December 13, 2024

Quick Note: Due to the Christmas holiday, you will receive the next Cabot Turnaround Letter issue a week early, on Wednesday, December 18, 2024.

In today’s note, we discuss a number of positive developments and bullish outlooks for several of our portfolio positions, including American Airlines (AAL), SLB Ltd. (SLB), the SPDR S&P Retail ETF (XRT) and Super Hi International Holding (HDL).

Seasonal broad market strength continues to support many of our portfolio holdings, but recent bond market developments will be particularly important to watch.

We take a closer look at the expansion plans of Chinese cuisine specialist Super Hi International Holding (HDL).

We’ll also discuss some potentially positive catalysts for two attractive companies in the retail and farm equipment sectors.

Comments on Portfolio Holdings

Our holding in American Airlines (AAL) rallied to new yearly highs last week after several leading U.S. passenger airlines provided upbeat forecasts for the holiday travel season, giving investors a reason to cheer.

American Airlines is expected to benefit from continued improvement in the travel demand backdrop after providing its own bullish forecast for the Christmas flying season and raised its Q4 adjusted earnings forecast to a midpoint of 65 cents a share, up a whopping 86% from the previous forecast.

The sanguine guidance follows a Q3 earnings report that saw revenue of nearly $14 billion increase 1% year-on-year and EPS of 30 cents beat estimates by 76%. In the earnings call, management emphasized that it’s taking “aggressive action” to reset the airline’s sales and distribution (S&D) strategy while reengaging the business travel community, a strategy it expects will improve the revenue performance over time. (The S&D strategy involves renegotiating competitive contracts with a majority of the largest travel agencies and many of its top corporate customers, plus the reintroduction of Corporate Experience benefits for corporate travelers.)

Meanwhile, on the performance front, despite disruptions and financial impacts from the recent hurricanes and the CrowdStrike outage, American reported the highest flight completion rate among U.S. network carriers while registering its best Q3 in terms of load factor since merging with U.S. Airways in 2013 in a show of efficiency and reliability.

Going forward, deleveraging is a major goal for American, and it strengthened the balance sheet in Q3 by reducing total debt by $360 million; it’s also more than $13 billion toward its goal of reducing total debt by $15 billion by the end of 2025. Wall Street expects the bottom line to decline this year, but sees the success of the S&D strategy bearing fruit next year with earnings lifting 40% in 2025 and 25% in 2026.

Earlier this week, a major investment bank upgraded the airline stock to an Outperform rating from its previous rating of Market Perform based on positive pricing and revenue trends for the company. After taking a partial profit in the stock, we’ll retain the remaining three-quarters position of AAL with a Hold rating in our portfolio.

In the petroleum sector, SLB Ltd. (SLB) was just awarded a contract from Brazil’s state-owned Petrobras, following a competitive tender, to its OneSubsea joint venture for two subsea raw seawater injection systems to increase recovery from the prolific Búzios field.

Per Seeking Alpha, “As part of this project, SLB OneSubsea will further strengthen its multidisciplinary team in-country, which will cover the full processing value chain from field development to system engineering and life-of-field support.”

SLB is currently a Buy in the portfolio with an upside target of 55.

On the holiday sales front, the widely watched CNBC/NRF Retail Monitor reported that retail sales still grew in November. Total retail sales, excluding automobiles and gasoline, were up 0.2% month-over-month and up 2.4% year-over-year in November, compared with increases of 0.7% month-over-month and 4% year-over-year in October.

According to the National Retail Federation (NRF): “November sales increased on top of a strong October and would have been even higher if Thanksgiving Sunday and Cyber Monday hadn’t fallen in December. Year-over-year gains were solid even as retail prices in many categories are lower this year, showing that consumers are buying more merchandise as the economy continues to grow.”

The NRF said it remains confident in its bullish holiday forecast for the rest of the season, which should bode well for our position in the SPDR S&P Retail ETF (XRT), which remains a Buy with an upside target of 88.

Shares of Super Hi International Holding (HDL) continue to soar and came within a dollar of our upside target of 27 on Thursday. The leading Chinese restaurant brand is in the midst of an international expansion, with a current global footprint encompassing 14 different countries.

North America is where Super Hi sees much of its potential going forward, with 13 locations of its Haidilao hot pot restaurant brand presently in the U.S., which is now its largest non-Asian presence. But Asia remains the main strongpoint for the restaurant, with 19 locations in Singapore, 16 in Vietnam, 15 in Malaysia, plus an additional 33 spread across Thailand, Japan, Indonesia and South Korea.

But with only 15% of its total locations in North America, the continent represents one of the most lucrative expansion opportunities for Super Hi going forward. The company grew its number of locations by over 6% in Q3 on a year-on-year basis, while adding four Haidilaos in Southeast Asia and two in North America in the quarter.

The stability of revenues is impressive for the hot pot specialist, and Wall Street analysts have recently updated their sales projections to reflect 15% growth for 2024, as well 15% growth in each of the next two years. The stock remains a Hold in the portfolio.

RATING CHANGES: None this week.

Friday, December 13, 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 15 minutes and covers:

• This year’s Santa Claus Rally window should provide insights into how early 2025 will play out for the broad equity market.
• The junk bond market’s December performance will provide further equity market clues.
• Two potential turnaround candidates have lately come into focus as well-known activist investors take stakes in Macy’s (M) and CNH Industrial (CNH).
• Comments on portfolio holdings.
• Final note
  
  • Super Hi International Holding (HDL) is closing in on our upside target after a stellar post-earnings performance.

Turnaround Watchlist

The latest blog from our friend Jeff Hirsch of Stock Trader’s Almanac focuses on the famous “Santa Claus Rally” concept developed by his late grandfather, Yale Hirsch. Many investors seem to believe the Santa Claus Rally is the seasonal strength that’s typically seen in the last quarter of the year. But while it’s true November, December and January are historically the best three months of the year, this isn’t what comprises the Santa Claus Rally.

As Jeff informs us, the famous rally is specifically the last five trading days of the year, plus the first two days of the New Year. According to Jeff, this year it begins on December 22 and lasts until January 3, and he notes that average gains in the S&P 500 over this seven-day trading stretch over the last 55 years are a respectable 1.3%. However, he also warns that:

“Failure to have a Santa Claus Rally (SCR) tends to precede bear markets or times when stocks could be purchased at lower prices later in the year. Down SCRs were followed by flat years in 1994, 2005 and 2015, two nasty bear markets in 2000 and 2008 and a mild bear that ended in February 2016.”

It’s too early to predict whether or not this year’s SCR will appear or not, and even Jeff acknowledges anything can happen between now and then. I have no special insights to offer on that front, either, but if the late-December rally fails to materialize, we’ll certainly have reason to enter the New Year with an extra measure of caution.

For those who might be skeptical of the market’s seasonal tendencies, there’s another useful indicator that merits a close watch as we head toward the end of the year. It’s the relationship between junk bonds and equity prices, with the former tending to lead the latter at pivotal turning points. As Tom Essaye of Kinsale Trading’s The Sevens Report noted in a recent blog, the bond market is regarded as the “smart market” due to the relative lack of retail investor participation vis-à-vis the equity market, with corporate and government bond trading volumes primarily controlled by institutional participants. He notes:

“Bond traders are required to make decisions with strong conviction focused on the macroeconomic backdrop, including policy rates, inflation trends and growth prospects, with recession risks always in the back of their minds…”

To that end, he notes that a recent show of weakness in the SPDR Bloomberg High Yield Bond ETF (JNK) is worthy of close attention. Already the junk bond ETF has established a lower high in the last couple of months, and Tom believes if it goes on to further make a lower low beneath its recent support near 95.70, “the economic outlook may be dimming, at least in the opinion of the ‘smart market’.”

For now, though, JNK remains above this key level and isn’t far below its September high around 98. I’m keeping a close watch on this indicator between now and year’s end, and I suspect its performance until then will provide us with a valuable clue as to how we can expect the first part of 2025 to unfold for equities.

Shareholder activism is one of the catalysts I look at very closely when evaluating potential turnarounds, and lately there has been an uptick on that front in a number of big-name companies across several different industries. That said, I think this would be a good opportunity to take a closer look at a couple of them as we evaluate the timing of a possible rebound in each of these stocks.

One company that has been commanding most of the activist investor headlines of late is of course the well-known retailer, Macy’s (M). The company has come into the crosshairs of value-focused activist equity firm Barington Capital, which believes Macy’s shares are “significantly undervalued” relative to its industry peers and “doesn’t reflect the potential of its turnaround plan.” Barington has recently built a stake in Macy’s of undisclosed size in conjunction with the private equity firm, Thor Equities.

Barington has laid out what it sees as the ideal path to a successful turnaround for Macy’s, including the following points:

1. A reduction of capital expenditures from the current 4% to around 2% of total sales.

2. The commencement of a $2-to-$3 billion stock buyback authorization over the next three years.

3. The creation of a real estate subsidiary that would collect rents from the company’s retail ventures.

4. Consider the possible sale of its luxury Bloomingdale’s and Bluemercury lines, along with other strategic alternatives.

After revealing partial third-quarter results last month, Macy’s reported its complete Q3 earnings on Wednesday, with revenue of $4.7 billion decreasing 3% from a year ago and earnings of four cents a share beating estimates by a penny.

A positive aspect of the report was a 2% comparable sales increase for Macy’s First 50 locations (stores with stronger merchandising, better visual presentation, and enhanced customer services) for the quarter, while Bloomingdale’s reported comp sales growth of owned and owned-plus-licensed-plus-marketplace of 1% and 3%, respectively. Bluemercury, meanwhile, reported comparable sales growth of 3%. Credit card revenue also came in above Wall Street’s expectations.

Commenting on the Q3 results, management said they “reflect the positive momentum we are building through our Bold New Chapter strategy,” and value investors see a compelling valuation in Macy’s in the form of the company’s EV/EBITDA multiple of 3.4x, or a 34% discount against the average 5x forward EV/EBITDA multiple of its industry peers. Income investors, meanwhile, may be allured by Macy’s attractive 4.3% dividend yield versus the retail industry average of 3.8%.

However, intraweek volatility remains a major concern right now, which is why timing is of paramount importance for interested buyers of this stock. I’ve got Macy’s high on my watchlist, but I’m not yet ready to pull the trigger on a buy just yet.

Another well-known activist investor, David Einhorn of Greenlight Capital, has recently initiated a stake in agricultural equipment maker CNH Industrial (CNH). CNH is admittedly more of a cyclical turnaround play, but as the stock is coming off a nearly 50% drop over the last couple of years, I think we can classify it as a potentially worthwhile candidate for value-oriented investors.

Einhorn sees value in CNH due to the fact that the farm equipment spending cycle is currently still in a downturn and retail investors see little value in the sector—exactly the type of backdrop he like to see from a contrarian perspective.

Additionally, he finds the 4% dividend yield to be an attraction and notes the company is repurchasing around 6% of its shares, while there’s also “very little financial leverage” and that “sometime next year or in early 2026” ag equipment industry will likely commence a renewed upcycle.

With an attractive forward P/E ratio relative to industry peers, the stock is high on my watchlist for potential new buy recommendations in the Turnaround Letter portfolio between now and the end of this year.

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.

Portfolio

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