August 2019

In this issue, we list six additional out-of-favor stocks that have high dividend yields which we believe are sustainable and also have turnaround potential:

Cabot Turnaround Letter 819

In This Issue:
High Dividend Turnaround Stocks
They Don’t All Go Up
Recommendations:
Buy: Biogen (BIIB)
Sell: NII Holdings and Bank of America
News Notes & Performance

High Dividend Yield Turnaround Stocks:
Getting Paid While You Wait

By their nature, turnaround stocks involve a fair amount of risk. One way to help reduce that risk is to find out-of-favor stocks that offer high dividend yields. This puts hard cash in your pocket while you wait for the turnaround to take effect. The benefits of these dividends can be significant: for a three-year turnaround, a stock paying a 5% dividend will produce a 15% cash payback even if the stock goes nowhere for a while.

Because a high yield often implies some skepticism that the dividend can be maintained, prospective investors should be selective, emphasizing those companies with a solid commitment and ability to sustain their dividend.

Several Turnaround Letter-recommended stocks have high dividend yields, including Washington Prime Group (27.9% yield), Oaktree Specialty Lending (7.6%), AMC Entertainment (7.0%), Ford Motor Company (6.3%), Kraft Heinz (5.0%), Macy’s (6.7%), Newell Brands (6.5%), BP (6.4%), Janus Henderson Group (6.4%) and Royal Dutch Shell (5.9%). Some dividends look rock-solid, like those of BP and Royal Dutch Shell, while others (particularly Washington Prime Group) look likely to be cut or eliminated. We like all of these recommended stocks regardless of their dividend prospects.

Listed below are six additional out-of-favor stocks that have high dividend yields which we believe are sustainable and also have turnaround potential:

AT&T (T) - Shares of the world’s largest communications company have languished for over 15 years and currently are well below their highs. Unlike its arch-rival Verizon, AT&T has chosen to aggressively diversify into media, entertainment and technology businesses, most recently with their purchase of TimeWarner. While offering a promising future, the expansion has left the company with an enormous $171 billion debt balance. However, AT&T should generate over $28 billion of free cash flow in 2018, providing plenty of cash to pay down some debt and cover the dividend. Trading at 7.4x EBITDA, AT&T’s shares and yield are attractive.

B&G Foods (BGS) - B&G Foods has grown by buying the cast-off but valuable brands of other packaged food companies, including Green Giant, Ortega, Emeril’s, Durkee and Clabber Girl. The company takes great pride in consistently paying a generous and growing cash dividend since its initial public offering over fourteen years ago. Investors, however, worry that its business model is pressured by the growing strength of mega-grocers as well as changing consumer tastes that could bypass B&Gs brands. Reflecting this, BGS shares have fallen 65% from their peak in mid-2016. However, the company is paying down its debt, working to boost its margins and has transitioned its leadership to help re-invigorate its prospects. At 9.4x EV/EBITDA with a reasonably well-covered dividend, the shares offer considerable appeal.

Dow Chemical (DOW) – Dow shares have remained weak since the conclusion of the complicated and protracted merger and 3-way break-up of Dow and DuPont. Dow produces a broad range of commodity and specialty chemicals that provide it with stable (but slow-growing) revenues yet strong free cash flow. Investor worries include the difficult pricing environment and a possible recession. However, the company’s sizeable cost-cutting program, debt paydown plans and healthy dividend coverage, along with an attractive valuation, make Dow an appealing stock.

Enterprise Products Partners (EPD) – This company is considered one of the highest quality pipeline, storage and export facilities companies for oil, natural gas, refined products and chemicals. Its 49,000 miles of pipes and related infrastructure are a critical component of the nation’s energy backbone. Most of its revenues are fee-based, helping insulate it from commodity price changes. Its respected management team has produced steady, well-covered dividend growth over the past 20 years while maintaining below-average debt levels.

Hersha Hospitality Trust (HT) – This real estate investment trust (REIT), with 48 hotels primarily on the east coast, Florida, and the west coast, has been upgrading its properties to focus on higher-end luxury brands. It is producing healthy unit revenue growth and benefitting from the strong recovery from its post-hurricane renovations at its south Florida properties. Profits should also increase from other capital improvements and acquisitions. The share price weakness can be at least partly attributable to recession worries, labor costs and sluggish results in the Washington, D.C. market, as well as its elevated debt (which management will work to reduce). Hersha shares trade at a considerable discount to peers while offering an attractive and reasonably well covered dividend.

Iron Mountain (IRM) – Real estate investment trust Iron Mountain is the world leader in paper document storage in highly secure facilities. Although revenues and cash flow continue to grow at healthy rates, investors worry about a secular shift away from paper storage, as well as Iron Mountain’s elevated debt level. However, the company is adapting with its own data storage centers and finding other new paths for growth, as well as improving its costs, even as its dividend remains well covered. Iron Mountain’s 30 million square feet of owned real estate provides a solid asset backing for future cash needs. Its August 1st earnings report will offer some clarity on these and other issues.

THEY DON’T ALL GO UP…

… at least, not right away. As much as we would like to see all of our recommended stocks (which we also buy in our personal accounts) immediately go up, this often is not the case. With turnaround stocks, and contrarian stocks in general, getting the timing exactly right is nearly impossible. Either we buy too early, and feel some (hopefully temporary) angst as the stock continues to decline, or we risk missing the opportunity entirely by waiting too long.

What should investors do when their newly purchased shares fall in value?

A useful adage to remember is, “price is what you pay, value is what you get.” The market assigns a second-by-second price to your stock based on dozens of factors, including near-term sentiment and momentum. Until the fundamentals clearly turn positive, selling pressure can keep pushing this price down.

However, contrarian investors want to focus on the value they are buying… and have the patience to wait out the interim price volatility. Having a well-defined price target – based on what the stock should be worth, and why, once the company’s turnaround is complete – makes it easier to be patient. Few things in investing are more frustrating than selling a poorly performing stock right before its fundamentals turn the corner and the stock takes off.

More generally, to make the best decisions on underwater stocks (and any stock, for that matter), objectively evaluate the fundamental outlook and the stock’s valuation based on everything you understand at the current moment in time. Ask, “if I didn’t own the stock, would I buy it here?” If the long-term value is intact, for intrepid investors the answer may be “yes”, and they should buy more. Since some turnarounds don’t work out, and may occasionally even result in a stock becoming worthless, for investors who can’t tolerate a further loss the answer is probably “sell now.”

Five years ago, in the August, 2014 Turnaround Letter, we highlighted 15 stocks whose prices hadn’t done well since our recommendation. These 15 stocks went on to produce a wide range of subsequent outcomes (including one with a 400% return, six with 90% to 300% returns, and two with 100% losses), with an average return of 87%.

With this perspective in mind, we listed below ten currently-recommended stocks whose prices are well below where we initially recommended them but that we think have strong upside potential. While we remain committed to all of our Recommended List stocks, these in particular seem to have the most appealing and timely prospects for significant recoveries.

Adient (ADNT) – The effects of the weaker global automobile market are masking the major overhaul of Adient’s operations and cost structure, led by the skilled new CEO Douglas Delgrosso. Despite their recent bounce, Adient shares have considerable upside potential.

Blue Apron Holdings (APRN) – The typical narrative describing Blue Apron’s epic share price collapse from its 2017 initial public offering ignores the company’s brighter future. Today, the company has stabilized its finances, turned EBITDA-profitable, and has a highly-capable new CEO (Linda Kozlowski, from Etsy) who is launching innovations to generate revenue growth. While Blue Apron’s recovery is by no means assured, it clearly is moving in the right direction.

Conduent (CNDT) – Activist Carl Icahn is now firmly in control with a 15% ownership stake (recently raised from 9%) and with one of his employees newly installed as board chairman. While the stock languishes near its post-spinoff lows, the chances for meaningful shareholder value creation are increasing rapidly.

GameStop (GME) – While secularly challenged, GameStop’s shares are trading for less than the cash on its balance sheet, despite the fact that the company is producing sizeable free cash flow that is more than adequate to service its debt. New leadership will likely outline their turnaround plan soon.

General Electric (GE) – While there are critical steps yet to be completed, including the pending sale of its BioPharma business, and GE remains vulnerable to an economic slowdown, the company is clearly on the mend under the skilled leadership of new CEO Lawrence Culp.

Macy’s (M) – Despite the narrative that “retail is dead”, Macy’s continues to maintain its revenues, generate cash flow and whittle away at its debt. The company’s shares have an attractive valuation, are trading near their long-time lows, and provide investors with a generous 6.7% dividend while the turnaround continues.

Mattel (MAT) – Daunted by the depth of Mattel’s operating problems, leadership turnover and slow pace of progress, investors have aggressively sold Mattel shares. However, the company is successfully boosting the relevance of its core Barbie, Hot Wheels and action figure offerings and rebuilding its new product pipeline. The cost structure is also showing clear and major improvements.

McDermott International (MDR) – The shares have returned to their year-end lows following disappointing second quarter results and forward guidance, as inherited CB&I contracts and some other project delays weigh on 2019 results. However, we remain confident that the company is working through its problems and will have a much more profitable 2020.

Mosaic (MOS) – After weak first quarter results and disappointing near-term earnings guidance, Mosaic shares are approaching multi-year lows. However, near-term expense issues and weak phosphate pricing should improve over the next year. Mosaic shares are selling at a significant discount to their peers and to their warranted value.

Newell Brands (NWL) – Mismanaged for decades and struggling to recover from their disastrous 2016 acquisition of Jarden, Newell is now in the midst of a complicated turnaround. Its depressed profits should begin to improve as it cuts duplicative costs from recently sold businesses and boosts the efficiency of its remaining operations. The recent appointment of a new CEO should help improve the pace of change.

Purchase Recommendation: Biogen INC.

Background: Biogen is a major biopharmaceutical company specializing in treatments for multiple sclerosis (about 60% of sales) and spinal muscular atrophy (about 15% of sales). Its founding in 1978 makes it one of the oldest firms in the industry. Biogen completed its initial public offering in 1983 and has grown through both internal innovations and acquisitions, including the $6.8 billion merger with IDEC in 2003. In 2018, the company completed the spin-off of Bioverativ, its hemophilia treatment business (itself a former Turnaround Letter recommendation that produced a +95% return).

The company’s shares have fallen sharply from their high of $475 in early 2015, and suffered a 25% drop this past March following the failed clinical trial of its Alzheimers’ drug. In the market’s view, this disappointment only served to heighten the pressure on Biogen’s current roster of treatments – which are exposed to rising competition that could threaten the company’s revenues and profits. Its Tecfidera franchise for multiple sclerosis faces a major threat from a patent lawsuit by Mylan as well as emerging generic competition. Spinraza, a fast-growing treatment for spinal muscular atrophy, will likely see alternatives from Roche and Novartis. Other core products, including Avonex, also seem to have a less-prosperous future as new competition enters the field.

With its revenue growth prospects appearing hazy at best, consensus estimates pointing to a decline in EBITDA in a few years and the risks of its pipeline highlighted by the Alzheimers’ failure, investors have abandoned Biogen shares.

Analysis: While there may be a few clouds over Biogen at present, investors are pricing in a fairly stormy future. At 5.9x EV/EBITDA, the market assigns almost no value to its pipeline of new products. Yet Biogen is not only developing innovations to maintain its multiple sclerosis and other neuromuscular disease franchises, but it is also expanding into promising new therapeutic areas including ophthalmology and neurosciences. The company’s biosimilar platform (which produces biologic therapies based on a competitor’s product that is losing its patent protection) offers additional growth opportunities.

Recent results also suggest that investors may be overly gloomy about Biogen’s prospects. The company reported surprisingly strong second quarter results and raised its guidance for the full year.

Bolstering its ambitions and valuation is Biogen’s sturdy financial condition. Its $2 billion in net cash flows from operations in the second quarter, combined with only $1.6 billion in net debt (debt in excess of its cash balances), indicates its ability to pursue a variety of strategic options including acquisitions and share repurchases. Biogen’s $2.4 billion in share buybacks last quarter illustrates its commitment to shareholder value.

For patient investors, Biogen shares offer considerable upside potential.

We recommend the PURCHASE of shares of Biogen (BIIB) with a $360 price target.

Sale Recommendations: NII Holdings & Bank of America

NII Holdings – Shareholders will receive about $1.40/share when the acquisition by America Movil closes later this year. Payouts over the next 18 months may be as much as another $1/share. However, the post-deal shares will become very difficult to trade for all but professional investment managers, and the current price of about $1.80 reflects a fair amount of the ultimate value. Given this coming lack of liquidity, we think most subscribers will want to sell their NII Holdings shares over the next month or two, and we are changing the recommendation to a Sell.

Bank of America – With the bank’s turnaround essentially complete, and the valuation no longer attractive enough to warrant a Buy rating, we are moving these shares to a Sell.

NEWS NOTES & Performance

Vodafone reported improved first quarter earnings. It also announced that it is exploring the separation of its European wireless tower operations, which would highlight the value of this hidden asset.