The bull market in our turnaround stocks continues to drive several names to prices above our targets. We are reviewing price targets for Adient (ADNT), Macy’s (M), Mohawk (MHK) and Jeld-Wen (JELD).
Following investors’ exuberance over Volkswagen’s (VWAGY) aggressive moves into electric vehicles and batteries, as outlined in their investor presentations earlier this week, we moved the shares to a Sell.
Other Cabot Turnaround Letter recommended stocks are either at or just below our price targets. We want to think more about their valuation and fundamentals in the context of volatile but historically low interest rates, enormous government stimulus spending and a likely strong economic reopening.
Earnings Reports
Two companies reported earnings this week. The next earnings report is likely to be in April, when earnings season kicks in again.
Duluth Holdings (DLTH) – After struggling with a disjointed and overly aggressive retail store expansion strategy, the company removed its CEO (now led by the founder) and is rebuilding its infrastructure, improving its operational efficiency and slowing its store expansion program.
Fourth quarter earnings were mixed. Revenues slipped by 1.4% from a year ago – not bad given that the year-ago results were pre-pandemic while this year’s results were hurt by pandemic-reduced store traffic. Still, this was about 7% below estimates. Per share net income of $0.67 fell 11% from a year ago and was also 7% below estimates.
Adjusted EBITDA was better, down only 3% from a year ago and slightly below estimates, suggesting that the company’s underlying profit picture isn’t impaired.
Also, direct sales (digital/e-commerce) rose 15%, mostly offsetting the 29% decline in retail store sales. Direct sales are about 73% of total sales, reflecting Duluth’s legacy as a mail-order catalog company.
The debate over whether physical stores help boost direct sales to customers in those markets hasn’t been clearly resolved, but there continues to be some positive evidence in that direction. However, given all of the capital spending and operating costs required by physical stores, it remains unclear if they are solid investments.
Duluth’s balance sheet improved from a year ago, with its cash now at $47 million, up from $2 million. Debt remains reasonable and increased modestly, by $9 million. Cash flow was the primary driver behind the cash accumulation.
While seemingly trivial, Duluth mentioned that it is doing a pilot program to sell their Buck Naked™ men’s underwear in 13 Tractor Supply stores. One of our hopes for Duluth is that they move beyond their currently small world of email and 60 stores into the larger world of third-party selling. There are nearly 2,000 Tractor Supply stores with a customer base that would seem to be highly aligned with the Duluth brand but may have zero knowledge of its existence. We have no idea if this market would ultimately develop, but it sure seems promising and we are highly encouraged to see that Duluth is doing this pilot.
The company is slated to add Brett Paschke to its board to replace a retiring member. Paschke is a senior investment banker at Wm Blair firm in Chicago and was instrumental in Duluth’s IPO. We have a lot of respect for the Wm Blair firm. Although we don’t know Mr. Paschke, we anticipate that his presence will be a positive addition for shareholders. Also, the company has now engaged a search firm to find a permanent CEO to replace the founder/interim CEO.
We remain patient with Duluth Holdings.
Signet Jewelers (SIG) – Under its previous leadership, Signet suffered large losses in its in-house credit operations after using easy credit terms to boost sales, neglected to update its merchandising and marketing, had an ineffective e-commerce strategy and had tolerated a toxic culture. New leadership is making impressive progress in reversing all of these problems while rebuilding the company into a more relevant, profitable and valuable business.
Fiscal fourth quarter results were strong. Revenues grew by 2% from the pre-pandemic year ago period, and same store sales increased by 7%. Revenues were about 4% above estimates. Per share adjusted net income of $4.15 was 13% higher than a year ago and 17% higher than estimates. The company guided for FY2022 sales of between $5.85 billion and $6.0 billion, with a mid-point that is about 3% higher than consensus estimates. The guided operating income implies an EBITDA of about $470 million, which would be about 7% above estimates.
E-commerce sales grew 71% and now represent 23.4% of total revenues. This is an impressive transition to the digital world. The international operations (United Kingdom) were weakened by pandemic lockdowns, with same store sales falling 28%.
Strong cash flow production from higher profits, lower capital spending and tighter working capital has led the company to now be in a net cash position, with its $1.2 billion in cash vastly exceeding its $147 million in debt. With the convertible preferred shares (which convert at around $80) approaching in-the-money, we would not be surprised to see them eventually buy-out this $625 million stake at a premium to avoid what would likely be about 12% equity dilution if converted.
Signet is producing strong results, as its leadership continues to show it can lead the company toward higher customer relevance, sharper operating efficiency and better use of its capital. Management said that they have completed their “Path to Brilliance” stage of the turnaround (basically, fixing the problems) and is moving toward a “Inspire Brilliance” stage which will accelerate their growth.
For this calendar year, they anticipate that consumers will shift spending toward experiences and away from jewelry, and that Signet will boost capital spending to $150 million - $175 million to continue their technology and product upgrades and to cover spending deferred from calendar 2020.
The shares trade at about 5.9x forward EBITDA. This is a low valuation for what has increasingly becoming a solid company with more improvements ahead. What is this business ultimately worth? Their international operations, when stabilized, might be worthy of a sale or may add value on their own to Signet’s overall business. After the calendar 2021 pandemic transition year is over, we should get a better view of the normalized growth and margin picture, as well as more clarity on its customer credit exposure, along with some color on the convertible preferred shares and Signet’s common stock dividend policy. There is a lot of cash piling up on the balance sheet that could find a home in investors’ pockets.
Ratings/Price Target Changes
Volkswagen (VWAGY) – Moving to Sell on Wednesday, March 17.
Volkswagen shares have been on a tear this year, up about 120% through mid-week. The shares traded 40% above their prior all-time high set in early 2015 prior to the diesel debacle.
What is behind the move? We see several drivers. First, the company has moved past the diesel scandal by paying large fines and changing its leadership and governance. Second, the company appears to be operating more efficiently and benefitting from a strong demand recovery, particularly in China. Management has alluded to a possible spin-off of its high-value brands like Porsche and its more prosaic Traton truck business. Most important, though, VW is positioning itself as a leader in electric vehicles and the battery technology that will power these vehicles.
At its first-ever Power Day earlier this week, the company highlighted its goals of reducing battery costs by 50%, building a wide-spread charging network in key markets, constructing six battery factories, and other impressive targets including having 60% of its European sales coming from electric vehicles by 2030. We think VW is moving in the right direction with its EV initiatives.
However, the shares are discounting a prosperous future. But that future may not arrive for ten years, and by then the anticipated prosperity may not be quite so golden. Competition for EVs will be fierce, and it’s not clear how profitable these vehicles will actually be. In the meantime, Volkswagen will still be a gas-powered vehicle company with average profitability that remains vulnerable to cyclical car demand. Its EV initiatives will have a voracious capital appetite. There are many hurdles to overcome to justify a share price much higher than the current price.
As such, we are moving shares of Volkswagen (VWAGY) to a Sell. Since initiating with a Buy in March 2017 at $15.91, the position has produced a roughly 164% gain, excluding dividends.
We are limited to a binary approach to our ratings: a stock is either a Buy or a Sell. We rarely use Holds and have no capacity for partial positions. In this momentum-driven market, holders of VWAGY shares may, however, want to sell only part of their position (perhaps half or three-quarters) now, leaving the balance to the possibility that momentum-oriented investors push the shares even higher. Stocks reaching unjustifiable levels often continue to drive upwards, and there’s nothing wrong with participating in that with a few shares.
Friday, March 19, 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 15½ minutes and covers:
- Brief updates on:
- Duluth Holdings (DLTH) – Mixed fourth quarter earnings but a better balance sheet. We like the pilot program at Tractor Supply stores.
- Signet Jewelers (SIG) – Strong results as the turnaround continues.
- Volkswagen (VWAGY) – Moving to a Sell.
- Nokia (NOK) – At its Capital Markets Day, it showed that it is making the right moves to become a more competitive company.
- Toshiba (TOSYY) – Shareholders won the vote that called for an independent investigation of irregularities that appear to be entrenching management.
- Oaktree Specialty Lending (OCSL) – Completed their acquisition of sister company Oaktree Strategic Income in a sensible deal.
- Elsewhere in the Market:
- Value is the new Momentum
- Cabot Turnaround Letter subscribers hear about attractiveness of U.K. stocks sooner than clients of $157 billion Research Affiliates.
- Final note:
- Matt Levine at Bloomberg on whether CEOs need to use Twitter to uphold their fiduciary duties.
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.