June 30, 2023

This week, we comment on earnings from Walgreens Boots Alliance (WBA). We also include the Catalyst Report and a summary of the July 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: While much of our emphasis is on mid-cap and large-cap turnarounds, there are often attractive turnarounds in the small-cap segment of the market. Companies in this group, with market values generally below $1 billion, can offer worthwhile investment opportunities. This month, we are focusing our research exclusively on small-cap turnarounds and discuss eight names with interesting potential.

Our feature recommendation this month is L. B. Foster Company (FSTR), a small-cap manufacturing and distribution company focused on the railroad, precast concrete structures and customized steel fabrication industries as well as coatings and measurements. After years of difficulties, a diligent and impressive turnaround effort is underway and starting to show progress, even as investors overly discount its prospects.

Earnings Updates:

Walgreens Boots Alliance (WBA) – Once a retail pharmacy powerhouse, Walgreens faces hefty secular challenges from an overbuilt and mature store base, with customers who have plenty of alternatives to visiting its often poorly run and expensively priced stores. And, pricing pressure from private and government payors is squeezing its prescription profit margin. Walgreens is concentrating on the United States market where it is developing its stores into a healthcare network, led by the much-needed fresh perspective from the new CEO.

The company reported a disappointing quarter and reduced its full-year earnings guidance by 12%. With only one quarter remaining, the updated guidance cut fourth-quarter earnings by over 40%.

The uninspiring results – not the first during its transition strategy – continue to demonstrate that Walgreens isn’t meeting its growth targets. Post-pandemic vaccine trends and other near-term consumer behavior may well have weakened this particular quarter’s results. But, if the long-term growth story can be derailed by a predictable short-term issue, then it isn’t much of a long-term growth story.

This readily leads to THE major question: is its transition strategy any good?

Our concern is that Walgreens’ efforts to build its “next growth engine with consumer-centric healthcare solutions” may have two fatal flaws. First, building a healthy, large and growing business, launched from scratch and assembled by acquisitions of young companies, is difficult at best. A hide-bound company like Walgreens, even with its previously strong free cash flow, might not be up to the task, especially in an overly complicated, highly regulated industry like healthcare in which nearly countless companies of all sizes are competing aggressively for survival and growth.

Second, Walgreens genuflects in the direction of profits but seems mostly focused on revenue growth. So, we may be left with a company that is using the reasonably large and reasonably steady profits from its retail pharmacy business (excluding the hulking opioid settlement costs) to fund low-return or negative-return investments in healthcare solutions.

Management’s mandate from the board appears to be “get this ship moving into the healthcare services direction however you can.” Our fear is that the new leadership is doing exactly that – which is a major risk to shareholder value. It reminds us of a humorous phrase (suitably) from the medical profession, “the operation was a success, but the patient died.” We now wonder aloud about the possibility that the CEO (and several board members) are on a short leash.

To preserve its financial flexibility, Walgreens is liquidating its non-core assets like its position in AmerisourceBergen (ABC), harvesting cash from working capital and cutting capital spending. It continues to maintain its investment-grade credit rating, and management said on the conference call that it is “absolutely committed” to keeping this rating. Management also said it is “absolutely committed” to the current quarterly dividend. Favorably, the impressive recovery in the U.K. Boots operations may allow Walgreens to successfully offload this segment at a respectable price, after a failed prior attempt too soon after the pandemic (and in the teeth of a tumbling stock market).

In the quarter, revenues rose 9% on a constant currency basis to $35.4 billion, which was about 4% above consensus estimates. Adjusted earnings of $1.00/share rose 4% on a constant currency basis but were 7% below estimates.

The Walgreens thesis is off-track but not yet on life-support. Our comments here only scratch the surface of our thoughts, and we want to dig further into the updated information before we decide what to do from here. The shares, trading at 11x EV/EBITDA and 7.1x per-share earnings, seem cheap-esque, but the value trap risk is already being realized and could readily expand further. For now, we are meekly keeping our Buy rating as we are highly reluctant to use our Hold rating. Our most likely next rating update will be to either reiterate our Buy or move to a Sell.

Friday, June 30, 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 12 minutes and covers:

• Summary of monthly Cabot Turnaround Letter
• Comments on recommended companies
  
  • Walgreens Boots Alliance (WBA) – Recent earnings report. Is its transition strategy any good?
  • Brookfield Re (BNRE) – Offers to buy remaining stake in American Life Equity insurance company.
  • Newell Brands (NWL) – New CEO’s turnaround effort may work.
  • Wells Fargo (WFC) – Fed stress tests had favorable results for major banks.
  • Berkshire Hathaway (BRK.B) – Buying more Occidental Petroleum shares.
  • Volkswagen AG (VWAGY) – Teaming up with Tesla. Is Tesla the new Standard Oil?
• Final note
  
  • Markets on shortened hours on Monday, but many people seem to be taking a five or six-day-long weekend.

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

June saw continued modest catalyst activity, although several high-profile campaigns like those against NRG Energy (NRG) and Illumina (ILMN) captured the headlines. We anticipate increased activity in future months as proxy season winds down.

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:

SilverBow Resources (SBOW) $645 million market cap – This small-cap oil and gas exploration company is already under pressure from activist Kimmeridge (14.5% stake) and others. Riposte Capital recently joined the club with a 7.5% stake. SilverBow extended its poison pill through mid-2024. Something is bound to happen here.

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Harte Hanks (HHS) $38 million market cap – Following its successful resuscitation by a turnaround-focused CEO, Harte Hanks now has a highly capable new CEO with impressive experience producing profitable growth. This stock was included in our most recent Cabot Turnaround Letter as a promising small-cap turnaround.

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Lazard, Ltd (LAZ) $3.5 billion market cap – New CEO is Peter Orszag, who led Lazard’s Financial Advisory practice since 2019 and previously led its North American M&A and Healthcare groups. The former CEO moves up to executive chair of the board yet will continue to advise clients. This clumsy governance setup could spawn internal issues and another leadership change.

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.