July 28, 2023

This week, we comment on results from General Electric (GE), Mattel (MAT), Polaris (PII), Vodafone (VOD), Volkswagen AG (VWAGY), Western Union (WU) and Xerox Holdings (XRX).

Next week, twelve companies are scheduled to report.

We also include the Catalyst Report and a summary of the August edition of the Cabot Turnaround Letter, which was published on 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 Cabot Turnaround Letter, we include updates for our stock and high-yield bond market outlooks. Our updates also include a breakdown of what has happened so far in 2023. Our Year-End 2022 Stock Market Outlook was right on just about every metric except the one that perhaps matters most (the stock market). We think that the S&P 500 index will end 2023 about where it is now. Our Year-End 2022 High-Yield Bond Market Outlook was more accurate. We still see this market’s current state as “not unfair enough” for most investors.

Our feature recommendation this month is Kopin Corporation (KOPN), a small company that focuses on developing high-performance optical display technologies, including headsets, for military, enterprise, industrial and consumer products. Since its 1992 IPO, the company has been essentially a research hobby for its founder who is a brilliant scientist. The main highlights of its history include a moribund (flat) stock price, a milieu of impressive-sounding technologies but few commercially viable products, an almost uninterrupted stream of operating losses, and stunning dilution due to routine equity raises.

Seismic changes are underway at Kopin that look poised to radically improve this company’s trajectory. Its founder, CEO and chairman has stepped away from the company and has been replaced by an impressive new outside hire, Michael Murray. Another outsider is the new chairman, and the board is likely to undergo a more complete refresh in the next year. The new CEO’s top strategic priority is to exit 2023 at cash flow break-even and generate an operating profit in the first quarter of 2024. To achieve these goals, Murray is undertaking a full strategic and operational overhaul of the company.

Kopin has a fresh infusion of capital (in what likely will be its last equity raise), zero debt, a roster of long-established defense and commercial customers, and over 200 patents that provide a solid in-house intellectual base for all of the critical technologies.

While the shares have doubled from their $1 floor, and the risks are substantial, if Kopin executes well, the upside is immense and likely much higher than our admittedly arbitrary $5.00 price target.

Earnings Updates:

General Electric (GE) – Led by impressive new CEO Lawrence Culp, GE finally appears to be righting its previously severely damaged businesses. Key priorities include much better execution and a strategic emphasis on cash flow and debt reduction. Following the spin-off of 80% of GE Healthcare (GEHC) in January 2023, General Electric now comprises GE Aerospace (commercial and military jet engines) and GE Vernova, which includes the Renewables segment (on-shore and offshore wind power) and the Power segment (gas turbines, coal, nuclear). GE Aerospace and GE Vernova will separate in 2024.

GE reported a strong quarter and raised its full-year guidance. Organic revenues, orders, profits and free cash flow rose sharply from a year ago. GE raised its guidance for full-year 2023 revenue (by ~4%), adjusted EPS (by ~20%) and free cash flow (by ~11%). Strength in GE Aerospace and notable improvements in GE Vernova to essentially breakeven are contributing to the raised guidance.

The company increasingly is operated as two separate companies ahead of the early 2024 spin-off of GE Vernova. The company continues to clean up its balance sheet, with the sale of $2.2 billion, or 32%, of its stake in GE Healthcare, the repurchase of all of its $2.8 billion of preferred shares, and some offloading of legacy liabilities.

GE appears to have finally turned the corner, supported by skillful leadership and operational improvements as well as the resilient economy and aircraft market.

In the quarter, revenues rose 19% organically from a year ago and were about 10% above estimates. Adjusted earnings of $0.68/share rose 89% from somewhat depressed results a year ago and were about 48% above estimates. Organic orders rose 58% and free cash flow doubled to $400 million from depressed results a year ago.

Mattel (MAT) – At our initial recommendation in 2015, Mattel was struggling with its failure to adjust to the realities of how young children spent their playtime. This failure had produced years of revenue decay. In addition, its cost structure became bloated, and its debt levels increased. However, led by its new CEO, Mattel now appears to be finding its way.

Mattel reported a strong-enough quarter compared to weak expectations and reiterated its full-year guidance. Results were lower than a year ago due to an already-known inventory glut at retailers and modestly softer end demand. Free cash flow continues to be robust, and the balance sheet is in good shape. Mattel is executing well on its basic products. The Barbie movie (released after quarter-end) will produce some profits but is a major positive in showcasing the value inherent in Mattel’s brands, which it can later monetize for sizeable profits.

Our $38 price target was looking out of reach, but perhaps is now more attainable given the ongoing strength in the company’s fundamentals and the optionality produced by its new movie ventures. The shares currently trade at 10.4x estimated 2023 EBITDA, which is probably reasonable as-is, but more appealing is the 9.3x multiple on next year’s profits, assuming these estimates are on the mark.

In the quarter, revenues fell 13% ex-currency and were 9% above estimates. Adjusted earnings of $0.10/share were sharply higher than estimates for a $(0.03)/share loss. Adjusted EBITDA of $148 million was more than double the $67 million consensus estimate.

The reiterated 2023 outlook calls for flat revenues, stronger gross margins, weaker EBITDA (down 4%) and 50% higher free cash flow.

Newell Brands (NWL) – The company has struggled, literally for decades, with weak strategic direction and expense control, epitomized by its over-reaching $16 billion acquisition of Jarden in 2016. Pressured by activist investors last year, and now led by a capable new CEO, Newell appears to be finally fixing its problems, yet the shares remain significantly undervalued relative to their post-turnaround potential.

Newell reported a mixed quarter. Revenues and earnings fell meaningfully from a year ago but were higher (particularly earnings) than estimates, indicating that expectations were too low. However, the company slashed its third-quarter and full-year profit guidance (from only three months ago). Favorably, operating cash flow guidance remains unchanged and company margins will be “up significantly.”

The turnaround is entering the ugliest stage. Results are sliding but there isn’t yet much clarity or confidence in the endgame. But, Newell seems to have finally found someone who is dealing with the disease head-on, at the operating level: a decent core business struggling under the bloat and chaos of too many unworthy products and processes. Prior leadership focused on the top-down strategy. But curing the disease requires an in-the-weeds focus, with only a general view on the endgame strategy. With a CEO in place now who understands this and is capable of executing, we remain steadfast in our Buy rating on Newell shares.

What’s going on here? Our view is that the company is following its new strategy under the new CEO: cutting unprofitable brands and products to focus on the best 25. This is boosting margins as the low-margin goods are being phased out, and generating large cash flows as the unwanted product inventory isn’t being replaced. The culling process won’t happen overnight but is likely happening faster than the management anticipated when they crafted their strategy not that long ago. This is accelerating the margin pressure now as low-margin goods are being discounted to move quickly, perhaps to take advantage of the back-to-school season. With these goods out of the picture later this year, margin gains will accelerate but new, higher-margin products won’t yet fully replace the phased-out ones. Macro headwinds also will weigh on results. Thus, the weaker guidance for the third quarter and the rest of the year.

One indication of how much cash is released from the purge: inventories are down nearly $700 million from a year ago. This is “found” money and can be applied to reducing Newell’s overbearing $5.4 billion debt burden.

One unknown is what the new core sales and profit margins will look like after this purge. Sales may be lower, but profits should be much better. The wasted efforts to produce and distribute low-margin goods can be eliminated or redirected to more profitable activities, which at its essence is the core of the Project Phoenix turnaround plan. Management is providing some guidance on this, but we’ll need to update our model to more fully evaluate where this is likely headed.

In the quarter, revenues fell 13%, with core revenues (organic) falling 12%, and were 2% above estimates. Normalized earnings of $0.24/share fell 57% from a year ago but were 71% above estimates.

Polaris (PII) – Shares of this high-quality manufacturer of powersports equipment like off-road vehicles, snowmobiles, motorcycles and boats fell out of favor due to concerns over a post-stimulus falloff in demand as well as supply chain disruptions. We believe the company’s long-term prospects remain intact. Polaris produces strong profits and free cash flow, has a solid balance sheet, and a strong, shareholder-friendly management team.

The company reported a decent quarter with revenues and earnings that were ahead of consensus estimates. End-market demand remains resilient/steady, especially as Polaris has been able to incrementally raise its prices. There has been little indication of a retail slowdown, although demand appears to be at a normal level with little indication of renewed strength.

Polaris’ profit margin expansion is stalling due to lingering operational inefficiencies and to rising dealer financing costs, currency effects and rising R&D and marketing spending. The company raised its full-year sales guidance by two percentage points to a range of +3-6% and fractionally raised its profit guidance to roughly 1% growth. The guidance calls for tiny increases in the gross margin and EBITDA margin yet sharply higher free cash flow. Polaris’ balance sheet continues to carry modest debt.

All-in, the recovery remains on track. From here, we anticipate that profits will grind higher and that, with more confidence in the company’s resilience, investors will push the shares upward to our price target.

In the quarter, revenues rose 7% and were about 3% above estimates. Adjusted earnings of $2.42/share were flat compared to a year ago and 4% above estimates.

Vodafone (VOD) – This major European wireless telecom, broadband and cable TV service provider has produced dismal operating results since our recommendation. However, new hope has arrived with the forced departure of the CEO along with heightened activist pressure. Given the huge undervaluation of the shares, we are now much more optimistic about this stock. From here, we want to see a skilled and motivated outsider CEO take the helm with a strong turnaround plan that can be implemented successfully. A sharp dividend cut could readily be part of this plan, with the released funds at least partly dedicated to cutting Vodafone’s elevated debt. Vodafone has a few obscure assets: it is the leading provider of mobile data and payments services in Africa and has a vast network of high-capacity data pipelines that may increase in value as 5G rolls out.

Vodafone reported its first quarter FY 2024 trading (revenues only) update and reiterated its FY 2024 adjusted EBITDAaL and adjusted free cash flow guidance. Organic service revenues rose 1.8% from a year ago. Excluding Turkey, which is suffering from intense inflation and economic turmoil, organic service revenues rose 3.7%. Broadly, it appears that revenue growth is incrementally accelerating after the year-ago dip. Vodafone is exercising some pricing power to support its revenues – so far, this seems to be working.

The German market continues to be a major source of weakness for Vodafone, but at least the negative revenue trend moderated in the period to (-1.3%) from (-2.8%) in the fourth quarter. Price increases drove the improvement.

Revenues in Africa Vodacom, a largely ignored asset, rose 9% as growth remains sturdy. The company has moved Vodafone Egypt from “Other” to Vodacom Africa, a seemingly minor change but one that we see was an obvious move to tighten the company’s reporting and perhaps set the stage for a sale or spin of Vodacom Africa.

Vodafone hired SAP’s former CFO to be the new Vodafone CFO starting on September 1. This is an additional piece of encouraging news.

For reference: organic service revenues are total revenues less the smallish and volatile equipment and financial services revenues, adjusted for changes in currencies, mergers, hyperinflation adjustments in Turkey and other adjustments that may affect comparability. For Vodafone, organic service revenues is the primary metric for measuring the core revenue growth.

Adjusted EBITDAal is a convoluted metric unique to Vodafone that captures EBITDA with an adjustment for leases.

Volkswagen AG (VWAGY) – Volkswagen is one of the world’s largest car makers, with a portfolio of brands including Volkswagen, Audi, Porsche and Lamborghini, as well as commercial trucks and a financial services unit. China is Volkswagen’s largest market, (38% of vehicle unit sales), followed by Western Europe (32%) and North America (10%). Investors worry about the sizeable China exposure, large but unsettled bet on electric vehicles, complicated governance structure, issues with its in-car software, and the likely effects of a recession. We acknowledge the numerous headwinds, yet believe the market is over-discounting these while overlooking the company’s strengths, including its sturdy balance sheet and sizeable profits and free cash flow, which give it plenty of time to execute its plans. Several important catalysts look primed to unlock value within the company, including the Porsche IPO and new leadership.

Volkswagen reported a good first half, with revenues rising 18% and underlying profits increasing 13%. The underlying profit margin of 8.9% is strong, although weaker than the year-ago margin of 9.3%. Unit deliveries rose 13% from a year ago. Demand remains sturdy as the company is increasingly able to complete and deliver vehicles that had been delayed due to supply chain issues. Pricing per vehicle and mix toward more expensive vehicles are helping boost revenues. Electric vehicle deliveries rose 48% and now comprise over 7% of total deliveries.

The company reaffirmed its full-year guidance although it ticked its delivery outlook downward by 3%. The balance sheet and free cash flow remain sturdy.

China deliveries fell 1%, buttressed by an 18% increase in electric vehicle sales. This market is increasingly shifting away from Western carmakers like VW, so it is somewhat encouraging that VW is boosting sales there.

The Western Union Company (WU) – This widely recognized money transfer company is facing secular headwinds from the transition to digital money. Prior efforts to diversify away from the core retail business using the company’s sizeable cash flows were unsuccessful, but a new CEO with impressive fintech experience brings the real possibility of a meaningful improvement in both execution and strategy as it makes its transition to the digital world. Investors have aggressively sold WU shares, ignoring the company’s relatively stable revenues, sizeable free cash flow and valuable intangible assets as well as its generous dividend yield.

Western reported an encouraging quarter. After dipping into negative growth territory a year ago, key metrics including revenues (+9% organic), transactions (+4%) and branded digital transactions (+12%) are clearly turning upward. Retail transactions (-2.4%) are approaching positive territory after sliding (-7.1%) in the year-ago quarter. The company’s strategy and execution appear to be working, so far. Profits and margins are recovering but still below year-ago levels due to spending on its turnaround program. The company raised its full-year revenue guidance by about 3% and EPS guidance by 6%.

In the quarter, revenues rose 9% on a constant currency basis excluding the now-divested Business Solutions operations. Excluding the effects of inflation in Argentina, constant currency revenue growth was 6%. Revenues were about 11% above estimates. Adjusted earnings of $0.51/share were flat but nearly 31% above estimates.

Interestingly, the company saw a huge increase in remittances through its Iraq network. Following changes to the U.S. Government policy in this matter, and with Western implementing tighter compliance and risk controls, volumes in the rest of the year will be sharply lower. This change is built into company guidance.

Xerox Holdings (XRX) – While the near-term outlook remains clouded, as office workers remain in partial work-from-home mode, we believe the company’s revenue and cash flow will recover. Investors underestimate Xerox’s value due to its zero-growth prospects, but the company’s hefty free cash flow has considerable value. The balance sheet is strong, new and capable leadership is working to drive shareholder value higher, and its generous dividend looks reliable.

Xerox reported an encouraging quarter, with earnings well ahead of estimates and with management increasing their full-year profit margin and free cash flow guidance. The company is entering an upcycle, which is likely to continue for several quarters, at least.

Revenues were flat in the quarter. For most companies, flat revenues would be disappointing. For Xerox, flat means steady. So, when investors are worried that the company’s products and services are becoming irrelevant in a work-from-home digital world, steady is quite good. And, with lower costs, steady revenues mean stronger profits and cash flow, which is what Xerox is now delivering.

Xerox will never be a growth company, but all we need is a steady annuity of generous free cash flows for a re-rating of the shares.

The company’s revenues are following the typical upcycle: first, equipment is sold, then service and supplies revenues follow. Xerox reported strong equipment sales (+14%) while service and supplies fell (-3%). As equipment is used, service and supplies sales should recover.

While revenues were flat, the gross margin expanded by over 2 percentage points and overhead costs fell 10%. Lower operating costs, better supply chain conditions and more sales of higher-margin products are helping lift operating profits.

The company is increasingly moving the equipment leasing ops to a stand-alone structure which we believe points to an eventual sale.

In the quarter, revenues rose 0.5% ex-currency and were in line with the consensus estimate. Adjusted earnings of $0.44/share improved from $0.13/share a year ago and were about 38% above the consensus estimate. Adjusted EBITDA of $159 million rose 71% from a year ago and was about 8% above the consensus estimate.

Friday, July 28, 2023, 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 13 minutes and covers:

• Summary of monthly Cabot Turnaround Letter
• Comments on earnings
• Comments on other recommended companies
  
  • Mattel (MAT) – Barbie blowout at $162 million.
  • Goodyear Tire & Rubber (GT) – Elliott gets several board seats.
  • Wells Fargo & Company (WFC) – New $30 billion share buyback.
  • Walgreens Boots Alliance (WBA) – CFO departs for a tech company.
• Elsewhere in the market
  
  • Forecasts, grains of salt and some fitting quotes from Alan Greenspan.

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

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.

The Catalyst Report

July was a very quiet month with only 23 catalysts. Several high-profile companies changed their leadership while others saw some activist activity.

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:

Gap Stores (GPS) $3.7 billion market cap – After a seemingly interminable search, this company finally makes its selection. Richard Dickson, formerly president and COO of Mattel, looks like a solid choice. Dickson is widely credited for turning around Mattel’s Barbie franchise. His departure from Mattel was inevitable as the company never gave him the CEO seat.

—————————————————————————————————————————————————————

Cracker Barrel Old Country Store (CBRL) $2.1 billion market cap – A new CEO joins from a senior executive position at Taco Bell. This impressive hire could restore some luster to the company’s weary image and store operations.

—————————————————————————————————————————————————————

Clear Channel Outdoors (CCO) $690 million market cap – Activist investor Legion Partners is engaging the company to address its wide performance lag relative to its peers. Fixes include divesting Europe-North, Latin America and selected U.S. assets or a sale of the entire company.

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.