On May 3rd, Turnaround Letter Buy-rated Newell Brands (NWL) reported first quarter 2019 results that show that the turnaround is making progress. While revenues still need to stabilize, better expense control is bolstering profits. Management re-iterated their full-year guidance. Improved working capital management is freeing up otherwise captive cash on the balance sheet. We anticipate the company will appoint a new CEO by the end of the third quarter, providing an additional catalyst for the shares.
Newell shares surged 14% on the news and have maintained most of their strength since then.
Newell’s revenues fell by 5.5%, but after adjusting for divestitures and currency changes, core revenues fell by only 2.4%, indicating a reasonably stable top line. Currency changes were outsized: converting foreign sales into the strong dollar removed $46 million, or 2.6%, from revenues. Newell needs to begin producing revenue growth in its core businesses, but for now we find the modest revenue decline acceptable.
Part of the revenue decline may be attributable to the company’s reduction in the number of different products (or SKUs) it sells. From a total of 90,000 SKUs last year, Newell is working to cut this number to about 45,000 by the end of 2020. About 3,000, or 3%, were eliminated in 1Q19. Typically, the pruning of redundant or low-value permutations of core products results in lower revenues, but has a minimal effect on profits.
Other drivers of revenue in the quarter included weaker contributions from Toys’R’Us, whose bankruptcy effects are tapering, a weak comparison to higher volumes a year ago related to filling up a Latin American distribution channel, closure of underperforming Yankee Candle stores, and the disappointing loss of a retailer that will no longer carry Coleman products.
The gross margin of 31.9% (compared to 33.3% a year ago) shrank due to currency changes, tariffs and higher procurement costs. Better pricing, productivity and restructuring expenses weren’t sufficiently strong to overcome these unfavorable costs.
However, more important, operating profit margins were higher, more than offsetting lower gross margins. Significantly better overhead costs boosted the operating profit margin to 4.3%, up from 2.5% last year. The EBITDA margin of 7.4% was not directly comparable to last year’s results due to lack of disclosure by Newell.
Operating cash outflow was $200 million, but this was improved from a $402 million outflow a year ago.
The company’s divestiture program has yielded about $6 billion in proceeds. While their plan is to generate about $9 billion (down from $10 billion originally), we expect them to fall modestly short. While disappointing, it won’t derail the turnaround. As the share price is lower than our expectations, the company would wisely begin their repurchases to help offset the effect of the lower proceeds.
Management re-affirms full-year guidance
The company guided full-year 2019 revenues to decline 3%-5% from last year. This decline is estimated to be driven by core sales declining in the low single-digits (which we would put at about 3%) combined with a currency headwind of perhaps 0%-2%.
Normalized operating margins were guided to increase 20-60 basis points from the 9.1% margin in 2018. Total company operating cash flow guidance is for $300 million-$500 million.
Management guided operating cash flows to be $300 million to $500 million for the year.
Due to seasonality, first quarter operating profits tend to be the smallest of the year, likely to be only 8%-10% of annual operating profits in 2019. As such, the quarter’s trends are helpful but only modestly useful in estimating full-year results.
Chinese tariffs
Newell is exposed to the direct and indirect effects of higher tariffs, as it sources a sizeable amount of its products in China. The company estimated that the delay in new List 3 tariffs (the increase to 25% from 10% on $200 billion of a wide variety of Chinese-origin products) which otherwise would have been imposed on March 1st, saved it about $20 million in the quarter. Under a simple annualization, which may not be entirely accurate, the higher tariffs would have a $240 million annual effect (about 3% of sales) on Newell’s cost base.
Tariffs may also affect Newell’s efforts to sell more goods in China. While unpredictable, the Chinese trade disruptions, including changing currency values, could have a sizeable impact beyond what is in management’s guidance.
New CEO likely in 3Q
We anticipate that the company will have found a new CEO by the end of the third quarter. With activist Carl Icahn overseeing much of the change, we anticipate that Newell will appoint a strong new leader, providing an important catalyst for NWL shares.
Overall, the turnaround is starting to make progress. The shares do not reflect the positive changes underway at Newell, and we continue to recommend NWL shares as a BUY.
We continue to rate NWL shares a BUY with a price target of $39.
Disclosure Note: An employee of the Publisher owns NWL shares.