August 30, 2024

In today’s note, we discuss the recent earnings reports from Foot Locker (FL), along with our decision to completely exit our position in the stock and take profits. We also discuss the latest addition to the portfolio in the form of Zillow (Z).

I’m also continuing my aggressive restructuring of the portfolio I inherited upon assuming the Chief Analyst mantle for the Cabot Turnaround Letter. This includes cutting what I regard as “dead weight” in the form of underperformers among some of the long-term holdings. This change will allow us to free up space for new portfolio additions in the coming weeks and months.

I will also discuss the latest additions to this month’s Catalyst Report, and have some follow-up thoughts on last month’s Catalyst Report leader, Starbucks (SBUX).

We also take a look at potential early-stage turnarounds among some players in the biopharmaceutical, healthcare and cloud software spaces: Incyte Corp. (INCY), Bristol-Myers Squibb (BMY), Solventum (SOLV), Twilio (TWLO) and Roku (ROKU).

Comments on Earnings

Turning our attention to the latest earnings among our Cabot Turnaround Letter portfolio stocks, only one holding reported this week.

That was athletic footwear and apparel giant Foot Locker (FL), which released a Q2 report that prompted strong selling pressure on Wednesday, posting an adjusted loss of $4 million (or a five-cent EPS loss).

Moreover, a series of store closures added to the negative sentiment, with plans to close 30 of its 140 stores in Asia Pacific and 629 stores in Europe as part of its Lace Up Plan and ongoing efforts to simplify its business model by focusing on its core banners and regions. The closures are expected to be completed in mid-2025.

The stock was subsequently sold off in reaction to the underwhelming news, but we anticipated it last week by selling a half of our long position in the stock, and we sold the remainder of our position Wednesday, getting out with a solid overall profit.

While a continuation of the overall cyclical turnaround is certainly possible, I don’t feel comfortable holding an apparel retailer in the portfolio heading into what is typically a volatile time for apparel retailers (namely the holiday shopping season)—particularly those already under stress. For that reason, I’m recommending that we avoid FL for now.

RATING CHANGES: I’m continuing an ongoing series of aggressive cuts to the portfolio after assuming the Chief Analyst position in early August. As previously discussed, many of the stocks in the portfolio are unlikely to reach the upside targets set by former chief analysts in the foreseeable future for various reasons.

Bayer AG (BAYRY) has been moved from HOLD to SELL.

Dril-Quip (DRQ) has been moved from a BUY to SELL. The subsea oil equipment provider is seeking a merger with privately owned Innovex, with the latter company backed by Amberjack Capital Partners (which will own 48% of the proposed combined company if it’s approved by shareholders). However, Amberjack will likely seek exit liquidity, which could pressure DRQ shares. Dril-Quip also just suspended earnings guidance updates, adding transparency risk.

Newell (NWL) has been moved from BUY to SELL. The stock was initially added in June 2018 and has drastically underperformed in recent years, with overhead supply considerations serving as a major obstacle for a return to its original target price in the foreseeable future.

Walgreens Boots Alliance (WBA) has been moved from a BUY to SELL.

Xerox Holdings (XRX) has been moved from BUY to SELL.

NEW POSITION: On Wednesday, we placed Zillow (Z), America’s premier online real estate portal, on a buy. The company’s online platform allows prospective homebuyers and renters to save time and money by using search filters (for views, amenities such as air conditioning, upcoming open houses and square footage), and by taking virtual 3D tours and inspections of the properties they’re interested in.

An integral part of the turnaround story for Zillow involves a new set of real estate industry rules that will take effect in August. The rules show favor to prospective buyers who decide against using agents and conduct their own independent research on the homes they’re interested in, which definitely favors digital platforms like Zillow.

In the latest reporting period, Zillow reported Q2 earnings that featured broad-based home sales and rental growth. Total revenue of $572 million rose 13% from the year-ago Q2, with non-GAAP earnings of 39 cents a share beating estimates by 30% and adjusted EBITDA of $134 million increasing 21%.

Another key to the Zillow story is the latest change on the management front: CEO Rich Barton was instrumental in kicking off the company’s major growth phase during the pandemic years. Although he was originally the chief executive from Zillow’s founding until 2010, he returned to the CEO position in 2019 before recently transitioning to co-executive chairman in August.

The incoming CEO is Jeremy Wacksman, the company’s long-time chief operating officer. Wacksman joined Zillow from Microsoft in 2009 and has earned multiple promotions throughout his 15 years at Zillow. He has been an innovation driver during his tenure with the company, helping to pioneer mobile real estate shopping, with Zillow Group apps having three times more daily active users than any other company in the category thanks to his contributions.

Moreover, in his prior role as Chief Marketing Officer, Wacksman guided the pivotal strategy that helped Zillow grow into the household brand it is today, with 231 million average monthly unique users and the word “Zillow” searched more than the term “real estate.” His entrée as CEO should serve as a catalyst for additional growth at Zillow going forward. BUY

Friday, August 30, 2024 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 13 minutes and covers:

• Discussion of the implications of the recent shift among investors from Nasdaq stocks into NYSE stocks.
• Why rate-sensitive and defensive sectors should continue outperforming.
• Comments on potential turnarounds in biopharma, cloud computing and streaming services.
• Comments on earnings.
• Elsewhere in the markets.
  
  • A review of this week’s lone earnings report in our holdings, namely Foot Locker (FL).
• Final note.
  
  • Comments on the additions to this month’s edition of the Catalyst Report.

Please know that while I don’t yet personally own shares of all Cabot Turnaround Letter recommended stocks, this will materially change in the coming weeks as I become fully integrated as your new Chief Analyst.

Please feel free to share your ideas and suggestions for the podcast and the letter with an email to either me at cdroke@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.

The Catalyst Report

Incyte Corp. (INCY) is a global biopharmaceutical company focused on finding solutions for cancer and skin disease patients. Its drug portfolio includes treatments for ailments ranging from blood cancer, bone marrow disorders, autoimmune diseases and dermatological disorders.

I noted last time that recent news and revenue trends from its top-selling lymphoma drug and its recently approved biologic therapy injected some much-needed new life into the stock. The stock itself has already established a multi-month series of higher highs and lows since bottoming in late April at 55, yet it’s still a long way from the all-time high of 150. And with the company’s pipeline strength, there’s also plenty of potential to keep the turnaround going for quite some time. All told, I like what I see so far in this early-stage turnaround, and I view the 85-90 area as an achievable intermediate-term price target.

Another potential turnaround in the pharmaceutical category is Bristol-Myers Squibb (BMY), which was also discussed in the latest newsletter. The company is well known for its treatments across several indications, including hematology, oncology, cardiovascular and neuroscience diseases. A big potential revenue leader for the firm is its expanding cardiovascular portfolio, with sales of its oral cardiac-specific myosin inhibitor estimated to reach a whopping $4 billion by 2030. And in terms of blockbusters, Bristol-Myers currently has at least six drugs that generate annual sales of at least $1 billion dollars across various disease indications.

In the most recent news, the FDA agreed to review the company’s marketing application submitted to expand the product labeling of its liver cancer drug, Opdivo plus Yervoy. Bristol-Myers said that the FDA accepted a supplemental biologics license application filed to seek the regulatory nod for its use as a first-line therapy for adults with a rare liver cancer.

Another potential revenue leader going forward is Camzyos, which one analyst has called “the crown jewel” of Bristol-Myers’ cardiovascular franchise. Indeed, sales of the drug in the second quarter grew more than 200% year-on-year, well above Wall Street’s consensus expectations, and the drug is now expected to outperform in the quarters ahead.

There’s a lot to look at in the company’s commercial portfolio and the developmental pipeline—too many to mention here—but suffice it to say, there are plenty of catalysts to fuel the continuation of Bristol-Myers’ early-stage turnaround.

Further within the healthcare sector is Solventum (SOLV), a spinoff of 3M’s healthcare business, which experienced a 45% decline from its IPO price peak in late March. The company engages in the developing, manufacturing, and commercializing a portfolio of solutions to address critical customer and patient needs, including advanced wound care, I.V. site management, sterilization, temperature management, surgical supplies and dental products.

Solventum falls firmly under the Cyclical/Technical Issues category, but the catalyst here is the spinoff. What I like here is that SOLV displays a similar pattern from many post-IPO stocks, which often quickly fall out of favor after going public. Now that the IPO chasers are out of the market, there has been strong evidence lately that deep-pocket value investors and institutions have stepped in to fill the void. One of them was the billionaire investor Nelson Peltz’s Trian Fund Management, which recently initiated a stake in Solventum, to the tune of 5.4 million shares.

What typically follows is a gradual return to the IPO high, which I believe will eventually happen for Solventum. The stock is not without risks, of course, given its relative lack of trading history, but participants who don’t mind it can start a small position around the current level of 63 with a conservative stop-loss in case the technical turnaround doesn’t materialize.

Next up is a stock that’s completely outside any of the categories I’ve mentioned, namely Twilio (TWLO), a cloud-based platform that provides communication tools for developers to add to their applications. Like many of its peers, the stock was a pandemic-era darling but fell out of favor in 2022, with shares dropping 400 points before hitting rock bottom at 50 later that year and spending the last couple of years etching out a solid bottom above that level.

The stock hasn’t taken off yet, but there are signs a turnaround is likely ahead. Twilio’s free cash flow profile and net retention rate, which are key metrics for cloud companies, are showing notable improvement. This is an important consideration for Twilio since it supports higher stock buyback potential, in turn adding to the stock’s turnaround appeal.

On that score, earlier this year Twilio announced a new $2 billion repurchase authorization, which was on top of a prior $1 billion buyback program from last year. A number of Wall Street analysts see management’s growing emphasis on buybacks as an important catalyst for the turnaround, and I agree with them. The stock remains high on my watchlist and merits inclusion in the Catalyst Report.

Another stock with intermediate-term turnaround potential is Roku Inc. (ROKU), the streaming provider whose platform is the go-to neutral gateway for millions of consumers, and which offers a variety of entertainment options, including TV shows, movies, sports and music. The stock is another one of those Covid-era highfliers that lost favor with investors and, much like Twilio, it dropped by about 400 points from its peak price in 2021 to late 2022, eventually establishing a solid-looking bottom at 50.

Despite losing favor since its pandemic-era peak, Roku continues to report strong viewership growth, with streaming accounts increasing to 84 million in Q2, up 14% from the year-ago quarter. Analysts expect that Roku will soon begin to monetize subscribers at significantly higher rates with each additional hourly increment spent on the platform.

Looking ahead, Wall Street sees earnings kiting 75% for 2024, then growing by high double digits in the next couple of years before reaching profitability in 2026. The stock itself is etching out what looks to be the early stages of what could be a very significant turnaround, driven most recently by heavy short-covering activity.

Finally, I would be remiss if I didn’t mention coffee retailer Starbucks (SBUX), which was highlighted in last month’s Catalyst Report and which rallied nearly 30% shortly afterward. The catalyst was the new CEO addition, and I continue to look for an attractive entry point to make Starbucks a portfolio addition.

Lately there has been some heavy put option buying activity surrounding the stock—especially around the 93 strike price—which suggests the influence of big traders and hedge funds looking to capitalize on a post-rally pullback. As overstretched as the stock is on a short-term technical basis, a pullback would make sense, and if we get it, I’ll likely take advantage of the opportunity by formally adding it to the portfolio.

In the latest company news, Starbucks just introduced its fall menu lineup earlier than ever as it looks to leverage strong customer interest, including some new additions along with the old favorite, Pumpkin Spice Latte, which continues to be Starbucks’ most popular seasonal beverage.

Portfolio

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