Today’s note includes earnings updates, ratings changes and the podcast.
We review earnings from the two companies reporting this past week, including Viatris (VTRS) and Toshiba (TOSYY).
This past Wednesday, we moved Mohawk Industries (MHK) from a Buy to a Sell. We are making no other changes to our ratings or price targets in today’s note.
Earnings Updates
Viatris (VTRS) – Viatris was formed in November 2020 through the merger of pharmaceutical generics producer Mylan, N.V. and Pfizer’s Upjohn division. Investor expectations are low, with major concerns over its declining revenues, limited visibility into its new drug pipeline, elevated debt, production quality problems, loss of exclusivity for Lyrica in Japan, and reforms to China’s volume-based procurement programs. Faced with this long list of doubts, particularly in a surging bull market, investors have turned their attention elsewhere. We see Viatris as essentially an undervalued stream of reasonably stable free cash flow. As evidence of this stability is produced, along with better capital allocation, governance and transparency, we see strong potential for a higher share price.
First quarter results were encouraging for this very early-stage turnaround, as the company is starting to deliver what we are anticipating. Revenue stability was reasonable: compared to a year ago, when adjusting for the merger, revenues fell 6%, but only 2% for products other than Lyrica and Celebrex, which are losing their patent protection. Revenues were 5% better than consensus estimates.
The 2% decline excluding Lyrica/Celebrex shows that Viatris’ revenues are relatively stable outside of already-known and discounted patent losses. Generics revenues (about 30% of total sales) fell 8% - reasonable for Viatris. New products added $163 million to sales, or about 4%, providing some hope that Viatris’ pipeline offers interesting revenue (and profit) opportunities. Management said that they remain on-track for $690 million of new product revenue this year and that they expect a normalized base erosion of 3-4%.
Clean earnings comparisons against the pre-merger company weren’t provided. Compared to estimates, earnings per share were 15% better than expected. Adjusted EBITDA was $1.6 billion (about 11% higher than estimates) and is on-track to meet prior full-year guidance for $6.0-6.4 billion. The implied 35% full-year margin is making progress toward our 37% target margin. The $500 million cost-cutting program is also on-track.
Free cash flow was a respectable $799 million. The company declared a quarterly dividend of $0.11/share, well-below our initial estimate but in keeping with management’s guidelines of paying out 25% of free cash flow. Viatris repaid $1 billion in debt on its way to ending 2023 with about $6.5 billion in debt (still, more than 2½ years away).
Management reaffirmed their full-year 2021 guidance, amid skepticism by investors about the revenue and earnings stability, helping lift the shares 7% on the news. Overall, the results suggest that the company has the stability that we want to see. Given the low share valuation, this stability is enough to drive the shares higher. Overall, a good inaugural 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 Kioxia 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 = $0.91
Toshiba reported reasonable full fiscal year results (FYE= March 31) early this morning. We’re working through the numbers and will have more color next week. More important is the strategic drama underway as several activist investors continue to pressure the company to improve its focus on shareholder value.
Change is happening, albeit slowly, at Toshiba. New president and CEO Satoshi Tsunakawa said he will focus on improving relationships with all stakeholders and work to maximize corporate value as well as improve the company’s internal controls and corporate governance. A new Strategic Review Committee was created, which includes outside advice by investment bank UBS and a Japanese law firm. The committee will report its plan by October, 2021. Also, the company announced that a UBS banker will be nominated to its board – another sign that outside pressure is working. The CEO said that the company “… has no reluctance to consider various proposals to increase corporate value, including going private.” This is quite a statement for a Japanese company.
Toshiba outlined a basic dividend policy for a 30% payout ratio starting in FY21, and stated its plans to monetize Kioxia along with returning a majority of the proceeds to shareholders. The company announced a year-end dividend of ¥70, which is a 30% increase from their earlier forecast, for a total full year dividend of ¥80. Toshiba also announced a ¥150 billion additional return of capital to shareholders ($1.5 billion).
Activist investors are keeping the pressure on. 3D Investments, which holds a 7.2% stake, recently pressed for an auction of the company. Investors such as KKR, Bain, CVC and Brookfield remain in the wings although each operate at different speeds and degrees of patience. This battle is setting up to be a possible watershed moment in Japanese corporate governance.
Adding to management’s stress, it has been reported that a Toshiba unit was hit by the DarkSide ransomware group, the same people who attacked the Colonial Pipeline. Apparently, damage was somewhat contained.
Ratings Changes
We moved Mohawk Industries (MHK) from a Buy to a Sell on Wednesday. The company’s turnaround from its modest difficulties yet overly-depressed stock appears complete, and the shares have reached our 220 price target, although they modestly retreated during the day. From here, this cyclical company would likely need several things to go right: enduring recovery in the residential market, stronger rebound in the commercial market, no more input cost inflation, no/minimal capacity increases within the flooring/ceramic industries, and no operational, legal or other problems over the next few quarters, at least. Some of these will no doubt go right, but needing all of them to go right is a bit too much to ask. After a volatile two years, with the shares dipping as low as 59, the investment produced a 51% profit.
Friday, May 14, 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 11½ minutes and covers:
- Brief updates on:
- Viatris (VTRS) – encouraging earnings report
- Toshiba (TOSYY) – reasonable earnings, strategic drama moving slowly in right direction
- Other comments on recommended stocks:
- Dril-Quip (DRQ) – wins its trade secrets lawsuit
- Macy’s (M) – big project at Herald Square store, reports earnings on May 18th
- Altria (MO) – new board chair
- Jeld-Wen (JELD) – private equity firm selling about 2/3 of its position; investor day on May 18th
- Nokia (NOK) – wins $97 million legal award from Ericsson.
- Final note:
- Retirement letter from James Anderson, portfolio manager at Baillie Gifford
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.
Disclosure: The chief analyst of the Cabot Turnaround Letter personally holds shares of every Rated Recommendation. The chief analyst may purchase or sell securities discussed in the “Ratings Changes” 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 Friday update at any time.