We all probably use something from Newell Brands (NYSE: NWL) at least on a weekly basis.
When such a company with so many strong brands gets into trouble, one must always look at whether it’s an opportunity or a trap.
The price to book is 0.91, the price to earnings ratio is 5.64 (distorted by income tax provision), while the expected forward price to earnings ratio is still just at 10.78 which is a real bargain when compared to other stocks.
In this article, I’ll describe the situation with NWL and the risk reward of the investment, but I will also discuss goodwill, an acquisition strategy, and the turnaround concept which are very valuable lessons we investors can learn from this situation.
What Happened To NWL?
As you saw above, the stock price was above $50 not even a year ago, but if we take a longer term perspective, the stock was at $5 in 2009 and $11 in 2011. Up until 2017, the company was doing well but as Wall Street expects everlasting growth, management often does complex things to satisfy the expectations and push stock prices up.
In December 2015, the company announced the $13 billion acquisition of Jarden which owns various brands of which one is Coleman outdoor gear. When such an acquisition is made, the management counts on synergy and savings. The goal was to unlock $500 million in cost efficiencies and saving, an expansion of the company’s global reach, and be immediately accretive to earnings.
However, things usually don’t go as planned. NWL’s debt spiked as NWL kept paying bigger and bigger dividends and the transaction was financed with shares and cash while the expected benefits through 2017 didn’t materialize. And when a company is highly leveraged, such bad news really hits the stock price.
The message here is to really differentiate between growth at all cost companies and companies that grow fast thanks to a high return on invested capital internally. The first always run into trouble sooner or later, the latter are the gems in your portfolio.
Another interesting point is NWL’s price to book value of 0.91. However, NWL’s price to tangible book value would be $2 per share for a price to tangible book value of 13. When a company acquires other companies, it usually pays a premium as nobody would want to sell something at a fair price. The difference between what a company pays and the book value of the assets is called goodwill and is recorded on the balance of the acquirer. However, as is the case with NWL, when the acquisitions don’t work out as planned, one must impair that estimated goodwill which is exactly the place where NWL is now as it plans to sell brands for about $10 billion.
NWL hopes to use the proceeds of the sales for buybacks at these low prices and about 45% for debt repayment. If all goes as planned, EPS for 2018 should be between $2.65 and $2.85 which gives a price to earnings ratio of 10.
After the divestitures happen, NWL will be a much smaller company as revenues will be down 40% and operating income will be down 50%.
With operating income down 50%, we can expect profits to be around $1, which is a bit better per share. However, the $10 billion coming from the divestitures should give $25 per share. At current stock prices, $5.5 billion in repurchases would remove 42% of outstanding shares bringing down the number of shares outstanding from 488 million to 284 million and significantly improving EPS pushing them close to $2. Further, $4.5 billion should halve long term debt and lower interest payments while also increasing earnings. If the management succeeds in the plan, the company might be revalued and you would see a much higher stock price.
Carl Icahn Stepping In
Now, this is all interesting but lately, some new players in the form of Carl Icahn came into the game which makes this a bit more interesting. Icahn is famous for regarding most American corporate management as idiotic and he sees there the biggest problem with the U.S. He bought a stake in the company and managed to get 4 board seats which makes things more interesting and perhaps more likely to succeed.
However, you must understand that Icahn’s investment horizon might be a bit different than yours as he is happy with placing various bets where 2 out of 3 work out so that he ends up in the green eventually. You have to see if you can accept the risk or not just as Icahn does.
The trailing free cash flow of the company is $393 million where the company pays a dividend of $0.92 per share, or $448 million, which means more debt is needed to sustain the business. With the divestitures, there might be more pain coming in the form of impairments and if the selling sprees doesn’t bring $10 billion as expected, but let’s say $8 as we still have to see whether there are many buyers in line willing to pay whatever price, there could be more trouble for the stock.
But if they really spend at least $4 billion on buybacks, that must be a positive on the stock and perhaps even the strongest factor in the whole story, so we might see good things happen here in the next two years. The key is to assess each factor individually, see its potential impact and probabilistic outcome, and then compare the risk reward with other investment options you have or might hold.