Turnaround Letter Buy-recommended Newell Brands (NYSE: NWL) reported reasonable 4Q18 results, but subdued guidance for 2019 revenues and profits drove the shares to a sharp loss. The multi-year turnaround is running into several macro headwinds along with some internal disruptions. While these issues cloud the near-term outlook, the company is making progress toward its goal of improving its margins and cash generation, reducing its share count and debt outstanding, while maintaining its dividend. Like any complicated renovation project, it can be difficult to see how it will all turn out well when it currently looks messy, at best. Despite its headwinds and reduced 2019 outlook, we remain confident in the board’s ability to guide the company to a successful completion. The 4.2% dividend looks safe and provides investors with a relatively high cash return during the wait.
Newell reported normalized 4Q18 earnings of $321 million, down 4.2% from 4Q17 normalized earnings of $335 million. As Newell’s diluted share count declined 7.6%, its per-share earnings of $0.71 was 4.4% higher than the year-ago $0.68/share.
Revenues of $2.34 billion fell 6% from a year ago, although core revenues of $2.38 billion were only 1.2% lower than a year ago. Core revenues removes the effects of changes in currencies and from acquisitions and divestitures.
Normalized operating income of $267.8 million, which excludes a wide range of integration, acquisition, divestiture and other one-time costs, was essentially unchanged from a year ago. The profit margin of 11.4% was better than the year-ago margin of 10.7%. While we understand the assumptions behind the adjustments, they are enormous and recurring which we find unacceptable. Helping this somewhat: management will no longer exclude the integration costs from normalized earnings. However, as these costs decline each year, the shift will provide an artificial boost to margins. We expect to see these adjustments shrink to a dramatically smaller total in 2019 and beyond as the turnaround progresses.
Compared to analysts’ consensus estimates, revenues were about 4% light while earnings per share was more than 9% better.
Why the stock was weak
Newell shares fell 21% on Friday following the earnings report, leaving the shares down 8% for the year to date, but 11% higher than their low of $15.40 set on October 29 last year.
Driving the shares lower was the disappointing guidance for the first quarter and full year 2019. Full-year revenue guidance fell about 6% short of consensus estimates while full-year normalized earnings per share fell about 18% short. First quarter guidance was worse. For investors hoping for a relatively fast, disruption-free turnaround, the guidance was disappointing.
Two primary reasons for the weak 2019 guidance
A broad range of headwinds are pressing against Newell’s turnaround. Macro-economic pressures, including the strong dollar, higher costs from commodity prices and freight, and the tariffs, will likely continue to drag down revenues and profits in 2019. The company estimated that these macro headwinds will hurt operating profits by about $200 million, equivalent to about 2.4% of sales. The lingering effect of the Toys R Us bankruptcy will also weigh on the year, mostly hurting 1Q results. Unit-specific issues, like Yankee Candle’s mall-based stores suffering along with its retail peers, add to the sluggishness.
A related macro pressure is the moderately weaker investor appetite for the businesses that Newell is selling. Management reduced their expectations for cash proceeds from these divestitures to $9 billion from the previous $10 billion, with some delays due to changes in the sale process. Our estimate for $11 billion in proceeds is looking optimistic.
The complexity of Newell’s turnaround is generating some internal disruption, which are adding costs and slowing the pace of change. Employees and managers need time to adjust to new mandates, incentive plans, reporting lines and responsibilities. As the company reduces its 43 company-wide tech systems to three, we would expect further disruption. The degree of disruption reflects poorly on the pre-turnaround integration of Jarden and the previous lack of capable leadership overall at Newell.
Part of the drag on sales comes from intentional reduction in sales of unprofitable products. While giving the appearance of sluggish sales, removing these weak products should boost profit margins.
The turnaround is making progress
Despite all the changes, Newell’s 4Q normalized gross margins expanded 1.7 percentage points and normalized operating margins expanded .70 percentage points. Newell was able to raise its prices and offset much of the headwinds through tighter cost controls.
The company expects operating margins to continue to expand in 2019. The expected 20-60 basis points increase (100 basis points is one percentage point) comes despite higher investment in the business as well as about the 2.4% of sales from the macro headwinds. Newell may be optimistic in anticipating that higher prices will fully offset the tariffs.
The new CFO is ramping up quickly, having visited each division, many manufacturing and distribution facilities, all top-10 retail customers, and created a 2019 budget for each unit and corporate.
Staying on plan with use of cash proceeds
Newell’s cash-usage is staying on-plan. In the quarter, it spent $1.1 billion on dividends and share repurchases along with $2.6 billion in debt paydown. Total debt of $7.0 billion is down 35% from $10.6 billion a year ago, while the cash balances remains largely unchanged at a healthy $496 million. Newell ended the quarter with 423 million shares outstanding, about 13% fewer than a year ago. The company reached its net debt/EBITDA target of 3.5x. Management highlighted the sizable opportunity to reduce working capital, freeing up additional cash.
Management will provide more color at the CAGNY investor conference on February 22. Interested investors can listen to the webcast through the investor relations website.
As outlined at the beginning of this note, Newell is in the midst of a complex transition. The pace of the turnaround is slower than the market wants to see, and the depth of its internal problems along with some outside-the-company headwinds are deeper than anticipated. The weak 4Q results raises the pressure on CEO Michael Polk, who engineered the troubled Jarden acquisition and botched the post-merger integration. We remain confident in the board, led by the respected Starboard Value activist investor, and its ability to guide the company to a successful turnaround.
We continue to rate shares of Newell Brands (NYSE: NWL) a BUY with a 39 price target.
Disclosure Note: An employee of the Publisher owns NWL shares.