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Turnaround Letter
Out-of-Favor Stocks with Real Value

October 14, 2022

For our recommended stocks, earnings season started this week with reports from Walgreens Boots Alliance (WBA) and Wells Fargo (WFC). Next week, Nokia (NOK) reports, and the deluge for our companies starts the following week on October 24 with fourteen companies reporting.

For our recommended stocks, earnings season started this week with reports from Walgreens Boots Alliance (WBA) and Wells Fargo (WFC). Next week, Nokia (NOK) reports, and the deluge for our companies starts the following week on October 24 with fourteen companies reporting.

Earnings Reports

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’s shares are bargain-priced even as Walgreens is in solid financial condition and produces large and stable profits and cash flow.

Walgreens reported an encouraging fiscal fourth quarter and fiscal 2023 outlook. Adjusted net income of $0.80/share fell 32% from a year ago but was about 4% above estimates. Sales fell 5.3% but were only down 3.2% in local currency and were about 1% above estimates. Much of the declines in sales and profits were due to strong vaccine-driven results a year ago.

The company guided fiscal 2023 adjusted per-share profits to $4.45-$4.65, down about 10% from this past year. Most of the decline was attributed to a difficult comparison to vaccine-driven 2022 results and headwinds from the strong dollar, with the company saying that its 8-10% core earnings per share growth rate remains intact. We’re skeptical of the company’s ability to meet this guidance given the sluggish economies in the U.S. and the U.K. as well as the challenges of meeting its new healthcare initiatives’ earnings targets – but no one else likely believes the guidance either, which provides the company with some leeway.

The company said that its emerging U.S. Healthcare group, which houses all of its new initiatives including VillageMD, Shields and CareCentrix, should produce positive EBITDA by the end of fiscal year 2024, which is two years away. If it happens, it would be a strong positive for the stock, given the $(230) million loss expected for the coming year.

Strategically, Walgreens is re-focusing on reducing its debt and could be selling some non-core assets in the coming year to accomplish this.

On a highly scrubbed basis, adjusted operating earnings were a reasonable $744 million, although this fell 40% from a year ago and 47% from the fiscal 2019 fourth-quarter results (entirely pre-pandemic). The most recent quarter fell short of the pre-pandemic quarter due to $800 million in lower gross profits (mostly due to lower margins) and $70 million in higher overhead costs. This comparison captures the entire effect of all of the changes in Walgreens’ business mix and strategy, including the sizeable $(151) million loss in the U.S. Healthcare segment, and highlights the elevated cost pressures involved.

On a full-year basis, results were generally flat compared to a year ago, indicating some of the volatility in quarterly results due to pandemic comparisons both in the U.S. and the U.K.

The “transformation” appears to be making progress, but there is so much underway that the endgame financial picture remains murky despite the company’s commentary and slide deck illustration. Revenue-based and activity-based metrics for its newly renamed U.S. Healthcare group (its new healthcare services initiatives) are generally ahead of the company’s goals even if profits remain elusive for now.

Walgreens’ balance sheet remains solid, its cash flow was weak this year but was guided for a sizeable improvement, and the management reiterated their commitment to maintaining the dividend which is well-covered by free cash flow

Wells Fargo & Co. (WFC) – Wells Fargo is one of the nation’s largest banks. Under its previously weak leadership, the company never fully recovered from the 2009 financial crisis and its loose compliance culture led to a fake accounts scandal and other reputation-tarnishing problems. Also, like all banks, it is struggling with low interest rates and limited loan growth, although the much-feared pandemic-related loan losses no longer look likely. An additional constraint is a regulator-imposed cap on Wells Fargo’s asset size. Under new CEO Charles Scharf, the bank is aggressively restructuring its operations, cost structure and regulatory compliance.

Wells reported a reasonably good quarter and continues to make progress with its compliance and risk-management turnaround. The shares trade at 1.3x tangible book value of $34.27, yield about 2.7% and remain attractively valued.

Adjusted earnings of $1.30/share were up 11% from a year ago and about 19% above the consensus estimate. Revenues rose 4% and were about 4% above the consensus estimate which projected flat growth. Wells took charges of $0.45/share to cover losses from litigation and a variety of regulatory matters. Our view is that these charges indicate that the bank is addressing its compliance and operational issues.

Higher interest rates helped the bank earn more on its loans and other assets, while its borrowing costs remained relatively low. The resulting net interest spread of 2.55% was sharply higher than the 1.93% from a year ago. Helping profits was the 11% increase in loans which both have higher yields and more fee income than the bank’s bond holdings.

Fee income fell 25%, mostly due to lower deposit-related fees, lower wealth management fees and weaker results in the bank’s venture capital and other investments. Expenses were contained but are still elevated. Credit quality remains impressively sound, with non-performing assets of only 0.60% of total loans and loan charge-offs of only 0.17% of assets. The bank set aside about twice its charge-offs in new reserves and will likely set aside even more in future quarters – a prudent move in our view. Overall loss reserves appear more than adequate for anything but a deep and prolonged recession.

The bank’s assets slipped 4%, with deposits falling 3% as customers pursued higher rates elsewhere. This is fine – Wells can afford to lose deposits as it remains constrained by its regulatory asset cap – as this decline helps shift its asset mix to higher-yielding assets. A lower-asset balance also helps bolster the bank’s capital ratios. The CET1 capital ratio nevertheless declined to 10.3% from 11.6% a year ago, but we see this level as readily acceptable even if in the current environment Wells and other banks won’t likely repurchase shares, preferring rather to conserve their capital going into the recession.

Friday, October 14, 2022, 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:

  • Earnings updates:
    • Walgreens Boots Alliance (WBA) – better than estimates but a lot of work ahead.
    • Wells Fargo & Company (WFC) – reasonably good quarter that was higher than estimates.
  • Comments on other recommended companies:
    • Viatris (VTRS) – rumored to be considering a sale of their European consumer assets.
    • Toshiba (TOSYY) – granted preferred bidder status to a Japanese private equity firm. A lot of negotiating/fighting still ahead.
    • Dow (DOW) – declares its regular $0.70/share quarterly dividend.
    • M/I Homes (MHO) – shares weak on near-7% mortgage interest rates.
  • Elsewhere in the markets:
    • Private equity valuations are almost certain to tumble.
    • Kroger and Albertson’s merger – a win even if huge divestitures required?
  • Final note:
    • A trip to the Apple store.

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

Market CapRecommendationSymbolRec.
Price at
Rating and Price Target
Small capGannett CompanyGCIAug 20179.22 1.37Buy (9)
Small capDuluth HoldingsDLTHFeb 20208.68 7.42Buy (20)
Small capDril-QuipDRQMay 202128.28 21.37Buy (44)
Small capZimVieZIMVApr 202223.00 7.68Buy (32)
Mid capMattelMATMay 201528.43 20.11Buy (38)
Mid capConduentCNDTFeb 201714.96 3.51Buy (9)
Mid capAdient plcADNTOct 201839.77 30.41Buy (55)
Mid capXerox HoldingsXRXDec 202021.91 15.026.7%Buy (33)
Mid capIronwood PharmaceuticalsIRWDJan 202112.02 10.31Buy (19)
Mid capViatrisVTRSFeb 202117.43 9.655.0%Buy (26)
Mid capOrganon & Co.OGNJul 202130.19 24.034.7%Buy (46)
Mid capTreeHouse FoodsTHSOct 202139.43 47.00Buy (60)
Mid capKaman CorporationKAMNNov 202137.41 29.232.7%Buy (57)
Mid capThe Western Union Co.WUDec 202116.40 14.046.7%Buy (25)
Mid capBrookfield ReBAMRJan 202261.32 39.161.4%Buy (93)
Mid capPolarisPIIFeb 2022105.78 98.84Buy (160)
Mid capGoodyear Tire & RubberGTMar 202216.01 11.27Buy (24.50)
Mid capM/I HomesMHOMay 202244.28 40.13Buy (67)
Mid capJanus Henderson GroupJHGJun 202227.17 21.267.3%Buy (67)
Mid capESAB CorpESABJul 202245.64 33.37Buy (68)
Large capGeneral ElectricGEJul 2007304.96 67.940.5%Buy (160)
Large capShell plcSHELJan 201569.95 52.193.8%Buy (60)
Large capNokia CorporationNOKMar 20158.02 4.522.0%Buy (12)
Large capMacy’sMJul 201633.61 18.003.5%Buy (20)
Large capToshiba CorporationTOSYYNov 201714.49 19.113.3%Buy (28)
Large capHolcim Ltd.HCMLYApr 201810.92 8.305.3%Buy (16)
Large capNewell BrandsNWLJun 201824.78 14.646.3%Buy (39)
Large capVodafone Group plcVODDec 201821.24 11.458.9%Buy (32)
Large capKraft HeinzKHCJun 201928.68 35.784.5%Buy (45)
Large capMolson CoorsTAPJul 201954.96 49.453.1%Buy (69)
Large capBerkshire HathawayBRK.BApr 2020183.18 275.78HOLD
Large capWells Fargo & CompanyWFCJun 202027.22 42.382.8%Buy (64)
Large capWestern Digital CorporationWDCOct 202038.47 35.10Buy (78)
Large capElanco Animal HealthELANApr 202127.85 11.84Buy (44)
Large capWalgreens Boots AllianceWBAAug 202146.53 33.655.7%Buy (70)
Large capVolkswagen AGVWAGYAug 202219.76 16.034.7%Buy (70)
Large capWarner Bros DiscoveryWBDSep 202213.13 12.50Buy (20)
Large capDowDOWOct 202243.90 45.926.1%Buy (60)