Today’s note includes earnings updates, ratings changes and the podcast.
We review earnings from the 11 companies reporting this past week, including Adient (ADNT), Berkshire Hathaway (BRK.B), Borg Warner (BWA), Conduent (CNDT), Elanco Animal Health (ELAN), Gannett (GCI), GCP Applied Technologies (GCP), General Motors (GM), Ironwood Pharmaceuticals (IRWD), Mosaic (MOS) and Oaktree Specialty Lending (OCSL).
We are making no changes to our ratings or price targets in today’s note.
Earnings Updates
Adient (ADNT) – Adient, one of the world’s largest automobile seat makers, struggled due to weak leadership after its 2016 spin-off from Johnson Controls. We became interested in late 2018, after the shares fell sharply, due to the arrival of Doug Del Grosso as CEO. While we were a bit early on this name, Del Grosso’s highly capable leadership has produced an impressive turnaround so far. As seats go into EVs just as readily as into gas-powered vehicles, Adient is somewhat immune to this transition.
Fiscal second quarter results were encouraging and much stronger than the pandemic-afflicted year-ago results. Revenue of $3.8 billion grew 9% from a year ago and was about 6% higher than expectations. Adjusted earnings per share of $1.15 increased 85% from a year ago and was sharply higher than the $0.55 estimate. Adjusted EBITDA of $303 million rose 44% from a year ago and was 28% higher than expectations.
Better leadership is improving the company’s operations significantly. Management reaffirmed their full-year sales and EBITDA guidance, acknowledging rising costs and other pressures, and raised their free cash flow guidance by $50 million due to higher dividends from China.
Net debt was unchanged and free cash flow was modestly positive, but the company repaid $700 million in debt (despite painfully high fees) indicating confidence in its future cash flow. The exit from the YanFeng joint venture in China will bring $1.4 billion of cash to Adient later this year, greatly improving its balance sheet. It is not clear yet what effect the exit will have on its China earnings as it will be taking a “go alone” strategy, although with already-running and partly-owned China-based entities that it will fully control.
Adient continues to win placements in new gas-powered and EV launches globally, helping ensure a steady flow of revenues in future years. The Adient story remains healthy.
Berkshire Hathaway (BRK/B) – Recommended at the end of March 2020 in the depths of the market’s pandemic-driven sell-down, Berkshire Hathaway is an exceptionally well-managed financial and industrial conglomerate.
First quarter results were strong, with operating earnings increasing 30% from a year ago. Profits on the industrial side, which includes Railroad, Utilities, Energy and Other Businesses, rose 21%, while Insurance earnings grew 13%. Total revenues increased 5.4%. Berkshire’s total float was about $140 billion, up about 1.5% from year-end. Berkshire repurchased $6.6 billion, or about 1.2%, of its shares in the quarter. Overall, the company is performing well.
Profits were higher year-over-year in all major business segments, with Insurance and Retailing providing the largest boosts. The Retailing segment includes Berkshire’s 80+ auto dealerships, other automobile-related services, furniture stores like Nebraska Furniture Mart and Jordan’s, and See’s Candies, among others.
At the annual shareholder’s meeting, Berkshire said (later confirmed) that Greg Abel will take the reins after Warren Buffett retires. This is a good choice, but the company won’t be the same without Buffett.
Borg Warner (BWA) – BorgWarner produces turbocharger and drivetrain components for cars and trucks. It recently acquired Delphi Technologies, adding electronics capabilities and cut-cutting opportunities yet also integration risks. The company is fairly well-positioned for the transition to electric vehicles.
First quarter results were encouraging. Revenue of $4 billion rose 18% when adjusted for the Delphi acquisition and currency changes, and was 12% above estimates. Adjusted earnings per share of $1.21 were about 30% above consensus estimates. EPS data on an organic basis was not provided. Adjusted operating income of $444 million rose 62% from year-ago on a pro forma basis (assumes that Delphi was owned during the year-ago quarter). The 11.1% margin was higher than the pro forma 8.5% margin a year ago. Adjusted EBITDA was 23% above expectations.
Management incrementally raised their full-year guidance. As consensus estimates had anticipated weaker results, estimates will be rising.
The company continues to grow faster than global light vehicle sales (which increased 13% from a year ago). Growth in China was strong year/year, as it was hit hardest in last year’s first quarter, while North American year/year growth was negative. These trends will reverse as the year progresses. Borg Warner is improving its EV positioning and expects that more than 25% of its revenues will come from EVs in 2025. One of our concerns with the company is that it will likely continue to make EV-related acquisitions that will consume its free cash flow. While this should result in an increase in Borg’s terminal value, it is more speculative and expensive than incremental/organic adaptation.
Conduent (CNDT) – Conduent was spun-off from Xerox in 2017. After a promising start, the company’s revenues fell sharply due to management problems, leading to a collapse in its share price. In late 2019, the company replaced the CEO, who began a major overhaul that is starting to show progress. Activist investor Carl Icahn owns 18% of Conduent’s shares, while Darwin Deason (who sold his business to Xerox which later was spun-off as Conduent) holds a 3.3% stake.
First quarter results were encouraging. Revenue of $1.1 billion fell 2% from a year ago but was slightly ahead of consensus expectations. Adjusted earnings per share of $0.15 compared to $0.05 a year ago and estimates of $0.11. Adjusted EBITDA of $115 million was 20% above a year ago and were about 8% above expectations. All three segments (commercial, government and transportation) showed improvements. Forward guidance was mildly encouraging and was slightly above consensus estimates. Most important, it pointed upward rather than downward.
Conduent announced the departure of the CFO, who will be replaced by a protégé of the new and capable CEO – a positive development. The balance sheet remained essentially unchanged from year-end, while first quarter cash consumption was much lower than a year ago.
New business signings totaled $356 million, up 10% from a year ago. Conduent appears to be stabilizing its signings after a sharp fall-off. While $356 million isn’t that impressive by itself, it is a positive-enough number to suggest that Conduent is restoring some competitiveness. We hope that these signings come with respectable profit margins. Overall, the company appears to be improving its service offerings, marketing capabilities and operational efficiency. We also like the cultural shift underway at Conduent.
The EBITDA margin, at 11.1%, is much-improved from a year ago and inching toward Conduent’s targeted 13-15% margin and our 13% target.
Elanco Animal Health (ELAN) – Elanco is one of the world’s largest providers of pet and farm animal health products, ranging from flea and tick collars, prescription treatments and farm animal nutritional supplements. Following its September 2018 IPO at $24 as part of its spin-off from pharmaceutical giant Eli Lilly, Elanco shares have been lackluster, due to weak revenue growth, high expenses and an uninspiring new product pipeline. Veteran activist investor Sachem Head recently gained a board seat, likely leading to an upturn in the company’s execution and driving its undervalued shares higher. The August 2020 acquisition of Bayer Animal Health offers additional opportunities for improved results.
First quarter results were encouraging and were ahead of consensus estimates. There were many adjustments which makes comparisons and analysis murky – in future quarters we hope to see cleaner results. Reported results included Bayer this quarter but not a year ago, so most of the year/year comparisons are not meaningful. We will focus on other provided metrics.
Revenues were about 7% higher than estimates and adjusted earnings per share of $0.37 were about 61% above estimates. Adjusted EBITDA of $343 million was about 45% higher than estimates. Management raised their full-year guidance for revenues by about 3% and for adjusted EBITDA by about 6%. The implied margin would be about 22.5%.
Legacy Elanco, which excludes Bayer, produced revenue growth of 4% – somewhat lackluster as it compared to an unusually weak first quarter a year ago. A year ago, retailers and other pet health buyers drew down their inventories by about $30 million rather than ordering more products. Excluding this artificially easy comparison, Legacy Elanco sales would have declined by about 1%. Clearly, more work needs to be done in its core operations excluding Bayer.
Net debt was largely unchanged from the prior quarter. The company said it would repay $500 million in debt this year, and when combined with higher earnings its leverage should decline to about 5.0x adjusted EBITDA, better than its prior 5.5x target. Reducing its high leverage needs to remain a high priority.
The company reiterated (not surprisingly) its confidence in its flea and tick collars.
Gannett (GCI) – Gannett, publisher of USA Today and many local newspapers, is fighting for relevancy, as its print circulation and ad revenues face secular decline. It is aggressively transitioning to the digital world. The turnaround was set back by the pandemic-reduced decline in advertising revenues. However, aggressive cost-cutting has helped the company maintain positive cash flow (a key to the story) and whittle away at its debt and interest expense.
First quarter results were mixed – encouraging in some ways and illustrative of the daunting challenge ahead. Revenues fell 18% from a year ago and were about 2% below estimates. Earnings per share was a loss of $(1.06), but this is unadjusted for one-off items and isn’t illustrative of Gannett’s challenges.
The company reported this morning, so we have yet to review the conference call and run a more thorough analysis. GCI shares are down 11% this morning, reflecting the report.
Gannett’s fundamental challenge is to transition to digital revenues (primarily online subscriptions and advertising) fast enough to offset declines in its print revenues, and cut costs fast enough, to work its way out from under its expensive and elevated debt burden.
In the first quarter, total revenues fell by $172 million. Nearly all of the decline came from print, as digital revenues fell only by perhaps $15 million. Yet, digital revenues are still only about 30% of total revenues, and total revenues won’t stabilize until the mix is perhaps 75% digital. Also, digital revenues should be growing rapidly, and not falling, especially as digital-only subscriber numbers are surging. And, overall advertising should be growing rapidly in the economic rebound, but apparently is not.
The cost picture is encouraging given the savings realized, but this, too, is a challenge going forward. Costs, as measured by EBITDA costs, fell by $173 million, fully offsetting the loss of revenue. Adjusted EBITDA increased by $1 million – a remarkable feat for sure. From here, the question is how much more can costs be cut? We think a lot more, especially as printing has considerable volume-related costs, but there is a limit. We don’t know for sure, and the company hasn’t provided much color on this.
Gannett’s debt burden has been improved by replacing some debt with convertible notes and lower-cost debt. But this still is an overhang – the fees have been high (who, exactly, is this company being run for… Apollo Capital?), the dilution is heavy, and the re-fi debt still carries a minimum 7.75% coupon. Gannett has little chance of reaching investment grade in the foreseeable future. So, the debt millstone will remain around Gannett’s neck.
GCP Applied Technologies (GCP) – After an initially strong start following its spin-off from WR Grace in 2016, the company’s weak leadership led to a steady stream of disappointing results. Activist investor Starboard Value (with an 8.9% stake) successfully replaced most of the board and the CEO in 2020 as the opening round of its turnaround. During 2020, the company laid the foundation for better revenue growth, margin improvement and cash production.
First quarter results were moderately encouraging, as all metrics improved from a year ago. Sales of $223 million grew 3% and were about 10% above consensus estimates. Earnings per share of $0.12 increased by 20% and were 9% higher than consensus estimates. Adjusted EBITDA of $28 million rose 7% and was above estimates. Gross margins and adjusted EBITDA margins improved incrementally, as well. The balance sheet showed incremental changes from year-end.
We’re a bit surprised that the Specialty Construction Chemicals segment is struggling. This business produces cement and related compounds – in a surging economy they should be seeing sharp revenue and profit increases, but instead sales and profits are falling compared to a year ago. We understand the lag effect in the commercial cycle, but this segment needs more work. Or, perhaps they should sell it to Cabot Turnaround Letter-recommended LafargeHolcim.
The Specialty Building Materials segment is participating in the housing boom, with 8% higher revenues and profits increasing by 38%.
GCP kept their full-year 2021 guidance intact, with pricing increases and operating efficiencies more than offsetting input and transportation cost inflation. The company is moving its headquarters to Atlanta, maintaining a research presence in Boston, and consolidating its regional facilities and offices, which overall should reduce its costs. Several new key leaders are being hired, which should lead to better results. GCP disclosed that it will need to revise its 2020 financial statements for expense and other adjustments. We anticipate that this will not be material to the turnaround, and likely reflects pre-turnaround problems.
Overall, the GCP turnaround is in its early days.
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 85% of the way through its gas-powered vehicle turnaround, and is well-positioned but in the early stages of its EV development. GM Financial will likely continue to be a sizeable profit generator.
First quarter results were strong. Automotive segment revenue of $29.1 billion was unchanged from a year ago, while adjusted net income of $2.25/share compared to $0.62/share a year ago when the company aggressively adjusted its operations and credit reserves for the then-accelerating pandemic. Compared to the $1.05/share consensus estimate, results were sharply higher.
GM also reaffirmed its guidance for full-year EBIT of $10-11 billion (“seeing results coming in at the higher end of this range”). Guidance for EBIT of $5.5 billion for the first six months of 2021 implies a sharply weaker second quarter following the $4.4 billion first quarter EBIT. With all the concerns over the semiconductor shortage, the first quarter earnings and the forward guidance were encouragingly robust.
Automotive profits were driven mostly by higher pricing: GM redirected its resources toward higher-margin and higher-demand vehicles to adjust to component shortage. While volumes were subdued GM sold more higher-margin vehicles and gave fewer discounts. Higher prices were only partly offset by rising input costs. GM lost market share as retail inventory is tight (likely boosting 2Q sales and pricing) and as fleet sales were only 17% of sales compared to almost 28% a year ago, but this is fine – these sales are low-margin. Automotive cash flow was $(1.1) billion, as a huge $4.7 billion inventory build consumed cash, partly driven by rising numbers of mostly-produced vehicles that are waiting on semiconductors.
GM International was break-even for the second consecutive quarter after years of losses. The China operation was decently profitable. GM Financial remains highly profitable, buoyed by charge-offs at only a 0.8% rate and retail delinquencies at a modest 1.9%. GM Financial’s results remain impressive at $1.2 billion in operating profits helped by low credit losses and higher used vehicle prices (boosting their proceeds when they offload cars coming off-lease). GM’s Automotive balance sheet remains sturdy, with cash of $19 billion fully offsetting automotive debt of $18 billion.
The company outlined their goal of “#1 EV market share in North America,” with “margins similar to or higher than ICE (internal combustion engines)” and selling 1 million+ EVs globally by 2025. These are simple and clear goals that indicate GMs ambition as well as assuage investors’ worries about the profitability of EVs.
One frustrating aspect of GM is its vast capital spending. We appreciate the need for heavy investing in EVs – this is a driver of GM’s future and much-responsible for the surge in GM’s share price. However, the $9-$10 billion in 2021 capital spending will consume all but $1-$2 billion of the company’s cash flow this year and a good bulk of it next year (assuming that the auto cycle doesn’t fade and the company doesn’t make any major acquisitions or new investments). We recognize that GM said that the chip shortage will cost it $1.5-$2.5 billion of free cash flow this year (implying FCF of $3.0-$4.0 billion if no shortage, but this ignores the price-enhancing benefit of a car shortage that is produced by the chip shortage).
Low free cash flow places more pressure on the valuation of its emerging EV operations which are impressive but remain speculative. Helping support the valuation are recent investments in Cruise from Walmart, Honda, Microsoft and GM totaling $2.7 billion at a $30+ billion valuation.
GM is running on all cylinders, or rather, has fully-charged batteries in preparation for the future while maintaining solid profitability in its core gas-powered vehicle and credit businesses. We are balancing the impressive future prospects with today’s booming consumer economy and a likely post-boom slowdown, along with a generous but not over-zealous valuation.
Ironwood Pharmaceuticals (IRWD) – After years of weak leadership, Ironwood has one remaining product, Linzess, so investors view the company as a failed business. However, Linzess is a steady revenue producer with growing volumes that offset its slow per-unit price decline. As cash accumulates on the balance sheet and now exceeds its debt, Ironwood is repurchasing its shares. Respected activist investor Alex Denner, who now holds a board seat, is exerting his influence, including ousting the CEO and slashing spending. Ironwood’s shares trade at a highly discounted valuation.
First quarter results continue the favorable fundamental trends. Revenue increased by 11%, as sales of Linzess remained healthy, and was about 1% above consensus. Earnings per share of $0.24 were sharply higher than $0.04 a year ago and about 20% above consensus estimates. Ironwood announced a $150 million share buyback. The Linzess franchise and outlook remain sturdy.
The company maintained its full-year 2021 guidance – the revenue guidance was unchanged but fell about 3% below the previously-rising estimates, which apparently was enough to pressure the shares. EBITDA guidance was for greater than $190 million, compared to the $190 million consensus. For investors to sell on this “miss” is near-sighted. Ironwood is generating large amounts of cash and if it produces $190 million in EBITDA it should produce $140 million of free cash flow. This equates to 10% of its market cap. Furthermore, Ironwood’s expense base shrank by 35% from a year ago. We see this shrinking even further as there is little for the company to do other than help Abbvie sell Linzess.
One possible risk: the company has as its second priority (after its first priority of maximizing Linzess) the building of a gastro-intestinal treatment pipeline (#3 priority is now delivering sustainable profits and free cash flow). On the post-earnings call, management spoke about some low-risk, high-reward development activity - we are watching for signs of any meaningful shift in capital allocation.
Mosaic (MOS) – We kept this turnaround (initially recommended in Sept 2015) on the Recommended list as it remained out of favor with significant upside potential when a commodities recovery arrived. That recovery is finally underway, leading to higher profits and cash flow. Also, the company is keeping costs under control, and remaining reasonably diligent about restraining its capital spending.
First quarter profits results were strong. Revenue of $2.3 billion rose 28% from a year ago and was 2% above consensus estimates. Earnings of $0.57/share compared to a $(0.06)/share loss a year ago and was about 8% above consensus estimates. Adjusted EBITDA of $560 million more than doubled the year-ago results and was the highest first quarter in eight years. But, this was fractionally lower than consensus estimates. In all three segments, volumes were either higher or stable, while gross profits per ton sold were sharply higher.
Forward guidance was a tad lower than investors had expected, leading to a modest sell-off in the shares. However, the picture over the next year or so looks strong. Surging global crop prices mean strong demand for the fertilizers that Mosaic sells. Import competition seems likely to remain subdued. Partly dragging on the company’s outlook are rising raw materials as well as a near-term sulfur shortage (used to dissolve phosphate rocks).
Mosaic’s cash flow production was uninspiring. A surge in inventory consumed the otherwise strong operating cash flow, while higher capital spending absorbed much of what was left. The company managed to reduce its net debt by $210 million – a use of cash which we highly encourage, especially with a cyclical company like Mosaic with a management that could easily be tempted to waste the cash on self-immolating capacity increases or over-priced acquisitions. Management spoke of its priorities to reduce debt by $1 billion, including the upcoming retirement of a $450 million note due in November.
We are staying with our Buy on Mosaic shares as the next few quarters look promising for higher profits and strong free cash flow production.
Oaktree Specialty Lending (OCSL) – In 2017, highly regarded investment manager Oaktree Capital was voted in by shareholders as the new outside manager to turn around this company. It is now exceptionally well-managed yet remains undervalued.
First quarter results showed continued improvements. Adjusted net investment income was $0.14/share, up 16% from a year ago and up about 7% from the prior sequential quarter. Net asset value (NAV) was $7.09/share, up 9% from a year ago and 3.5% from the prior sequential period. Oaktree Specialty raised its quarterly dividend by 8% to $0.13/share, the fourth consecutive quarter of increases.
Origination growth remains reasonable within the company’s self-imposed conservative market outlook. New lending, combined with exits and the addition of the now-acquired Oaktree Strategic Income operations, is supporting the portfolio’s yield while also improving its credit quality. At quarter-end, no investments were on non-accrual status. Credit market conditions are very loose – the company was not very encouraging on this note and remains somewhat cautious although not daunted in its new lending.
At the current stock price, OCSL shares trade at 95% of NAV and offer a 7.7% yield on the new $0.13/share quarterly dividend.
Ratings Changes
None.
Friday, May 7, 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 17 minutes and covers:
- Brief updates on:
- All 11 companies reporting earnings.
- Meredith Corporation (MDP) – selling its local TV stations for $2.7 billion.
- Berkshire Hathaway (BRK.B) – Buffett’s successor is Greg Abel.
- Credit Suisse (CS) – new chairman arrives with changes ahead.
- Altria (MO) – participating in positive changes at 10%-owned Anheuser Busch InBev.
- Final note:
- Inflation is here.
- Elon Musk.
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.