November 17, 2023

This week’s note includes our comments on earnings from Advance Auto Parts (AAP), Macy’s (M), Tyson Foods (TSN) and Vodafone (VOD). The earnings season is winding down, with Kohl’s (KSS) reporting next Tuesday (Nov. 21) and Duluth Holdings (DLTH) reporting on November 30.

Earlier this week, we moved shares of Kopin Corp (KOPN) from Suspended to Buy. With the release of Kopin’s third-quarter results, 10Q and related conference call, our reason for suspending the shares has been resolved. We are restoring the shares to Buy along with our original $5.00 price target.

As a reminder, with the long Thanksgiving weekend next week, we won’t be publishing a Friday note.

Comments on Earnings

Advance Auto Parts (AAP) – One of the four major auto parts retailers, Advance Auto continues to struggle as its years-ago acquisition spree overstretched its ability to operate efficiently. The board is finally taking aggressive action, including replacing its ineffective CEO with a more capable leader, refreshing the board, undertaking a comprehensive operational and strategic review and slashing its dividend to preserve cash. We anticipate hearing significant details by early 2024. Debt is elevated but at fixed rates with no major maturities until 2026. Free cash flow is positive. The shares trade at a depressed multiple of depressed earnings.

Advance reported a good news/bad news quarter. The good news is that revenues rose 3% and comparable store sales rose 1%, indicating that Advance’s customer relevance remains reasonably sturdy. Also, the company replaced its CFO with a senior finance executive from retailer Lowe’s and provided some favorable color on its turnaround plan, including an initial cost-cutting program (equal to 1% of revenues) and plans to divest its WorldPac and Canadian operations. The bad news is that what was to be a sizeable 3Q profit turned out to be a sizeable loss and guidance for the fourth quarter was slashed. Also, the company’s debt increased to cover the loss and an increase in working capital.

The company’s turnaround is in its very early stages and the shares could readily slide as year’s end approaches as investors bail on higher-risk names.

Despite the dismal current profit picture, we think the turnaround effort is starting to make some progress. The cost-cutting program is relatively modest but includes a $50 million pay boost to its employees, who apparently are underpaid. This should boost morale and retention. Divestitures represent major surgery for any company and the relatively quick decision to offload two segments indicates that Advance is taking the restructuring seriously and with the board’s apparent full support. The divestitures could raise upwards of $1.5 billion in cash, which would relieve Advance Auto’s balance sheet and liquidity problems.

Much of the profit wipe-out is due to non-recurring expenses (Advance doesn’t provide “adjusted” profits) and what we see as generally sloppy operational management. There is likely also some deck-clearing by the new CEO ahead of a new year.

Revenues rose 3% and were 2% above estimates. The $(0.82)/share loss compared to the year-ago profit of $1.92 and estimates for a profit of $1.44.

Macy’s (M) – Macy’s is aggressively overhauling its store base, cost structure and e-commerce strategy to adapt to the secular shift away from mall-based stores.

Macy’s reported decent profits even as revenues fell 7%, as tighter inventories (which helped reduce markdowns) and lower shipping costs boosted the gross margin. Full-year guidance was fractionally increased and implied a 3% increase in fourth-quarter estimates. The confidence in the fourth quarter is highly encouraging as the period generates more than half of Macy’s annual profits. Low investor expectations helped boost the shares in a weak stock market. The shares remain deeply undervalued but investors likely won’t give the company full credit until the economy enters and then begins to exit a recession. No change to our rating.

We view the 7% revenue decline, produced by a 7% decline in same-store sales, as reasonable. Many consumers are slowing their retail purchases as well as delaying their holiday-related shopping. The 31% decline in credit card revenues was sizeable and remains a key indicator that we worry about. Credit card revenues are nearly pure profit and comprise as much as half of EBITDA. Macy’s doesn’t carry any balance sheet risk from the cards, but the revenues are adjusted to offset consumer credit losses.

The gross margin expanded to 40.3% from 38.7%. Overhead expenses fell 2%, indicating that Macy’s is generally controlling its costs. The balance sheet is in good shape, with inventories down 6% from a year ago and 17% from 2019. Net debt is essentially unchanged from a year ago. Macy’s has no significant debt due until at least 2028.

Tony Spring will officially become CEO this coming February, but he likely is near-fully in charge at this point in the transition.

In the quarter, revenues fell 7% but were in line with estimates. Adjusted earnings of $0.21/share fell 46% but were sharply higher than estimates for earnings of $0.01.

Tyson Foods (TSN) – Tyson is a major food company specializing in beef products (37% of sales), chicken (32%), pork (12%) and Prepared Foods (18%). Its chicken operations are vertically integrated, while its beef and pork operations buy from independent farmers. The shares have slid sharply due to an unusual simultaneous downcycle in all three protein groups. The profit wipe-out, combined with a multi-year boost in capital spending, had led to elevated debt. While Tyson is admittedly an average company in a commodity industry, its share price assumes dim earnings prospects. We see an eventual upturn that offers considerable upside potential. The hardest time to invest in a cyclical company is at the bottom of the cycle, when it appears that there is little chance of a recovery.

Tyson reported a reasonable quarter that indicated what appears to be a bottoming of the three-way cycle but only limited visibility into an upturn among the protein segments. Prepared Foods continues to perform reasonably well, with flattish sales but a 6% profit margin that increased from 5.8% a year ago. Guidance for 2024 is for a roughly 25% increase in EBITDA to around $2.7 billion. This was below estimates but could produce free cash flow of $1 billion, depending on working capital and other outlays. Surprising for a company at the bottom of a cycle, Tyson raised its dividend (by 2%). The Tyson turnaround will likely take a while – certainly longer than analysts forecast.

The chicken segment is showing the best relative outlook, with profits in 2024 guided to a midpoint of $550 million, compared to a $(77) million loss in 2023, due to lower input costs and internal cost-cutting (including closing six plants). Beef segment profits were guided to a midpoint loss of $(200) million from a $200 million profit as input costs (cattle) are likely to remain elevated. The pork segment was guided to breakeven from a $(128) million loss but continues to struggle.

Prepared Foods is improving but the 6% margin seems too low compared to other prepared food companies where margins are more than twice this level.

Tyson’s free cash outflow in 2023 pushed its debt load up to nearly $9 billion, or over 4.1x somewhat-scrubbed EBITDA. If guidance is accurate, Tyson could produce a respectable $1 billion of free cash flow in fiscal 2024, more than enough to cover its $700 million in dividends and help chip away at its debt.

In the quarter, revenues fell 3% and were 3% below estimates that called for flat revenues. Adjusted earnings of $0.37/share fell 77% but were 48% above estimates. Adjusted EBITDA of $526 million fell 52% and was in line with estimates.

Vodafone (VOD) – Shares of this major European mobile telecom, broadband and cable TV service provider have produced dismal 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 the new CEO implement an aggressive cost-cutting and divestiture plan. A sharp dividend cut may be coming, which could help reduce 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 a reasonable first-half 2023 (like many European companies, Vodafone reports profits only on a semi-annual basis). Scrubbed revenues rose 2.3% and scrubbed profits, which adjusts for currency changes, divestitures and other items, rose 0.3%. Full-year guidance remains unchanged at “broadly flat” adjusted EBITDAaL and “around” €3.3 billion of adjusted free cash flow, assuming no major changes to the company’s structure or holdings. The company maintained its interim dividend which is producing a high dividend yield. Strategic changes are underway, but slowly, with other headwinds weighing on results. All in, however, we are encouraged that Vodafone’s previously near-hopeless future is becoming less negative.

Management described some incremental progress with its new “Customers, Simplicity and Growth” roadmap. Clearly, much more needs to be done, but at least Vodafone has a sensible plan and is moving in the right direction.

Strategic changes are underway with the pending purchase of Three in the U.K. (Vodafone is boosting its presence in its home markets), the pending sale of its Vodafone Spain business and a potential divestiture of its Italy operations.

Organic revenues ex-Turkey increased 2.3% and were 2% above estimates. Second-quarter-only organic revenues ex-Turkey increased 2.8%, which was the fastest pace in six quarters. Growth in Germany, at +1.1%, was positive for the first time in 2½ years. Growth in Africa remained strong at 9%. Price increases helped support revenue growth.

Like-for-like adjusted EBITDAaL increased by a tiny yet positive 0.3%. On a local basis, profits fell 8% in the four major European markets (Germany, Italy, U.K., Spain) and were lower in most other markets including Africa. Higher energy costs were a major contributor to the weaker profits. Adjustments for currency, divestitures and other items produced the difference between like-for-like and local profits.

Vodafone’s net debt is going the wrong direction (up 9% year to date) and is now €36.2 billion. This represents 2.7x adjusted EBITDA. Adjusted free cash flow was €(1.5) billion, as cash profits were more than offset by capital spending, lease liabilities and other cash drains. The company maintained its interim dividend, perhaps due to the strong free cash flow likely in the second half, as well as limited need to refinance its debt (which will help keep interest costs modest) over the next two years.

Friday, November 17, 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 14 minutes and covers:

• Summary of comments on earnings reports
• Other comments on recommended companies
  
  • Goodyear Tire & Rubber (GT) – Major changes as CEO to exit and several divisions to be sold.
  • General Electric (GE) – Divesting its remaining stake in AerCap.
• Elsewhere in the market
  
  • Is market shifting incrementally toward higher-risk stocks?
• Final note
  
  • Major controversy: Did Michigan cheat?

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

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.