This week’s Friday Update includes our comments on earnings from Brookfield Re (BAMR), Credit Suisse (CS), Mattel (MAT), Newell Brands (NWL) and The Western Union Company (WU).
Next week brings earnings reports from Toshiba (TOSYY), TreeHouse Foods (THS), Kraft Heinz (KHC), Conduent (CNDT), Ironwood Pharmaceuticals (IRWD) and Organon (OGN).
We are raising our price target on Wells Fargo (WFC) from 55 to 64. Rising interest rates are boosting the bank’s underlying profitability, while Wells is also making progress with its regulatory relief initiatives. The shares trade at 1.6x tangible book value, which is too much of a discount to its healthier peers that trade around 2.4x.
Foot-dragging no more! We are raising our price targets on Marathon Oil (MRO) from 18 to 24 and on Shell plc (SHEL) from 55 to 60 as these shares remain inexpensive relative to oil prices in the $90-100/barrel range. However, if we lose confidence that oil prices will remain in this range, we could exit some or all of these shares before they reach our new price targets.
Earnings updates:
Brookfield Asset Mgt Reinsurance Partners (BAMR) – Recently spun out of highly regarded Canadian investment management firm Brookfield Asset Management, Brookfield Re is a new investment company that acquires the assets of and future contributions to pension plans and life insurance books. It invests these assets with the expectation that the returns will be significantly greater than the build-up in the related payout obligations. Over time, excess returns can accumulate considerable value for shareholders.
Brookfield Re reported an encouraging quarter. As it is in the early stages of its acquisition and build-out program, traditional earnings and other metrics generally have limited value in assessing the company’s progress. The ($43) million net loss reflected unrealized hedging losses as well as operating costs. Brookfield Re raised its quarterly dividend by 8% to $0.14/share.
The company completed deals on several large and smaller blocks in the quarter. Its pending acquisition of insurance company American National Group is on track for completion by mid-year and is an important milestone in Brookfield Re’s development.
BAMR shares remain linked to the parent company’s price. The parent company Brookfield Asset Management said they are considering spinning off its investment management operations – this news helped drive the group’s shares sharply higher yesterday. We anticipate that a spin-off will occur, as it seems out of character that parent Brookfield would even mention this as a possibility unless they had essentially already approved the idea.
Credit Suisse (CS) – This Swiss bank never recovered from the Global Financial Crisis, so it is shifting its strategy to more stable Switzerland banking and global investment management and away from weak/volatile trading and investment banking. The bank is struggling with chronic bad decision-making and a loose risk-control culture that could threaten its existence if not aggressively addressed. (1 Swiss franc, or CHF, equals $1.08).
Credit Suisse reported weak fourth-quarter results and gave a disappointing outlook for 2022. Revenues fell 12% from a year ago. The highly scrubbed adjusted pre-tax profit of CHF 328 million dropped 62% from a year ago and fell well-short of the consensus estimate of about CHF 540 million. The bank took CHF 2.1 billion in charges in the quarter. For 2022, Credit Suisse said revenues would be pressured but expenses would increase. We continue to retain our Buy rating, for reasons outlined below.
The bank continues to move forward with the strategy, new organizational structure and other initiatives laid out by former chairman Antonio Horta-Osorio. Its slide presentation includes all the right words – risk reduction, capital strength, efficiency/expense improvements, discipline, pace – but talk is cheap. It is not clear how many of these words will be in the year-end 2022 slide deck or how well the bank will have executed on its targets, especially with a new chairman. We are not yet convinced that the CEO has the right mindset and capabilities for the role. The Credit Suisse turnaround is very much a work in progress, is highly complex, fraught with potential for major missteps and could easily take two or more years.
This year (full-year 2022) will likely produce ugly results, as revenues will weaken from the pullback in risk-taking, lower capital markets activity, exit from Prime Brokerage, low employee morale and higher turnover and many other headwinds. Expenses will be higher as the bank hires new employees and consultants, invests in cost-saving initiatives and increases its incentive compensation to more normalized levels.
What keeps us interested in CS shares? First, trading at 54% of tangible book value, compared to a healthy comparable bank that would trade at no less than 100%, the shares leave plenty of room for a steady flow of weak results. Second, the bank’s capital ratio at 14.4% is robust enough to withstand further write-offs while also retaining the confidence of its customers and business partners. Third, aside from current and future write-offs, the bank remains reasonably profitable in its core operations. Even in the weak current quarter, the bank produced pre-tax profits of CHF 328 million – admittedly scrubbed for many hopefully one-off items. Fourth, board awareness of the bank’s serious issues and shareholder pressure to fix them is increasing. We believe that eventually the right leadership team (it may be there now but this is not clear) will emerge to execute a turnaround. Somewhere within the tangled, overgrown mess that is the current Credit Suisse is a strong company. The leadership needs to weed out everything else to let this appear.
In short, the return potential (more than 100%) is attractive relative to the loss potential (reasonable at about 25% from here, in our view).
Mattel (MAT) – At our initial recommendation in 2015, Mattel was struggling with its failure to adjust to the realities of how young children spent their playtime. This failure produced years of revenue decay. In addition, its cost structure became bloated and its debt leverage surged. However, led by its new CEO, Mattel now appears to be finding its way.
Mattel reported an impressive quarter, with sales and profits meaningfully higher than a year ago and sharply better than consensus estimates. The company declared the years-long turnaround complete as it now turns its focus more fully on its growth initiatives. Core products are selling well while new products, including the recently regained Disney franchises and new media and entertainment initiatives, look promising. Guidance for 2022 was raised and new guidance for 2023 was for continued robust sales and profit growth. Mattel is generating strong free cash flow which it is channeling toward reducing its previously unwieldy debt load. The balance sheet is essentially at investment-grade strength and we anticipate that ratings agencies will upgrade their views sometime this year. Mattel shares have surged 16% this week through early Friday trading.
In the quarter, sales of $1.8 billion rose 10% from a year ago and were 8% above the consensus estimate. Adjusted earnings of $0.53/share rose 33% from a year ago and were 71% higher than the consensus estimate. Adjusted EBITDA of $321 million rose 18% from a year ago and was 33% above estimates.
Sales growth was driven by Dolls (+19%) and Other (+16%) which includes everything other than Dolls, Hot Wheels and Fisher-Price/Thomas & Friends, and is the largest bucket of sales for the firm (31% of total sales). Hot Wheels and Fisher-Price/Thomas & Friends revenues were down 1-3% in the period. Gross margins dipped modestly due to some cost pressure but operating costs were flat, lifting the operating margin to a healthy 14.7% compared to 12.3% a year ago.
Five years ago, Mattel was in desperate shape. Revenues were falling as its product base was stale, it was producing operating losses and bleeding cash while its debt was almost too high to service. In 2021, the numbers are impressive: sales growth was 18%, operating profits were $763 million which produced $334 million in free cash flow, and debt was reduced to almost investment-grade levels.
From here, Mattel needs to continue to innovate while keeping costs under control. It has benefitted from the pandemic’s stay-at-home effect on toy demand, which will likely fade this summer yet have an unknowable effect next winter. Overall, the company is executing well and its future looks bright. The shares remain attractively valued.
Newell Brands (NWL) – The company has struggled, literally for decades, with weak strategic direction and expense control, epitomized by its over-reaching $16 billion acquisition of Jarden in 2016. Pressured by activist investors, and now led by a capable new CEO, Newell appears to be finally fixing its problems, yet the shares remain significantly undervalued relative to their post-turnaround potential.
Newell reported a good quarter with higher sales but lower profits due to rising input, labor and freight costs. Guidance for the upcoming quarter and full year was mixed but generally positive for earnings relative to sales. Overall, the story remains on track.
In the quarter, revenues of $2.8 billion rose 4% from a year ago and were about 6% above estimates. Normalized earnings of $0.42/share fell 25% but were 31% above estimates.
Sales were stronger in all segments, as pricing and new products were broadly helpful, supported by segment-specific factors like higher demand for outdoor gear and pens. Operating profits fell due to higher costs: the gross margin slipped to 30.2% from 32.9%, dragging down gross profits by $79 million. Overhead fell by $14 million, partly offsetting the drag.
For 2022, the guided decline in sales is due to the divestiture of the security business, as well as closures of several Yankee Candle stores and exits from lower-margin product lines. In terms of profits, Newell said that it should be able to more than offset higher manufacturing costs, while ongoing productivity improvements should keep overhead costs restrained. Earnings per share will be supported by higher profits and a lower share count. All-in, the company expects earnings per share to increase by 4% in 2022, even as sales will fall by 5%.
The balance sheet continued to improve as debt fell 13% from a year ago, although debt net of cash fell only 4%. Leverage is an important source of risk-reduction for the Newell investment and the company is making respectable progress as net debt is falling while EBITDA is rising. Leverage is now at 3.0x, down from 3.5x a year ago.
The Western Union Company (WU) – This widely recognized money transfer company is facing secular headwinds from the transition to digital money. Prior efforts to diversify away from the core retail business using the company’s sizeable cash flows were unsuccessful. Now, a new CEO with impressive fintech experience brings the real possibility of a meaningful improvement in both execution and strategy as the company makes its transition to the digital world. Investors have aggressively sold WU shares, ignoring the company’s relatively stable revenues, sizeable free cash flow and valuable intangible assets as well as its generous dividend yield.
The company reported a strong quarter and provided 2022 guidance for flattish revenues and flat/slightly lower operating margins. It also announced a new $1 billion share repurchase program as the new CEO takes the helm. The turnaround is in its very early stage.
Media reports say that the 2022 guidance was 10% below the consensus estimate, suggesting a disappointing outlook. However, the estimate includes some contribution from the to-be-sold Business Solutions segment, so it is not directly comparable to the guidance (which fully excludes Business Solutions profits).
In the quarter, revenues of $1.3 billion rose 2% ex-currency from a year ago and were in line with estimates. Adjusted earnings of $0.64/share were 42% higher than a year ago and were 25% above the consensus estimate.
Excluding the Business Solutions segment, which is being sold (transaction will close this year), revenues were flat while operating profits grew 17%. The operating margin expanded to 24.2% from 20.5% a year ago.
Western Union returned over $780 million to shareholders in 2021, essentially from annual cash flow. Total debt was unchanged for the year while the cash balance fell modestly.
Looking ahead, the company is undertaking a standard turnaround strategy: leveraging its strong core products into new growth opportunities while making its operations more cost-efficient. Capital will be generously returned to investors.
Key to our thesis is that the company expands its product/service offerings such that investors are convinced that revenues and profit margins are durable with at least some growth. Western Union has a solid balance sheet and produces generous free cash flow, but investors need to be convinced that the company won’t fade away. The new CEO’s ability to produce this durability is core to the story. New CEO Devin McGranahan started on January 1st, only 40 or so days ago.
Friday, February 11, 2022 Subscribers-Only Podcast:
Covering recent news and analysis for our portfolio companies and other topics relevant to value/contrarian investors.
Today’s podcast is about 15 minutes and covers:
- Brief commentary on earnings reports.
- Comments on other recommended companies:
- Toshiba (TOSYY) – may be splitting in two rather than three
- Newell Brands (NWL) – selling Home Security business
- Western Digital (WDC) – chip production problems
- Vodafone (VOD) – a bid for its Italy operations may create strategic changes.
- Elsewhere in the market
- Markets seem to believe that inflation is transitory.
- Final note:
- Rooting for turnaround story Cincinnati Bengals in the Super Bowl.
Please know that I personally own shares of all Cabot Turnaround Letter recommended stocks, including the stocks mentioned in this note.
| Market Cap | Recommendation | Symbol | Rec. Issue | Price at Rec. | Price on 2/3/2022 | Current Yield | Current Status |
| Small cap | Gannett Company | GCI | Aug 2017 | 9.22 | 6.05 | 0.0% | Buy (9) |
| Small cap | Duluth Holdings | DLTH | Feb 2020 | 8.68 | 14.83 | 0.0% | Buy (20) |
| Small cap | Dril-Quip | DRQ | May 2021 | 28.28 | 23.00 | 0.0% | Buy (44) |
| Mid cap | Mattel | MAT | May 2015 | 28.43 | 24.49 | 0.0% | Buy (38) |
| Mid cap | Conduent | CNDT | Feb 2017 | 14.96 | 4.59 | 0.0% | Buy (9) |
| Mid cap | Adient plc | ADNT | Oct 2018 | 39.77 | 46.94 | 0.0% | Buy (55) |
| Mid cap | Lamb Weston Holdings | LW | May 2020 | 61.36 | 66.22 | 1.5% | Buy (85) |
| Mid cap | Xerox Holdings | XRX | Dec 2020 | 21.91 | 21.40 | 4.7% | Buy (33) |
| Mid cap | Ironwood Pharmaceuticals | IRWD | Jan 2021 | 12.02 | 11.01 | 0.0% | Buy (19) |
| Mid cap | Viatris | VTRS | Feb 2021 | 17.43 | 15.37 | 2.9% | Buy (26) |
| Mid cap | Vistra Corporation | VST | Jun 2021 | 16.68 | 22.08 | 2.7% | Buy (25) |
| Mid cap | Organon & Co. | OGN | Jul 2021 | 30.19 | 34.45 | 3.3% | Buy (46) |
| Mid cap | Marathon Oil | MRO | Sep 2021 | 12.01 | 21.41 | 1.1% | Buy (24) |
| Mid cap | TreeHouse Foods | THS | Oct 2021 | 39.43 | 34.80 | 0.0% | Buy (60) |
| Mid cap | Kaman Corporation | KAMN | Nov 2021 | 37.41 | 40.64 | 2.0% | Buy (57) |
| Mid cap | The Western Union Co. | WU | Dec 2021 | 16.40 | 18.48 | 5.1% | Buy (57) |
| Mid cap | Brookfield Re | BAMR | Jan 2022 | 61.32 | 60.81 | 0.0% | Buy (93) |
| Mid cap | Polaris | PII | Feb 2022 | 105.78 | 119.43 | 0.0% | Buy (160) |
| Large cap | General Electric | GE | Jul 2007 | 304.96 | 98.79 | 0.3% | Buy (160) |
| Large cap | Shell plc | SHEL | Jan 2015 | 69.95 | 54.52 | 3.5% | Buy (60) |
| Large cap | Nokia Corporation | NOK | Mar 2015 | 8.02 | 5.65 | 6.5% | Buy (12) |
| Large cap | Macy’s | M | Jul 2016 | 33.61 | 26.59 | 2.3% | HOLD |
| Large cap | Credit Suisse Group AG | CS | Jun 2017 | 14.48 | 9.08 | 2.9% | Buy (24) |
| Large cap | Toshiba Corporation | TOSYY | Nov 2017 | 14.49 | 19.70 | 3.2% | Buy (28) |
| Large cap | Holcim Ltd. | HCMLY | Apr 2018 | 10.92 | 11.04 | 4.0% | Buy (16) |
| Large cap | Newell Brands | NWL | Jun 2018 | 24.78 | 21.96 | 4.2% | Buy (39) |
| Large cap | Vodafone Group plc | VOD | Dec 2018 | 21.24 | 18.64 | 5.5% | Buy (32) |
| Large cap | Kraft Heinz | KHC | Jun 2019 | 28.68 | 34.29 | 4.7% | Buy (45) |
| Large cap | Molson Coors | TAP | Jul 2019 | 54.96 | 49.23 | 2.8% | Buy (69) |
| Large cap | Berkshire Hathaway | BRK.B | Apr 2020 | 183.18 | 319.85 | 0.0% | HOLD |
| Large cap | Wells Fargo & Company | WFC | Jun 2020 | 27.22 | 59.05 | 1.4% | Buy (64) |
| Large cap | Baker Hughes Company | BKR | Sep 2020 | 14.53 | 27.44 | 2.6% | Buy (31) |
| Large cap | Western Digital Corporation | WDC | Oct 2020 | 38.47 | 54.09 | 0.0% | Buy (78) |
| Large cap | Altria Group | MO | Mar 2021 | 43.80 | 50.18 | 7.2% | Buy (66) |
| Large cap | Elanco Animal Health | ELAN | Apr 2021 | 27.85 | 25.31 | 0.0% | Buy (44) |
| Large cap | Walgreens Boots Alliance | WBA | Aug 2021 | 46.53 | 49.22 | 3.9% | Buy (70) |
Market cap is as-of the Initial Recommendation date. Current status indicates the rating and Price Target in ( ). Prices are closing prices as-of date indicated, except for those indicated by a "*", which are price as-of SELL recommendation date.
Please feel free to share your ideas and suggestions for the podcast with an email to either me at bruce@cabotwealth.com or to our friendly customer support team at support@cabotwealth.com. 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.
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.