April 1, 2022

This week’s Friday Update includes a summary of the recent Cabot Turnaround Letter, comments on earnings from Walgreens Boots Alliance (WBA) and Viatris (VTRA), and the podcast with updates on several recommended companies. It also includes the Catalyst Report, which is a powerful tool that anyone can use for finding attractive turnaround stocks.

This past week we published the April edition of the Cabot Turnaround Letter. In the issue, we describe how a new CEO at a struggling company can be a valuable catalyst for a turnaround. If a company is a collection of assets, with by far the most important asset being its people, the person directing how these assets are utilized is obviously critical to the direction of the company. Our article highlights three companies, including El Pollo Loco Holdings (LOCO), Munro (MNRO) and Smith+Nephew (SNN) as struggling companies with new CEOs whose stocks look interesting.

We also summarize our deep dive into the cannabis industry. We have been reluctant to consider these companies, partly due to their formerly high valuations and partly due to social/ethical/legal considerations. But, times are changing: legalization is spreading and societal acceptance is increasingly strong. For investors new to the industry, our analysis can be a useful introduction to the issues and opportunities. We highlight six companies whose shares look appealing for long-term investors.

Our feature recommendation is ZimVie (ZIMV), a small-cap medical products company recently spun off from Zimmer Biomet Holdings (ZBH). ZimVie’s shares have been summarily discarded by investors, but offer worthwhile potential due to their low valuation, strong dental implants business, pending turnaround in their spinal products segment and healthy earnings and cash flow.

The letter also includes our previously distributed changes: Baker Hughes (BKR) from Buy to Sell, and Marathon Oil (MRO) price target from 24 to 30.

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’ strategic plan seems unclear and unoriginal. Yet, the company has several appealing traits. Its shares are bargain priced, particularly when Amerisource’s value is delineated. Walgreens is in solid financial condition, produces large and stable profits and cash flow, and replaced its CEO who brings a much-needed fresh perspective.

On March 31, the company reported healthy fiscal second-quarter results that were ahead of estimates. The company maintained its full-year 2022 outlook, but investors are growing more concerned about the company’s ability to hit its growth targets, which is contributing to the share selloff. Once concern is that, once Covid-related store traffic fades, revenue and profit growth will fade as well.

Key indicators for Walgreen’s transition to a wellness-oriented company are encouraging, although this transition is a multi-year process. We have no blinders on about the difficulty of the transition and recognize the market’s worries. For now, the core business fundamentals, including margins and cash flow, continue to remain on the positive side of stable even as the shares are increasingly assuming a guide-down at some point in the next quarter or two. No change in our rating for WBA shares.

Another weight on the shares is the potential liability for opioid settlements. Competitor CVS recently agreed to pay $484 million to settle claims in Florida. Walgreens, CVS and other pharmacies may face similar pressure to settle in other states.

In the quarter, revenues rose 3.8% on a constant currency basis and were about 1% above the consensus estimate. Same-store retail sales (merchandise) were strong in both the U.S. and the U.K., but pharmacy sales were more tempered, largely due to a sizeable decline in the AllianceRx Walgreens unit.

Adjusted earnings of $1.59/share rose 27% from a year ago and were 14% above estimates. Helping drive earnings higher was a better gross margin (22.8%, up from 20.7%) and reasonable expense control, partly weighed down by investments in the emerging Walgreens Health segment, which produced a $(77) million loss in the quarter as it builds out its operations. Adjusted operating income rose 35%.

Viatris (VTRS) – Following our further review of this company’s shares after the disastrous earnings report and strategic reset, we are tentatively keeping our Buy rating on the shares.

The bear case is obvious: The acquisition of Pfizer’s Upjohn’s assets, along with the infusion of Pfizer executives, has mostly resulted in strategic confusion and a waste of capital rather than clarity and higher returns. The surprise sale of its biosimilars business, even if Viatris is getting a stake in a potentially valuable third company, was a complete reversal of its former stance that this was a core business and indicates weak leadership and a complete disregard for the company’s public shareholders.

Also, the bear case includes real doubts about the stability of Viatris’ revenue and earnings base. Revenues were projected by Pfizer and Mylan managements in their joint post-merger slide presentation to be about $19-20 billion in 2020, but now are guided by Viatris’ management to be only about $17 billion. As much of this decay is price-related, the bottom line is directly affected – this is seen in the decay of projected EBITDA from $7.5-$8.0 billion to the current guide for only $6 billion. This strongly suggests that revenues and profits are eroding, such that the company will make acquisitions (and elevate its R&D spending by a staggering 5.5 percentage points), funded by divestitures like the biosimilar sale (yielding ~$2 billion in cash and another $6 billion in assets sales) and new debt, to maintain Viatris’ revenue and profit stability. This could readily waste yet more shareholder capital, particularly as the management hasn’t shown much prowess in making sensible acquisitions or in demonstrating its ability to succeed with its new-found strategic direction that emphasizes three high-value therapeutic product groups. Management’s promises about paying down debt and returning more cash to shareholders would prove illusory as capital is redirected to acquisitions.

The bull case is murkier but supportable: Investors have assumed a very dour future for Viatris, including almost unanimous revulsion exhibited by the sell-side brokerage community, leaving expectations and valuation so low that even this management overseeing this asset base would be hard-pressed to disappoint. The company should generate around $2.5 billion in free cash flow this year and likely more in 2023 (based on our own dour assumptions) as a range of cash restructuring payments fades away. This excludes several billions in asset sale proceeds. And, given the appalling mismanagement and opportunity for a much more shareholder-friendly use of the company’s cash flow, there is a sizeable chance that an activist investor exerts pressure for a complete overhaul.

On balance, we are inclined to retain VTRS shares for now.

Friday, April 1, 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 8 minutes and covers:

• Earnings:
  
  • Walgreens Boots Alliance (WBA) – decent quarter but questions about growth
  • Viatris (VTRS) – retain Buy rating despite awful management

• Comments on other recommended companies:
  
  • Toshiba (TOSYY) – renewed buyout interest
  • Macy’s (M) – two additions to the board

Catalyst Report
March was a strong month with 78 catalysts, with 29 CEO changes (we highlighted three in our recent letter), 21 activist campaigns, numerous deals and numerous spin-off announcements, restructurings and other turnarounds. Several recommended names, including Berkshire Hathaway (BRK.B), Credit Suisse (CS), Toshiba (TOSYY) and Vistra Energy (VST) had catalyst events.

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.

You can access our Catalyst Report

.

The following catalyst-driven stocks look interesting:

Big Lots (BIG) $1.0 billion market cap – This company is a niche retailer focusing on discounted furniture, home, electronics and other merchandise, with 1,431 stores across 47 states. The company has had on/off success with its various turnarounds, yet the shares haven’t gone anywhere in over a decade and now trade at a low 3.2x EBITDA valuation. Credible activist investor Mill Road Capital now has a 5.1% stake and could press for aggressive changes. Debt-free Big Lots trades at 3.1x estimated EBITDA.

Canadian Tire (CDNAF) $9.7 billion market cap – Shares of this ubiquitous, 1,700-store Canadian company, which sells an unusual range of automotive, hardware, sports, leisure and housewares goods, are cheap at about 4.5x EBITDA. Yet, the company is starting to more aggressively improve its results as described in its recent investor day presentation.

Bombardier (BDRAF) $2.9 billion market cap – This Canadian company has had at least one close brush with bankruptcy, followed by impressive but short-lived turnarounds. Once again, the company is embarking on a turnaround effort. We hedge our wording, as this turnaround effort may be no more enduring than prior ones, but the shares are worth a look. The two-year-tenure CEO is making changes and the company may now be on a sustainable track even as investors have little interest.

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 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 limit we may not be able to cover every topic each week, but we will work to cover as much as possible or respond by email.Market cap is as-of the Initial Recommendation date. Current status indicates the rating and Price Target in ( ). Prices are closing prices as-of date indicated, except for those indicated by a "*", which are price as-of SELL recommendation date.