Category: Earnings Recap

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… still not cheap enough yet… $MHK

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

Fast forward a bit following that article, and MHK 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 the 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.

Overdue Nexeo Q2’18 Recap. Performance remains strong, yet market hasn’t appreciated it yet. Stock warrants, NXEOW, are my top pick for investors with high risk appetite

I’m a little overdue for a recap on Nexeo’s results. The company reported Q2’18 sales growth of 14% and EBITDA growth of 18%. Most of the growth was in its Chemicals segment, which showed top line growth of 17.5% (though 4.8% of that was from the Ultrachem acquisition) mainly due to higher prices. Plastics was also up 9.6% due to 14% price growth offset by 4% volume decline.

This was a really solid result and if you think about the balance of the year, the performance should continue. The company distributes chemicals and plastics, which in some sense are oil-linked derivatives. Since oil is up considerably year over year, the pricing gains should continue. Importantly, the company benefits most from this inflationary environment, as they buy inventory at a lower price and sell at a higher one.

Indeed, as the economy improves as well, volume growth should continue. I don’t model much in this regard, I’m only at 1-2% over the long term, and this will be upside to my estimates.

The stock is now at $9.13, which means it is only up 8% since I first wrote about it. However, I still think it is a bargain.

Warrants:

I now want to draw your attention to Nexeo’s warrants. In fairness of disclosure, I own a significant amount of these in my PA now, as these are high risk / high reward plays on Nexeo’s stock.

A warrant is essentially the same thing as a call option. I pay a price today to have the option to buy the underlying security in the future at a specified price. If the underlying security ends up being below the threshold at the end of the period, the option expires worthless.

Nexeo’s warrants (Ticker: NXEOW) are just like that. They give the buyer the right, but not the obligation, to buy 1/2 of Nexeo’s stock at a certain price (strike price). Nexeo’s warrants strike price is $11.50.  That’s the price you’ll buy it at, plus you pay the price of the warrant for the option. Here is the language from their 10K on the subject.

“As of December 5, 2017, outstanding warrants to purchase an aggregate of 25,012,500 shares of our common stock became exercisable in accordance with the terms of the warrant agreement governing those securities. These warrants will expire at 5:00 p.m., New York time, on June 9, 2021 or earlier upon redemption or liquidation. The exercise price of these warrants is $5.75 per half share, or $11.50 per one full share, subject to certain adjustments.”

The math looks something like this. Let’s say Nexeo’s stock gets to $15. I then pay $11.50 to exercise the option. That should mean if the warrant gave me the right to buy 1 whole share, that the implied price of the warrant would be $3.50 ($15 – 11.50). Since Nexeo’s warrants give the right to buy 1/2 of a share, you need to divide that by 2, which gives you $1.75.  However, if the warrant stays under $11.50, its implied worth is zero.

NXEO Warrant Math

So, as if this needed to be stated, these are highly risky instruments and warrants can be highly volatile. What I like about them is that we have until June 2021 until they expire. That is a lot of time for Nexeo to build value.

The Company also noted that they would like to take out the warrants, as it makes the capital structure more complex and people worry about dilution (from day 1, I’ve included warrants in my share count using the treasury stock method and based on my target price). Here’s the CEO, David Bradley, on the subject:

“we’re in an active dialogue, have been for a while with our board about the complexity of our capital structure and getting it simplified. Clearly, there’s several opportunities, the primary one probably being the warrants that are outstanding. There’s a lot of those. We hear a lot from investors that, that’s quite a bit of overhang. So we would like to clean those up at some point.”

There has been precedent for tenders of warrants from SPACS, as shown here and here and here for premiums to where they were trading.

I think its a win / win. Either Nexeo tenders the warrants at a premium, or the stock goes up like I suspect and they realize value that way. The warrants are currently trading at less than 60 cents. My updated price target math looks like the below. Sure, in the short term maybe they don’t make as much sense as buying the stock outright. But as investors look out to 2019 and 2020, I think the warrants will be worth much much more.

NXEO Warrant valuation