Today’s note includes earnings updates on Duluth Holdings (DLTH) and Signet Jewelers (SIG), the podcast and the Catalyst Report. We publish the Catalyst Report on the Friday after each monthly issue of the Cabot Turnaround Letter. There were no changes to any of our ratings this week.
We encourage you to take a look at the Catalyst Report – it is popular among many of our subscribers and unique on Wall Street. This report lists all of the companies that had a major catalyst in the past month, including CEO changes, new activist involvement, emergence from bankruptcy, major acquisitions, and others. If for no other reason, it’s an interesting list of what is going on in the market from a company-level perspective, rather than a stock-price performance perspective like most of the media.
For stock-picking, the names provide a shopping list, of sorts. For names that have out-of-favor stocks, they can point to interesting turnaround candidates, which we highlight with a * on the report. Often enough, some of these names become Buy recommendations for the Cabot Turnaround Letter.
This past week we published the September edition of the Cabot Turnaround Letter, where we looked at five interesting oil E&P companies, three one-off contrarian stocks, three former winning stock picks whose shares have fallen back to attractive prices, and discuss our feature recommendation, Marathon Oil Company (MRO).
Earnings updates:
Duluth Holdings (DLTH) – This retailer of rugged workwear and outdoor gear struggled with a disjointed and overly aggressive store expansion strategy. Duluth ousted the CEO in September 2019, brought the founder back to the CEO seat on an interim basis, terminated the failed strategy, and hired a new, permanent CEO in May 2021. The company has immense opportunities – its challenge is to strike a successful balance between pursuit and execution.
Duluth reported reasonably good results, provided full-year revenue and profit guidance that was fractionally above current estimates and introduced the new CEO’s four-year plan. The company has halted and begun to reverse the damage caused by its prior, flawed strategy, but the turnaround is in many ways restarting. We remain patient – there are parts of the strategy we like and parts we aren’t yet on board with – and understand that this will be a multi-year turnaround.
Sales rose 8.6%, to $149 million, from a year ago and 22% from two years ago, and were about 5% higher than the consensus estimate. Earnings per share (unadjusted) of $0.27 compared to $0.18 a year ago and was sharply higher than the $0.05 consensus estimate. Adjusted EBITDA of $22 million rose about 30% from a year ago and was nearly triple the consensus estimate. Duluth does not provide same-store sales data, so there is no way to accurately determine whether their sales and marketing efforts are having a positive impact. Overall, we’d say the company is making slow progress, but is at least moving forward.
The balance sheet is seasonally strong, with $19 million in cash and no corporate debt, although it continues to hold $45 million in financial leases (essentially debt) and $27 million in non-recourse debt related to its properties. Our preference would be for Duluth to clean up these balance sheet items – their small tax savings benefits are more than offset by investors having to check yet another box as “probably yes” when thinking about whether Duluth has too much debt or slightly murky financial obligations.
The company’s new CEO, Sam Sato, introduced his turnaround plan, called “Big Dam Blueprint” which plays off of Duluth’s beaver cartoon character. Math first: the plan calls for $1 billion in sales by 2025 (compared to about $700 million likely for this year), about $2 in earnings per share and positive free cash flow. At face value, this would imply a price target in the mid-20s or more. But, there are so many ifs, maybe’s and maybe-not’s that we are keeping our current 20 price target.
The new CEO’s blueprint has a great name, no doubt. We like the new digital-first mindset, slow pace of new store openings, emphasis on their core brands, and focus on building tech infrastructure. But, it seems that they should focus more on their customers than digital per-se, unless the culture is so Luddite that this obvious need to adapt to the digital world is somewhat radical. Although they spoke on the call about their core-brand focus, the strategy highlights creating new brands. While their efforts so far have gone well, creating new brands is a high-risk and expensive strategy for a crowded market. And, a proliferation of brands risks creating consumer confusion. Duluth has good core brands – they should go slowly on creating new ones.
Frustratingly, the company barely mentions what we see as a huge opportunity – third-party sales. Their products are plenty good, but not enough people seem to know about them or bother to go to their stores to buy them. More aggressive third-party sales would basically be like franchising in the restaurant business – accelerated marketing and market presence with almost no capital outlay.
We like the priority given to operations and logistics, as this is critical as a foundation for growth, but it had appeared that the company resolved most of these a year ago. We wonder if there are deeper problems that we don’t know about.
So, it all comes down to execution, and we’ll have to be patient to see how things progress.
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 tolerated a toxic culture. New leadership is making impressive progress in reversing all of these problems as it overhauls every aspect of the company. With the turnaround, Signet is becoming much more relevant, profitable and valuable.
Signet’s exceptionally impressive turnaround continues. The company reported another strong quarter and raised its full-year revenue guidance by about 5% and full-year earnings by about 25% – even after sharp guidance raises last quarter. The company raised their share repurchase authorization to $225 million (to be completed on an opportunistic basis) and restarted their dividend at $0.18/quarter (producing a yield of about 0.9%).
The shares are still moderately undervalued on reasonable projections (which keep being raised). Fundamentally, the company is riding the strength in jewelry demand, which is a strong tailwind but will eventually fade to a normalized pace, perhaps starting in calendar 2022. Interestingly, the new Covid variant has been a positive as it has delayed the transition of consumer spending from jewelry to travel and entertainment.
Yet, following the total overhaul of its operations and strategy, Signet is top-to-bottom a vastly different and better company than it was three years ago: it is adapting to customer trends in product/services and in channel preference (online, in-store, other), managing its business much more tightly, hiring better talent (seems to have become a talent magnet in the jewelry industry due to its innovations) and strengthening its balance sheet, profit and cash flow profile. We don’t see an unraveling of the business.
However, like any stock that has surged 12x (in Signet’s case, 12x from its early 2020 low of about 6.50 to the current 85.26), it is vulnerable to temporary pullbacks, some possibly large. For now, we are retaining our Buy rating given the reasonable valuation and strong fundamentals.
In the quarter, comparisons to a year ago are not relevant as most of Signet’s stores were closed due to the pandemic.
Second-quarter sales of $1.8 billion doubled from a year ago and were about 9% above consensus estimates. Same-store sales rose 38% from the comparable quarter two years ago, an exceptionally strong improvement highlighting the merchandising and operating changes underway. E-commerce sales doubled from two years ago and were almost 20% of sales. Even excluding the effect of strong e-commerce sales, same-store brick and mortar sales rose 28% from two years ago.
Adjusted operating profits of $223 million compared to a loss a year ago and a profit of $53 million two years ago. The adjustments were insignificantly minor at $2 million, so the results were clean. Signet’s operating margin expanded to 12.5% from 3.9% two years ago. Better sourcing and merchandising are boosting their gross margins, while a much more effective cost structure is restraining their expenses.
Adjusted earnings per share of $3.57 compared to a $(1.13) loss a year ago and a profit of $0.51 two years ago, and were more than double the consensus estimate. This quarter’s results include a 20% increase in the share count to reflect the dilution from the convertible shares, which is factored into our valuation.
Cash flow was robust and the company now has $1.6 billion in cash against only $147 million in long term debt. The convertible debt of $625 million (now $673 million after factoring in PIK dividends), which looked ridiculously out-of-the-money with its $82/share conversion price compared to the $17.47 share price at our recommendation date, is now in the money. The conversion would add about 8.2 million shares to the share count if converted. Signet made no comments during their earnings call about whether they will buy out these converts.
So, overall, we are staying with the story, but our views may change.
Ratings changes:
None.
Friday, September 3, 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:
- Signet Jewelers (SIG) – Another strong earnings report.
- Duluth Holdings (DLTH) – Decent results, new CEO outlines strategy, this might take a while.
- Wells Fargo (WFC) – New sanctions instead of sanctions relief?
- Berkshire Hathaway (BRK.B) – New economy investments working out well.
- Western Digital and Toshiba – Getting closer to a Western/Kioxia deal?
- General Motors (GM) – Battery fires and semiconductors.
- Dril-Quip (DRQ) – New CEO and chairman, no likely change in strategy.
- Gannett (GCI) – Hires a top data scientist.
- Altria (MO) – Raises its dividend in an encouraging signal for future profits.
- Walgreens Boots Alliance (WBA) – New CEO adding to her team.
- Elsewhere in the Market:
- Tech war between the U.S. and China heats up a bit.
- Final note:
- Quote from Ted Weschler at Berkshire Hathaway on losses.
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.
Catalyst Report
August saw a return to large numbers of catalysts (56), after a remarkably quiet July (13). The month saw several agreed-to deals and a few bidding wars (including Veoneer and Kansas City Southern). Spin-off activity and CEO changes returned to life, as well. Two interesting new CEOs were in the electric vehicle industry: Lordstown Motors (RIDE) and Workhorse Group (WKHS) both brought in a highly regarded new CEO. These are very speculative situations but at a minimum are worth watching.
The Catalyst Report is a proprietary monthly report that is unique on Wall Street. It is an extensive listing of companies that have experienced a recent strategic event, such as new leadership, a spin-off transaction, interest from an activist investor, emergence from bankruptcy, and others. An effective catalyst can jump-start a struggling company toward a more prosperous future.
This list is intended to be comprehensive. While not all catalysts are meaningful, some can bring much-needed positive changes to out-of-favor companies.
One highly effective way to use this tool is to pair the names with weak stocks. Combining these two traits can generate a short list of high-potential turnaround investment candidates. The spreadsheet indicates these companies with an asterisk (*), some of which are highlighted below. Market caps reflect current market prices.
You can access our Catalyst Report here.
The following catalyst-driven stocks look interesting:
Brookfield Reinsurance Partners (BAMR) $675 million market cap– This new company was recently created by highly regarded Brookfield Asset Management to buy annuity and pension liabilities that insurance and other companies want to offload, following an industry trend. Brookfield Re’s deal to acquire American National Group is their opening move.
United Natural Foods (UNFI) $2.1 billion market cap – Unifi’s new CEO was previously the head of highly regarded Staples, and prior to that was President of Coca-Cola North America. This could be just what United needs. One interesting twist is that the new lead independent director is Jack Stahl, former Coca-Cola president and former president/CEO of Revlon (2002-2006), who brings considerable board experience.
Danone S.A. (DANOY) $50.3 billion market cap– The entire board of directors agreed to resign over the next two years, paving the way for incoming CEO de Saint-Affrique to craft and implement his turnaround plan. Danone shares have gone nowhere in over a decade and trade at a relatively modest 11.1x estimated 2022 EBITDA. The ADR yields about 3.4% (1 ADR: one-fifth of a common share).
SK Telecom (SKM) $19.3 billion market cap – South Korea Telecom will vote soon to approve the spin-off of its non-core operations, including memory chip maker SK Hynix. This could unlock considerable value for both the former parent and the newly-spun company.
Disclosure: The chief analyst of the Cabot Turnaround Letter personally holds shares of every Rated recommendation. The chief analyst may purchase securities discussed in the “Purchase Recommendation” section or sell securities discussed in the “Sell Recommendation” 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 at any time.