Due to unexpected circumstances, the Cabot Turnaround Letter monthly edition for May will be published on a one-week delay. Also, today’s note will not include the podcast. We apologize for the inconvenience.
The circumstances: I am currently stuck in London on an unplanned extended visit due to my exceptionally mild case of Covid. While my symptoms have long faded, the Centers for Disease Control and Prevention remains undaunted in their fruitless efforts to prevent Covid from entering the United States, and thus I am prohibited from returning to my home country. Let’s just say that my opinions regarding the CDC’s policies are just a bit more energetic than I might convey here. Fortunately, London is an amazing city, and it’s been a fun adventure with one of my sons here. We’ve had a chance to live almost like ex-pats – experiencing the city and surrounding towns in a more relaxed manner.
Altria Group (MO) – Altria is the largest seller of cigarettes in the U.S., with a 48% market share. Its Marlboro brand by itself has a 43% market share. Non-U.S. operations were separated years ago into Philip Morris International. The company has struggled with declining cigarette volumes, slow development of non-combustible products and its disastrous $12.8 billion JUUL investment. Other issues: possible new regulations on menthol cigarettes and nicotine content, an IQUS import ban, and the market’s focus on ESG-favored companies. However, Altria’s resilience and value is underestimated by investors. Led by a new CEO, the company continues to generate stable/rising earnings and cash flow, even as it develops new non-combustible products. Altria returns about 80% of its free cash flow to investors, including a generous dividend.
Altria reported first-quarter earnings of $1.12/share, up 5% from a year ago and about 3% above the consensus estimate. Revenues fell 1% and were about 1% short of estimates. Altria reaffirmed its full-year earnings per share guidance but said that most of the growth will be weighted toward the second half of the year (when companies offer this back-ended guidance, it is often based more on hope than evidence, unfortunately). The company stated that this guidance includes the drag from inflation and no access to the IQOS product. Separately, press reports say that the FDA is preparing a proposal to ban menthol cigarettes, which could take effect starting in 2024 – this would be a small incremental negative for Altria and might not take effect until 2026. Overall, a reasonable quarter that also highlights issues to be watched. No changes to our price target or rating.
Revenues excluding the effect of the exit from the wine business were essentially flat. In the Smokable Products segment (by far the company’s largest segment), revenues grew 2% and segment profits rose 6%. Revenue and profit growth was driven by pricing, as shipments fell a hefty 8%, although its operating costs actually fell 3% in the quarter. A major concern for our Altria investment is that volumes could return to the pre-pandemic 6-8% decline rate, and we seem to be there now. Adding further pressure, the market share for discount cigarettes is ticking up as consumers are becoming sensitive to rising gasoline and other costs. Altria has minimal discount segment products, so it is losing incremental share. Also, general inflation is raising its operating costs. We view these as overhangs on the shares that are unlikely to relent. Altria seems to be raising its prices enough to offset these drags on its profits, but it would continue to lose market share under this strategy.
Oral Tobacco revenues slipped 2% and segment profits fell 5%. Volumes were unchanged, and Altria’s products lost about 1% of market share.
The company repurchased $576 million in shares in the quarter, and in total is about a third of the way through the $3.5 billion program that it expects to complete by year end.
Despite this and the $1.6 billion in quarterly dividends, the company reduced its net debt by nearly $1 billion in the quarter – reflecting Altria’s immense free cash flow and a significant feature of our favorable thesis for the company’s shares.
Credit Suisse (CS) – This Swiss bank never recovered from the Global Financial Crisis, so it is shifting its strategy to more stable Switzerland banking and global investment management and away from weak/volatile trading and investment banking. The bank is struggling with chronic bad decision-making and a loose risk-control culture that could threaten its existence if not aggressively addressed. (1 Swiss franc CHF = $US 1.04).
The bank reported an adjusted pre-tax profit of CHF300 million, down 92% from a year ago. Revenues fell 38% from a year ago. On an unadjusted basis, the bank reported a loss of CHF(273) million, or CHF(0.10)/share. Credit Suisse seems to be stuck in the murky early-turnaround period of heavy write-offs, elevated expenses, sloppy core results and doubts about management’s ability to execute. With equity investors having little patience for murkiness or weak results, CS shares have been driven sharply lower. This quarter’s results provide no clarity, so we anticipate no improvement in the near-term share performance.
Credit Suisse continues to be plagued by a long list of problems. The most recent include a CHF(206) million write-off related to its Russia operations and a sizeable reduction in capital markets (raising capital for clients) and wealth management revenues due to weak markets. Fortunately, its core Swiss Bank operations are relatively resilient and the overall bank’s capital level is sturdy. Credit Suisse continues to trim its balance sheet (an important way to reduce risk and an indicator that management is pulling out of marginal activities), with assets down 15% from a year ago. Fortunately, its capital ratio remains robust at 13.8%.
We are holding onto the shares yet want to see an aggressive overhaul of the senior leadership including the installation of a hands-on, highly capable and assertive outsider brought in as CEO. The shares remain remarkably inexpensive relative to tangible book value, which partly discounts additional yet unknown losses and as-yet-unproven underlying earning power. But, the most significant weight on the valuation is management – neither we nor probably any diligent investor has much if any confidence in the current senior executive team. And, without changes at the top, the company will remain in disarray. We will wait, as shareholder frustration and pressure are mounting for change.
Dril-Quip (DRQ) – A major supplier of subsea equipment, Dril-Quip is struggling with the downturn in offshore oil and natural gas drilling. It generates positive free cash flow and has a sizeable cash balance yet no debt, all of which should allow it to endure until industry conditions improve.
The company reported a loss of $(0.26)/share, improved from a loss of $(0.97) a year ago. Revenues rose about 2% from a year ago. Adjusted EBITDA slipped 61% from a year ago but remained positive. As the company reported this morning, we will review the results in more detail, but for now we would rate the quarter as mildly disappointing.
General Electric (GE) – Led by impressive new CEO Lawrence Culp, GE finally appears to be righting its previously severely damaged business. Key priorities include a primary focus on the Industrial businesses (and an exit from the financial businesses), much better execution and a strategic emphasis on cash flow and debt reduction. To help achieve its goals, GE is decentralizing its operations and pushing more responsibility and accountability down to each business line.
GE reported highly polished adjusted earnings of $0.24/share, nearly double the year-ago earnings of $0.13 and about 26% above the consensus estimate. However, we are losing a bit of patience with GE’s excessive and complicated adjustments, which in this quarter converted a loss of $(0.74)/share into a $0.24/share profit. We appreciate the complexities of the turnaround and the benefits from removing a myriad of costs to gain visibility into GE’s core profitability, but these costs add up quickly and recur quarter after quarter. CEO Larry Culp risks losing credibility if the company’s reporting standards aren’t improved.
Another issue with the quarter was that management essentially reduced their guidance by saying that the company is trending toward the “low end” of its annual earnings guidance range. This triggered investor fears that the company’s turnaround will be yet-again delayed, this time by the inflation, war in Europe, supply chain problems and other issues. Nevertheless, the company is moving forward with its 3-way break-up and other strategic changes.
In the quarter, organic revenues rose 1% and were in line with estimates. The Aviation segment is showing considerable revenue and profit improvements, the Healthcare and Power segments are showing mixed results while the Renewable Energy segment looks weaker. Free cash flow improved from a year ago.
All-in, a mixed quarter and an updated/subdued outlook that cast doubts on the pace of the turnaround, leading the shares to fall 10% in a weak overall stock market. We remain patient, acknowledging that the turnaround’s completion is probably well more than a year away, even if most investors assume that if the turnaround isn’t happening this year then there is no point in owning GE shares.
Kraft Heinz Company (KHC) – Following a disastrous cost-cutting strategy that left the company with diminishing relevance to consumers, Kraft Heinz is rebuilding its brands and products, led by new CEO Miguel Patricio (July 2019). The pandemic is providing a much-needed tailwind, particularly as Kraft Heinz is carrying a sizeable debt burden.
Kraft reported adjusted earnings of $0.60/share, down 17% from a year ago but about 13% above the consensus estimate. Revenues fell 6%, but excluding divestitures rose 7% and was 4% above estimates, supported by strong price increases. The company raised its revenue guidance but left its EBITDA guidance unchanged as inflation in the mid-teens range means profit margins will slip incrementally even as the company protects the dollar amount of profits. Overall, a reasonable and perhaps encouraging result and we have no changes to our price target or ratings.
The company is exercising its pricing power, raising its average price by a generous 9%, which easily offset a 2% volume decline. Costs rose, which led to a decline in the gross margin compared to a year ago but produced an increase compared to two years ago. Kraft’s price increases are beginning to offset its higher costs and should catch up by year end or so. The company’s product and other innovations are also having a positive effect, although the extent is unclear.
Kraft’s balance sheet continues to improve, with debt net of cash at 3.3x EBITDA, down from 3.6x a year ago and 4.5x two years ago. We would consider 3.3x a healthy steady state level.
Mattel (MAT) – At our initial recommendation in 2015, Mattel was struggling with its failure to adjust to the realities of how young children spent their playtime. This failure had produced years of revenue decay. In addition, its cost structure became bloated, and its debt levels increased. However, led by its new CEO, Mattel now appears to be finding its way.
Mattel reported adjusted earnings of $0.08/share compared to a loss of $(0.10) a year ago and sharply higher than the $(0.04) consensus estimate. Net sales rose 22% net of currency changes and was 13% above the consensus estimate. The company maintained its full-year 2022 guidance and 2023 goals. All-in, another strong quarter for Mattel as its turnaround is making impressive progress. Separately, news reports say the company is exploring a possible sale with private equity investors. Combined, these led to a 12% jump in Mattel shares. We have no change to our price target or rating, and of course would welcome a bid around our 38 price target.
Revenues were helped by strong demand as well as a high-functioning supply chain that seems to be supplying Mattel’s customers with all the merchandise they are ordering. Retailers are restocking their inventories and preparing for new product launches that tie into upcoming theatrical releases. Product strength was across nearly all products except American Girl, and across nearly all geographies. Higher costs pulled down the gross margin, but this was more than offset by tame overhead costs, leading to higher operating profit and EBITDA margins.
Cash flow was weaker as Mattel is building inventories, but Mattel now has a healthy balance sheet (net debt/EBITDA of 2.4x) and can afford this type of temporary drag on its finances. We don’t want to see any deterioration, however, in future quarters.
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, yet the shares remain significantly undervalued relative to their post-turnaround potential.
Newell reported normalized earnings of $0.36/share, up 20% from a year ago and about 33% above the consensus estimate. Core sales grew 7% - an encouraging sign that the company’s product strategy is producing growth even as it trims out extraneous products. Newell reiterated its full-year revenue and earnings guidance. As the company reported its results this morning, we will be taking more time next week to digest the results. However, our initial review points to this being a decent quarter.
Nokia (NOK) – Initially recommended in 2015, Nokia has struggled for years to regain its competitiveness. It appears that the new CEO, Pekka Lundmark (March 2020), is capable of finally getting the company back into the game, particularly with the critical change-over to 5G over the next few years.
Nokia reported comparable earnings of €0.07/share, unchanged from a year ago and in line with the consensus estimate. Revenues rose 1% ex-currency and were fractionally higher than estimates. The company reiterated its full-year 2022 sales, profit margin and free cash flow outlook. For Nokia, flat profits with positive revenue growth is still encouraging as it indicates continued fundamental strength and as cash continues to pile up on the balance sheet.
Revenues rose a strong 9% ex-currency in the Network Infrastructure segment and 5% in the Cloud segment, indicating better opportunities for its most promising businesses. Mobile Networks revenues slipped 4% ex-currency due to supply constraints. The Technologies segment, which houses various patents that Nokia licenses to third parties, saw a 17% revenue decline as some patents are in renewal negotiations – with a 72% profit margin, this tiny segment actually generates more profits than any other segment. The company said it expects revenues to recover in future quarters.
Despite weak Technologies profits and sluggish sales growth, full-company comparable profits (adjusted for acquisitions and divestitures) grew 6%, helped by higher profits in the Mobile, Network and Cloud segments.
Nokia is exiting Russia although it is doing so in a way that maintains its customers’ networks (it is not clear what exactly this means) and is providing support for its many employees in Ukraine.
The cash balance was €9.5 billion, or €4.9 billion net of debt, boosted by over €300 million in free cash flow in the quarter. Nokia continues its share buyback program and is paying a EUR 0.02 per share dividend.
Polaris (PII) – Shares of this high-quality and market-leading manufacturer of powersports equipment like off-road vehicles, snowmobiles, motorcycles and boats, have fallen out of favor with investors. Major concerns include the risk of a post-stimulus falloff in demand as well as supply chain disruptions that are weighing on margins by 3-4 percentage points. We believe the company’s long-term prospects remain intact. Polaris produces strong profits and free cash flow, has a solid balance sheet, and a strong, shareholder-friendly management team.
The company reported adjusted earnings of $1.29/share, down 44% from a year ago and about 27% below the consensus estimate. Revenues were unchanged but were about 7% below the consensus estimate. Guidance for full-year 2022 results was maintained, but the disappointing results and a weak stock market dragged the shares down about 8% in trading on the day. However, we rate this as a reasonable quarter as the company progresses with its turnaround.
Revenues were reasonably stable as customer demand remains sturdy and the company was able to implement price increases. Dealer inventories continue to run at historic lows. However, higher costs and delays in its supply chain boosts its production costs, weighing on profits. Overhead costs were unchanged from a year ago. Polaris’ share count fell 3.5% from a year ago as the company continues its share repurchase program. We note a sizeable uptick in inventories and a small uptick in debt from a year ago.
Western Digital (WDC) – Western’s 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. The company generates free cash flow and holds plenty of cash to buy time for the turnaround and to help pay down its elevated debt.
The company reported adjusted earnings of $1.65/share, down 28% from a year ago and beating the consensus estimate by about 11%. Revenues fell 9% but were fractionally ahead of estimates. Fourth-quarter revenue and earnings guidance was incrementally positive. All-in, mildly encouraging, and no change to our rating or price target.
While secular demand for Western’s products remains healthy, growth in the Client (corporate customers) and Consumer segments continues to tick slightly negative. The new 18 and 20 terabyte drives appear to be gaining traction fairly quickly.
The company is making progress with its turnaround, although this is progress is sluggish due to forces somewhat outside of its control. Its products remain profitable, indicated by the steady/improving gross margin. Its overhead costs were flat compared to the year-ago and the sequential prior quarter. Free cash flow of $148 million was up $159 million from a year ago, and Western paid down its debt by $150 million, leaving the cash balance unchanged. Debt repayment is an important reduction in our view.
The Western Union Company (WU) – This widely recognized money transfer company is facing secular headwinds from the transition to digital money. Prior efforts to diversify away from the core retail business using the company’s sizeable cash flows were unsuccessful, but a new CEO with impressive fintech experience brings the real possibility of a meaningful improvement in both execution and strategy as it makes its transition to the digital world. Investors have aggressively sold WU shares, ignoring the company’s relatively stable revenues, sizeable free cash flow and valuable intangible assets as well as its generous dividend yield.
The company reported adjusted earnings of $0.51/share, up 16% from a year ago and 19% above the consensus estimate. Revenues fell 4%, but down only 1% ex-currency, although the revenues fell fractionally below the consensus estimate. The company guided its full-year 2022 results downward due to its exit from Russia and Belarus. New CEO Devin McGranahan said he will detail his plans for the company in the fall. Cash flow was healthy. All-in, mixed update as we assume that the Russia/Belarus exit is a permanent move and thus a permanent reduction in value for Western Union. Reflecting the exit, WU shares fell 11% by mid-day today, yet remain above our $16.40 entry price. At this early stage of its turnaround, we have no change in our rating or price target.
Western Union continues to experience only modest revenue decay, allowing it to improve its operating efficiency such that margins and profits improve. We believe the new CEO will develop a more assertive plan to build value rather than to just slow its decay.
Cash net of debt rose nearly $600 million (or about $1.40/share) from a year ago, mostly due to the proceeds from the sale of the Business Services operations. The share count fell 4% and the company continues to pay a robust dividend.
Quick notes on recent news and analysis for other portfolio companies this past week are included below:
- Comments on other recommended companies:
- Walgreens Boot Alliance (WBA) – several potential buyers are preparing bids for the company’s Boots operations in the U.K. With multiple bidders for the stable, recession-resistant business, and plenty of opportunities to improve its results, we believe Walgreens should receive an attractive price for Boots.
- Marathon Oil (MRO) – increased its base dividend from $0.07/quarter to $0.08/quarter.
Please know that I personally own shares of all Cabot Turnaround Letter recommended stocks, including the stocks mentioned in this note.
|Small cap||Gannett Company||GCI||Aug 2017||9.22||4.16||0.0%||Buy (9)|
|Small cap||Duluth Holdings||DLTH||Feb 2020||8.68||12.21||0.0%||Buy (20)|
|Small cap||Dril-Quip||DRQ||May 2021||28.28||30.68||0.0%||Buy (44)|
|Small cap||ZimVie||ZIMV||Apr 2022||23.00||23.29||0.0%||Buy (32)|
|Mid cap||Mattel||MAT||May 2015||28.43||24.67||0.0%||Buy (38)|
|Mid cap||Conduent||CNDT||Feb 2017||14.96||5.68||0.0%||Buy (9)|
|Mid cap||Adient plc||ADNT||Oct 2018||39.77||34.97||0.0%||Buy (55)|
|Mid cap||Lamb Weston Holdings||LW||May 2020||61.36||67.76||1.4%||Buy (85)|
|Mid cap||Xerox Holdings||XRX||Dec 2020||21.91||17.53||5.7%||Buy (33)|
|Mid cap||Ironwood Pharmaceuticals||IRWD||Jan 2021||12.02||11.89||0.0%||Buy (19)|
|Mid cap||Viatris||VTRS||Feb 2021||17.43||10.49||4.6%||Buy (26)|
|Mid cap||Vistra Corporation||VST||Jun 2021||16.68||25.13||2.7%||SELL|
|Mid cap||Organon & Co.||OGN||Jul 2021||30.19||33.00||3.4%||Buy (46)|
|Mid cap||Marathon Oil||MRO||Sep 2021||12.01||25.46||1.3%||Buy (30)|
|Mid cap||TreeHouse Foods||THS||Oct 2021||39.43||33.42||0.0%||Buy (60)|
|Mid cap||Kaman Corporation||KAMN||Nov 2021||37.41||40.67||2.0%||Buy (57)|
|Mid cap||The Western Union Co.||WU||Dec 2021||16.40||19.17||4.9%||Buy (25)|
|Mid cap||Brookfield Re||BAMR||Jan 2022||61.32||52.06||0.0%||Buy (93)|
|Mid cap||Polaris||PII||Feb 2022||105.78||97.63||0.0%||Buy (160)|
|Mid cap||Goodyear Tire & Rubber||GT||Mar 2022||16.01||13.58||0.0%||Buy (24.50)|
|Large cap||General Electric||GE||Jul 2007||304.96||77.73||0.4%||Buy (160)|
|Large cap||Shell plc||SHEL||Jan 2015||69.95||54.97||3.5%||Buy (60)|
|Large cap||Nokia Corporation||NOK||Mar 2015||8.02||4.90||1.9%||Buy (12)|
|Large cap||Macy’s||M||Jul 2016||33.61||25.73||2.4%||HOLD|
|Large cap||Credit Suisse Group AG||CS||Jun 2017||14.48||6.61||3.9%||Buy (24)|
|Large cap||Toshiba Corporation||TOSYY||Nov 2017||14.49||20.94||3.1%||Buy (28)|
|Large cap||Holcim Ltd.||HCMLY||Apr 2018||10.92||9.87||4.5%||Buy (16)|
|Large cap||Newell Brands||NWL||Jun 2018||24.78||23.03||4.0%||Buy (39)|
|Large cap||Vodafone Group plc||VOD||Dec 2018||21.24||16.27||6.3%||Buy (32)|
|Large cap||Kraft Heinz||KHC||Jun 2019||28.68||43.61||3.7%||Buy (45)|
|Large cap||Molson Coors||TAP||Jul 2019||54.96||55.10||2.8%||Buy (69)|
|Large cap||Berkshire Hathaway||BRK.B||Apr 2020||183.18||331.27||0.0%||HOLD|
|Large cap||Wells Fargo & Company||WFC||Jun 2020||27.22||45.17||1.8%||Buy (64)|
|Large cap||Western Digital Corporation||WDC||Oct 2020||38.47||52.61||0.0%||Buy (78)|
|Large cap||Altria Group||MO||Mar 2021||43.80||55.20||6.5%||Buy (66)|
|Large cap||Elanco Animal Health||ELAN||Apr 2021||27.85||25.65||0.0%||Buy (44)|
|Large cap||Walgreens Boots Alliance||WBA||Aug 2021||46.53||44.53||4.3%||Buy (70)|
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.
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