Please ensure Javascript is enabled for purposes of website accessibility
Turnaround Letter
Out-of-Favor Stocks with Real Value

October 29, 2021

This week’s note includes comments on earnings reports from ten recommended companies as well as The Catalyst Report. Our podcast also includes our views on Facebook (FB) and the metaverse, and the secret of low expectations.


This past Wednesday, we published the November edition of the Cabot Turnaround Letter. We make our case for four consumer staples stocks that have been discarded and now look like bargains, including Campbell Soup (CPB), Calavo Growers (CVGW), Energizer Holdings (ENR) and Utz Brands (UTZ). We also discuss four decent banks with P/Es below 10x, including Amalgamated Financial (AMAL), Citigroup (C), Hope Bancorp (HOPE) and Horizon Bancorp (HBNC).

Our featured BUY is Kaman Corporation (KAMN). Investors see a low-margin aerospace contractor tied to the soft commercial jet market and a fading weapons igniter program, but we see a beaten-down stock of a company with capable new leadership that is working to highlight a valuable precision engineering segment that otherwise is hidden behind several lackluster businesses.

This week’s Friday Update includes our comments on earnings from ten companies. Newell Brands (NWL) and Holcim Ltd. (HCMLY) reported this morning – on a first-impression basis their earnings looked fine, and we will have a more complete update next week.

We had no price target or ratings changes this week.

Next week, the earnings deluge continues, with reports from Berkshire Hathaway (BRK.B), GCP Applied Technologies (GCP), Credit Suisse (CS), Ironwood Pharmaceuticals (IRWD), Marathon Oil (MRO), Conduent (CNDT), Elanco Animal Health (ELAN), Gannett (GCI) and Vistra (VST).

Earnings updates:
Altria Group (MO) Altria is the domestic seller of Marlboro cigarettes which hold a 43% market share (non-U.S. operations were separated years ago into Philip Morris International). The company has struggled with declining cigarette volumes, slow development of non-combustible products and its disastrous $12.8 billion JUUL investment. Other issues: possible new regulations on menthol cigarettes and nicotine content, an IQUS patent lawsuit, and the market’s focus on ESG-favored companies. However, Altria’s resilience is underestimated by investors. Smokable volume declines have flattened while price increases buoy revenues. Led by a new CEO, the company is also developing promising new non-combustible products, and Altria generates and returns to shareholders considerable free cash flow, such that the high dividend yield appears secure.

Altria’s third quarter was uninspiring. Sales fell 3% (net of excise taxes), mostly due to weak smokeable products volumes which fell 13%. Operating company income fell 3%. Results were modestly below consensus estimates, cigarette volumes sold at retail may be returning to the 5% historical decline rate, and the tailwind from stimulus checks are meeting rising inflation that may hit smokers disproportionately high, partly offset by strong wage growth. Investors see little near-term upside so the shares sold off following the news. We remain patient, as the company’s cash flow looks resilient and eventually the value will accrue to shareholders.

In the quarter, cigarette volumes fell 13%, but that mostly reflects slower shipments to wholesalers and stores which are reducing their inventories. Retail demand slipped 5% – not ideal but manageable. Oral tobacco product growth was uninspiring at (-2%). Altria’s products held or gained market share in the quarter. The new on! brand gained a full percentage point of share and now has a 3% share.

Altria is working to find a solution to the likely ban on importing IQOS products. At this point it is difficult to accurately measure the impact of this ban – Altria may either find domestic manufacturing or pay a high royalty, or find some other resolution, few of which are encouraging at this point.

In terms of segment profits, Smokable product operating profits fell 2%, while Oral tobacco profits fell 8%. The company incrementally raised their full-year earnings guidance to a midpoint of $4.60/share, which would produce a 5-6% increase over last year. Management raised their share buyback program to $3.5 billion from $2 billion, and kept the year-end 2022 completion date.

A surprising and disappointing decision by the board was to retain the company’s 185 million shares in Anheuser Busch Inbev, which it received five years ago related to the SABMiller deal. The five-year lock-up expired on October 10. We had expected the company to sell this $11.5 billion stake. The only logic we can see to retaining these shares is that BUD stock remains depressed (down about 20% from the pre-pandemic price). If sold, we estimate the after-tax proceeds to be about $9 billion, which Altria could then use to repurchase more than 10% of MO’s total shares. We think eventually they will liquidate this stake.

Dril-Quip (DRQ)A major supplier of subsea equipment, Dril-Quip is struggling with the downturn in offshore oil and natural gas drilling. It generates positive free cash flow and has a sizeable cash balance yet no debt, all of which should allow it to endure until industry conditions improve.

Dril-Quip reported an uninspiring quarter, but it continues to produce positive free cash flow, has a fortress balance sheet ($375 million in cash and zero debt) and is likely to start seeing orders and revenues tick upward as energy prices remain robust. We will patiently wait, even if the market won’t.

Revenues of $83 million fell 8% from a year ago but were essentially in line with the consensus estimate. Adjusted earnings of $(0.35)/share was sharply lower than the $(0.14)/share loss a year ago. Adjusted EBITDA of $3.9 million fell 60% from a year ago – we consider this the cleanest measure of operating profits.

A year ago, the company was still working off some backlog, so revenues were higher back then. Weak new order flow has reduced the backlog, yielding lower revenues. However, Dril-Quip is seeing some indications of stronger activity in both onshore and offshore markets, and management is staying with their fourth-quarter guidance for new orders being “at the high end” of the $40-$60 million range. This would be the strongest order rate in at least a year.

Another indication of its confidence is Dril-Quip’s resumption of its share repurchase program, as it bought 1% of total shares outstanding in October. We would like them to be bold – by repurchasing $200 million of shares, or about 23% of total shares. This would leave them with over $175 million in cash (still debt-free), even as they generate over $30 million in free cash flow at the bottom of the cycle.

General Electric (GE)Led by impressive new CEO Lawrence Culp, GE finally appears to be righting its otherwise severely damaged business. Key priorities include a primary focus on the Industrial businesses (and an exit from the financial businesses), much better execution and a strategic emphasis on cash flow and debt reduction. To help achieve its goals, GE is decentralizing its operations, pushing more responsibility and accountability down to each business line.

GE continues to grind forward with its turnaround. Sales slipped fractionally, but profits increased due to cost cutting. Overall, CEO Culp is executing an impressive turnaround, driven party by sensible but aggressive strategic moves as well as by ground-level, nuts-and-bolts better management. Most segments are producing respectable profits, product offerings are more competitive, cash flow is much-improved (even as the appalling practice of factoring receivables is being terminated), the size of the GE Capital balance sheet is being slashed and the Industrial balance sheet is sturdy with zero net debt. Notably, the hugely important sale of GECAS, the aircraft leasing business, is on track for a November 1 closing, bringing in as much as $24 billion in cash. GE will reduce its debt further with much of the sale proceeds.

GE trimmed its full-year revenue guidance but boosted its full-year earnings estimate. It narrowed its Industrial free cash flow guidance although it kept the same midpoint – essentially this reflects higher confidence in its visibility for the fourth quarter. There is further favorable progress ahead for the GE turnaround, as management expects higher revenues, wider margins and higher free cash flow in 2022.

In the quarter, revenue of $18.4 billion slipped 1% from a year ago on an organic basis and was about 4% light compared to estimates. Adjusted earnings of $0.57/share rose 50% from a year ago and were about 30% higher than estimates. Adjusted Industrial operating profit margin rose 55% from a year ago, with the 7.5% margin increasing from 4.8% a year ago.

General Motors (GM) is making immense progress with its years-long turnaround. It is perhaps 90% of the way through its gas-powered vehicle turnaround, and is well-positioned but in the early stages of its electric vehicle (EV) development. GM Financial will likely continue to be a sizeable profit generator. GM is fully charged for both today’s environment and the EV world of the future, although the underlying value of its emerging EV business is unclear.

This was one of the more unusual quarterly results in GM’s post-bankruptcy history.

On the surface, GM’s third quarter looked awful. Nearly every headline metric fell sharply from a year ago: revenues fell 25%, its worldwide market share fell by a huge 1.5 percentage points, adjusted operating profits fell 55% and GM North America margins fell by 4.7 percentage points. Even the stalwart GM Financial saw its profits fall 9%.

However, the results were much better than analysts had expected. While sales were slightly below the consensus estimate, earnings of $1.52/share “blew away” the $0.97 consensus estimate. And, GM raised its full-year earnings per share guidance by 5%.

Yet, this new full-year guidance implied a weaker fourth quarter than analysts were expecting. This bad piece of news is what ultimately weighed on the shares, which traded down about 5%.

Beneath the bad news was some good news: GM vehicles are in strong demand, with more favorable pricing and a more-profitable mix than in the strong year-ago period. The problem was that the company couldn’t complete and then deliver enough vehicles due to shortages of semiconductor chips. We can see this in the 40% increase in GM’s own inventories compared to a year ago – the company has a lot of vehicles sitting around that are mostly completed. The company anticipates some relief in the fourth quarter, which should help profits and cash flow. Another contributor to the weak profits was higher costs – this won’t likely be going away anytime soon. Apparently, the chip shortage is going to be around for a while as well.

GM continues to move forward with its various EV, AV and other initiatives.

We have mixed views on GM now. Yes, they are an earnings powerhouse and will continue to generate huge profits as long as the vehicle market stays firm. And, the shares remain below our target price. But, we are not convinced that fully autonomous cars will be road-worthy anytime in the next five years, at least. And, we are not yet convinced that the U.S. is ready to shift to electric vehicles at anything but a snail’s pace. Maybe EVs can gain a percentage point of market share a year, but this share is currently only about 3%, so it might take until the end of the decade to get a 10% share. This is radically below the consensus and management’s view. Whether this is good or not is hard to say – it would disappoint dreamy tech investors that might drive up GM’s valuation and would show that a lot of GM’s $35 billion of advanced tech spending was wasted. But, it would ensure huge profits from gas-powered vehicles keep rolling in for a long time.

For now, we’re keeping our Buy rating, yet are thinking a lot harder about this stock.

Kraft Heinz Company (KHC) Following a disastrous cost-cutting strategy that left the company with diminishing relevance to consumers, Kraft Heinz is rebuilding its brands and products, led by new CEO Miguel Patricio (July 2019). The pandemic is providing a much-needed tailwind, particularly as Kraft Heinz is carrying a sizeable debt burden.

Overall, a respectable third-quarter report. Revenue was resilient even compared to year-ago results which were boosted by pantry-loading during the pandemic. Kraft was able to raise prices on average by about 1.5%, as it is trying to pass through cost increases of perhaps 8%. The higher prices had almost no impact on volumes which fell (-0.2%). The weak volume appears mostly due to some supply-related problems that reduced how much Kraft could produce and ship to stores. Sales to the foodservice channel recovered sharply, up 24%. Profits slipped mostly due to higher logistics, commodity and packaging costs. Nevertheless, free cash flow was a robust $2 billion. The dividend remains durable with a 4.4% yield. Management incrementally raised its full-year revenue and profit guidance.

In the quarter, revenues of $6.3 billion rose 1.3% from a year ago when adjusted for acquisitions, divestitures and currency changes, and was about 4% above the consensus estimate. Adjusted earnings of $0.65/share fell 7% from a year ago but was 12% higher than the estimate. Adjusted EBITDA of $1.5 billion fell 11% from a year ago but was 3% higher than the estimate.

Revenue growth was strongest in the International segment (which excludes Canada), posting 2.2% organic growth. Adjusted EBITDA was slightly higher this quarter than in the pre-pandemic third quarter of 2019. The Adjusted EBITDA margin this quarter was 23.6%, down from 25.2% two years ago. Kraft’s balance sheet remains strong enough, as the company whittles away at its debt, now at 3.4x leverage compared to 4.4x two years ago.

Molson Coors Beverage Company (TAP) Molson Coors is struggling with weak growth, yet is working under a new CEO to more aggressively develop specialty/higher-end beverages and reduce its reliance on mainstream and value offerings. Also, the company is increasingly focusing on its cost structure. Molson Coors continues to trade at a discount to its peers and its fundamental prospects.

The third-quarter results showed that company is making incremental progress with its turnaround, but we had expected better results, especially as Europe seems to have mostly reopened.

Revenues ticked upward (1% ex-currency), as higher prices offset a 3.6% decline in volumes. The Coors Light and “Above Premium” brands gained market share, and its non-alcoholic products like the ZOA energy drink and the La Colombe coffee drink continue to grow rapidly. Volumes were weak for one-time and enduring reasons including: wind-down of some brands, the exit from India, higher pandemic-related pub closures in Europe and a slowdown in economy brands in the U.S. Adjusted EBITDA fell by 11% due to higher input costs (which rose by 9%) and by higher marketing costs (up 4%).

Management remains confident in its fourth-quarter outlook, reiterating its full-year revenue (down 5% compared to 2020) and earnings guidance (no change from 2020).

In the quarter, revenues of $2.8 billion rose 1% in constant currency but were 3% below estimates. Earnings of $1.75/share rose 8% from a year ago and were 16% above the consensus estimate. Adjusted EBITDA of $643 million fell 11% and was 5% below estimates.

Underlying free cash flow is running about $933 million year-to-date, weaker than a year ago but is plenty large (if the company can sustain this rate) to continue to pay down its debt, fund its capital spending and dividend, and repurchase shares.

Nokia (NOK) Initially recommended in 2015, Nokia has struggled for years to regain its competitiveness. It appears that the new CEO, Peter Lundmark (March 2020), is capable of finally getting the company back into the game, particularly with the critical change-over to 5G over the next few years.

Nokia’s results were encouraging. Sales grew a modest 2% although North America sales grew an encouraging 9% and might be considered a leading indicator for global sales. Operating profits increased 30% and the 11.7% margin is now meeting its 10-13% target range. Cash production was a strong €0.7 billion, putting cash balances net of debt at €4.3 billion, more than double the year-ago amount. Overall, the story remains on track.

Revenues of €5.4 billion rose 2% and was in line with estimates. Adjusted net income of €0.08/share rose 60% from a year ago and was 14% above estimates. Management said that supply chain problems restrained revenue growth. The company’s operating efficiency continues to improve along with their technology development which is now basically on-par with competitors. Nokia is permanently raising its research and development spending. We’re fine with this – we trust that the current management is spending wisely to maintain its competitiveness.

As with General Electric, Nokia is ending its horrid practice of selling its receivables – a low-quality and expensive way to generate cashflow. As this practice winds down, cash production will be understated. We anticipate that Nokia will return some of its cash hoard to shareholder with a dividend and/or buyback.

Nokia is producing results now that it had targeted for 2023, so from that perspective the turnaround is operationally mostly done. To get the stock price higher, the company needs to continue producing strong results – this might take a year but we remain confident in our $12 price target.

Royal Dutch Shell (RDS/B) Shell has been on the recommended list for a long time (January 2015), so we are circumspect about its continued presence there. The company is well-managed and has navigated the weak oil/natural gas environment better than its peers, but its upside (and downside) is tied to unpredictable energy prices. The recently raised dividend now appears secure, to the extent that commodity prices remain stable, under its new policy.

Shell reported a remarkably strong third quarter. Cash flow from operations was a record, at $17.5 billion. Per-share earnings were more than 4x the year ago result and free cash flow was a huge $11.1 billion (excluding divestiture proceeds), up 65% compared to a year ago. Higher oil and natural gas prices, and a strong $4 billion commodity derivatives inflow, drive the increase. Compared to the prior quarter (second quarter 2021), Adjusted EBITDA was essentially flat, while free cash flow increased by 32%.

Despite the strong results, the market was disappointed as earnings of $0.53/share fell well short of the $0.70 estimate. Some of the shortfall was due to issues in its natural gas and refining operations. Also, the $4 billion derivatives inflow will reverse next quarter, so its effect was merely timing, not substance.

Shell’s balance sheet now holds only $57 billion in debt net of cash, down from $73.5 billion a year ago. Strong cash flows plus divestiture proceeds drove the improvement. Shell will use some of the proceeds from its $9.5 billion sale of the Permian Basin operations to reduce its debt and pay out $7 billion to shareholders. The company is becoming a cash flow machine, although it is held back by high spending on renewables.

On this point, activist Dan Loeb/Third Point has taken a sizeable position in Shell, noting that the company is “one of the cheapest large-cap stocks in the world.” He (rightfully in our view) attributes this cheapness to Shell’s impossible task of satisfying two groups: one who wants strong free cash flow and cash returns to shareholders while another wants it to aggressively invest in renewable energies. Its strategy currently satisfies neither group. His solution is for Shell to split into two companies: one that houses the oil, refining and chemicals businesses with a focus on cash distribution to investors, and another that houses the natural gas, marketing and renewables businesses with a high reinvestment focus.

We say “hear, hear” and hope that Shell adopts this strategy. We don’t want to underestimate Loeb’s ability to garner strong support among all Shell shareholders – we think many (most?) Shell investors agree with him. Rather than having the option of simply ignoring this proposal, we think that Shell’s management is immediately put in a defensive position. They responded with a rebuttal dismissing the idea, with the CFO saying essentially that while the idea sounds good on paper, it would hobble Shell’s ability to “make a difference in the energy transition.” We view this as missing the entire point of Loeb’s argument. The logic of his idea is so solid and so obvious that we’d put the odds of adoption at over 60% at some time in the next 2-3 years.

Western Digital (WDC) Western’s new and highly capable CEO, David Goeckeler, who previously ran Cisco’s Networking & Security segment, is making aggressive changes to improve the company’s competitiveness in disk drives and other storage devices, as well as bolster its financial strength. The company generates free cash flow and holds plenty of cash to buy time for the turnaround and to help pay down its elevated debt.

Western put up good fiscal first-quarter results, but fiscal second-quarter guidance was weak, dragging the shares down about 10% in Friday post-earnings trading. All-in, the long-term story remains intact, but delayed.

In the quarter, revenues rose 29% from a year ago and was in line with estimates. Adjusted earnings of $2.49/share was nearly 4x earnings of $0.65 a year ago and 2% better than estimates.

Gross margins and operating margins expanded sharply from a year ago due to the stronger revenues as well as decent expense controls despite supply chain and other difficulties. Free cash flow was robust at $224 million, which the company used to pay down some of its modestly elevated debt load. Product upgrades and innovations look likely to continue the company’s growth and development.

Second-quarter revenue guidance was about 9% below the consensus estimate while earnings guidance of $1.95-2.25/share was about 20% light. Two problems will drag on the second quarter. First, supply chain issues are broadening from PC and consumer products to cloud and datacenter companies. These customers can’t get all of the components they need to build their units, so they are ordering fewer of Western’s products. And, Western can’t get all of the components it needs, so it can’t assemble and ship its customers’ orders. Western said its December quarter hard drive sales will be down as much as 12-13%. This is worse than Seagate’s likely flattish outlook, raising competitiveness concerns.

Second, the flash/NAND market pricing is weakening a tad, leading investors to worry about a sharp drop in future pricing – a chronic risk in a commodity industry.

Management said that end-demand, particularly for hard drives, remains incredibly strong, and we are inclined to believe them. As far as competitiveness goes, Western seems to be at least on par with its peers. We’d see some of the revenue spread between Western and Seagate being due to normal back-and-forth of volumes typical in any given quarter. For NAND pricing, we acknowledge the risk but it appears manageable.

The company had no comments on any deal with Kioxia or a split of itself into hard drives and NAND flash memory.

Xerox Holdings (XRX) While the near-term outlook remains clouded, as office workers remain in partial work-from-home mode, we believe the company’s revenue and cash flow will recover. Investors underestimate Xerox’s value due to its zero-growth prospects, but the company’s hefty free cash flow has considerable value. The balance sheet is strong, new and capable leadership is working to drive shareholder value higher, and its generous dividend looks reliable.

Third-quarter results showed that Xerox’ recovery will take longer, as office workers are not returning as quickly as we and most investors had anticipated. Also, supply chain issues are limiting sales. These effects led to essentially flat revenues compared to a pandemic-weakened year-ago quarter. Profits fell 15% but per share net income was flat due to Xerox’s aggressive share repurchases (impressive). We are staying with the Xerox story.

In the quarter, revenues of $1.8 billion were flat with a year ago but were about 3% below the consensus estimate. Adjusted earnings of $0.48/share were flat compared to a year ago but were about 12% higher than estimates. Adjusted EBITDA of $153 million fell 31% and was about 35% below estimates.

Equipment sales fell 8%, as machines used primarily in offices and at commercial printers were weak. Sales of entry-level machines used at homes and in smaller offices jumped 4%. Encouragingly, sales of paper and other supplies surged 15%, as workers consume more. Also, component shortages and other production issues reduced the volume that Xerox could manufacture and ship. Due to this problem, the backlog of ordered but unfinished goods was about double normal levels. Xerox’s profit margin fell due to these issues and to rising shipping and input costs.

Xerox’s balance sheet remains sturdy, free cash flow remains healthy, the dividend looks solid, and the on-paper carve-out of the financial services is progressing, as is the turnaround overall.

Looking forward, revenue guidance for the full year was reduced to about 3% below the consensus estimate, as the company anticipated the problems extending into 2022. Favorably, free cash flow guidance was unchanged at $500 million, perhaps as the backlog jump was only a one-time step-up rather than an ongoing issue. At some point, when backlog declines back to normal, we anticipate that Xerox will have a cash flow boost. Overall, the results were OK and leave plenty justification for holding tight onto XRX shares.

Friday, October 29, 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 19 minutes and covers:

  • Brief updates on:
    • This month’s Cabot Turnaround Letter
    • Companies reporting earnings

  • Elsewhere in the Market:
    • Facebook (FB) confirms our metaverse conjecture

  • Final note:
    • Red Sox fans and the secret of low expectations.

Please feel free to share your ideas and suggestions for the podcast with an email to either me at or to our friendly customer support team at 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
October was a tad quieter than September. Activists stepped up with more activity, although many of their targets were stocks that can’t reasonably be considered turnarounds. Several Cabot Turnaround Letter stocks were targeted by activists this month. Acquisition activity in the small/regional banking sector increased, as well.

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:

columbia bank logo

Columbia Banking System (COLB) $2.7 billion market cap – Based in Tacoma, Washington, this $17 billion in assets bank is on an acquisition spree, and has added new talent and directors to help manage its growth. There are many moving parts here, but at a modest 1.6x tangible book multiple and 12.1x earnings valuation, the valuation is unchallenging.

alerus logo

Alerus Financial Corporation (ALRS) $538 million market cap – This $3 billion bank, based in small-town North Dakota, has a solid banking, tech and cultural foundation to continue to expand its geographic reach. The new CEO looks highly qualified to keep Alerus on track. While the shares have moved some, the valuation is inexpensive at about 1.8x tangible book value and 11.6x earnings.

us foods logo

US Foods Holdings Corporation (USFD) $8.0 billion market cap – US Foods is one of the nation’s largest food distribution companies. In the past few years, the company has made several acquisitions to expand its reach. However, since the 2016 IPO at $23, the shares have lagged the broad market, helping attract the interest of activist Sachem Head which has taken a 9.2% stake.

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.