Category: Earnings Recap

Why Facebook Stock is Still a Buy

Facebook reported a great Q1’19 and the stock has climbed a wall-of-worry back to the $195 area. However, Facebook stock is still a buy.

To recap, investors have been concerned about the list of negative headlines out of Facebook regarding privacy issues. In addition, based on commentary I’ve heard from friends and FinTwit, there is a growing list of “I don’t even use Facebook anymore”. Nevermind the fact that social media is proving addictive…

I recently argued that, while I am concerned with the Facebook headlines, the core business of Facebook is doing fantastic. The arguments of “Delete Facebook” are understood, but completely anecdotal.

That is why I argued back in November and October that you should be buying Facebook stock. My argument was based on these points:

  • Facebook is a dominant platform with >2.5 billion unique users
  • Advertising via social media platforms is still in its infancy
  • The ROI advertisers receive from using social media platforms is much higher than traditional methods, which will grow the advertising pie and should benefit the FB platform given how many users it has
  • Expect high growth from FB as it monetizes Facebook and ramps Instagram, video, Whatsapp and FB messenger

So did Q1’19 help assuage investors’ fears? Certainly – take a look at the opening statement on the earnings call:

This was a strong quarter, and our community and business continue to grow. There are now around 2.7 billion people using Facebook, Instagram, WhatsApp or Messenger each month and more than 2.1 billion people using at least 1 every day

Even in Europe where GDPR hit, MAUs grew nearly 2% Y/Y.

It’s great that they have lots of eyeballs on their sites still, but is that translating into profitable growth? Yes.

The company is seeing the most growth from a user perspective and an “average revenue per user” out of Asia and the RoW. That is actually why I think Facebook has much more room to run. As ARPU’s for these segments converge to where the US and Europe are (which will take time) I think Facebook can reach $80BN of EBITDA by 2022. Given the company’s strong returns on invested capital, I think it warrants a premium multiple. But if the stock traded at 12x at that point (in-line with the median S&P multiple today), I think the stock can double from here.

Remember that WhatsApp today is still largely under-monetized, but has >1.5 billion MAUs. Facebook has plans to turn WhatsApp into a payments and commerce platform, which should drive strong returns going forward.

As of right now, the company has a large goodwill item on the balance sheet after buying WhatsApp for $19BN.  Even so, the return on invested capital is extremely high. Facebook earns ~$0.40-$0.50 for every $1.00 it invests in year 1. This is extremely attractive and well above market average. Therefore, you could argue it deserves a premium multiple and my PT could be too low.

B&G stock pressures continue. Starting to think the company should pursue a sale of itself, either to a strategic or sponsor (supported by back-of-the-envelope LBO math). $BGS

Although there are no earnings updates or any particular newsworthy items on B&G Foods, I thought it would be a good time to update on the company as the stock has come under significant pressure. It also gives me time to gripe about the way dividends are viewed in the US.

You see, BGS’ stock is down 20.5% YTD (compared to SPY being up 14.5%). The dividend yield is now ~8.3%. However, all things considered, I’d prefer the company to turn that dividend off and buyback shares at these levels.  

Companies typically establish dividends as a way of saying, “here you go, investors, I can’t invest this cash at levels that would create value for our company (i.e. in excess of our cost of capital), so I am giving it back to you.”

That’s all fine and good, but what about when things change (as they always do)? The way it works now is that dividends are viewed as sacrosanct. A company that cuts its dividend from the previous level will see its stock get crushed. It seems silly to me for that to be a rule. In some cases, the result is that CEOs/ CFOs initiate dividends to get into stock indices or attract incremental buyers. If I were CEO / CFO of a public company, the last thing I would do would be a regular dividend (even if it meant some funds couldn’t buy my stock). Special dividends, or dividends that are understood as non-recurring, seem much more prudent.

Anyway, back to B&G. It appears that private values of companies are now in excess of public companies. I also think that public investors are not valuing B&G’s platform as it should. As such, I wish B&G would (a) cut the dividend and buyback stock and (b) pursue a sale of itself. While the company would lose its public stock as currency to buy things, private markets are more comfortable with LBOs of highly cash generative companies.

What do I think B&G could sell itself for? Well, Ferrero just bought Kellogg’s cookies, fruit & fruit-flavored snacks, pie crusts and ice cream cones business for $1.3BN, or 12x EBITDA. Kellogg decided to sell this business because it had areas that it felt it could invest in for a higher return.  Campell Soup, which is struggling with growth, trades for 11.5x. I think B&G should at least trade for that. Also recall that Campbell bought Snyder’s-Lance for 19.9x EBITDA pre-synergies and 12.8x post-synergies.

If B&G sold itself for 12x, that would imply a $31 price target (excluding any synergies or cost outs of no longer being a public company). I wouldn’t necessarily like that price, but it could be a catalyst for people to pay attention to the stock.

Does 12x make sense? Let’s look at the private equity math. I assume PE can carve out some costs and also the company should be lapping freight and other inflation costs. I also assume they use cash to pay down debt. It amounts to a ~16% IRR. Not a 20% winner, but not too shabby either.

$HDSN Q4’18 Recap: Headwinds continue, but signs are pointing to the summer season heating up for Hudson. Maintain a Buy despite the rally.

Rounding out a tough year for Hudson, Q4’18 showed further pricing pressure for the company. Based on mgmt commentary, pricing was ~$10.5/lbs for its benchmark product, down from ~$14.5/lbs in the prior year quarter. However, sales volumes actually increased 38% in the quarter, in what is typically a seasonally slow period.

This is encouraging to me as it seems the original thesis is showing signs of playing out. Recall, I attributed much of the pressure in the business to destocking ahead of the phase-out of R-22. With prices declining, particularly as foreign producers try to capture the last bit of market share, buyers are incentivized to wait to buy inventory. Why buy now when I can wait a couple weeks and get a better price?

The Q4 volume print tells me a couple things. First, volumes likely hit their low point and now customers need to re-stock in 2019. With r-22 refrigerants set to phase-down virgin production from 9MM lbs to just 4.5MM and then zero in 2020, I think we could see a restock plus pricing moving up dramatically from lower supply. As the company noted on its latest call, it thinks there is about 40MM lbs of demand, which bodes well for the company and pricing.

As the company stated on the call:

There’s nothing that tells us that the price of 22 shouldn’t be back in the $20s and maybe beyond that. And there are times that we’ve said, maybe it goes to $30 a pound as was the case with the CFC phaseout, and some of the CFCs still are trading above that level. So we still believe that’s going to happen. What is difficult to say is what year is that going to happen and when is it going to rebound. We certainly still believe that 2019 is the last year of any material stockpile in the supply chain. So we do think there is the possibility of higher prices later this year in R-22, and we certainly do think there will be higher prices of R-22 next year, 2020. So we do expect to start to pay again higher economics, which hopefully then induces folks to return more gas

Using the company’s disclosure of realized prices during the quarter, I can back into a proxy for pounds of product sold. This gets me to ~15.5MM lbs sold. If I then assume we will see re-stocking to the tune of ~30%, that moves the volume sold to 20MM lbs. I don’t think this is unreasonable for a few reasons.

First, the company witnessed destocking of this amount already in 2018. This would just get us back to the base level. This then, therefore, would ignore that virgin production is going away, which should be incremental volume opportunity for the company.

Assuming pricing gets back to $20/lbs and gross margins improve, I think the company could reasonably get to $50MM of EBITDA. The company’s GMs were ~30% of sales in 2016 and in the future, they will be reclaiming spent product and re-selling it. That theoretically should be higher margin. The company stated that reclaim may be bigger in 2020 and 2021, so I’m baking in some additional conservatism.

For valuation context, I think the company still has significant upside from here, as shown below. Note, I support this with a normalized FCF figure as well and my price target is >7% FCF yield, which I think is attractive.

B&G 2018 Wrap Up: Not even the Green Giant is immune to food sector challenges. Been wrong on the name so far, but reaction creates solid entry point + high dividend. $BGS

B&G reported Q4’18 EBITDA of $59MM compared to $69MM in the prior year. While this was partially impacted by the sale of Pirate Brands to Hershey, it was still a tough comp due to input cost inflation (freight, procurement, as well as mix). As a result, EBITDA was 200bps lower as a % of sales than the prior year.

I expect B&G’s stock will react negatively to this (already down 10% after hours to $22) and I am disappointed with the stock’s performance since I wrote on it first in Aug 2017 (down ~25-30% depending on where it opens).

That said, I think there are a few positive take-aways from this quarter that will keep me grounded. Bottom line, I still think B&G is a long-term compounder. Food sector sentiment is particularly negative right now (especially with the KHC news) and 2019 should be an easier comp from a freight and inflation perspective.

  • Green Giant Continues to Grow at Attractive Levels, Despite Challenges in Shelf Stable:
    • Green Giant’s sales increased 4.9% this Q and grew 6.1% for the entire year. This has been mainly driven by new innovations in the frozen food aisle that have countered challenging trends in the canned, shelf stable category (down 8.2% for the year).
    • Part of the thesis in buying B&G is that these managers are good at buying mature assets, harvesting the cash, and restarting the process (rinse & repeat). They sold Pirates Booty to Hershey for $420MM after they bought it for $195MM in 2013. I continue to think Green Giant was a solid acquisition.
    • Given there are many other consumer staple brands struggling to date, I think this is an opportunity for B&G. They repaid $500MM of their TL with help of the Pirates’ sale so that also adds some capacity.
  • Company is managing other mature brands well. Would you have believed me if I said Cream of Wheat increased sales 4.3% this Q? Or Ortega was up 7.2%? Excluding Victoria, which saw a $2.5MM decrease in sales from a shift in promotional activity, I think the company is doing a good job with this portfolio.
  • Continues to generate significant FCF to support dividend. B&G pays $1.90 dividend which based on the after-hours quoted price currently amounts to a 8.6% yield. Typically, dividend yields that high imply the market thinks there is risk of being cut. Setting aside the fact that the company generated $165MM of FCF this year (reduced a lot of inventory), I still think the dividend is covered.
    • Using ~66MM shares outstanding, this implies a $125MM cash use.
    • Based on the company’s guidance range, this implies you are ~1.3-1.4x covered.
    • Said another way, based on my FCF walk, we would need to see EBITDA decline 17% from the mid-point of guidance for it to be 1.0x covered.
BGS Dividend RIsk

Personally, I’d prefer if the company bought back a significant amount of stock at these levels. Unfortunately, the stigma of keeping a dividend out there forever (which is dumb) prevents that from happening (as the stock would get crushed).

Guide from the company:

BGS Guidance

Mohawk posts another ugly quarter… its stock is still not cheap enough yet…

In early November, I wrote that Mohawk stock (the leading carpet and tile manufacturer) had more pain to come… the stock was down some 55%, but was not reflecting this yet.

Fast forward a bit following that article, and Mohawk stock went down another ~10% post-article, but now is up 8%. So what happened? Did something encouraging come from its latest earnings report?

Well, do you call a 20% year-over-year decline in EBITDA good?

I didn’t either. The company called out similar factors as it did in the last call. “The period was affected by significant inflation, slowing markets and LVT impacting sales of other products.”

Unfortunately, I don’t these headwinds are abating any time soon. As I noted in my last post, MHK has gotten a massive margin uplift from a decline in raw materials. That’s starting to normalize.

Here’s the trend on LTM EBITDA margins over time.

MHK Margins_dec2018

Contrarian investors might say, “well, what if it snaps back? Then the stock is cheap”. That may be true, but I doubt it. The street is currently expecting 17% EBITDA margins for next year and 18.5% the following year. So essentially they are expecting a snap back. As such, I think the company is trading more at around 8.0x+ 2020 EBITDA, instead of 7.3x it would suggest.

Are the forgetting before the commodity collapse, Mohawk had ~13-14% EBITDA margins??

MHK Margins

I think Mohawk stock is still too expensive considering these expected headwinds. More importantly, I think sentiment has room to fall, which we all know can be a larger driver of stock performance.