Category: Columns

Quick Recap on $WDFC Q4: GMs +400bps sequentially. Europe main disappointment. No change to thesis.

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Quick update of WDFC, doubt I do this often, but they reported so soon after I wrote on it I thought I’d give some thoughts. We’re seeing the green shoots of recovery on margins, but EMEA was weak, much more than expected. All in all, nothing changed in my thesis, but I’ll expand.

Maintenance sales (their core product) declined about 30% in EMEA. That’s stark for a business that was resilient in 2008. It would have been just 15% FX-neutral and they did exit some Russian and Belarus business, but still. It was only down 1% in the Q ended Aug. They sell through distributors in the EU, so no surprise in the face of uncertainty, distributors are destocking.

As such, EBITDA missed my estimate by about $5MM ($23MM vs. $28MM) solely due to this. GMs even beat my estimate by about 50bps. And mgmt basically said they have no change to their expectations, which is a second-half story. Normally I take the under on any second-half story, but this one makes complete sense.

I reviewed the “cost of a can” to see what is really driving the margin erosion. Basically 65% of a WD-40 can is either related to oil or tin. While packaging doubled in $s, the real needle movers are the chemical inputs, can, and manufacturing fees. These manufacturing fees are essentially warehousing and freight costs.

I think all of these will be tailwinds in second half.

Plus, China sales grew 22% on the maintenance side and 32.5% in APAC-ex China. So that is a good sign and probably more room to run as China re-opens.

Outside of that, last thing I’ll highlight is they have way too much inventory. They should destock themselves. But anyway, I expect that’ll be a 2H cash source. Could be up to $85MM, honestly. That may seem small, but it ain’t nothing for a company I expect to recover to $120MM+ EBITDA plus have a cash release like that.


Re-examining Big Lots Stock – Case for Optimism? $BIG

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It’s a start of the new year, and the end of a year where the S&P500 was down nearly 20%. Some may focus on what worked, I’ll look at an idea that did not go well. Big Lots stock, down 68% in 2022, it’s market cap is just ~$425MM.

I think there’s still room for optimism (even if its just a “dogs of the Dow” type of viewpoint). This bagholder just won’t quit. Mainly because I think the stock is trading at ~3x FY’24 EBITDA, 8% dividend yield, with some upside if they continue to sell some assets.

Don’t get me wrong. Don’t take this as “Big Lots stock is my largest position.” Far, far from it. Could we go into a recession? Sure. Am I happy that FCF may be mediocre despite the low EBITDA multiple? Of course not. That’s why position sizing is important.

That said, from here the stock looks interesting (even if that means when I first wrote it up was much too high). This could be one to add to the radar at the very least. I’m also looking out to 2024. So if you’re someone who is looking for something that will definitely do well this year, not sure this is the place. Especially because if under this new lens it just looks “interesting”, then it probably has a bit more downside before the upside arrives (just my experience).

I think my biggest mistakes in 2022 were buying low-quality business that seemed like they had tailwinds. Things can quickly change, tailwinds can evaporate, and you’re left with a low-quality business! It worked for awhile and then it really did not work…

Retail is a tough business. That’s apparent right now where many are caught with too much inventory (in the face of destocking), mark downs are evaporating profits and working capital has eaten liquidity. Freight and labor have also been challenging.

What makes this a particularly bad pick for me is I’ve been calling for the bull whip to play out for some time now and this is a clear example (here and here).

But I really liked what Big Lots was doing – pivoting store formats, bought brands with staying power (Broyhill), improving cost structure and growing stores to help absorb fixed cost leverage. I still think all of those are true. But as I’ll show below, they really got hit with freight, promotional activity, and labor costs.

Theoretically, the challenges mentioned above should be “one time” in nature, or at least cyclical problems, not secular. And they are all known now, at least I think they are…

I built a waterfall chart from 2019 to show the pressures Big Lots has seen. But just to rehash in FY2022 (which will end Jan’23, so Q4 is still an estimate).

  • Sales will have declined ~11%
  • GMs down >400bps
  • Opex up as a % of sales >350bps

Big Lots ended 2019 with ~6.5% EBITDA margins, so no surprise it is now negative.

But when you break down the reasons, Big Lots has called out freight being 400-500bps of operating margin pressure via GM and Opex. And they said that has peaked at this point. Promotional activity has peaked, too.

Looking forward, Big Lots has already faced destocking as mentioned. If we assume modest sales growth to 2024 and some of these headwinds abating, I could see Big Lots easily getting back to $255MM of EBITDA in FY’24 with some reasonable assumptions.

Bridging Big Lot’s EBITDA from 2019 to the current year to my expectation a couple years from now

With a ~$425MM market cap and ~$825MM Enterprise Value, that means Big Lots stock is trading at 3.2x EBITDA!

Is it the cheapest retailer I have ever seen? No. But I think that multiple could look even lower given more asset sales are on the come:

I have no idea what these assets could sell for. Back in 2020, they did a sale leaseback of 4 distribution centers for a gross amount of $725MM (net proceeds was more like $575mm after taxes and such). That’s not really a comp, but was interesting how low book value was compared to the actual proceeds (recorded a $463MM gain on sale).

I did find several listings of Big Lots stores that ranged anywhere from $2.5-$4.5MM (honestly averages in the middle). If it could sell 25 stores for $2MM a piece, that is $50MM gross. There’d probably be $3.5MM of incremental rent expense as a result, but that’d still be a win in my book given where the market cap is.

Big Lots has nearly $720MM of PP&E on its balance sheet. Selling assets at better than a 10% cap rate is accretive given Big Lots stock is trading at such a low multiple. It helps liquidity and can help pay down debt. I’ll take it.

While dangerous to anchor on, let’s not forget book value is $27/share.

As I mentioned at the top, a big concern here is $255MM of EBITDA may not generate much FCF. They’ll probably spend $170MM on capex per year (albeit to grow stores). I think with interest the stock is probably trading at a 10% FCF yield at best.

So one to watch. I still think this business and brand are underappreciated long-term. But alas, buying low-quality businesses even at cheap prices can be a dangerous game.

Can’t wait for Fed Speak to be over… long-live Fed Speak?

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Do you feel like all anyone is talking about is what the Fed will do next? I feel like conversations have shifted from fundamental work to “will the Fed cause a recession?”… and we’ve been doing that in earnest for a year now and I’m over it.

Well, we’ve been doing it for 14 years at least, but it feels really heightened right now.

Some people may say, “yeah, they can cause a recession and impact earnings!” and I get that. But it feels like digesting “Fed speak” is the only conversation right now.

Some people may say, “that’s how it has always been. The Fed moves markets. Don’t fight the Fed.” Was it really always this way? As a result, I guess do limited fundamental work and just monitor the Fed? A lot of people do that I guess. It sure does take the fun out of fundamentals. It doesn’t feel like companies like Autozone or Monster Beverage did well simply based on what the Fed did.

I remember when it was “jobs Friday” and everyone waited on bated breath for a weaker jobs number so that it meant the QE spigot stayed on. And a weak number sent stocks higher. But did a lot of that anxiety really matter? I don’t know. Maybe. But we’re doing it again, on steroids.

I think after each crisis we say to ourselves, “the Fed is been so dominant because of extraordinary measures taken to support the economy [or stifle inflation].” But even so, it stays part of the conversation…

Truth is, something will always dominate the conversation. Probably just to distract. Especially when there’s limited new earnings releases.

Anyway, more of a “musings” post, but I wonder if it’s an opportunity if we were to zoom out with a longer-term perspective. I’m not saying people aren’t doing any fundamental work, and I am not saying you can tune out the Fed completely.

But I am asking myself if I would be a better investor for tuning out 80%+ of the Fed stuff and poured myself into at least medium-term analysis of where I think a company will be. I think its tough to argue with that.

Quick October YTD Update and Other Musings

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I haven’t been able to write as much on the blog this year do to other commitments, but wanted to do this post as a quick update on names I’ve posted on in the past and future thoughts. Can’t quite call it a mid-year update, or full year update, so think of this as a 5/6ths year update…

In no particular order:

  • $AGFS – This week Paine Schwartz announced it would acquire the company for $3/shr. They already have a very onerous pref and control a lot of votes. They clearly know the company well. That said, the offer was not subject to having financing. I’ve followed AGFS for some time and financing was always tough (hence the onerous pref) and financing is even more difficult right now. I’m closing out this position and moving on @ $2.75.
  • $NCMI – what a disaster. Cineworld declared bankruptcy and that gives them the right to restrike the deal with NCMI. Plus, advertising continues to be weak as the economy slows down. As a post-mortem, I’m comfortable with my call to buy it as a levered play on theaters recovering, but I missed Cineworld risk. I thought even in BK, re-striking the NCMI deal made no sense (they just cut the deal in 2019, NCMI is superior to alternatives, re-striking the deal creates a big claim for NCMI as a unsecured creditor, and so on). No need to dwell on all the details, mistakes were made. Moving on.
  • $BBBY ’24s – as expected, BBBY launched a distressed exchange.  The offer is pretty “meh” for the ’24s, despite swapping into either a non-convertible 2L security or a convertible one with a lower coupon vs. unsecured. However, in the non-convertible, they can call it in 1 year at 40c. In the convert, the strike is $12/share. Maybe if there’s a reddit mania again that makes sense, but pah-lease. In the meantime, they company continues to complete its ATM equity program and has raised $75MM + filed to raise another $150MM. I’ll wait for another offer….
  • $AXL and other auto suppliers – I think the auto thesis is delayed due to inflation hitting earnings plus continued supply chain problems, but the thesis isn’t dead yet. I still like auto suppliers despite what seems to be a looming recession given production is still constrained.
  • $ABM – a quiet winner YTD being up ~9.5%. They continue to grow well organically and margins are holding in. I still like it as a name no one seems to follow well.
  • $BIG – can’t escape the woes of other retailers. They have a lot of issues, but I think with prices where they are, I’ll do ok in the next 5 years (famous last words)
  • $CVEO – touches energy so no wonder it is up 58% YTD. Yet with leverage so low now and literal leverage to an energy up-cycle, why would I close out now?
  • Muni Bonds & GSEs – rates continued their march up after I posted about Munis. I still think the value is quite strong. I also think I see more signs of a deflationary bust than continued increase in inflation. Sure, it is “stubborn” for now, but the Fed’s tools are a blunt instrument and take time. The main thing that keeps me up at night is Europe and their supply shock (see bottom of post for more).

But if you ignore that, the Fed has told you it wants to get back to 2% inflation. Do you believe them? If you do, but think pain comes in between now and then, do you own stocks right now? I’m OK owning highly-rated fixed income securities for what comes on the other side but in either case, are offering 7-8% tax-equivalent yields.

I tweeted about GSEs recently too (FHLB and Farm Credit bonds). These were offering yields >100bps than the same-rated treasury securities. There are reasons for that, such as the Fed stepping out of buying MBS, but also these becoming longer duration assets as rates went up, but also banks capital rules this year mean they aren’t buyers and probably sellers this year, BUT ALSO, foreign buyers have been priced out of the market due to FX hedging…

So you’re telling me all the buyers are out and I’m getting a historically massive spread for AAA paper? I’ll take it.

As for what keeps me up at night from here, it has basically nothing to do with the Fed. It is 100% Europe. I’m not sure how they will effectively deal with such a large energy shock and unfortunately, while 2022->2023 winter looks like no one will freeze, who knows about 2023->2024 winter and beyond. And in particular, how will that impact the economy?

I recently came across this slide from a chemical service, ICIS, which showed how much capacity had been idled or reduced in Europe. It’s insane. Especially when you look at the top constituents actually tend to be more critical (fertilizers are the top 3 and then polyethylene, PTA, PET which go into a lot of out everyday products and packaging). 

If you want to convince me of a more “embedded” inflation problem, I see it there. And it isn’t related to stimulus. It’s a supply shock. 

Here’s another one, excluding fertilizers, but also shows it based on % of capacity in chemicals. 

This earnings season, companies I follow with European exposure have noted a pretty precipitous drop off in demand in Europe. It makes sense. When you are worried about heat bills, you are less worried about buying a new car, TV, window treatments, or basically anything discretionary.

This seems like a big problem. I’m normally a really optimistic guy, but if I had to be a bear, I’d point here.

How will the ECB Handle Europe’s Gas Crisis?

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We’ve all seen the headlines and charts of European electricity prices and gas prices. Each time the Nordstream pipeline is serviced, we brace ourselves for Russia to not bring it back. And we brace ourselves for Germany, Italy and likely all of Europe to fall into a deep recession with no easy way out.

Front Month Netherlands Nat Gas Contract Price

I don’t have much to add to the energy conversation other than to remember optimists usually make the most money in investing. But the situation is so untenable.

Since I have no idea how Germany’s chemical and industrial sector will deal with the loss of gas (I’ve read reports, but I don’t know the long-term solution), I decided to jot down what is happening with the Euro currency and if that’s something to stifle the blow.

Unfortunately I just don’t see it.

Here’s my scratch on what could happen. Happy to hear others thoughts

In a nutshell, the EUR has already weakened considerably against the US$. That may help tourism.

Theoretically it helps exports on paper, but this is an interesting situation. How? In fact, Europe has quickly become the highest cost producer of many chemicals and other products. Note BASF and Yara have cut fertilizer production because of the gas cost. That is likely true for many other products. Instead, Europe will need to import these fertilizers from the US.

So generically, if Europe can import products cheaper than it can make, it will have to. And that’s a lot of things at this point given the disparity in prices. It doesn’t help that commodities are typically priced in US$ either. Europe has become a high cost island.

So what can the ECB do? Raise rates? Drive the currency higher? I guess, but the magnitude likely kills the economy anyway.

Do they raise rates but provide stimulus? Do the governments try to take the whole burden? I could see the merit as this is the equivalent of war time spending. Maybe that helps the currency as investors see Europe is building a sustainable path out.

Do they do nothing? Hmm.

Should the Euro be disbanded? Maybe the countries that have cheaper power may want this. Maybe they wouldn’t.

Will the U.S. benefit? I could see our chemical and industrial sector get a larger boost as the low cost producer. But it will also drive up our energy costs, as we’ve already seen with natural gas hitting $9 again. The U.S. Fed also probably wants a stronger currency as it helps tame our inflation. But it is a bit easier being the reserve currency to strengthen when Europe is in such a troubling situation. It is also hard to imagine the US being unscathed in a major European recession.

Should the US conduct some sort of defense era production act? Drill baby drill, but in our own country? Some sort of Marshall plan? I see the merit, but do US voters?

We shall see!