Earnings reports from 12 companies. Most encouraging were reports from BWA, CNDT, GCP, JELD, MOS and VIAC. All stocks retain their Buy ratings and price targets, although we reduced ADNT’s price target to 28.
Adient (ADNT) - The automobile seat maker’s previously impressive turnaround has hit a pothole with the pandemic, reflected in the weak results and the 14% hit that the stock took on the earning release date. Revenue was essentially zero in April but had returned to about 75% of normal by the end of June. The company is now targeting additional cost-cuts such that cash flow will be about at breakeven in 2021 at a much lower vehicle production level. Fourth quarter guidance was encouraging, pointing to revenues and profits in-line with year-ago results. We continue to have high conviction in the turnaround despite the near-term challenges, but are reducing our price target to $28 to reflect the new reality.
Revenues fell 61% and Adjusted EBITDA fell to a loss of ($122 million) compared to $205 million a year ago. Adjusted loss per share of $(2.78) compared to a profit of $0.38 a year ago and to estimates of $(2.05).
Liquidity is healthy: although the company burned through $530 million in negative free cash flow in the first half of the year, it still carried $1 billion in cash and had available another $200 million in cash from its credit line. In July, Adient fully repaid its credit line. In the fourth quarter, Adient is expecting to receive $500 million in proceeds from the sale of its China joint ventures. Much of the cash outflow was driven by the production ramp-up, so in the next quarter much of this outflow should reverse.
We retain our Buy rating with our updated $28 price target on Adient (ADNT)
Amplify Energy (AMPY) - Following the combination with Midstates Petroleum last year, Amplify has cut its operating and drilling costs significantly. With oil and natural gas prices down sharply, this buys them time and supports the call option value of AMPY shares. Amplify is getting close to cash-flow break-even, which would extend the life of this call option. But, the company has fewer levers to pull to generate cash and the call option might run out of time by year-end without any uplift in oil and gas prices. AMPY shares carry a high risk of bankruptcy.
Revenues in the quarter fell 45% from the first quarter of 2020, mostly due to lower commodity prices as the company’s production volumes fell only 7%. Given its sharp cut-back in capital spending, the production stability is surprisingly resilient. Lease operating costs and general/admin costs fell in the quarter, helping Amplify increase its adjusted EBITDA from the first quarter of 2020. For exploration companies like Amplify, that have essentially no seasonality effect, comparisons to the previous quarter (not year-ago) can illustrate its progress.
Amplify has $265 million in total debt, with only a small cash balance. It has a few more sources of cash that it can tap until it is fully cash-flow break-even including a $25 million hedge profit and $21 million of availability on its credit line.
We retain our HOLD rating on Amplify Energy (AMPY).
Berkshire Hathaway (BRK/B) - Led by Warren Buffett, this company is an undervalued yet very high quality collection of businesses and investments. We are looking for continued recoveries in revenues and profits as well as share buybacks. At Friday’s close of $209, the shares trade at a 27% premium to their $164.31 book value.
Revenues in the quarter fell 11%, while operating earnings of $5.5 billion fell 10% from a year ago. Berkshire’s widely diversified portfolio has held up reasonably well in the pandemic. The operating earnings exclude a $11 billion charge that includes the write-down of its Precision Castparts acquisition from 2016 due to the difficult conditions in the airliner industry, as well as changes in the value of its investment portfolio.
The company still has a gargantuan $147 billion in cash, excluding its $207 billion in equity securities. Berkshire held $92 billion in Apple shares, nearly 45% of its total equity securities holdings.
Berkshire (finally) repurchased its shares, totalling $5.1 billion, one of the largest repurchases ever by the company. Year-to-date, Berkshire has repurchased $6.7 billion. Buffett also raised his stake in BankofAmerica.
We retain our BUY rating and $250 price target on Berkshire Hathaway (BRK/B)
Borg Warner (BWA) - Borg Warner is executing well given the pandemic’s effect on automobile production, reporting a surprisingly strong nearly-breakeven quarter on 44% lower revenues. The company raised its guidance for the full year. BWA shares jumped about 4% on the news.
Sales fell 44% from a year ago as auto industry production was shut down for much of the quarter. That Borg Warner produced a nearly breakeven quarter with this sharp decline in sales was impressive. The adjusted per share loss of $(0.14) compared to estimates for a $(0.46) loss. The adjustments excluded $69 million in restructuring, merger and impairment expenses - not entirely justifiable for a company that is actively managing its business for the secular shifts in the auto industry.
The company is making inroads into the electric vehicle market, winning the drive module (similar to a transmission) for Ford’s new all-electric Mustang Mach-E SUV. Management’s comments implied that the industry’s transition to electric vehicles will allow Borg Warner to accelerate their market share gains. This is encouraging, as a significant investor concern is that Borg Warner could be left behind in the transition.
Importantly, the drag on Borg Warner’s turbo business from lower demand for diesel engines is becoming less of a factor.
Free cash flow was slightly positive but surprisingly strong in the quarter, partly due to lower capital spending on tool outlays. The company guided that full-year free cash flow would be about $300-$400 million assuming no meaningful pandemic second wave. BorgWarner has plenty of liquidity, with $2 billion in cash holdings, although about half of this is from their recent bond issue, and much of this will be spent on the Delphi acquisition which should close by year-end.
Updated guidance points to overall sales at about 22-25% below 2019 levels, not bad considering the pandemic.
We retain our Buy rating and $40 price target on Borg Warner (BWA)
Conduent (CNDT) - After seeing its fundamentals unravel for two years, Conduent’s future may be looking up. It posted a stunning 90% increase in new business signings in the quarter, indicating that it remains relevant and that its sales efforts are increasingly effective under the new CEO. Conduent’s turnaround still has a long way to go: it does not yet produce a profit on a non-adjusted basis, carries $1.7 billion in debt and preferred shares, and produces minimal free cash flow. We don’t yet know the profitability of the newly-won contracts. For investors, though, it showed that the stock isn’t a lost cause nor an easy tool for short-selling. The 83% (eighty-three percent ... not a misprint) jump in the stock reflected this.
CNDT shares trade at 5.5x EBITDA, pricing in minimal future improvements. If the new leadership can continue the company’s complete overhaul at anywhere near its recent pace, the shares have a lot of upside remaining.
Revenues of $1.0 billion fell 9% from a year ago. Adjusted EBITDA of $110 million fell 4% from a year ago but was 85% higher than consensus estimates. Adjusted earnings per share of $0.12 was 10% lower than a year ago but well-ahead of the $(0.05) estimate. Conduent also provided an encouraging third quarter outlook.
Conduent benefited from the surge in government assistance programs (like food stamps and unemployment pre-paid cards) that it administers. Its Transportation segment, where it administers highway tolls, was weak but recovering quickly along with traffic volumes.
The company’s cost-cutting efforts are working, as well. The $100 million target should be reached by year-end, with perhaps 60% being permanent cost reductions. This is meaningful for a company that is only marginally profitable.
The balance sheet remains liquid with $437 million in cash.
We retain our Buy rating and $6 price target on Conduent (CNDT)
Gannett Company (GCI) - Our expectations following the merger with New Media last year were too high. The company’s revenues have fallen off much more quickly, with same-store revenues falling 28% in the quarter, much faster than our ~15% estimates for the full-year. Weak advertising revenues have had the largest impact, weighing heavily on profits. Gannett’s content relevance seems less-damaged as paid digital-only subscriptions grew 31%. The cost-cutting efforts have been aggressive and appear to be on-target, however and Gannett is chipping away at its debt balance with asset sales.
Gannett’s debt clock is ticking, but slowly as there are minimal covenants associated with the debt or convertible notes. The debt carries an onerous 11.5% interest rate, and both the debt and convertible notes are due in 2024. Under the pandemic-related CARES Act, the company was able to defer $50 million in pension payments but these will come due later this year.
Gannett’s exceptionally weak shares remain interesting-enough to retain our Buy rating. Better 3Q revenues along with more cost-cutting could boost the stock. If credit market conditions allow it to refinance its debt at a lower interest rate the company would have more cash flow for debt reduction. Still, overall, this company is in a precarious position and the shares have a high degree of risk.
In the quarter, revenues fell 28%, hurt by the sharp 45% decline in print advertising revenues. Compared to a year ago, Adjusted EBITDA of $78 million fell 40% on a pro-forma basis for the merger. Free cash flow was a negative $44 million. Overall, the operational aspects of the integration look like they remain on-track.
We retain our Buy rating and $9 price target on Gannett (GCI)
GCP Applied Technologies (GCP) - Since our recommendation in the July 2020 letter, GCP shares have surged 48%. Change is coming quickly after activist investor Starboard Value replaced nearly the entire board of directors in May. The company has completed the sale of GCP’s headquarters building for $125 million (net proceeds of $122.5 million), which will help fund a new $100 million share buyback (about 5% of the share count).
The company reported a $0.09/share adjusted profit compared to consensus estimates for a small loss. GCP also announced a $100 million share buyback. Management made some encouraging comments about the recovery in its end-markets, indicating that demand is currently trailing year-ago levels by only about 5%.
Sales fell 26% from a year ago, mostly due to weaker construction and manufacturing demand. International markets were considerably weaker than the domestic market. Adjusted EBITDA fell by 31%, as a higher gross margin and lower operating expenses didn’t offset lower revenues. Several of GCP’s manufacturing facilities were closed during the quarter.
Management is targeting new products, better sales incentives and inefficient basic operating processes to boost GCP’s profits. Despite the sharp drop in sales and profits, GCP has remained cash flow neutral for the first six months of the year, so it has not seen any pressure on its solid balance sheet. The company’s balance sheet and liquidity are strong. Cash of $318 million is backed up by another $350 million line of credit (no borrowings currently). Debt is only $352 million and the nearest maturity is in 2026.
We retain our Buy rating and $28 price target on GCP Applied Technologies (GCP)
Jeld-Wen Holdings (JELD) - The window and door maker’s turnaround was only partly sidetracked by the pandemic, but the resurgence in the housing market has greatly improved the company’s outlook. The efficiency program led by the relatively new CEO appears to be helping boost margins. Overall, the company is doing remarkably well. Jeld-Wen’s shares are approaching our $25 price target.
Revenues fell 11% from a year ago, while adjusted per share earnings of $0.47 increased 4% from a year ago. Revenues were slightly ahead of estimates while earnings were more than double the $0.20/share estimate.
Revenues were helped by a 3% overall increase in prices but this was more than offset by a 13% headwind from volume/mix. Price increases, however, boosted profits, as did higher productivity and lower operating expenses. The company sees pricing remaining strong into the rest of the year. Adjusted EBITDA was only 2% below the year ago result, at $200 million, but with the lower revenues this created a higher profit margin. Year-to-date free cash flow was $12 million higher than a year ago.
Liquidity remains sturdy: cash balances were $458 million, funded partly by an increase it debt. The company generated modestly positive free cash flow.
The Steves & Company litigation appeal should reach a resolution later this year. Jeld-Wen lost this novel case in lower courts and would likely have to make a cash payment and divest a factory if it lost the appeal.
We retain our Buy rating and $25 price target on Jeld-Wen (JELD)
Mohawk Industries (MHK) - Mohawk is wrestling with the pandemic-driven downturn and having missed the luxury vinyl tile trend, but is starting to see a recovery as housing construction and remodeling pick up. Business in July was running equal to last July. A new weight on the shares is the investigation into its accounting for sales and inventory. The company vigorously denies wrong-doing but there is enough “smoke” that investors are wary. We’re abit surprised by the seemingly legitimate charges but are remaining firm in our conviction on the shares.
The company had little comment on the investigation, other than to assert that its audit committee finished their investigation, that the financial statements are correct and that it is fully cooperating with the government.
In the quarter, sales fell 21% and operating income fell to a $(75) million loss. After removing $100 million in restructuring, integration and other costs, the company posted adjusted operating profits of $26 million. This huge adjustment strikes us as excessive and a tad curious. Even accepting the adjustments at face value, the company showed that it has limited ability to meaningfully cut costs, given its manufacturing-intensive business model: adjusted operating profit fell $241 million on a $504 million decline in sales, for a 45% decremental margin. We hope that the incremental margin when sales rebound is at least this high.
Adjusted earnings per share of $0.37 was well-ahead of the consensus for a $(0.05) loss. Adjusted EBITDA of $398 million was more than double the $148 million estimate.
Free cash flow was strong at $488 million but much of this appears to be from working down inventories (which will reverse in future quarters) as well as from reductions in capital spending. Mohawk’s liquidity is sturdy but the company will either need to return its profits to higher levels (likely, as the cycle improves) or pay down its previously-reasonable debt.
We retain our Buy rating and $147 price target on Mohawk Industries (MHK)
Mosaic (MOS) - Mosaic’s shares jumped 19% in the two days following its earnings report, as adjusted earnings of $0.11/share was significantly higher than the $0.02/share consensus. Mosaic’s results and outlook are much better than they were six months ago. Volumes are robust and in some cases reaching records for Mosaic, even though pricing is still weak. Cost-cutting programs are adding to profits. The phosphate business is clearly improving while the potash segment is stable. Mosaic Fertizilantes (in Brazil) continues to improve toward a high level of performance.
In the quarter, revenues fell by 6% from a year ago, while adjusted EBITDA increased 6% as higher volumes (+16%) and cost-cutting helped boost profits. Average prices fell. Adjusted earnings per share were $0.11, down slightly from $0.12/share a year ago. Mosaic received $189 million in tax refunds and anticipates another $41 million. To defend against import pricing pressure, the company is petitioning the government for countervailing duties against Morocco and Russia, which helped lift MOS shares.
We retain our Buy rating and $27 price target on Mosaic Company (MOS)
Peabody Energy (BTU) - Peabody shares continue to feel the weight of the secular decline in demand for thermal coal, while the weak global economy has also hurt demand for metallurgical coal. The company is aggressively reducing its workforce, furloughing miners at low-volume mines and cutting other costs to stabilize its cash outflow. Two potential catalysts: a sale of its North Goonyella mine (sounds like this is only making moderate progress) and a favorable resolution to its now-contested efforts to merge its Powder River Basin mines with those of Arch Coal (a court ruling could come by late September).
Peabody’s dim outlook, particularly due to its high debt, is increasingly making BTU shares behave more like a call option on a recovery in coal pricing. The company’s negative cash flow means that it is paying interest and capital spending with borrowed money. This can continue only so long. Our willingness to hold onto this position is limited.
In the quarter, despite a 45% decline in revenues the company posted adjusted EBITDA of $23 million. This compares to $230 million a year ago. Weaker volumes and weaker pricing both weighed on revenues.
Positive adjusted EBITDA translated into $48 million of negative operating cash flow. Combined with $55 million in capital spending, Peabody is slowly draining its $849 million in cash balances. The company borrowed $300 million in the quarter to replenish cash.
We retain our Buy rating and $15 price target on Peabody Energy (BTU).
ViacomCBS (VIAC) - Under CEO Bob Bakish, who was well on the way to improving Viacom when it merged with CBS late last year, ViacomCBS is now being overhauled to stabilize revenues, boost relevancy for current/future viewing habits and improve free cash flow. The pandemic has weighed on these efforts, but the company has increased its relevance with new distribution and new content. ViacomCBS still needs to translate these improvements into revenue stability and cash flows. Working capital is a particularly heavy consumer of cash that needs attention.
Viacom reported adjusted per share earnings of $1.25, down 16% from a year ago. Adjustments included restructuring, gains/losses and pandemic-related project abandonment costs. Earnings were 36% higher than estimates.
Revenues, which were slightly ahead of estimates, fell 12% from a year ago. Advertising revenues fell $711 million (-27%) as advertisers cut back on ads and as the NCAA basketball tournament and other sports events were cancelled or postponed. Also, theatrical revenues fell $149 million to almost zero as theaters were closed. Affiliate revenues (the largest revenue category) rose 2% even though pay-TV subscription revenues fell.
ViacomCBS is expanding its rapidly growing Pluto TV platform and is developing CBS All Access subscription service into a “super service,” essentially a platform to compete against Netflix, Disney and others. So far, this is looking promising but way too early to determine its eventual level of success. A new international streaming service will start in early 2021.
Cash operating profits actually rose 8% from a year ago, driven by a $1 billion decline in cash operating expenses. Much of the expense decline came from lower production and programming costs - demonstrating some resiliency of profits even when revenues decline. Cash operating profits were about 27% ahead of analysts’ estimates. Viacom raised its merger cost-savings target to $800 million from $750 million.
Liquidity is strong, and no debt is due until 2022. However, Viacom is not making any progress with repaying its debt (was actually a net borrower in the quarter). We would like to see debt reduced by at least a third to reduce the company’s vulnerability to rising rates and to reduce its overall risk level.
We retain our Buy rating and $54 price target on ViacomCBS (VIAC).
Disclosure Note: One or more employees of the Publisher own shares of all Turnaround Letter recommended stocks, including the stocks mentioned in this note.