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Turnaround Letter
Out-of-Favor Stocks with Real Value

May 15, 2020

We review the four recommended companies reported earnings this week, including Meredith Corp (MDP), Mohawk Industries (MHK), Toshiba (TOSYY) and Vodafone (VOD), as well as Conduent (CNDT) which reported last week.

We retain our Buy ratings on all stocks, although we are reducing our price targets on Conduent (to $6) and Mohawk Industries (to $147) to reflect changes in the longer term prospects for their businesses.

While Meredith reported a weak quarter, its shares appear heavily over-discounted even as its sturdy financial condition and sensitivity to an economic recovery provide considerable appeal.

Conduent (CNDT) - Revenues of $1.1 billion were 9.2% lower than a year ago. When adjusted for the effects of divestitures, revenues fell 6.2% from a year ago as the company continues to struggle. Adjusted EBITDA was $96 million, down 14% from a year ago excluding the effects of divestitures. The company posted a $38 million operating profit, a little more than half the year-ago results. Revenues and Adjusted EBITDA were roughly in-line with estimates but per-share net income of $0.05 fell short of the $0.07 consensus estimate.

One encouraging sign is the $324 million in new business signings, up 44% from a year ago. Signings in the second quarter so far have continued this momentum. The contract renewal rate returned to 93%, within its targeted range, compared to a dismal 76% rate last quarter and 81% for all of 2019. Revenues from its government segment (involved in government payments to citizens) will likely increase while revenues from the corporate and transportation segments will likely weaken near-term.

Conduent had negative cash flow from operations (- $192 million), of which $97 million was for its final Texas Litigation payment. Liquidity appears reasonable with $395 million in cash on hand. For all of 2020, the company has a good chance of producing positive free cash flow, alleviating pressure on its mildly leveraged balance sheet. No major debts mature until 2022.

The company is under the leadership of a new CEO, Cliff Skelton, who is narrowing the company’s focus, improving its efficiency and re-engineering how it operates. These should produce higher margins over time. Interestingly, the company may make permanent some of its work-from-home initiatives, saving potentially 20% of its annual office lease expense, which runs about $200 million a year.

CNDT is a weaker company since our original recommendation, so we reducing our price target to $6 (from $20). However, its turnaround appears increasingly likely to succeed under the new leadership, its financial condition looks sturdy enough, yet its shares have been left for dead at under $2. Activist Carl Icahn holds 18.3% of CNDT’s shares. The stock makes an appealing micro-cap turnaround story and we retain our Buy rating.

Meredith Corporation (MDP) - Fiscal third quarter revenues of $702 million, adjusted per-share earnings of $0.49 and Adjusted EBITDA (a measure of cash operating earnings) of $151 million were each 6% below a year ago. Free cash flow was $100 million, 22% higher than a year ago.

Revenues were modestly worse than consensus estimates, but earnings were less than half the estimates. We believe this earnings estimate was stale and not indicator of current expectations. Adjusted EBITDA was 7% ahead of consensus. The dour guidance for next-quarter advertising revenues (down 30-40%) help drive the shares to long-time intraday lows. Since then, the shares have recovered nearly all of their losses.

On a comparable basis (adjusted for divestitures), revenues fell only 1%, indicating that the core businesses overall remain steady. The company is seeing meaningful increases in viewer/reader engagement. Local TV ratings have jumped up, and Meredith’s revenues from Apple News+ are starting to contribute. People magazine printed subscription renewals increased 13%. However, the closure of some publications is weighing on subscription and advertising revenues and the near-term outlook for advertising is very weak. In the quarter, political advertising revenues of $11 million helped bolster overall ad revenues.

While the positive free cash flow of $100 million helps Meredith buy time, the second quarter and possibly beyond will be weaker. The company is conserving cash by suspending its dividend (announced in April), cutting capital and operating expenses (including executive and board compensation), and releasing cash tied up in working capital. The company has $150 million in cash at the end of April (up from $103 million at quarter-end with no increase in credit line use) another $312 million available in its credit line. No major debt maturities occur until 2023.

While Meredith’s revenues and profits are currently hobbled, we believe that political advertising revenues will ramp sharply as the November election approaches, and that overall ad revenues will recover as the stay-at-home restrictions are lifted. Magazine subscriptions and other engagement-related revenues will likely remain at least steady and probably improve. With its cost-cutting and portfolio changes now underway, Meredith could emerge as a structurally more-profitable company. With the shares trading at about $12, essentially at all-time lows, there is a strong potential for a sharp recovery once the outlook improves. The stock trades at a heavily discounted 6x estimated EBITDA of $550 million (compared to $688 million last year), which assumes no net cash accumulation for the next 24 months and no rebound in advertising from the currently depressed levels.

Mohawk Industries (MHK) - Revenues of $2.3 billion fell 6.4% from a year ago, but only by 3.5% when adjusted for currencies (indicating that local growth wasn’t as weak). Per-share adjusted net income of $1.66 was 22% below a year ago. Results were in-line with estimates.

Slowing new construction and remodeling in all of its geographies contributed to the weaker revenues and profits. Reflecting its steady product upgrades and new product introductions, Mohawk has held/gained market share in many categories. The company is conserving cash by slowing its production, cutting capital spending and operating expenses and working down inventories. The company said it would produce an operating loss for the second quarter, as revenues in April were running 35% below a year ago.

Financially, Mohawk is in good shape. After the quarter-end, the company raised $500 million in new term loans to repay a €300 million debt coming due, so it has no maturities for the balance of 2020. In early May, it has an estimated $443 million in cash and another $850 million in credit line availability. Selling down their inventories is helping produce incremental cash flow.

Mohawk brought back its long-time CFO, who previously held the role from 2005 until his retirement in 2019, indicating that the outgoing CFO wasn’t a good fit.

Overall, we believe Mohawk is well-managed with strong financial resources to weather the current economic storm. However, we are reducing our price target to $147, to reflect the weaker revenue, profit and free cash flow outlook over the next 3 years, as well as the higher (but necessary) dead-weight loss from incremental debt that won’t be used to upgrade/grow its product array.

Toshiba (TOSYY) - The company reported preliminary fiscal year 2019 results. Sales were ¥3.4 trillion (1 Yen = 93 US cents), or about $3.2 billion. Toshiba expects operating income of over ¥130 billion. These are slightly weaker than their forecast provided in February, due to the effects of the coronavirus. Its production facilities are almost all operating with limited Covid-19 impact going forward. Toshiba’s balance sheet and liquidity appear sturdy.

Vodafone (VOD) - Overall, the earnings report was encouraging. Service revenues, adjusted to remove the effects of acquisitions/ divestitures, currencies and accounting changes, increased 0.8% compared to a year ago. Service revenues are derived from on-going telecom services, which we consider core and recurring revenues. Total revenues increased 3%. Vodafone produced Adjusted EBITDA of €14.8 billion and free cash flow of €4.9 billion (€1 = $1.08). The company will pay its €.045/share dividend for the second half of 2020, which was in some doubt.

Vodafone launched a new €1 billion, 3-year “digital transformation” program which should help it expand its reach and reduce its costs. Its spin-off of its European cellphone towers is on-track for early 2021, unlocking value for shareholders.

The company’s massive €42.2 billion in debt (net of cash), up from €27.0 billion a year ago due to borrowing to fund the Liberty Global purchase and to acquire wireless spectrum, remains an issue. However, the net debt represents a reasonable 2.8x adjusted EBITDA.

Vodafone offers a reasonably safe port in the very difficult storm and pays a 6.4% dividend yield.

Disclosure Note: One or more employees of the Publisher own shares of all Turnaround Letter recommended stocks, including the stocks mentioned in this note.