November 3, 2023

This week’s note includes our comments on earnings from Gannett (GCI), Kaman Corp (KAMN), Janus Henderson Group (JHG), Newell Brands (NWL), Six Flags Entertainment (SIX) and Western Digital (WDC). Several companies that had been expected to report this week will report next week, as the earnings deluge continues.

COMMENTS ON EARNINGS

Gannett (GCI) – Gannett, publisher of the USA Today and many local newspapers, is racing to replace its declining print circulation and ad revenues with digital revenues. It also is aggressively cutting costs to maintain its profits and help cut its expensive and elevated debt. The biggest challenge for Gannett is to overcome investors’ perception that the company is not viable.

Gannett’s results were mildly encouraging as revenues remained stable while profits and cash flow improved. However, full-year guidance was cut across the board. Notably, free cash flow guidance was cut by 25%, implying that 4Q free cash flow will now be about half what management previously expected. In last year’s fourth quarter, Gannett had an outflow of about $(2) million, so the guided $31 million of fourth-quarter 2023 free cash flow is still a large improvement. And, the full-year guides for all profit metrics were for better results than 2022. Nevertheless, investors indiscriminately sold off the shares.

One additional problem with the guidance is that management had raised full-year guidance after the second quarter. So, the reversal to even lower levels was embarrassing and suggests that management isn’t able to provide accurate or conservative guidance.

Highly favorably, Gannett continues to chip away at its debt burden – a key component of our thesis – as it cut debt by $65 million (about 6%) yet still has $109 million in cash.

Overall, the transition to a digital company continues to make progress. The guide-down was attributed to cyclical pressures in advertising from small/medium-sized businesses as their customers are experiencing softer demand.

In the quarter, revenues fell 9% and were 1% below estimates. Same-store revenues fell 8%. Adjusted net loss of $(0.15)/share was better than the $(0.35) loss a year ago but fell short of the $(0.03) estimate. Adjusted EBITDA of $60 million rose 15% but was 16% below estimates.

While revenues fell 9%, core expenses fell 10% so profits increased and the EBITDA margin expanded. Interest costs remain unchanged as Gannett’s interest rates are generally fixed.

Kaman Corporation (KAMN) – Based in Connecticut, Kaman is a high-quality defense and aerospace company. A reconfigured board along with a new CEO and several other new senior executives are prioritizing Kaman’s high-value precision engineering operations and are emphasizing higher margins and shareholder returns while exiting/de-emphasizing the company’s lower-value businesses.

Kaman reported a good quarter, with sales and profits increasing from a year ago. The company incrementally raised (by about 4%) its full-year revenue and profit guidance. Kaman’s free cash flow guidance was unchanged but healthy at around $40 million.

Kaman’s turnaround is coming together. End markets are strong and appear poised to remain so, and the company’s efficiency efforts are working with more improvements ahead. One less-appreciated effect is that the company’s corporate costs of $9 million/quarter remain unchanged, so as the business line profits increase the overall company profit margin will also increase. Interest expense has more than doubled from the boost in debt to finance the Aircraft Wheel & Brake (AWB) acquisition. Kaman is well aware of this drain and is working down its debt balances, which will cut its interest expenses.

The core Engineered Products segment is the future of Kaman as it has the most promising and most likely prospects for growth and profit improvement. Sales in this segment grew 34%. More important, sales excluding the contribution from the AWB acquisition rose 21%. Adjusted EBITDA rose 77%, and we estimate that this doubled excluding the AWB contribution.

The other segments are struggling but this has been well-signaled. While unlikely, if the world continues to move toward a war footing, these segments could be notable beneficiaries.

In the quarter, revenues rose 6% and were 1% above estimates. Adjusted earnings of $0.10/share fell 66% from a year ago but were 25% above estimates. Adjusted EBITDA of $25.2 million increased 29% and was 1% above estimates.

Janus Henderson Group (JHG) – Janus is a global investment management company focused on publicly traded equities and bonds. The 2017 merger of Denver-based Janus Capital Group and London-based Henderson Group was unsuccessful on most counts. Activist Trian Partners, the firm’s largest shareholder with a 19% stake, is pressing a major overhaul by replacing the CEO and taking two board seats. Janus is highly profitable, has a fortress balance sheet and pays a generous dividend.

Janus reported a good quarter, as 3% higher revenues combined with cost-cutting to produce a 5% increase in per-share earnings. While the operating margin slipped from a year ago, it increased compared to the second quarter, indicating that the company is able to restrain expenses (expenses fell) and become more profitable as assets increase. Fund outflows (as clients pull money from Janus’ investment products) were $2.6 billion, but this was respectable given the company’s mature product categories and so-so fund performance.

For our thesis to work, Janus needs to maintain steady profits and cash flow, then return this cash flow to investors. So far, it is doing this. Key to profit and cash flow stability is better investment performance, as this helps Janus retain client assets in a world where its traditional mutual funds have less appeal compared to index funds and alternatives like private equity, venture capital and private credit. Third-quarter investment performance moved in the right direction but only incrementally.

The “Fuel for Growth” cost-cutting program was completed a year early and produced higher-than-planned $50 million in savings. Janus approved another $150 million share buyback program, equal to 4% of its market cap. The company is delisting its shares from the Australian stock market – a move that makes sense by simplifying its share structure and removing a relic of history that was incrementally weighing on its cost structure and share valuation.

The balance sheet remains fortress-like with $826 million in cash above its debt balance.

In the quarter, revenues rose 3% and were 1% above estimates. Adjusted earnings of $0.64/share rose 5% from a year ago and were 21% above estimates that called for a 13% decline.

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, although this complete overhaul could take a while. The shares are significantly undervalued relative to their post-turnaround potential.

Newell reported a weak quarter, as sales fell 9% and normalized operating profits slid 29%. Full-year guidance was cut: sales were guided to 3% lower than before, resulting in a likely 13% decline in full-year sales. Per share earnings guidance was cut by 12%, resulting in a likely 53% slide in full-year profits.

On the surface, the numbers were awful. But, underneath are important changes that suggest that Newell is on its way – ugly at first then better later – toward finally fixing its immensely inefficient operations.

We see the sales guide-down as inevitable: Newell’s products are being sold at discounts (partly due to clearing out excess inventory) as demand ticks lower and as retailers cut their own inventories and as several brands lose market share. The profit guide is lower as the company can’t cut its costs as fast as sales are falling.

But, cash flow improved as the company offloaded excess inventory and reversed other cash drains. These favorable trends will continue. Operating cash flow guidance was raised by 6% to a respectable $850 million, compared to an outflow of $272 million last year. Better free cash flow is reducing Newell’s hefty debt burden, with net debt down about 8% so far this year.

Newell’s turnaround appears to be in much more capable hands. We can see this in the write-offs that imply that the new management cares little about historical value but rather is focused on things as they are. The move to slash excess inventories and cut the product count simplifies its operations and frees up cash to reduce the unwieldy debt burden. Headcount is being cut, starting with a 13% reduction in office jobs. Nearly half of the brand managers are being replaced and new managers have more crisp accountability, showing that management is striking at the heart of bloat. Ineffective mid-level leadership is being replaced. Newell’s inefficient distribution system is being scrubbed through warehouse closures, technology updates and other efficiency improvements. The entire company is focusing on rebuilding its best brands and improving its performance with its best customers.

One helpful sign is that the gross margin improved to 31.3% from 29.6%. Usually, when inventory is being offloaded, the related discounts drag gross margins lower. One helpful factor is that Newell walked away from zero-margin business.

In the quarter, revenues fell 9% and were 3% below estimates. Adjusted earnings of $0.39/share fell 22% but were 70% better than estimates which called for earnings to be nearly cut in half.

Newell is a complete mess and 2024 results are likely to be sloppy, especially if the economy slides into a recession. But, the company is starting to move in the right direction for the right reasons. This has the potential to be an immensely successful turnaround.

Six Flags Entertainment (SIX) – This company is one of the world’s largest theme park operators. Since mid-2018, the shares have collapsed due to stalled growth, over-expansion and the pandemic. This has led to a complete changeover in the board of directors and senior leadership. Six Flags is implementing a new strategy focused on raising prices while significantly improving the guest experience to attract more families. Investors worry that this strategy will not be successful. We see an asymmetric payoff: the shares assume a dour future, but a reasonable turnaround could produce sharp gains. Six Flags generates considerable free cash flow that will help reduce the company’s elevated debt. A long-time 20% shareholder provides valuable shareholder-oriented oversight to keep management properly focused.

Six Flags reported a reasonable quarter in terms of revenues (+8%) but earnings were down (-3%). Revenues were boosted by 16% higher attendance despite weather-related headwinds, but weaker (-8%) spending on tickets and in-park items partly offset this. More significantly, Six Flags announced that it is merging with Cedar Fair Entertainment (FUN) in what appears to be a merger of equals.

All-in, we are rethinking our Six Flags thesis as we want to better understand the new entity. However, our initial view is that the increased scale and market power could make NewCo a much more valuable business.

Quarterly results
Management continues to experiment with its ticket and in-park pricing. As a highly seasonal business, it has only a limited number of experiments per season, which can lead to unexpected strength or weakness in results depending on how the experiments turn out. Six Flags tweaked its pricing and promotions on season passes, parking, trinkets, food and other items, which helped lead to better attendance but weaker admissions (ticket) revenues (-12%) in the quarter.

The various experiments also affect expenses. Higher advertising weighed on costs in the quarter. Also, Six Flags continues to invest heavily in upgrading its park environment, staffing and back-office technology – this spending will weigh on results for a few more years.

In the quarter, revenues rose 8% and were 1% above estimates. Adjusted earnings of $1.32/share fell 3% and were 10% below estimates. Adjusted EBITDA of $220 million fell 2% and was 9% below estimates.

Merger
The deal makes strategic sense, as it combines the two major regional theme park companies (that primarily attract local visitors as opposed to Disney and others that attract more distant visitors) into a single company. A combination better leverages new technologies, data analytics and practices and also removes a competitive element. Our view is that this increase in market power is the real reason behind the deal.

We view the incremental overhead synergies of $120 million (about 4% of combined sales) penciled-in for the next two years as a necessary nod to cost-conscious investors, but these synergies are small and unlikely to be visible in the post-deal financial results. We dismiss the $80 million in revenue synergies as pure speculation but could become very real if the combined company’s market power increases. The deal should reduce combined debt leverage over time but not immediately. As an all-stock deal (almost), leverage won’t increase as a result of the combination.

Less clear is the governance. Six Flags CEO Selim Bassoul will be the board chair, but Cedar Fair’s CEO will retain the CEO seat. The company will be called Six Flags but will trade under Cedar Fair’s “FUN” ticker. Six Flags shareholders exchange their shares at a .58x exchange ratio and get a $1/share cash payout, while Cedar Fair unitholders exchange at a 1.0x ratio, implying that Cedar is buying Six Flags. The new HQ will be in Charlotte, North Carolina, which is home to neither Six Flags (based in Texas) nor Cedar (based in Ohio).

We await more color on the deal.

Western Digital (WDC) – Western’s relatively new and highly capable CEO, David Goeckeler, who previously ran Cisco’s Networking & Security segment, is making aggressive changes to improve the company’s competitiveness in disk drives and other storage devices, as well as bolster its financial strength. Following our initial recommendation, the shares approached our price target, then slid sharply due to a deep industry downturn. The company has plenty of financial strength to endure until the next upturn, offering considerable share price upside.

Western reported two pieces of good news. First, it reported a respectable fiscal first quarter that suggests the downcycle has bottomed or is close to bottoming. Second, the company announced a long-awaited separation of its NAND memory chip business from its hard disk drive business.

In the quarter, revenues fell 26% from a year ago but were up 3% from the prior quarter. Revenues came in 3% above estimates. The adjusted loss of $(1.76)/share compared to a profit of $0.20 a year ago and a loss of $(1.98) in the prior quarter. The loss was better than estimates that called for a $(1.90) loss. Fourth-quarter guidance is for a loss of $(1.35) to $(1.05), which is better than current estimates.

Underlying demand for flash remains strong, up 49% in terms of number of bits, but deep price discounting due to the downcycle pressured revenues and profits. Management and the data support the view that the cycle is improving.

Net debt increased by about 10% from the prior quarter to $5.6 billion due to $544 million of negative free cash flow generated by losses and by higher working capital. The company has $2 billion in cash to meet its obligations until the cycle turns upward. Management said that free cash flow will turn positive in the fiscal third quarter.

The separation makes a lot of sense as these two businesses never belonged together. The huge $19 billion deal for SanDisk in 2015 was marginally sensible at the time as the hard drive business seemed to be fading while the flash business was rising on the emergence of the smartphone. But, this deal looks awful today as hard drive demand surges from cloud growth while the NAND business remains mired in capital-intensive cyclicality. For perspective, Western Digital today has a market value of $14 billion, nearly 25% below the SanDisk-only price.

The split will occur in the second half of 2024. Part of the logic of the deal timing is that the recovery for the two segments should be further along later next year.

Friday, November 3, 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 comments on earnings reports
• Other comments on recommended companies
  
  • Kohl’s (KSS), Macy’s (M) and Duluth Holdings (DLTH): Amazon is abandoning physical retail stores.
• Elsewhere in the market
  
  • Higher interest rates and incremental risk aversion have hammered turnaround stocks but a rebound may be underway.

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.