October 22, 2021

This week’s update includes our comments on earnings from Baker Hughes (BKR) and Mattel (MAT) as well as commentary on several stocks.

We are raising our price target on Wells Fargo (WFC) from $49 to $55. The shares have moved about our target, prompting our change. Third-quarter results were good enough, with more improvements ahead, and the shares remain undervalued, particularly if they are able to get relief from the asset cap.

Next week, the earnings deluge hits, with General Electric (GE), Xerox (XRX), Kraft Heinz (KHC), General Motors (GM), Altria (MO), Nokia (NOK), Royal Dutch Shell (RDS/B), Western Digital (WDC), Credit Suisse (CS), Molson Coors (TAP), Newell Brands (NWL) and Holcom, Ltd (HCMLY) scheduled to report earnings.

Earnings updates:
Baker Hughes (BKR) – One of the world’s largest energy service companies, Baker Hughes is currently beleaguered by the depression in global oil and gas drilling activity. Also, the shares are being weighed down by General Electric’s sale (over 3 years) of its huge 377 million share stake. The company’s investment-grade balance sheet and positive free cash flow should provide it with the ability to endure until the industry’s eventual (at least partial) recovery.

Baker’s third-quarter results were disappointing relative to the consensus estimates, pushing the shares down from their recent peak. However, the company continues to increase its orders and revenues as well as generate strong free cash flow. The oilfield recovery is coming, but not as fast as analysts had hoped for. Baker is also more clearly delineating its oilfield businesses from its industrial businesses, which may portend a split-up. We see the Digital Solutions segment, which produces hand-held and related industrial instruments, as being a particularly weak fit. Any divestitures or splits along these lines would be clear positives for BKR shares.

The company is using its cash flow to slowly chip away at its share count, repurchasing 4.4 million shares for about $106 million in the quarter as a starter for its new $2 billion repurchase program. Baker’s commitment and ability to pay its dividend remains strong.

Baker was optimistic, but realistic, about its 2022 outlook, not specifying numbers but spoke of better growth and margins. Even taken at face value, this is encouraging for BKR shares.

While the shares briefly reached our price target, and have now slipped below it, we continue to like BKR shares.

In the quarter, revenues of $5.1 billion rose 1% from a year ago but were 4% below the consensus estimate. Adjusted earnings of $0.16/share rose sharply from the $0.04/share profit a year ago but fell 24% shy of the consensus estimate.

Profits were strong regardless of the “miss” versus estimates. Adjusted operating income was $402 million, while adjusted EBITDA was $664 million, and both were meaningfully better compared to a year ago and the sequential prior quarter. Free cash flow of $305 million was encouraging as well. Since year end, Baker has reduced its debt net of cash by almost 20%.

Mattel (MAT) – At our initial recommendation in 2015, Mattel was struggling with its failure to adjust to the realities of how young children spent their playtime. This failure had produced years of revenue decay. In addition, its cost structure became bloated and its debt levels increased. However, led by its new CEO, Mattel now appears to be finding its way.

Mattel reported relatively strong third-quarter sales and profits that were above estimates and raised its full-year revenue guidance and earnings guidance by about 2%. The shares are flattish today, perhaps as investors sell on the good news or are worried about the gross margin pressure.

Revenue of $1.8 billion grew 8% from a year ago and was 4% higher than the consensus estimate. Adjusted earnings of $0.84/share fell 11% from a year ago but was 15% above the consensus estimate. Adjusted EBITDA of $463 million slipped fractionally but was 15% higher than the consensus estimate which forecast a decline.

Overall demand looks healthy across most categories. E-commerce is an important source of growth, now comprising 25% of total sales. Input cost inflation, unfavorable mix and unfavorable foreign currency rates (due to the strong dollar) restrained gross profits, but higher advertising spending was partly offset by lower administrative costs.

Mattel earns about half its full-year profits in the third quarter (as stores stock up on holiday products) and the rest of the year looks good – and, inflation/supply chain issues don’t appear to be creating too much of a profit headwind.

Strong free cash flow is helping incrementally improve the balance sheet, which should be much stronger after holiday receivables are collected in the fourth quarter. Mattel is progressing toward its goal of an investment-grade balance sheet.

Strategically, Mattel is making impressive progress: it renewed its license with WWE (World Wrestling Entertainment), signed a licensing deal that expands its relationship with Disney and Pixar, and is developing movies and other content for Netflix and others. The Mattel story continues to improve, even as the share valuation remains attractive.

Ratings changes:
None.

Friday, October 22, 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 15 minutes and covers:

• Brief updates on:
  
  • Macy’s (M) – More on the e-commerce spin-off concept
  • Credit Suisse (CS) – Old woes never seem to go away
  • Western Digital (WDC) – Kioxia deal talks stall, for now

• Elsewhere in the market:
  
  • Two unusual/bizarre market events: WeWork (WE) and Digital World Acquisition Corporation (DWAC)
  • Thoughts on the metaverse

• Final note:
  
  • End of the magic for Red Sox?

Prices are closing prices as of date indicated, except for those indicated by a "*", which are price as of SELL recommendation date.

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 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.