Today’s note includes earnings updates, ratings changes and the podcast.
We review earnings from the two companies reporting this past week, including Macy’s (M) and Vodafone (VOD) and provide some numbers from last week’s Toshiba (TOSYY) report. The next earnings report is Duluth Holdings (DLTH), which reports on June 3.
Earnings Updates
Macy’s (M) – With a capable new CEO since February 2018, Macy’s is aggressively overhauling its store base, cost structure and ecommerce strategy to adapt to the secular shift away from mall-based stores. Interest costs from its sizeable debt drain valuable cash. Macy’s was hit hard by the pandemic, setting back its turnaround from a financial perspective, but the company’s acceleration of its overhaul shows considerable promise.
Macy’s reported an impressive fiscal first quarter, as the company reported an unexpected (and unusual for a seasonally weak quarter) profit and overall results that were very respectable compared to pre-pandemic results two years ago (in 2019). The company raised its full-year 2021 sales guidance by 8% and adjusted EBITDA guidance by about 35%.
For much of this year, year-ago comparisons won’t mean much as most of Macy’s physical stores were closed. As the company is struggling with secular issues that threaten its future, comparisons to the pandemic 2019 provide useful measures of progress.
Net sales of $4.7 billion fell 15% compared to the comparable 2019 quarter, but were 10% above the consensus estimate. Adjusted earnings per share of $0.39 fell only 11% from the comparable 2019 quarter and were sharply higher than the expected $(0.38) loss. Adjusted EBITDA of $473 million was 6% above two-year ago results and more than triple the consensus estimate. For a company given up for dead by many, Macy’s delivered.
About a third of the sales decline was due to store closures – when combined with the increase in profits it suggests that the closed stores were sizeable drags on profits. We’re fine with this type of revenue decline.
The company has wasted little of the pandemic “opportunity.” Its aggressive upgrade of its e-commerce capabilities, more-focused merchandising and tighter expense controls are clearly working. Digital sales are now 37% of total sales, compared to 24% in the first quarter of 2019, and new-customer counts and Star Rewards Loyalty programs are producing meaningful gains.
Gross margins improved while inventories are down, reflecting the better merchandising. Overhead costs fell $364 million compared to 2019. Net credit card revenues, which reflect both customer use and customer credit quality, fell 8%, a lower pace than the overall sales decline. Even the balance sheet currently has $1.1 billion less net debt (or about 26% less) than two years ago, and Macy’s paid down $500 million in debt in the quarter. Free cash flow was a healthy $403 million.
What we didn’t like: the share-count rose nearly 3% from a year ago (too much dilution of patient shareholders), inventories look too high (despite the improvements) and cash flow was boosted by slow payments to its suppliers (as payables appear high). Also, same-store sales fell 10% compared to two years ago, highlighting the company’s struggles with the secular headwinds facing all department stores in a specialty-retailer, on-line world. Credit card penetration and new accounts continue to fall noticeably. Debt remains too high, as annual interest expenses of $320 million consume nearly 16% of adjusted EBITDA. Also, we are alert to the risk that sales deflate once the stimulus checks stop flowing.
Macy’s shares won’t get much credit for its stronger profits until revenue declines vs. 2019 come to a halt. And, the narrative of mall-based stores headed for extinction remains a major headwind regardless of any evidence to the contrary. The quarter shows that Macy’s is not evaporating, but actually showing that it has the potential to survive. A year ago, this was clearly not even a consideration among most investors.
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 = $0.92
Toshiba reported reasonable fourth-quarter results (FYE= March 31) early last Friday. Revenues increased 3%, which the company said would have been higher but for the pandemic. Adjusted EBITDA rose 18%, helped by an expanding margin.
The outlook was modestly encouraging: revenue guidance is for 6% growth while adjusted EBITDA guidance is for 39% growth. Free cash flow guidance is for an incremental improvement over 2020.
As we described last week, more important than the slowly improving operating performance is the strategic drama underway. Several activist investors continue to pressure the company to improve its focus on shareholder value. The replacement of the CEO, the addition of new outside board members, a new Strategic Review Committee that will deliver a plan by October, and several bids for the company by credible buyers are also likely to have a favorable impact for shareholders, although progress may be slow compared to the pace familiar to American-based investors.
Vodafone (VOD) – Vodafone is a major European wireless telecom, broadband and cable TV service provider based near London. It is several years into its five-year turnaround program led by relatively new CEO Nick Read (October 2018), which is aimed at increasing its return on capital. Priorities include strengthening its telecom “connectivity” platform, improving its operating efficiency and spending its capital more efficiently. Vodafone has a few obscure assets: it is the leading provider of mobile data and payments services in Africa and has a vast network of high-capacity data pipelines that may increase in value as 5G rolls out.
Vodafone posted mediocre fourth quarter (fiscal year 2021) results, yet provided some optimism about this coming year. The shares fell about 10% on the report, in our view partly due to a run-up heading into the report and partly on dashed expectations for more robust growth, as well as some disappointment over a planned increase in capital spending.
Service revenues rose only 0.8% on an organic basis (after removing the effects of currencies and acquisitions/divestitures). These revenues represent the core of Vodafone’s business and comprise about 85% of total revenues (they exclude connection fees and equipment sales), and indicate whether the company is remaining relevant in the telecom market. The company said that reduced mobile phone roaming charges and visitor revenues (from lower tourism) restrained growth. Excluding these effects, the underlying revenue growth would have been a respectable/sturdy 1.7% – providing some encouragement that once the pandemic is fully lifted, its revenue growth will recover to a healthy level.
By geographic region, performance varied widely. The largest market, Germany, was strong, while other parts of Europe, particularly Italy, continue to struggle. Africa’s Vodacom continues to produce good growth.
Vodafone provides only half-year profit information, and even that is not clearly detailed like in American reports. The company could make it easier for investors to understand their profit performance. Second-half Adjusted EBITDA looks to have declined about 5% from the year-ago period. We view this as reasonable given the decline in near-100%-margin roaming and visitor revenues.
The company is making progress with its strategic initiatives, saying that it has finished with its first phase of reshaping Vodafone. Its net debt balance declined, helped by free cash flow and proceeds from the Vantage Towers spin-off. The company will be increasing its capital spending to maintain its market presence as well as to provide new growth opportunities – we had expected that the company’s spending was adequate already, so this is incrementally disappointing. However, management remains committed to its generous dividend, which provides an attractive 5.8% yield and supports its share price during the company’s turnaround.
Also, the company provided its “medium term ambition” for 5% adjusted EBITDA and free cash flow growth – so it must have some confidence in its ability to achieve this goal. If it is successful, the shares would respond very favorably. We will remain patient.
Vodafone’s turnaround is slow but moving forward and the shares are undervalued. As the shares generally trade on organic service revenue growth, better comparisons in upcoming periods should be supportive of the stock.
Ratings Changes
None.
Friday, May 21, 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 14 minutes and covers:
- Brief updates on:
- Macy’s (M), Vodafone (VOD) and Toshiba (TOSYY)
- Other comments on recommended stocks:
- Jeld-Wen (JELD) – investor day update, stock remains a “true” HOLD.
- Elsewhere in the Market:
- AT&T (T) – are we interested yet?
- SPAC buying a SPAC.
- Fed meeting minutes and no less than 9 hedging words in its rate outlook.
- Final note:
- Monthly Cabot Turnaround Letter will be published next Wednesday.
- The Friday Note will be published on Thursday next week.
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.