Updated/Revised as of February 17, 2020
Earnings reports for Turnaround Letter recommended companies for this past week are summarized below (in alphabetical order). All companies mentioned retain our Buy rating and price targets. This updated note revises our original view on Kraft Heinz’ dividends as noted in the earnings commentary below
Barrick Gold (GOLD) - The company reported healthy revenues and earnings, both of which were higher than consensus estimates. Under the new leadership that is overseeing legacy Barrick, newly-acquired Randgold and the new Nevada joint venture, “new” Barrick continues to upgrade and increase the efficiency of its mining portfolio. Net debt declined by $2.2 billion, or about 47%, from a year ago. Lower debt reduces the company’s risks, increases its negotiating power with host countries, and offers strategic flexibility. Steadily rising gold prices provide a useful tailwind. The company raised its quarterly dividend 40% to $.07/share, which produces a 1.4% yield.
BorgWarner (BWA) - Revenues rose 2.6% excluding currencies and divestitures compared to a year ago. BorgWarner showed that it can grow much faster than its sluggish end-markets. Adjusted per-share earnings of $1.17 were about 3% below a year ago but about 14% higher than estimates. The 13.3% operating profit margin was impressively strong, helped by lower costs. Full-year free cash flow of nearly $700 million was 21% higher than a year ago. BorgWarner is executing well in a challenging environment.
BorgWarner offered 2020 guidance for flattish sales, a 5% decline in operating profits and steady free cash flow led by higher operating cash flow but offset by higher capital spending. However, this guidance excludes the impact of acquiring Delphi Technologies.
While BorgWarner is aggressively transitioning to an electric vehicle world with its in-house products, its ~$3 billion deal ($1.5 billion in stock, plus assumption of debt) for Delphi will accelerate this transition. While it should also produce stronger profits, the deal carries execution risk. We currently continue to view BorgWarner, and its Delphi combination, favorably.
Credit Suisse (CS) - Departing CEO Tidjane Thiam is leaving the company in much better shape than arguably at any time in the past decade. The company produced fourth quarter profits of 852 million Swiss francs, triple its year-ago profits. Full-year profits of 3.4 billion Swiss francs were nearly 70% above a year ago. Fourth quarter return on tangible equity of 8.6% indicates that the bank is using its capital much more effectively. Assets under management continue to grow, now at 1.5 trillion Swiss francs. Capital levels are robust, with the widely-watched CET1 capital ratio at 12.7%. Credit Suisse shares trade at .85x tangible book value, essentially in-line with the rule-of-thumb that values a bank at ten times its ROE.
With Thiam’s departure, we are watching to see if the company changes its strategic or operational priorities. The new CEO is a long-time insider that may not be as likely to shake up the organization’s cost structure, and appears more likely to redirect its focus on growth. We wonder if some friction may result from the somewhat sizeable shareholder group who supported Thiam but not the chairman. For now, we retain our Buy rating on CS shares.
Kraft Heinz Company (KHC) - Kraft is in the very early stages of its multi-year turnaround, as new CEO Miguel Patricio (June 2019) diagnoses the underlying issues, stabilizes the financial position and puts new people and a plan in place to improve the company. Results in the quarter were mixed, generally in-line with consensus but weaker than a year ago.
Revenues fell 5.1%, but after divestitures and currencies the revenues were only 2.2% below a year ago. Sales volumes were inversely correlated with pricing - in all but one region and for the company overall, where pricing was raised, volumes weakened, and vice verse. This isn’t particularly surprising, as consumers likely view Kraft’s prosaic product line-up as uninspiring and worth buying only if the “price is right”. While the experiment to raise prices was useful, pricing power won’t likely play a meaningful role in the company’s turnaround.
Adjusted EBITDA fell 6.6% from a year ago, and the margin narrowed modestly to 23.9% from 24.3% a year ago. About half the decline was due to divestitures and currency, reflecting some resilience in the company’s profitability. A spike in centralized corporate expenses (not at the regions) dragged down profits but we see this as eventually reversing. However, absolute profits matter to Kraft, as their debt must be paid in actual cash - in this regard Kraft’s unchanged debt balance from a year ago remains an overhang. The debt markets are nervous about this debt: on Friday, prices fell to around 90 cents on the dollar for some of the company’s longer-dated bonds, and S&P and Fitch reduced Kraft’s debt ratings to below investment grade. Kraft declared their $.40/share quarterly dividend and highlighted this as an indicator of their confidence in the turnaround. We appreciate the confidence, but recognize the risk of a cut as it is a nearly $2 billion/year cash outflow.
We worry little about the large write-downs in the value of Kraft’s assets. The charges to earnings only acknowledge what we and (hopefully) all equity investors already know.
Kraft shares have been volatile but are roughly in-line with the Buy-recommendation price of $28.68.
(Please note: our original note stated that “the debt markets continue to have strong confidence in Kraft’s debt,” and that “We …believe the dividend will be sustained, yet we recognize the risk of a cut as it is a nearly $2 billion/year cash outflow.”)
Mattel (MAT) - Mattel’s turnaround continues to advance. While revenues fell 3% from a year ago, led by a 9% decline in American Girl and Infant/Toddler/Preschool brands. Key brands like Barbie and Hot Wheels showed positive growth. Barbie’s 3% growth would likely have been higher except for strong new competition from Hasbro’s “Frozen” dolls.
Profits (Adjusted EBITDA) were flat compared to a year ago but were about 20% higher than dour consensus expectations. The company exceeded its $650 million cost-cutting target by 35%. [This is a remarkable feat - cutting costs equal to about 20% of revenues]. Mattel’s debt net of cash was unchanged from a year ago. Debt reduction is an important component in our view - we would like to see more cash flow devoted to this in 2020. In 2019, Mattel produced free cash flow of $65 million, the first positive number in three years.
New CEO (April 2018) Ynon Kreiz continues to improve Mattel, emphasizing better execution, cost-efficient operations and outsourced rather than in-house production. He is also working to develop new and more relevant revenue streams that leverage the company’s brands. The 2020 Adjusted EBITDA guidance of $575 million to $600 million represents a $125 million improvement over 2019, and would produce a healthy 12.8% profit margin. This would be an impressive achievement that would likely drive the shares higher.
Mohawk Industries (MHK) - Revenues were down 1% from a year ago. Adjusted per-share earnings were 11% below a year ago but slightly better than consensus estimates. Mohawk continues to battle numerous headwinds, including aggressive competition, slow demand, cost inflation and the growth of LVT (luxury vinyl tiling), which are all weighing on pricing and volumes. However, the company is addressing these with a wide range of operating adjustments which we believe will mostly offset the negative effects. First quarter 2020 earnings guidance point to an 8% decline from 1Q19 and are about 4% below consensus estimates.
The company generated strong free cash flow in the quarter and the full year. Debt net of cash is down 22% from a year ago to a low 1.6x Adjusted EBITDA. We get the sense that the company is keeping its balance sheet sturdy for both defensive reasons (in advance of a potential profit-sapping recession) and offensive reasons (to acquire recession-hobbled competitors at bargain prices).
Molson Coors (TAP) - Molson continues to grind away at its problems, reporting earnings that were about 16% better than consensus estimates. Fourth quarter revenues increased by 2.8%, helped by incrementally higher pricing and a higher-value mix of beverages as the company works to move toward premium products and away from economy brands. The higher pricing, however, led to a 1% decline in volumes, particularly in the weaker economy brands. Importantly, “priority” brand volumes grew 1.6%. The revenue growth was encouraging, but the company has more work ahead to make its shift up-market sustainable.
Underlying costs fell modestly as ingredient inflation was offset by cost controls and from some non-recurring shipment, compensation and other benefits. Underlying EBITDA increased by 15.8%.
For the full year, Molson Coors’ $1.3 billion of underlying free cash flow was near the low-end of its guidance for $1.4 billion (+/- 10%). Their 2020 underlying free cash flow guidance is for $1.1 billion (+/-10%), indicating continued modest decay in their fundamentals.
Molson Coors reduced its debt (net of cash) by about $915 million from a year ago. Debt reduction remains important to reducing the company’s overall risk level. The dividend looks sustainable but we don’t expect an increase this coming year: the current $.57/share quarterly dividend is in the middle of their implied target payout range, based on their guidance for 2020 underlying EBITDA of $2.2 billion.
The company is moving in the right direction: there is new leadership in key roles, including the CEO seat (Gavin Hattersley), with sharper priorities in place.
Newell Brands (NWL) - Fourth quarter revenues were modestly above estimates while per-share profits were 14% higher than estimates. Adjusted EBITDA was about 3% higher than estimates.
The massive divestiture program was completed in the fourth quarter, so Newell’s prospects are now driven by core sales and profits as well as cash flow production. Newell’s management provided some encouraging news: that full year operating cash flow was $1.0 billion and their expectation is that 2020 operating cash flow will be modestly higher at between $1.0 billion and $1.15 billion. Meeting this goal implies some stability to Newell’s outlook (guided to flat revenues adjusted for changing currencies, earnings per share down 11%, free cash flow equal to net income).
Newell has a fresh leadership team that is modernizing its sales efforts and streamlining its cost efforts. Overall, Newell’s turnaround remains on-track.
Disclosure Note: One or more employees of the Publisher own shares of all Turnaround Letter recommended stocks, including the stocks mentioned in this note.