September 2, 2022

This note includes our review of earnings from Duluth Holdings (DLTH), the Catalyst Report and a summary of the September edition of the Cabot Turnaround Letter, which was published on Wednesday.

With the Catalyst Report, we encourage you to look through this listing of all of the companies that have reported a catalyst in the past month. These catalysts include new CEOs, activist activity, spin-offs and other possible game changers. We source many of our feature recommendations from this list. You will find it nowhere else on Wall Street.

Earlier this week we published the September edition of the Cabot Turnaround Letter. One of our more productive methods for finding attractive turnaround stocks is to see what other like-minded investors are holding. We culled the list of hundreds of positions held by our evolving list of 50 or so preferred managers, as reported in the quarterly 13F filings, and discuss three of the most promising, including Intel (INTC), Jefferies Financial Group (JEF) and Zimmer Biomet Holdings (ZBH).

We also combed through the roster of stocks trading at low prices – another great source for turnaround stock ideas – and review four that have particular appeal, including Gap Stores (GPS), Gates Industrial Corporation (GTES), Hanes Brands (HBI) and Jeld-Wen Holdings (JELD).

While exceptionally rare, there are a few companies that trade at negative enterprise values. We discuss how this might occur and mentioned two.

Our feature recommendation this month is Warner Brothers Discovery (WBD). While most investors view this company as a “play” on streaming, we view it as an undervalued turnaround of the poorly managed WarnerMedia assets that it recently acquired from AT&T.

We note our recent ratings change of Lamb Weston Holdings (LW) from Buy to Sell.

Earnings Updates

Duluth Holdings (DLTH) – This retailer of rugged workwear and outdoor gear struggled with a disjointed and overly aggressive store expansion strategy. Duluth ousted the CEO in September 2019, brought the founder back to the CEO seat on an interim basis, terminated the failed strategy, and hired a new, permanent CEO in May 2021. The company has immense opportunities – its challenge is to strike a successful balance between pursuit and execution.

The company reported weak second-quarter results that also were considerably below estimates. Earnings of $0.07/share fell 74% and were well short of the $0.15 estimate. Revenues fell 5% and were about 10% shy of estimates. Adjusted EBITDA of $13.2 million fell 38% and was about 24% below estimates. Duluth reduced its full-year revenue guidance by 7%, EBITDA guidance by 17% and earnings per share guidance by 32%. It left the capital spending guidance unchanged at $40 million.

The quarter is seasonally one of Duluth’s weakest, generating perhaps 19% of annual sales and perhaps 10% of profits, so the weak results will have an undersized effect on full year results. However, conditions appear to be deteriorating, reflected in the lower guidance. We compared the guide-down in EBITDA (-$15 million) to the guide-down in sales (-$50 million) and see that the decremental margin is 30% ($15 mil ÷ $50 mil). This is much higher than the overall EBITDA margin of around 12%, suggesting the scale of the pricing and volume headwinds.

In the quarter, retail store sales fell 12%, which is essentially the same as comp-store sales, as the store count is essentially unchanged. Online sales rose fractionally. Gross profits fell due to inventory write-offs and some damage to goods during shipment. Inventories are about 22% from a year ago – we estimate that perhaps half of this is inflation and half is volume.

The balance sheet carries only $15 million of cash, compared to $77 million a year ago. To ward off liquidity issues, the company increased the size and pushed out the maturity of its line of credit.

We remain supportive of DLTH shares even in the difficult environment, as the company continues to upgrade its operations and improve its future prospects.

Friday, September 2, 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 8 ½ minutes and covers:

• Earnings report from Duluth Holdings (DLTH)

• Comments on other recommended companies:
  
  • Kraft Heinz Company (KHC) - sold powdered cheese business for undisclosed sum.
  • Walgreens Boot Alliance (WBA) - completed its acquisition of a majority stake in CareCentrix for $330 million.
  • Volkswagon AG (VWAGY) - Porsche hired Mercedes’ former tech chief, possibly in advance of an IPO.

• Elsewhere in the markets:
  
  • Rising interest rates and sloppy earnings push down stock prices but not necessarily stock valuations, so we wait.

• Final note

The Catalyst Report

August was a quiet month for catalysts. The mix skewed (18 of 31) toward CEO changes. At one company, Marqeta (MQ), the founder stepped aside after saying that “I have led Marqeta from 0 to 1, and soon it will be time to pass the baton to the best person to lead it from 1 to infinity.” This an exceptionally smart move and a rare acceptance of the near-100% chance that a founder isn’t the right person to run a young company forever. The surprise termination of Carlyle Group (CG) CEO Kewsong Lee makes for interesting viewing but this company could be in a protracted struggle as capital markets turn against it.

The Catalyst Report is a proprietary monthly report that is unique on Wall Street. It is an extensive listing of companies that have experienced a recent strategic event, such as new leadership, a spin-off transaction, interest from an activist investor, emergence from bankruptcy, and others. An effective catalyst can jump-start a struggling company toward a more prosperous future.

This list is intended to be comprehensive. While not all catalysts are meaningful, some can bring much-needed positive changes to out-of-favor companies.

One highly effective way to use this tool is to pair the names with weak stocks. Combining these two traits can generate a short list of high-potential turnaround investment candidates. The spreadsheet indicates these companies with an asterisk (*), some of which are highlighted below. Market caps reflect current market prices.
You can access our Catalyst Report

.

The following catalyst-driven stocks look interesting:

AMC Networks (AMCX) $1.2 billion market cap – This company has a valuable library of media content, including the “Better Call Saul” series. However, its push into streaming is challenged due to its small scale. The new leadership could rejuvenate AMC Networks’ prospects or perhaps bring a combination with a much larger media company.

Jeld-Wen Holdings (JELD) $939 million market cap – Also highlighted in the recent Cabot Turnaround Letter, this company is a major producer of windows and doors, primarily for the residential market. The just-ousted CEO was ineffective in developing this company’s potential, so the board is now searching for a replacement. The shares are depressed and undervalued.

Foot Locker (FL) $3.5 billion market cap – The arrival of Mary Dillon as CEO could be a game changer. She led the impressive growth of Ulta Beauty during her eight-year term at the helm, including rationalizing its store base, attracting new brands and driving its expansion into e-commerce – all areas where Foot Locker could use some help. Foot Locker trades at 3.9x EV/EBITDA and has zero debt.

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.

Please know that I personally own shares of all Cabot Turnaround Letter recommended stocks, including the stocks mentioned in this note.

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.