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Turnaround Letter
Out-of-Favor Stocks with Real Value

May 8, 2020

In another very busy earnings week, 15 recommended companies reported results. We retain our Buy ratings and price targets on all names, except for MDRX (moved to SELL), BWA (reduced price target to $40), and MOS (reduced price target to $27), as noted below:

Adient (ADNT) - Fiscal second quarter revenues of $3.5 billion fell 17% while adjusted per-share earnings of $0.62 were double the year-ago results and sharply higher than consensus estimates. Adjusted EBITDA of $211 million increased 10% from a year ago and slightly better than consensus estimates. The company said that even this $211 million level was depressed by $100 million in Covid-related costs, although we weight this comment only lightly.

While sales fell $717 million from a year ago, gross profits (with tiny adjustments) actually increased by $29 million. Overhead costs fell $49 million. These reflect an impressive improvement in the company’s underlying profitability, despite the weaker sales.

Overall, the Adient turnaround is advancing, perhaps accelerating.

Adjusted EBITDA improved in the Americas and EMEA (Europe, Middle East and Africa), but fell 50% in China. Currently all of their 79 Chinese production facilities are operating and their American and EMEA facilities are starting to re-open. Adient is assuming that the US and European auto markets will remain at least 20% weaker than pre-pandemic levels for at least a year.

Liquidity is strong: Adient has $1.6 billion in cash on hand at quarter-end and raised another $600 million from new senior notes. The company anticipates receiving $575 million in cash proceeds from its sale of its China joint venture before September 30. Debt net of cash remains essentially unchanged (a critical positive given the conditions).

The Covid-related adjustments have accelerated Adient’s efficiency improvements, and will likely make it a stronger, more profitable company in the post-recovery period.

Allscripts Healthcare Solutions (MDRX) - While we have remained patient with the fading turnaround prospects at Allscripts, our patience has ended. We are moving the company to a Sell.

In the quarter, every one of Allscripts’ metrics (including revenues, profits, margins, cash flow, bookings, receivables, balance sheet) except backlog continued their slow but steady deterioration. Even the increase in backlog was illusory as the company has been slow in delivering services to their clients.

We view the management as ineffective and unable to make meaningful improvements. The firm recently hired turnaround advisor Alix Partners, but having an outside firm find cost-cutting opportunities should be an embarrassment. And we wonder how a poorly-run firm can really benefit from the $75 million in cost-cuts that they apparently have found - we’ve seen too many companies with deep-rooted problems make some optically-pleasing cuts that leave the company in worse shape than before. Perhaps this is just a short-term adrenaline shot for a lame horse?

We believe Allscripts needs a complete operational and strategic overhaul led by an entirely new leadership team. Making matters worse, the president is also the CFO, not only straining his time and focus but also removing a check-and-balance role.

We wonder if the Alix move was motivated by the need to find investors to fund a replacement for the $345 million bond coming due in July. And, any new funding will almost certainly have a higher cost than the 1.5% coupon on the maturing bond.

We note that apparently Alix has also been hired to help competitor Cerner (CERN) with its operations. While there is a chance that these relationships could result in an acquisition of Allscripts by Cerner (Cerner has the size and balance sheet to readily complete a deal), Cerner may simply find it simpler and cheaper to continue grinding away at the Allscripts franchise.

Allscripts’ shares jumped about 8% in mid-day trading on these hopes. But these are thin reeds on which to base an investment thesis for an otherwise fading company.

We move MDRX shares to a Sell.

Amplify Energy (AMPY) - Revenues fell 25% compared to last year’s fourth quarter, as oil and natural gas prices fell 24% and production fell 1%. Operating costs were roughly flat, leading to a 58% decline in adjusted EBITDA (based on our calculation). Results were meaningfully lower than consensus expectations. The stock fell 20% on Wednesday, driven by the weak results on a day when nearly all energy stocks fell on a 2% drop in West Texas Intermediate oil prices but the shares have recovered most of the decline since then.

The company suspended its dividend, monetized $18 million of hedges and will be cutting spending. Amplify has much of 2020 production hedged, but less in 2021 and 2022, leaving it heavily exposed to weak commodity prices after this year. The market value of their hedges was $77 million as of May 1st, up from $58 million at the end of the prior quarter. This compares to the current market cap of $41 million.

Amplify remains a high-risk stock with tremendous sensitivity to oil and gas prices in both directions. For risk-tolerant shareholders, we continue to rate the stock a “hold”. The stock is not appropriate for more risk-averse investors.

Barrick Gold (GOLD) - Revenues of $2.7 billion were 30% higher than a year ago. Adjusted net earnings of $285 million, or $0.16/share, were 55% higher than a year ago (but a tad below the $0.17/share consensus estimate). Operating cash flow increased 71% to $889 million, while free cash flow increased to $438 million from only $146 million a year ago. The company is clearly benefitting from higher gold prices. However, its gold production fell 11% and copper prices fell 27%.

The company’s balance sheet and liquidity are “fortress” strength, with $3.3 billion in cash, with only $5.2 billion in debt, backed further by its hefty production of free cash flow.

Global mining companies like Barrick, with mines in less-developed countries, are subject to expropriation by cash-strapped governments. Barrick released news that the government of Papua New Guinea will not renew the company’s mining lease for the Porgera mine. The mine produced roughly 5% of Barrick’s total gold production in the first quarter, leading Barrick to trim its outlook for overall production. Often these situations result in a new negotiated arrangement as local governments recognize that a gold mine is only as valuable as the stream of revenue it produces, and that efficient and honest producers like Barrick may be vastly superior to alternative producers. However, these outcomes are not guaranteed and Barrick may walk away from the mine (after a heated dispute). The knock-on risk is that other countries attempt the same.

Gold prices have surged as investors worry about the inflation risk from extremely generous government stimulus efforts during the Covid-19 pandemic. When the pandemic risks subside, gold prices may weaken, perhaps considerably, likely pulling down Barrick’s share price. However, we believe the much-improved leadership at Barrick and a long-term gold price tailwind continue to make Barrick shares attractive in the long-term.

We retain our Buy rating and recently raised (to $30) price target.

BorgWarner (BWA) - Revenues of $2.3 billion fell 11% from a year ago while adjusted per-share earnings of $0.77 were 23% weaker. Lower profits were primarily due to lower revenues along with slightly increased research and development spending. Earnings were well-ahead of consensus estimates. Overall, the results indicate that BorgWarner is doing reasonably well in adjusting to the new environment, and is generally favorably positioned in the faster growing segments of the auto industry and in the emerging electric vehicle market.

The company provided full-year 2020 guidance (rare in this pandemic era), indicating that organic (excluding acquisitions, divestitures and currency) revenues would decline between 20% and 27% while operating cash flow would be between $530 million to $780 million, or $100 million to $300 million after capital spending. BorgWarner had $901 million in cash on hand and considerable borrowing capacity so its liquidity appears strong.

BorgWarner’s pending acquisition of Delphi is back on again with moderately improved terms. We are not big fans of this deal. While there perhaps is some strategic value from bulking up in the electric vehicle segment and some financial value from cost-cutting, it appears to be more of an overpriced diversification move. Issuing undervalued shares to pay for an overvalued company doesn’t make a lot of sense. The deal drags with it $1.4 billion in Delphi debt, which is even more than much-larger BorgWarner currently carries. Somewhat confounding as well, BorgWarner reiterated their commitment to their $1 billion share repurchase program, which would entail repurchasing nearly all of the shares that it will issue to buy Delphi, but probably at higher prices. Similarly, the company continues to spend $140 million/year on its cash dividends. We wonder what is going on at the BorgWarner capital allocation meetings.

For now, BorgWarner’s shares appear to overly-discount its future, so we are retaining our Buy rating, but reducing our price target to $40 to reflect its weaker future compared to our initial assumptions.

Conduent (CNDT) - We will be analyzing this company’s reported results next week.

DuPont (DD) - Revenues of $5.2 billion fell 4% from a year ago and fell 2% when excluding acquisitions/divestitures and currency changes. Revenues in Electronic & Imaging (+7%) and Nutrition & Biosciences (+1%) were not strong enough to offset weakness in the Transportation & Industrial (-13%), Safety & Construction (-1%) and Non-Core (-19%) segments. Adjusted per-share net income of $0.84 fell 9%, while Operating EBITDA of $1.3 billion fell 8% compared to a year ago. The gross margin expanded by 1.5 percentage points. The results were modestly ahead of consensus estimates.

DuPont declared its $.30/share quarterly dividend last week, unchanged from its prior rate. Its separation of the Nutritions & Biosciences business in the previously announced deal with International Flavors & Fragrances remains on-track for early 2021. The PFOA liability risk appears more limited with the favorable ruling in Ohio.

To address the weaker environment, DuPont improved its cash position to $1.7 billion and raised new financing to replace near-term maturing debts. It is cutting operating expenses, reducing capital spending and extracting cash from working capital. Near-term and particularly for the second quarter (April sales were down 13%-16% compared to a year ago), the outlook is challenging, especially as 15% of its revenues are tied to the automotive industry. However, DuPont’s position and outlook are brighter than its $45 stock (down 30% YTD) indicate, particularly under the new leadership of CEO Ed Breen and CFO Lori Koch and the catalyst of the completion of the N&B deal about a year from now.

Gannett (GCI) - Revenues of $949 million fell 10% from the year-ago revenues (using pro forma results which assume the merger of legacy Gannett and New Media Investment Group occurred a year ago, to provide comparable results). Same-store revenues, which excludes the effects of interim acquisitions/divestitures and currencies, fell 10%. The adjusted per-share net loss of ($0.60) was much worse than the estimated loss of ($0.21). Adjusted EBITDA of $99 million was slightly below estimates.

Despite missing estimates which may have been out of date, the company’s results were respectable, particularly as they generated $60 million in operating cash flow in a difficult quarter. However, the second and likely the third quarter will be weaker as they will bear the full brunt of the sharp declines in advertising, live events and other Covid-related disruptions.

The balance sheet has $200 million in cash, up by $46 million from year-end while its debt balance is unchanged. Gannett has worked down some of its receivables, helping boost cash.

Gannett is essentially a call option on the economic rebound given its high post-merger leverage and shrinking revenue and profit stream. It has a tailwind coming from the company’s aggressive efforts to attack the vast cost-cutting opportunities from its recent merger, which provides the potential for costs to fall faster than revenues, helping it preserve its cash flow. A strong political advertising season later this year combined with an economic rebound next year offer additional potential tailwinds. Our model (call/email for details) allows us to run a wide range of assumptions, which produce outcomes ranging from bankruptcy to our $9 price target and higher. The stock is not appropriate for risk-averse investors.

General Motors (GM) - Revenues fell 6% while adjusted operating profit of $1.2 billion fell 46% from a year ago. Adjusted per-share net income of $0.62/share fell 56% from a year ago but was nearly double the $0.34/share consensus estimate. Overall, GM is showing that is it a much better company than the “old” GM - it appears well-positioned to prosper in the incipient recovery despite its depressed shares.

Compared to a year ago, North American retail sales fell 11%, and were down 35% in April relative to last year’s April sales. Sales in China fell 60% but have rebounded. GM’s North America adjusted operating profit margin of 8.5% was considerably higher than the 6.9% a year ago. This is impressive.

GM’s products array continues to show healthy consumer appeal as the company upgrades its offerings while narrowing its product roster. GM vehicles gained over 1 percentage point of market share in the U.S., helped by a 27% increase in sales of its fill-sized pickup trucks. It also is reducing or exiting their weak operations in Australia, New Zealand and Thailand. GM said it is continuing without interruption its development of electric and autonomous vehicles.

GM Financial segment profit of $230 million was 36% lower than a year ago, but the business remains well-capitalized. Its leverage of 9.3x is below the 10x target, and can sustain $2 billion in losses (about 3.8% of its $53 billion in loans/leases, well-above the company’s recent estimate of perhaps 2.5% in full-year losses and 1.7% charge-off rate in the first quarter) before it requires support from GM corporate. GM Financial has nearly $12 billion in cash. In a prolonged recession with high credit losses, this segment carries vulnerability for GM’s future.

GM’s immense liquidity, with over $32 billion in cash in its Automotive operations (excludes GM Financial which has a legally-separate balance sheet and capital restrictions that may prevent cash from being transferred to GM Automotive). Its Automotive debt, net of cash, at $1.2 billion, actually decreased from the year-end balance of $2.4 billion. Automotive cash flows from operations was a positive $337 million - very impressive for a difficult quarter when segment profits fell 87% compared to the prior year.

The next few quarters will show large losses at GM Automotive, along with a cash outflow from working capital (as it spends to increase production while not being paid for perhaps 60 days) but the company enters this period in solid shape. The company estimated that even with zero production they could survive into the fourth quarter. As the company is ramping up production now, we think there is a rather slim (but not zero) chance that this estimate will be tested.

Overall, GM is strained by the pandemic but has the resources to survive unless the crisis remains unimproved for perhaps six more months, which we believe is highly unlikely. It is likely to emerge with higher debt but in a stronger position relative to most rivals. We’re impressed with the company’s turnaround efforts under CEO Mary Barra and remain committed to our Buy rating.

Jeld-Wen Holding (JELD) - Today’s formal report provided more details following their preliminary report on April 27th. Adjusted EBITDA fell 17% from a year ago, to $14.8 million, while the adjusted EBITDA margin fell by 120 basis points (100 basis points = 1 percentage point) to 7.6%. The company is deemed essential in most markets, so most of the revenue decline is related to slowing end-customer demand.

Strength in North America was offset by weakness in Europe and especially Australasia, although the company was able to pass through price increases and expanded its margins in Europe. For the second quarter, revenues looked poised to fall 15%-20% as construction and replacement markets shrink. Third and fourth quarter revenues will be weak as well due to the lag effect on window/door demand relative to the construction season. As of May 4th, the balance sheet had close to $400 million in cash on hand, with additional availability on its credit line.The litigation with Steves & Sons remains unsettled due to court delays. Overall, Jeld-Wen shares remain undervalued.

LafargeHolcim (HCMLY) - Revenues fell 3.3% on a “like-for-like” basis while recurring operating earnings fell 2.6%. The expanded margin reflects improvements in the company’s operating efficiency.

“Like-for-like” (or, “LFL”), used by many European companies, means the results are adjusted for acquisitions/divestitures and currency changes. “Recurring” results have been adjusted for one-time items. These would be comparable to “organic” and “adjusted” results used by American companies. While these terms are subject to management interpretation (unlike reported GAAP numbers), we find them helpful for understanding the underlying economics of the company.

Results were strong until mid-March, when the Covid-19 shut-downs affected their business. The largest impact will come in the second quarter. Overall, the construction industry has remained fairly resilient.

While Lafarge did not provide quarter-end balance sheet information, we estimate that its balance sheet remains solid with net debt/EBITDA at between 1.5x - 2.0x. It has CHF8 billion in cash and unused borrowing capacity (1Swiss franc = $1.02) and Moody’s and S&P both confirmed the company’s investment grade credit ratings.

Lafarge shares remain down about 30% year-to-date, an overly pessimistic level for a well-capitalized and well-managed company in a long-term secularly strong industry that has inflation-resistant earnings.

Mattel (MAT) - Net sales fell 14%, or -12% net of currency changes, while the adjusted per-share loss of ($0.56) was worse than the ($0.42) loss a year ago. While Mattel shares fell on the news, as the results were considerably weaker than the consensus estimates which expected flat year/year losses, they have since fully recovered. Mattel’s turnaround, which involves outsourcing toy production and changing its product development, marketing and administrative processes, was set back by Covid-19 supply chain and work-from-home disruptions and from retail store closures.

Despite net sales falling $95 million, adjusted gross profits fell only $4 million due to efficiency improvements and the avoidance of product recalls from last year. However, adjusted operating costs (including marketing, selling/admin costs) rose $33 million, leading to a $37 million decline in adjusted operating profits. From a timing perspective, the disruptions started in the best possible quarter as Mattel’s first quarter is seasonally the slowest of a normal year (15% of sales).

The second quarter will likely be weaker than the first, as the quarantines remained fully in play in April and will continue at least partly in May and June. Also weakening the year’s results: the likely-successful Minions movie launch and 2020 Olympics were delayed until next year.

Mattel has $500 million in cash and another $1.1 billion of availability on its credit line, with no debt maturities until 2023, so its liquidity is fine. Mattel’s turnaround is making progress but has been a long struggle, and the recent disruptions delay it further while adding incrementally to its high debt burden. We see light at the end of the tunnel, but our patience has worn a bit thin.

With the shares down 40% year-to-date, we see the light as this: sales have a decent potential to rebound sharply as parents eventually look to provide entertaining toys to their kids. To the extent that the trends from highly encouraging in-store sales in January and February remain in place later this year, Mattel’s product changes are working. Under CEO Ynon Kriez the company is beginning to monetize its valuable roster of brands (or, as the industry calls them, “intellectual property”) including the demand-boosting Minions movie and Olympics next year. The Covid disruptions will likely accelerate Mattel’s cost-cutting efforts. The company has already reduced its product-count (SKUs) by its targeted 30%, likely leading to better margins.

We retain our Buy rating on Mattel stock as its shares discount essentially no turnaround from here, a too-dim assumption in our view, particularly with its cost-cutting and upcoming revenue tailwinds.

The Mosaic Company (MOS) - Revenues of $1.8 billion were 5% below a year ago, while the adjusted per-share net loss of ($0.06) compared to an adjusted per share profit of $0.25 a year ago. Adjusted EBITDA of $214 million was down 50% from a year ago. Both revenues and per-share earnings were ahead of consensus estimates. Overall volumes were up 14% compared to a year ago. Prices, however, were much weaker, which drove the decline in profits.

Volumes of its North American potash (+2%) and phosphates (+7%) fertilizers were higher than a year ago. Encouragingly, the company said that April volumes have surged, as stronger North American demand indicates that crop season is shaping up to be normal compared to weak conditions a year ago. The lack of a Chinese contract held back some volume growth, but with that contract now signed demand is returning. These improvements are helping to work down industry inventories and tighten prices. One emerging risk is that considerable North American fertilizer volumes are used to grow corn for ethanol-based fuels, so with the price of all fuels likely to remain weak, demand for ethanol fuels and the related government price supports may weaken.

The Brazil operations produced 5% higher revenues and 12% higher segment profits on stronger demand (+36% volume) and more cost-cutting, although prices were soft.

Overall, Mosaic is ahead of its cost-cutting targets across all operations. Near-term, lower rail traffic has reduced rail prices, which reduces Mosaic’s transportation costs. The company had $1.1 billion in cash, funded by better working capital and large short-term borrowings, so its liquidity is healthy. An additional $170 million will flow into Mosaic from tax refunds and a closed-out swap. Long-term debt remains unchanged from year-end.

Mosaic’s shares discount an uninspiring future. We believe that not only will the company survive but will also prosper. However, we are reducing our price target to $27 (from $50) to reflect the structural changes in the fertilizer supply/demand market.

Oaktree Specialty Lending (OCSL) - Net income of $0.12/share increased from $0.10/share in last year’s fourth quarter. Net investment income of $0.16/share was 60% higher than the $0.10/share consensus estimate. Net asset value (NAV) per share declined by 19% due to wider credit spreads and some asset value reductions.The company declared a $0.095/share dividend, unchanged from the prior eight quarters.

Oaktree Specialty Lending’s portfolio has been cleaned up since Oaktree Capital assumed control over two years ago. It is highly diversified across dozens of industries, with its largest exposures being to industries only modestly affected by the pandemic, including software, IT services, healthcare providers and services and biotechnology. However, weaker market conditions for all higher-yielding debt instruments have weighed on valuations. Investments in the energy, airlines, aerospace, hotel/restaurant/entertainment and retail industries totals to 11.3% of the portfolio, which have now-weaker prospects so their valuations have declined. However, all portfolio companies except one remain current with their interest payments. Only 0.5% of the portfolio is on non-accrual status. The company continues to whittle away at its now-small non-core portfolio.

The company’s capital and liquidity remain sturdy. In the quarter, Oaktree made additional investments at attractive prices and refinanced some of its own debt at better yields (reducing its average interest rate by nearly a third), both of which boost its longer-term prospects. While the drop in NAV was disappointing but not a surprise given the Covid pandemic, Oaktree appears well-positioned and well-managed while also trading at a 23% discount to quarter-end NAV and paying a 9.2% dividend.

ViacomCBS (VIAC) - Revenues of $6.7 billion fell 6% from a year ago. The widely-watched metric Adjusted OIBDA (or, Operating income before depreciation and amortization, which is essentially EBITDA) fell 18% to $1.3 billion, but was about 12% above consensus estimates.

Advertising revenues fell 19% - while this is real money, it was entirely due to their not broadcasting the SuperBowl (Fox did it this year) and the cancellation of the NCAA basketball tournament, indicating that the overall ad environment remained steady. Combined revenues of its Affiliates, content licensing, theatrical and publishing businesses showed growth.

The timing of the stay-at-home couldn’t have been better for Viacom’s streaming platforms. Pluto TV now has over 24 million active users, up 55% from a year ago, while the company’s other streaming services showed decent growth as well.

Viacom announced an agreement to stream its Nickelodeon, MTV, Comedy Central and other networks on Google’s YouTube TV. This expanded distribution agreement (before the Viacom-CBS merger, several CBS networks were distributed through YouTube) may restore some viewership strength to ViacomCBS. It may also not be lost on investors that, given Google’s growing interest in YouTube content and vast cash hoard, ViacomCBS could be an acquisition target. While we believe the odds of an acquisition are slim at best they are not zero.

Looking ahead, Viacom has real challenges, including likely further ad revenue decline especially with a challenging upcoming football (NFL and college) season ahead, as well as decays in its distribution revenues.

Viacom has $589 million in cash, and generated $356 million in operating cash flow, providing it with financial strength in the challenging environment. It redeemed its near-term debt maturities with fresh longer-term funding and has plentiful credit line availability. Much of our enthusiasm rests in CEO Bob Bakish’s ability to cut costs and somewhat stabilize the revenue stream. While we recognize our $54 price target may be aggressive, we are retaining it pending further clarity on the post-Covid environment.

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