This week’s Friday Update includes our comments on earnings from Conduent (CNDT), Ironwood Pharmaceuticals (IRWD), Kraft Heinz (KHC), Marathon Oil (MRO), Organon (OGN), Toshiba (TOSYY) and TreeHouse Foods (THS).
Next week brings earnings reports from Macys (M), Molson Coors (TAP), Dril-Quip (DRQ), Gannett (GCI), Elanco (ELAN), Kaman (KAMN), Vistra Energy (VST) and Berkshire Hathaway (BRK/B).
Next week we publish the March edition of the Cabot Turnaround Letter as well as the Catalyst Report. As an early notice, there will be no weekly update the following week, on Friday, March 4, as we will be traveling.
Earnings updates:
Conduent (CNDT) – Conduent was spun off from Xerox in 2017. After a promising start, the company’s revenues fell sharply due to management problems, leading to a collapse in its share price. In late 2019, the company replaced the CEO, who began a major overhaul that is starting to show progress. Activist investor Carl Icahn owns 18% of Conduent’s shares, while Darwin Deason (who sold his business to Xerox which later was spun off as Conduent) holds a 3.3% stake.
Conduent reported reasonable fourth-quarter results, but forward revenue and profit guidance was disappointing. Management provided a favorable 2023 outlook but that is at least a year away so we attach little credibility to it. The turnaround will take longer than we anticipated.
Revenues of $1.0 billion fell 1% from a year ago and were in line with estimates. Earnings of $0.13/share fell 35% from a year ago but were also in line with estimates. New contract signings, a critical metric for future revenues, was much stronger than a year ago but fell off its impressive pace from the third quarter. Conduent’s tarnished reputation and contract run-offs continue to pressure its top line and profits. Run-off of one-time pandemic related contracts weighed on profits, driving adjusted EBITDA down 14%. One sign of revenue resilience, however, is that contract renewals were strong.
Net debt is essentially unchanged from a year ago. The recently closed sale of the Midas Solutions business will generate about $320 million in cash proceeds, helping to further improve the balance sheet and provide Conduent with staying power that it will need as it grinds its way very slowly through its turnaround.
Ironwood Pharmaceuticals (IRWD) – After years of weak leadership, Ironwood has one remaining product, Linzess, so investors view the company as a failed business. However, Linzess is a steady revenue producer with growing volumes that offset its slow per-unit price decline. As cash accumulates on the balance sheet and now exceeds its debt, Ironwood is repurchasing its shares. Respected activist investor Alex Denner, who now holds a board seat, is exerting his influence, including ousting the CEO and slashing spending. Ironwood’s shares trade at a highly discounted valuation.
The company reported a strong quarter for its Linzess franchise. Revenues rose fractionally but were about 6% above estimates while earnings of $0.27/share fell 25% and were short of the $0.34 estimate. Revenue guidance for 2022 was encouraging, but the EBITDA guidance was for no growth.
Except for one noticeable divergence, the Ironwood thesis remains on track. Its Linzess treatment continues to grow, reaching $1 billion in revenues for the year and thus attaining “blockbuster” status. The Linzess profits and margins continued to move in the right direction. Management guided for modest Linzess revenue growth in 2022 and while the treatment’s profit margin is close to its maximum, the franchise is proving its merits as we anticipated.
The divergence is that Ironwood is now spending to develop new treatments. This is what is weighing on overall company profits. While the general prospects of its two new initiatives seem reasonably positive, they are, from an investors’ perspective, purely speculative. They are very early in their development stage with no clarity whatsoever on the timing or size of their eventual profitability – they could be blockbusters or duds. Ironwood spent $32 million on research and development in the fourth quarter, double its year-ago spending. This spending detracts from our pure cost-cutting and cash flow generation thesis.
The balance sheet continues to strengthen, as it now holds $620 million in cash, up from $363 million a year ago. While balance sheet details were not in the publicly released data, we anticipate that the total debt balance remains unchanged at around $448 million. Management said they repurchased $27 million of shares in the fourth quarter as part of their $150 million authorization.
We are staying with the Buy rating for now, as the valuation even at incrementally higher R&D spending remains very attractive, the company is repurchasing shares and has a highly capable shareholder-friendly activist on the board of directors.
Kraft Heinz Company (KHC) – Following an overly aggressive cost-cutting strategy that left the company with diminishing relevance to consumers, Kraft Heinz is rebuilding its brands and products, led by new CEO Miguel Patricio (July 2019). The pandemic provided a much-needed tailwind, particularly as Kraft Heinz is carrying a sizeable debt burden.
Kraft reported reasonable revenue and earnings. Profits were significantly higher than estimates, lifting the shares. Overall, we’d grade the company’s progress as encouraging but not yet finished.
Revenues of $6.7 billion fell 7% from a year ago, but removing the effect of acquisitions, divestitures and currency changes, revenues rose 4% and were fractionally higher than estimates. Adjusted earnings of $0.79/share slipped 1 cent from a year ago but were 25% above estimates.
Kraft’s revenue growth was driven almost entirely by higher pricing (+3.8%), as volumes were essentially flat. The company said that its volumes were restrained by shortages of packaging and other materials. Despite this and several divestitures, for the full year, revenues and gross margins were ahead of comparable results 2 years ago, indicating overall progress with Kraft’s turnaround and some success with dealing with the pandemic.
Looking forward into 2022, the company guided for low single-digit (1-3%) organic sales growth and a decline of about 7% in Adjusted EBITDA. It is not clear whether these include the benefit of an additional week in the fiscal year. Kraft will raise prices again but is wary of over-pricing that might shift market share to store brands (which would benefit Cabot Turnaround Letter recommendation TreeHouse Foods).
Kraft is making meaningful progress with debt reduction. Net debt of $18.4 billion is down 26% from a year ago and 32% from two years ago. This not only reduces its interest expenses but also reduces the risk for equity investors.
Marathon Oil Company (MRO) – This oil and gas exploration and production company is fundamentally strong, with a high-quality resource base that generates remarkably generous free cash flow and is backed by a low-leverage balance sheet. A major appeal that we can buy shares of this company at a highly discounted 4.1x EV/EBITDAX valuation. We acknowledge the risks that commodity prices might fall, that management may choose to overly invest in production growth rather than returning most of its free cash flow to investors, and that regulations change.
Marathon delivered a strong quarter, with adjusted earnings of $0.77/share nearly doubling from a year ago and that were 38% above estimates. The company is clearly benefitting from higher oil prices and is executing on its promises to return most of its cash flow to shareholders.
The company’s financials illustrate the enormous cash generation under way. Production was flattish but energy prices doubled so revenues basically doubled. Of the incremental $970 million in revenues, $669 million went straight to cash operating profits, (or EBITDAX, which is EBITDA without some exploration-related capital spending that runs through the income statement), which more than doubled the year-ago results.
Marathon generated $1.17 billion of EBITDAX in the quarter. After capital spending and minimal taxes, working capital and other outflows, Marathon generated $898 million in free cash flow. Of this, $772 million went to share repurchases in the quarter and $47 was paid out as dividends. So, of the $970 million in incremental revenue, 84% was paid out to shareholders.
To put the size of this cash gusher into perspective, the $819 million in dividends and share repurchases are equal to about 5% of Marathon’s market value. On an annualized basis, it would equal about 20% of the company’s market value. While the chances of a capital return of this size are unpredictable, as oil and natural gas prices are unpredictable, the analysis highlights the strength of the company’s business model at elevated commodity prices. MRO shares remain highly sensitive to changes in oil prices in particular.
Looking ahead, Marathon said it will spend $1.2 billion on new well drilling in 2022, enough to keep its production flat, even if commodity prices remain strong. This is in keeping with management’s strategy and is highly encouraging that the company won’t stray from its rigid cash return discipline.
Marathon’s share count is 6% lower than a quarter ago. Total debt remains at about $4.0 billion, in line with the company’s target.
Organon & Co (OGN) – Recently spun off from Merck, Organon specializes in patented women’s healthcare products and biosimilars. It also has a portfolio of mostly off-patent treatments. Investors have ignored the company, but we believe that Organon will produce at least stable and large free cash flows with a reasonable potential for growth. At our initial recommendation, the stock traded at a highly attractive 4x earnings.
Organon reported an acceptable quarter. Revenues of $1.6 billion fell 1% from a year ago but were about 1% above estimates. Adjusted earnings of $1.37/share fell 30% from a year ago but were about 7% above estimates.
Women’s Health segment revenues rose 6% as its key Nexplanon sales rebounded by 37%. The rebound helped build management’s credibility as there was considerable investor skepticism around their confidence in Nexplanon. Biosimilars treatments, a source of future growth, rose an encouraging 15%. Established Brands sales slipped 2% but we consider this an improvement toward stability against headwinds from patent expirations and tighter pricing in China.
Adjusted EBITDA of $549 million fell 19% from a year ago, primarily due to higher costs that Organon is incurring as a public company compared to its subsidiary status a year ago.
Guidance for 2022 suggests that the year will basically look like 2021. Revenue growth will be flat while the adjusted EBITDA margin (and dollars) will dip about 8%. Higher research and development spending will weigh on profits. However, how Organon gets to flat revenues is encouraging – the decay rate of its products has flattened out and the trajectory is up. If one could look at the four years of 2020-2023 as four points on the letter “U”, we are now at the lower left, bottom part of the “U” and moving to the right. It seems like little is changing, but the transition from down to up is starting. Still, the company needs to execute and more work remains ahead.
The balance sheet weakened fractionally from the third quarter due to acquisitions but is stronger than at the spin-off date. Cash is $737 million while total debt is $9.1 billion, for net debt of $8.4 billion. This is about 7% below net debt of $9.0 billion just after its spin-off. We would like to see more debt reduction.
Toshiba (TOSYY) – This Japanese industrial conglomerate is recovering from its nuclear power plant construction business (Westinghouse Electric) debacle, which forced it to sell a majority stake in its Kioxia memory chip production operations. We are looking for a divestiture of its minority Kioxia stake, with proceeds paid out to shareholders, as well as operational improvement and better governance. Note: ¥100 = $0.87
The company reported a reasonable quarter as it gradually recovers from the pandemic-related downturn and also makes incremental internal improvements. Revenues rose 11%, while operating income more than doubled. Earnings per share rose 44%. The company’s operating profit margin remains too low at 5.3%, even though it was sharply higher than the 2.9% margin a year ago. Results were broadly in line with estimates.
New orders rose a strong 11% but the company said rising materials and logistics costs will drag on its full-year earnings by about 9%.
Toshiba’s balance sheet carries relatively little debt. Its $960 million in debt net of cash is only about 45% of its expected full-year EBITDA of $2.13 billion. A company like Toshiba could realistically triple (or more) its debt burden yet easily remain investment grade, thus providing it with cash to pay out to shareholders or repurchase its shares.
The company will hold its Extraordinary Shareholder Meeting on March 24. Our hope is that shareholders vote against the new 2-way split up plan, thus motivating the company to consider a full sale of its entire business which would likely yield the highest value for shareholders.
TreeHouse Foods (THS) – As a major contract producer of private label foods, TreeHouse has struggled with poor execution and elevated debt resulting from its acquisition-driven strategy even as the private label food industry remains healthy. The company remains profitable and generates reasonable free cash flow. Respected activist investor JANA Partners has a large 9.2% stake and is likely to pressure this undervalued company to either sell or change its strategy and leadership.
The company reported a mildly encouraging quarter and outlook. Investor expectations were overly dour, helping drive the shares up 18% since just prior to the report.
Revenues fell 1% from a year ago but were about 4% above estimates. Excluding acquisitions and currency changes, sales fell 4%. Adjusted earnings of $0.11/share fell 90% from a year ago but were 10% above estimates. The earnings had a remarkable number and scale of adjustments, most of which were of suspect legitimacy. Our version of scrubbed earnings would have produced a $(0.29)/share loss. Adjusted EBITDA fell nearly 50%.
The company continues to struggle with lower volumes (down 9.4% in the quarter) due to largely self-inflicted problems although the pandemic is impairing some of its production capability. Higher pricing (+5.6%) salvaged what could have been a disastrous quarter. Management said that it will continue to raise prices and that by mid/late 2022 its price increases should be able to overtake higher input and other costs.
TreeHouse’s cash flow for the year was $332 million. Not only was this down 20% from a year ago, but it was also boosted by the bad business practice of selling its receivables. Nevertheless, debt net of cash fell about 15% from a year ago.
Guidance for 2022 was encouraging, pointing to an 11% increase in sales and flat to +8% increase in adjusted EBITDA. We remain skeptical, but an alleviation of supply and production issues, stronger pricing and a tailwind as consumers trade down to store brands could lead to these results.
Key to the story is the presence of activist investor Jana Partners. Jana already replaced two directors with independent directors, and is now nominating two additional board members for the upcoming proxy vote. We anticipate that with four of ten board seats and a 9% stake, Jana will have the leverage to accelerate major changes to TreeHouse’s profitability and value to shareholders.
Friday, February 18, 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 13 minutes and covers:
- Brief commentary on earnings reports.
- Comments on other recommended companies:
- Organon (OGN) – acquired most of global rights to a contraceptive pill
- Macy’s (M) – activist investor Jana Partners sells their stake
- Wells Fargo (WFC) – CFO says they can reach 15% return on tangible equity without a lifting of its asset cap
- Final note:
- Congratulations to LA Rams. Cincinnati Bengals will be contenders for years to come.
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. | 2/17/22 | Current Yield | Current Status |
| Small cap | Gannett Company | GCI | Aug 2017 | 9.22 | 5.96 | 0.0% | Buy (9) |
| Small cap | Duluth Holdings | DLTH | Feb 2020 | 8.68 | 14.95 | 0.0% | Buy (20) |
| Small cap | Dril-Quip | DRQ | May 2021 | 28.28 | 25.24 | 0.0% | Buy (44) |
| Mid cap | Mattel | MAT | May 2015 | 28.43 | 24.97 | 0.0% | Buy (38) |
| Mid cap | Conduent | CNDT | Feb 2017 | 14.96 | 4.68 | 0.0% | Buy (9) |
| Mid cap | Adient plc | ADNT | Oct 2018 | 39.77 | 48.79 | 0.0% | Buy (55) |
| Mid cap | Lamb Weston Holdings | LW | May 2020 | 61.36 | 66.13 | 1.5% | Buy (85) |
| Mid cap | Xerox Holdings | XRX | Dec 2020 | 21.91 | 22.07 | 4.5% | Buy (33) |
| Mid cap | Ironwood Pharmaceuticals | IRWD | Jan 2021 | 12.02 | 10.61 | 0.0% | Buy (19) |
| Mid cap | Viatris | VTRS | Feb 2021 | 17.43 | 14.83 | 3.0% | Buy (26) |
| Mid cap | Vistra Corporation | VST | Jun 2021 | 16.68 | 21.49 | 2.8% | Buy (25) |
| Mid cap | Organon & Co. | OGN | Jul 2021 | 30.19 | 36.37 | 3.1% | Buy (46) |
| Mid cap | Marathon Oil | MRO | Sep 2021 | 12.01 | 21.89 | 1.3% | Buy (24) |
| Mid cap | TreeHouse Foods | THS | Oct 2021 | 39.43 | 41.85 | 0.0% | Buy (60) |
| Mid cap | Kaman Corporation | KAMN | Nov 2021 | 37.41 | 42.45 | 1.9% | Buy (57) |
| Mid cap | The Western Union Co. | WU | Dec 2021 | 16.40 | 19.81 | 4.7% | Buy (57) |
| Mid cap | Brookfield Re | BAMR | Jan 2022 | 61.32 | 55.19 | 0.0% | Buy (93) |
| Mid cap | Polaris | PII | Feb 2022 | 105.78 | 124.65 | 0.0% | Buy (160) |
| Large cap | General Electric | GE | Jul 2007 | 304.96 | 98.46 | 0.3% | Buy (160) |
| Large cap | Shell plc | SHEL | Jan 2015 | 69.95 | 53.63 | 3.6% | 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 | 25.20 | 2.4% | HOLD |
| Large cap | Credit Suisse Group AG | CS | Jun 2017 | 14.48 | 8.97 | 2.9% | Buy (24) |
| Large cap | Toshiba Corporation | TOSYY | Nov 2017 | 14.49 | 19.80 | 3.2% | Buy (28) |
| Large cap | Holcim Ltd. | HCMLY | Apr 2018 | 10.92 | 10.94 | 4.0% | Buy (16) |
| Large cap | Newell Brands | NWL | Jun 2018 | 24.78 | 25.92 | 3.5% | Buy (39) |
| Large cap | Vodafone Group plc | VOD | Dec 2018 | 21.24 | 18.69 | 5.5% | Buy (32) |
| Large cap | Kraft Heinz | KHC | Jun 2019 | 28.68 | 37.79 | 4.2% | Buy (45) |
| Large cap | Molson Coors | TAP | Jul 2019 | 54.96 | 48.75 | 2.8% | Buy (69) |
| Large cap | Berkshire Hathaway | BRK.B | Apr 2020 | 183.18 | 313.55 | 0.0% | HOLD |
| Large cap | Wells Fargo & Company | WFC | Jun 2020 | 27.22 | 56.15 | 1.4% | Buy (64) |
| Large cap | Baker Hughes Company | BKR | Sep 2020 | 14.53 | 29.43 | 2.4% | Buy (31) |
| Large cap | Western Digital Corporation | WDC | Oct 2020 | 38.47 | 56.45 | 0.0% | Buy (78) |
| Large cap | Altria Group | MO | Mar 2021 | 43.80 | 51.37 | 7.0% | Buy (66) |
| Large cap | Elanco Animal Health | ELAN | Apr 2021 | 27.85 | 25.78 | 0.0% | Buy (44) |
| Large cap | Walgreens Boots Alliance | WBA | Aug 2021 | 46.53 | 46.81 | 4.1% | 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.