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Turnaround Letter
Out-of-Favor Stocks with Real Value

February 12, 2021

Today’s note includes earnings updates, ratings changes and the podcast.


Today’s note includes earnings updates, ratings changes and the podcast.

Eight companies reported earnings this week: BorgWarner (BWA), General Motors (GM), Kraft Heinz Company (KHC), Mattel (MAT), Mohawk Industries (MKH), Molson Coors (TAP), Newell Brands (NWL) and Toshiba (TOSYY).

Next week Vodafone (VOD), Jeld-Wen (JELD), Ironwood Pharmaceuticals (IRWD), Credit Suisse (CS), Mosaic (MOS), Trinity Industries (TRN) and Conduent (CNDT) report earnings.

All ratings and price targets remain unchanged, except: we are raising the price targets on Western Digital (WDC) from 59 to 69 and Signet Jewelers (SIG) from 42 to 49. A number of other stocks are trading above our price targets so we are reviewing these.

Earnings Reports
Borg Warner (BWA) – BorgWarner produces turbocharger and drivetrain components for cars and trucks. It recently acquired Delphi Technologies, adding electronics capabilities and cost cutting opportunities as well as integration risks. The company is fairly well positioned for the transition to electric vehicles.

Fourth quarter adjusted earnings per share of $1.18 was 1% higher than a year ago and about 28% higher than the consensus estimate. Revenue of $3.9 billion, which included recently acquired Delphi Technologies, rose 53% from a year ago and was about 8% higher than the consensus estimate. On an organic basis, with adjustments for Delphi, sales rose 6.2% from a year ago. Guidance for 2021 was encouraging, calling for a 17% increase in sales and a 45% increase in adjusted operating income (both compared to the pro forma 2020 which includes Delphi). The guidance means that the estimates for BorgWarner will be rising.

Guidance points to a 2021 adjusted margin of 10% to 10.5%, compared to 8.3% in 2020 on a pro forma basis as if Delphi had been a part of the company for the full year. The margin boost is largely due to higher revenues and better pricing as well as cost cutting.

Free cash flow was $197 million, which was net of $219 million in capital spending. The company repurchased $216 million in shares during the quarter. The balance sheet carries about $1.8 billion more debt than a year ago. BorgWarner appears committed to both debt and share count reduction.

Interestingly, the largest adjustment to earnings was a $1.26/share gain on its investment in Romeo Systems, a previously private company that merged with a SPAC and is now publicly traded.

BorgWarner produced strong free cash flow last year, and looks positioned to generate even more this year. Importantly, its content potential per electric vehicle is higher than it is per internal combustion vehicle, so the transition will be favorable for BorgWarner.

General Motors (GM) – GM is making immense progress with its years-long turnaround from a poorly managed post-bankruptcy car maker to a highly profitable gas and electric vehicle producer. We would say it is perhaps 75% of the way through its gas-powered vehicle turnaround, and is well positioned but in the very early stages of its EV development.

General Motors reported an encouraging quarter that keeps the attractive long-term picture intact but has some near-term headwinds. Fourth quarter earnings of $1.93/share compared favorably to the strike-weakened $0.05 from a year ago and well ahead of the $1.64 consensus estimate. Revenues were 22% above a year ago and about 3% above consensus estimates. Guidance for 2021 was subdued but this appears to be entirely related to a computer chip shortage – otherwise the company looks well-positioned for higher profits and continued expansion of its electric vehicle and new technology capabilities.

Automotive revenues grew 25% from a year ago – impressive during a pandemic. GM’s market share increased to 11.0% from 10.9% a year ago. Much of the automotive profit growth came from higher prices that nearly offset the drag from lower volume. GM Financial continues to generate healthy profits, which were 27% higher than a year ago and reached a record fourth quarter high. The balance sheet remains sturdy, with automotive cash balance net of debt of $4.4 billion. GM Financial’s capital is also robust.

The company’s forward guidance is for full year 2021 adjusted earnings of between $4.50 and $5.25. However, that was weaker than the consensus estimate of $6.04 – a shortfall of about 19%. Most of the reduction is due to the computer chip shortage that will require the company to curtail production of vehicles other than its highly profitable full-sized pickup trucks. We think some of the profit reduction is also due to higher prices GM will pay to secure its chip supplies. The chip shortage was estimated to reduce profits by up to $2 billion.

GM’s earnings slide deck highlighted its commitment to electric and other alternative vehicles and initiatives. Upcoming is an aggressive rollout of a wide range of new vehicles and technology services as well as development of its battery, semi-autonomous vehicle and commercial truck offerings. The cost: capital spending will rise to around $9.5 billion in 2021, up 25% from the pre-pandemic 2019 levels. This spending will still allow for GM’s total free cash flow to be as high as $2.5 billion. The higher spending will crowd out a return of the dividend (as one analyst on the earnings call aptly put it), although the company said they would revisit this matter later in the year.

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.

The strong results indicate that the turnaround continues to make good progress. Adjusted earnings per share of $0.80 rose 11% from a year ago and was 8% above the consensus estimate. Revenue of $6.9 billion was 6.2% higher than a year ago and was fractionally above the consensus estimate. First quarter guidance points to flat/positive organic sales growth and roughly 2% EBITDA growth – fairly impressive compared to the first quarter last year which featured the start in mid-February of the pandemic.

Sales growth was a robust 8% in the United States, helped partly by a 5.2% increase in pricing and a 2.8% increase in volume. Pricing was higher as trade expense timing was favorable and as fewer goods were sold on promotion. Foodservice sales remained weak. Growth outside of the U.S. was less inspiring but domestic sales are 73% of total sales and are a key driver of Kraft’s turnaround.

The EBITDA profit margin expanded to 25.8% from 23.9% as better volumes and prices were further supported by operational efficiency improvements. So far, the new CEO is showing that reinvesting in the business can lead to better profits, the opposite of the company’s strategy in recent years.

Cash flow continues to be a key source of strength as Kraft labors under a heavy $24.9 billion debt (net of cash) load. However, that burden was reduced from $27.0 billion a year ago. If the company can continue to generate $4.3 billion in free cash flow, as it did in 2020, the debt can be whittled down without too much difficulty over the next several years.

The company confirmed that it will be selling its nuts business (primarily Planters) for $3.35 billion, about 10% higher than we expected. The 15x adjusted EBITDA multiple valuation is reasonable.

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, Mattel now appears to be finding its way.

All in, a strong quarter for Mattel. Adjusted earnings per share of $0.40 increased sharply from $0.11 a year ago and was 67% higher than the consensus estimate. Revenue grew 10% from a year ago and was slightly ahead of estimates. Adjusted EBITDA of $284 million was 58% higher than a year ago and 24% higher than consensus estimates.

Guidance for 2021 was less-inspiring but (we hope) conservative, as it essentially pointed to a modest 5% revenue growth and 10% EBITDA growth. CEO Kriez said that the pandemic boosted sales in 2020 but will likely be hard to top in 2021. The below-expectations guidance likely contributed to the shares’ weak flattish performance on Wednesday, despite the strong quarter.

Sales were strong in both North America and Internationally and across most product categories. Gross margins expanded from the cost efficiency program and from lower royalty payments. Admin expenses were (surprisingly) 13% lower than a year ago, although this was mostly offset by higher marketing spending. The company announced a new “Optimizing for Growth” program, standard for a turnaround company that needs to keep the pressure on after meeting its initial goals. This new plan is aiming for an additional $250 million in incremental cost savings by 2023.

Free cash flow for the full year was $167 million, up from $65 million in 2019. While the increase was encouraging, Mattel’s working capital sopped up $151 million in cash. The company needs to convert more of its profits into free cash flow and then pay down some of its $2.9 billion in debt. Its leverage as measured by debt/EBITDA is moving into the “OK” range at 4.0x. It should be brought down to 2.5x or less. This would not only boost its credit ratings back to investment grade, which would likely expand its investor base to include those looking for “high quality” companies, but also reduce its burdensome $200 million in interest expense. Lower debt would reduce the amount of interest-bearing debt and allow Mattel to re-finance the remaining debt at rates well-below its 6+% average rate. Combined, the investment grade rating could reduce the $200 million in interest costs to the $70 million range. Management said they are working to restore the investment grade rating.

Mohawk Industries (MKH) – We initiated a Buy on Mohawk shares in March 2019 when they had fallen heavily out of favor due to several sizeable earnings “misses.” The shares fell sharply during the March 2020 sell-off and after a brief bounce dropped to near their March lows on allegations of fraud. We think the fraud charges ultimately will not having a meaningful impact on the company and that Mohawk will continue to execute on its fundamental turnaround and improve its balance sheet.

Mohawk reported an impressive quarter. Adjusted earnings per share of $3.54 was 57% higher than the pre-pandemic fourth quarter a year ago and 23% higher than estimates. Revenue of $2.6 billion was a single-quarter record and grew 9% from a year ago, although only 5.5% when adjusted for currencies and fewer selling days in the period compared to a year ago. Revenue was 6% higher than estimates. The company generated strong free cash flow of $250 million, allowing debt net of cash (at $1.97 billion and down $500 million from a year ago) to be at historical lows. First quarter guidance was about 16% higher than the consensus estimate.

Revenue growth was healthy in most segments and geographies. Mohawk’s factories ran at high volumes and with good efficiency, boosting profit margins. Input and labor costs are rising but the company is recovering much of this through higher prices.

Molson Coors Beverage Company (TAP) – Molson Coors is struggling with weak revenue and profit growth, yet is working under a new CEO to more aggressively improve its strategic positioning toward more specialty/higher-end beverages so that it relies less on mainstream and value offerings. Also, the company is increasingly focusing on its cost structure. TAP shares continue to trade at a discount compared to its peers and its fundamental prospects.

Molson reported disappointing fourth quarter results, with adjusted earnings per share of $0.40 declining 60% from a year ago and falling well short of the $0.77 consensus estimate. Revenues of $2.3 billion fell 8% from a year ago and were about 5% below estimates.

Guidance appears conservative but investors aren’t interested, leading to the sell-off in TAP shares. We believe the reopening combined with strong cash flow will drive the shares higher later in the year. The company will likely re-instate its dividend later this year, which could provide a 3.2% yield.

The company had reasonable performance in the United States, which produces about two-thirds of its revenues. There, its branded sales grew about 2%, helped by stronger pricing. Outside of the U.S., sales were weak, with Europe revenues declining 39% on a constant-currency basis. The renewed lockdowns in the United Kingdom and elsewhere pulled down on-premise sales which constitute the bulk of European revenues.

Underlying EBITDA profits fell by 33%. Lower pricing in Europe plus higher aluminum can and transportation costs, combined with higher marketing spending, more than offset some price increases in the United States. On-premise sales carry higher margins, so fewer pub visits mean more profit pressure.

Cash flow was sturdy, and the company paid down about $1 billion in debt for all of 2020 – in a pandemic year, we’re OK with that. The cash balance remains healthy and Molson Coors retains its investment grade credit rating.

Guidance for 2021 was for essentially a repeat of 2020, with a 5% revenue increase producing unchanged EBITDA. We’re surprised at this, given the strong likelihood of the economic re-opening and the benefit to profit from higher volumes. We expect management is being very conservative in this guidance.

Newell Brands (NWL) – The company has struggled for literally 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.

Overall, a reasonable quarter as Newell’s turnaround is being energized by new leadership. Fourth quarter normalized earnings per share of $0.56 was 33% higher than a year ago and 17% higher than estimates. Revenues of $2.7 billion rose 2.5% from a year ago and were modestly ahead of estimates. Full-year 2021 guidance was mildly discouraging, calling for 2% sales growth and an 11% EPS decline (at midpoint of guidance range). The current 2021 consensus estimates sit at the top of the guidance range, so estimates will be coming down.

Management is probably being conservative, and the turnaround efforts under the new CEO are showing results. But the market is impatient, so the shares are weak today, although the decline only erases the run-up this month. We believe that Newell’s future continues to look brighter and will patiently wait.

Core revenue growth of 5% was watered down by business exits, store closures and unfavorable currency changes. Sales in the Commercial and Home segments were strong while the Outdoor & Recreation segment (-7%) and the Writing business were weak. The Writing business is driven by office workers so this is understandable. It’s not clear why the Outdoor & Recreation segment lagged when other recreational companies are showing good growth during the pandemic, although some weakness was due to accelerated shipments in 3Q. Growth in the Appliances & Cookware segment was fractionally positive – it would seem that this business should have been stronger in the pandemic.

Normalized operating margins expanded modestly to 11.4% from 11.3% - mildly encouraging. The Outdoor & Recreation segment produced a small loss. Free cash flow showed meaningful improvement and the company has a stronger balance sheet, with $748 million less debt net of cash than a year ago. Newell repaid $300 million in debt in the fourth quarter.

Toshiba (TOSYY) – This Japanese industrial conglomerate is recovering from its nuclear power plant construction business (Westinghouse Electric) debacle, which forced it to sell a majority stake in its memory chip production operations. We are looking for a divestiture of its minority stake, with proceeds paid out to shareholders, as well as operational improvement and better governance.

Note: ¥100 = $0.96
Fiscal third quarter sales of ¥2.0 trillion fell only 3%, a respectable recovery compared to the pre-pandemic year-ago period. Operating profits of ¥20.9 billion roughly doubled the year-ago profits. Sales in Electronic Devices & Storage Solutions (the largest segment at about 25% of total sales) rose 12%, while Digital Solutions sales rose 50%. The company modestly raised its guidance for the fourth quarter and raised its annual dividend by 25% to ¥50. It remains committed to divesting its Kioxia stake and returning the proceeds to shareholders.

Toshiba is under siege by at least two activist hedge funds. The company has an extraordinary general meeting on March 18th.

New orders increased 6% from a year ago, while free cash flow (while still negative) is approaching break-even. The EBITDA margin expanded to 5.8% from 4.2% a year ago – still meager but moving in the right direction. Much of the improvement, however, is due to lower Covid costs. Debt net of cash is small at ¥73 billion, or about $700 million. The Kioxia chip business contributed a loss of ¥(4.5) billion, but net of Covid costs would have been a ¥3.3 billion profit.

Ratings Changes
We are raising the price target on Western Digital (WDC) from 59 to 69, based on its impressive pace of operational improvements. We are also raising our price target on Signet Jewelers (SIG) from 42 to 49 as the turnaround appears to be much stronger than we anticipated.

As Trinity Industries (TRN) and ViacomCBS (VIAC) are trading above our price targets, we are reviewing them.

Friday, February 12, 2021 Subscribers-Only Podcast
Covering recent news and analysis for our portfolio companies and other topics relevant to value investors.

Today’s podcast is about 12 minutes and covers:

  • Earnings updates on:
    • Eight companies reporting earnings this week

  • Brief updates on:
    • Western Digital (WDC) and Signet Jewelers (SIG) – raising price targets.
    • Signet Jewelers (SIG) – Occasional activist DE Shaw takes a 5% stake.
    • Ironwood Pharmaceuticals (IRWD) – The CEO is ousted
    • Royal Dutch Shell (RDS/B) – Phasing out of fossil fuels

  • Final note

Please feel free to share your ideas and suggestions for the podcast with an email to either me at or to our friendly customer support team at 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.