing costs at the expense of customer service. All-in, we’re staying with our Buy recommendation on the expectation of better results under the new leadership.

In the quarter, sales rose 10% (+9% ex-currency) and were about 5% above estimates. Adjusted earnings of $0.66/share fell 44% but were 6% above estimates.

U.S. Retail Pharmacy sales rose 8% on a same-store basis, boosted by higher drug prices, while same-store retail sales (the front of the store) fell 5% due to weaker traffic and holiday-related closures. Segment operating profits fell 37% and the adjusted operating margin fell to 2.1% from 3.6% a year ago, mostly due to a smaller gross margin.

International segment sales jumped 4% ex-currency, supported by 6% UK Boots growth and 4% German wholesale growth. Segment operating profits rose 22% and the adjusted operating margin expanded to 2.4% from 2.2% a year ago.

U.S. Healthcare sales were $1.9 billion, reflecting 12% growth on a pro forma basis to adjust for its various acquisitions. The EBITDA loss of $(39) million improved from a $(123) million loss a year ago due to better revenues and cost controls.

Walgreens’ enormous cash outflow was partly due to a $1.2 billion inventory build-up in advance of the holidays and supported by $427 million in sale/leaseback transactions (a practice that generates near-term cash at the expense of higher long-term lease costs). Walgreens has plenty of liquidity but needs to start generating significant positive free cash flow from its operations, not just from asset sales.

Friday, January 5, 2024 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 7 minutes and covers:

• Comments on earnings
  
  • Walgreens Boots Alliance (WBA)
• Comments on recommended companies
  
  • Xerox Holdings (XRX) – New operating model to reflect new strategy
  • Elanco Animal Health (ELAN) – Board changes and cryptic but possibly very favorable reference to upcoming CEO change.
• Elsewhere in the markets
  
  • Weak start for stocks in the new year, with some perspective provided by legendary market strategist Bob Farrell.

Please know that I personally own shares of all Cabot Turnaround Letter recommended stocks, including the stocks mentioned in this note.

The Catalyst Report

December was a reasonably active month for catalysts. Several pharma companies announced large acquisitions and an icon of industrial America, U.S. Steel, reached a deal to be acquired by Nippon Steel. Bankruptcy activity continues – we see 2024 as a strong year for companies being forced to address their overburdened balance sheets and unprofitable business models. Our Buy-rated Elanco Animal Health (ELAN) received some welcome activist involvement.

The Catalyst Report is a proprietary monthly report that is unique on Wall Street. It is an extensive listing of companies that have experienced a recent strategic event, such as new leadership, a spin-off transaction, interest from an activist investor, emergence from bankruptcy, and others. An effective catalyst can jump-start a struggling company toward a more prosperous future.

This list is intended to be comprehensive. While not all catalysts are meaningful, some can bring much-needed positive changes to out-of-favor companies.

One highly effective way to use this tool is to pair the names with weak stocks. Combining these two traits can generate a short list of high-potential turnaround investment candidates. The spreadsheet indicates these companies with an asterisk (*), some of which are highlighted below. Market caps reflect current market prices.

The following catalyst-driven stocks look interesting:

Worthington Enterprises (WOR) $2.7 billion market cap
Worthington Steel (WS) $1.4 billion market cap
This pair of companies, previously united as Worthington Industries, completed their separation in December. The split could be a rare case of a break-up actually being worth more in the real world, not just in the theoretical and fee-hungry world of investment bankers. Both Worthingtons have strong and sensible managements backed by equally strong financials and strategic positioning.

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Crown Castle (CCI) $49.4 billion market cap – Shares of this wireless towers company have severely lagged those of peers, in no small part due to weak and strategically misguided leadership, at least according to activist investor Elliott Management. Elliott wants Crown to improve its fiber profitability (or divest/exit), change out its leadership and improve the company’s governance. The shares have bounced some, but as the company has fired its CEO and is reviewing its fiber operations, a better-managed Crown could be worth a lot more.

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.