This week’s Friday Update includes our comments on earnings reports from Brookfield Asset Management Reinsurance (BAMR), Elanco Animal Health (ELAN), Goodyear Tire & Rubber (GT), TreeHouse Foods (THS), and Viatris (VTRS).
Next week, Vodafone (VOD) is scheduled to report, followed by Macy’s (M) and Duluth Holdings (DLTH) over the next two weeks.
Earnings updates:
Brookfield Asset Mgt Reinsurance Partners (BAMR) – Recently spun out of highly-regarded Canadian investment management firm Brookfield Asset Management, BAM 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 build up considerable value for shareholders.
BAM Re reported revenues of $337 million and earnings per Class A and Class B share of $0.14. As a new company, it had no meaningful comparison to a year ago. There are no brokerage firm estimates. The company completed more acquisitions in the quarter and its deal to acquire American National Group will likely close in the next few weeks. Strategically, BAM Re is making good progress and has considerable cash, liquidity and capital to continue its development as planned. BAM Re declared a $0.14/share quarterly dividend. No change to our rating or price target.
Elanco Animal Health (ELAN) – Elanco is one of the world’s largest providers of pet and farm animal health products, ranging from flea and tick collars, prescription treatments and farm animal nutritional supplements. Following its September 2018 IPO at $24 as part of its spin-off from pharmaceutical giant Eli Lilly, Elanco shares have been lackluster, due to weak revenue growth, high expenses and an uninspiring new product pipeline. Veteran activist investor Sachem Head recently gained a board seat, likely leading to an upturn in the company’s execution and driving its undervalued shares higher. The August 2020 acquisition of Bayer Animal Health offers additional opportunities for improved results.
Elanco reported a reasonable quarter that nevertheless was greeted by investors with an 8% sell-off in a down-3% market. Revenues fell 1% and were in line with estimates. Adjusted earnings of $0.36/share fell 3% but were about 3% better than estimates. Adjusted EBITDA of $339 million fell 1% but was 6% above estimates. Management nudged down its full-year revenue and earnings guidance due to the negative effect of the unusually strong dollar. Second-quarter guidance was trimmed for currency, China lockdowns, stock-outs and other issues, but the company anticipates that it will offset most of this later in the year with volume and price increases, which may have led to investor worries. All-in, the report incrementally supports our thesis. No change in rating or price target.
Revenue growth was mixed/flat with minor plusses and minuses. The company cut its overhead and research & development costs by 8% and 9%, respectively, as it improved its efficiency. We like overhead cost cuts as most companies have bloated expense bases after major acquisitions like Elanco’s purchase of Bayer Animal Health. We accept management’s decision for cutting R&D costs but generally are more alert to this spending due to their critical nature in the company’s pipeline of proprietary products. Elanco is working to turn around its lackluster R&D program that so far hasn’t generated any major impact on the top line. Cost inflation doesn’t appear to be a relevant issue for Elanco. The adjusted EBITDA margin expanded fractionally to 27.7% from 27.6% a year ago – tiny but a step in the right direction.
The balance sheet showed marginal deterioration as incremental inventory build-up led to more borrowing. Elanco trimmed its debt by about $150 million in April and said it remains committed and on track for further reduction in its leverage (measured by net debt/EBITDA) by year end.
Goodyear Tire & Rubber Company (GT) – Last week, Goodyear reported earnings that were weaker than a year ago but stronger than consensus estimates, and that, all-in, the report was encouraging, particularly as Goodyear was able to raise prices enough to offset its higher costs. However, as the company reported the morning of our note, we hadn’t yet had a chance to review the earnings in detail nor review the post-report management conference call. We thought that the company must have said something less encouraging on the call, seeing that the shares fell sharply (7%) in mid-morning trading.
In reviewing the report and call, the primary negatives were that the company said that it was unable to raise prices enough outside of the Americas to offset higher costs, and that its inflation headwind in the second half will be about $800 million (matching first-half headwinds but apparently higher than investors anticipated). The biggest worry that investors have is that Goodyear won’t be able to overcome its cost inflation – the conference call did little to assuage those concerns even though in the Americas the outlook is more positive. This is likely why the shares fell sharply.
With the shares down 25% from our purchase price, they are more attractive as the valuation is now cheaper even as the fundamental picture remains largely unchanged.
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 reasonable quarter – actual results were sloppy compared to a year ago but sharply better than the consensus estimate and in keeping with our thesis that the situation at TreeHouse is not as dour as the market believes. The company posted an adjusted loss of $(0.15)/share compared to a $0.36/share profit a year ago and a consensus estimate for a loss of $(0.52). Revenues rose 8% compared to estimates for a 4% increase. Adjusted EBITDA of $58 million fell 44% from a year ago but was sharply higher than the $37 million consensus estimate. Management reiterated their guidance for full-year revenue of at least 11% and Adjusted EBITDA of at least $385 million. All this “good news” has driven a 28% rebound in THS shares.
TreeHouse pushed through an impressive 12% price increase during the quarter. This is going a long way toward alleviating its wide range of cost increases that includes food commodities, labor, inbound freight and other costs, as well as higher unit costs from disruptions to its production facilities. This pricing power is a major source of investor optimism, as it implies that TreeHouse’s products remain relevant, that customers (grocers, consumers) are willing to pay up for them, and that TreeHouse may be able to sharply improve its earnings.
Volumes fell 4%, but we attribute this mostly to delivery and other capacity disruptions. Service quality was a chronic problem for TreeHouse even before the pandemic – the company clearly has more work to do here.
Eventually, the company believes that its better pricing, stabilized volumes and improved operating efficiency will lead to better profit margins – we are inclined to agree but are patient as it may take longer than most investors anticipate. Fortunately, the tailwind from customers trading down to store brands looks to strengthen from here.
We remain unimpressed with management. TreeHouse’s accounting quality is miserable: They removed $32 million in “Growth, Reinvestment, Restructuring Programs & Other” expenses from their adjusted earnings, which is a bucket that is rife with potential for the dumping of all sorts of core costs and seems to be a recurring item. They also removed $11 million in acquisition/divestiture costs, but deals are a recurring part of its business. We will ignore their removal of stock-based compensation for now, as the number ($4 million this quarter) is relatively small and management is at least transparent about it. To sum up the accounting doubts: We look no further than the $58 million in adjusted EBITDA which becomes a $71 million cash outflow from operations.
Perhaps most appalling is their continued selling of their receivables for cash. While we appreciate (but don’t entirely believe) their claim that this source of funding is cheaper than their line of credit, use of this tool indicates that the CFO is unable to properly manage the company’s cash flows.
For now, we look to the presence of activist investor Jana Partners, a highly credible and detail-oriented group that holds a sizeable 9.2% stake in TreeHouse with its reputation on the line, for some comfort regarding the company’s future despite its accounting practices. We don’t believe there is any fraud, just that the company’s financial management is well below par.
No change to our rating or price target as we wait for more substantial activist change, further earnings strength, more accounting clarity and/or strategic actions like the sale of some of its divisions.
Viatris (VTRS) – Viatris was formed in November 2020 through the merger of pharmaceutical generics producer Mylan, N.V. and Pfizer’s Upjohn division. Investors worry about its declining revenues, limited drug pipeline visibility, elevated debt, loss of exclusivity for Lyrica and Celebrex in Japan, and reforms to China’s volume-based procurement programs. We see Viatris as an undervalued stream of reasonably stable free cash flow. As evidence of this stability is produced, along with better capital allocation, governance and transparency, we see strong potential for a higher share price.
After its dismal fourth-quarter report in which management completely changed its strategy, Viatris reported a respectable first quarter. Adjusted earnings of $0.92/share, up 1% from a year ago and 12% above the consensus estimate. Revenues fell 5% and were about 2% below estimates. Adjusted EBITDA fell fractionally but was about 10% above estimates. Overall, a reasonably decent quarter for Viatris.
We remain disappointed and frustrated by management’s abrupt and credibility-destroying strategic change, particularly their sale of the previously-touted-as-THE-growth-vehicle Biosimilars business. This unit, which posted 21% ex-currency sales growth in the quarter, compares to 2% and 5% declines for the other two Viatris segments. Did Viatris sell its gem for a bargain, or perhaps at best some cash plus a stake in a highly-speculative Indian biotech firm?
Free cash flow was a robust $1.1 billion. But we wonder if management will spend this away through higher expenses and acquisitions. The company repaid $840 million in debt in the quarter – a confidence builder for sure. Management estimates that it will receive $2 billion in proceeds from the Biosimilars sale in the second half of 2022, and said they will pay down debt and possibly repurchase shares. We would hope that the share buybacks are large and at low prices, which could readily redeem the leadership, but worry that the management may be pressured to offset its revenue decay with acquisitions. VTRS shares remain undervalued and broadly dismissed at near trash (one brokerage firm called the shares “untouchable”) yet we recognize that our price target may be too high given the fundamental and strategic changes since our initial recommendation.
Friday, May 13, 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 12½ minutes and covers:
- Earnings:
- Comments on the four companies reporting earnings and more color on Goodyear Tire & Rubber (GT) results from last week.
- Comments on other recommended companies:
- Western Digital (WDC) – investor day has little incremental news
- Shell (SHEL) – Third Point raises its stake
- Newell Brands (NWL) – CFO adds title of “President”
- Walgreens Boots Alliance (WBA) – sells about 10% of its strategic position in Amerisource Bergen
- Altria (MO) – former subsidiary Philip Morris International in talks to buy Swedish Match. This could create new smokeless tobacco competition for Altria so we are reviewing our rating and price target.
- Elsewhere in the market:
- If Hollywood makes a movie about this market cycle, perhaps it will be called “Revenge of the Moat.”
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. | 5/12/22 | Current Yield | Current Status |
| Small cap | Gannett Company | GCI | Aug 2017 | 9.22 | 3.77 | 0.0% | Buy (9) |
| Small cap | Duluth Holdings | DLTH | Feb 2020 | 8.68 | 11.29 | 0.0% | Buy (20) |
| Small cap | Dril-Quip | DRQ | May 2021 | 28.28 | 28.33 | 0.0% | Buy (44) |
| Small cap | ZimVie | ZIMV | Apr 2022 | 23.00 | 22.22 | 0.0% | Buy (32) |
| Mid cap | Mattel | MAT | May 2015 | 28.43 | 25.21 | 0.0% | Buy (38) |
| Mid cap | Conduent | CNDT | Feb 2017 | 14.96 | 4.57 | 0.0% | Buy (9) |
| Mid cap | Adient plc | ADNT | Oct 2018 | 39.77 | 29.22 | 0.0% | Buy (55) |
| Mid cap | Lamb Weston Holdings | LW | May 2020 | 61.36 | 61.44 | 1.6% | Buy (85) |
| Mid cap | Xerox Holdings | XRX | Dec 2020 | 21.91 | 16.78 | 6.0% | Buy (33) |
| Mid cap | Ironwood Pharmaceuticals | IRWD | Jan 2021 | 12.02 | 11.73 | 0.0% | Buy (19) |
| Mid cap | Viatris | VTRS | Feb 2021 | 17.43 | 10.85 | 4.4% | Buy (26) |
| Mid cap | Organon & Co. | OGN | Jul 2021 | 30.19 | 34.63 | 3.2% | Buy (46) |
| Mid cap | Marathon Oil | MRO | Sep 2021 | 12.01 | 25.13 | 1.3% | Buy (30) |
| Mid cap | TreeHouse Foods | THS | Oct 2021 | 39.43 | 37.89 | 0.0% | Buy (60) |
| Mid cap | Kaman Corporation | KAMN | Nov 2021 | 37.41 | 33.19 | 2.4% | Buy (57) |
| Mid cap | The Western Union Co. | WU | Dec 2021 | 16.40 | 16.66 | 5.6% | Buy (25) |
| Mid cap | Brookfield Re | BAMR | Jan 2022 | 61.32 | 45.60 | 1.2% | Buy (93) |
| Mid cap | Polaris | PII | Feb 2022 | 105.78 | 105.31 | 0.0% | Buy (160) |
| Mid cap | Goodyear Tire & Rubber | GT | Mar 2022 | 16.01 | 11.19 | 0.0% | Buy (24.50) |
| Mid cap | M/I Homes | MHO | May 2022 | 44.28 | 43.75 | 0.0% | Buy (67) |
| Large cap | General Electric | GE | Jul 2007 | 304.96 | 73.28 | 0.4% | Buy (160) |
| Large cap | Shell plc | SHEL | Jan 2015 | 69.95 | 55.22 | 3.6% | Buy (60) |
| Large cap | Nokia Corporation | NOK | Mar 2015 | 8.02 | 4.67 | 2.0% | Buy (12) |
| Large cap | Macy’s | M | Jul 2016 | 33.61 | 21.20 | 3.0% | HOLD |
| Large cap | Credit Suisse Group AG | CS | Jun 2017 | 14.48 | 6.24 | 4.2% | Buy (24) |
| Large cap | Toshiba Corporation | TOSYY | Nov 2017 | 14.49 | 20.83 | 3.1% | Buy (28) |
| Large cap | Holcim Ltd. | HCMLY | Apr 2018 | 10.92 | 9.11 | 4.8% | Buy (16) |
| Large cap | Newell Brands | NWL | Jun 2018 | 24.78 | 22.17 | 4.1% | Buy (39) |
| Large cap | Vodafone Group plc | VOD | Dec 2018 | 21.24 | 14.70 | 6.9% | Buy (32) |
| Large cap | Kraft Heinz | KHC | Jun 2019 | 28.68 | 43.05 | 3.7% | Buy (45) |
| Large cap | Molson Coors | TAP | Jul 2019 | 54.96 | 55.57 | 2.7% | Buy (69) |
| Large cap | Berkshire Hathaway | BRK.B | Apr 2020 | 183.18 | 308.06 | 0.0% | HOLD |
| Large cap | Wells Fargo & Company | WFC | Jun 2020 | 27.22 | 41.81 | 1.9% | Buy (64) |
| Large cap | Western Digital Corporation | WDC | Oct 2020 | 38.47 | 55.55 | 0.0% | Buy (78) |
| Large cap | Altria Group | MO | Mar 2021 | 43.80 | 52.17 | 6.9% | Buy (66) |
| Large cap | Elanco Animal Health | ELAN | Apr 2021 | 27.85 | 21.69 | 0.0% | Buy (44) |
| Large cap | Walgreens Boots Alliance | WBA | Aug 2021 | 46.53 | 43.16 | 4.4% | Buy (70) |
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.
Please feel free to share your ideas and suggestions for the podcast and the letter 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 and space limits we may not be able to cover every topic, but we will work to cover as much as possible or respond by email.