Newell Brands (NWL) made a nice divestiture, selling its non-core tools business at high valuation multiples, thereby reducing the leverage position without causing too much dilution to earnings.
I like the move, as additional divestments could further improve the leverage profile. After factoring in further divestments, I still see Newell being able to post earnings of +$3.00 per share going forwards. That suggests that shares trade at market-equivalent multiples, as leverage remains somewhat elevated. While current core growth rates are decent, I note that growth has not been that impressive in the long run.
To put it short, I see no margin of safety at these levels, even as I like the divestment. To create appeal, I would need to see a real pullback to the low-forties, before the earnings yield gets appealing enough for me to buy into this well-diversified consumer play.
A Mega-Deal Following Years Of Stagnation
Newell's investment thesis has been driven by the purchase of Jarden, a deal announced at the end of 2015. The deal was somewhat surprising given that Newell generated sales of $6 billion, while Jarden was much bigger with annual revenues of $10 billion.
The $16 billion merger was driven by diversification across product categories, and the promise of $500 million in synergies. Such a synergy number is very valuable, especially in a low interest rate environment. Besides cost savings, notably in terms of distribution, marketing and perhaps production as well, both companies did point towards the opportunities for cross selling across different retailers.
As Newell's shareholders were given a combined 55% equity stake in the business, and given that Jarden was a much bigger company, the deal called for a large cash component as well. This left Newell's balance sheet quite leveraged at around 4.5 times EBITDA. The company targeted a reduction in leverage towards 3.0-3.5 times in the next 2-3 years. It seems that leverage may come down much quicker, as the company is actively divesting some non-core assets.
How Has The Merger Turned Out So Far?
The mega-merger closed halfway April of this year, as the real integration work could start form that point in time. In July the second quarter results were announced, marking the first quarter which (partly) includes the contribution from Jarden. This business contributed for roughly 11 out of the 13 weeks in that quarter.
The company proudly claimed a 5.0% increase in second quarter core sales but this excludes a 130 basis point headwind from a strong dollar, de-consolidation of activities in Venezuela as well as the impact of Jarden, of course. Following a solid first quarter, the company reiterated its full year core sales growth target of 3-4%. This indicates that growth is anticipated to slow down a bit in the second half of the year.
The company reported second quarter revenues of $3.86 billion. Given the fact that Jarden only contributed for 11 weeks in the quarter, the $16 billion sales run rate still seems very reasonable.
Net of $627 million in cash, total debt stood at $12.4 billion. The 450 million shares of Newell trade at $52, for a +$23 billion equity valuation. Added together, Newell is valued at $36 billion at this point in time.
Based on the $16 billion sales run rate, the overall business is valued at 2.2 times revenues. The company reported normalized second quarter operating earnings of $608 million and $170 million in depreciation & amortization charges. The quarterly EBITDA number of $778 million comes in at +$3 billion per annum, for a 4.1 times leverage ratio and 12 times valuation. It should be said that it is a bit unfair to annualize the quarterly EBITDA number given that the second quarter is typically stronger.
Reducing Leverage, Getting Rid Of Tools
The mega deal with Jarden has created a huge conglomerate. Given the highly leveraged balance sheet, some portfolio rationalization makes sense. If Newell can divest non-core assets at high valuations, while it helps to reduce leverage, I certainly believe that such divestiture moves are the right thing to do.
Newell announced that it has sold most of its tool business to Stanley Black & Decker (SWK). Included in the sale are the Irwin, Lenox and Hilmor brands as they not have the greatest potential for growth, at least according to Newell. Newell will receive $1.95 billion in cash for a business which generates $760 million in sales and $150 million in EBITDA. The 2.5 times sales multiple and 13 times EBITDA multiple exceeds the overall valuation of Newell, indicating that the company surely got a good price for these assets. The latter is certainly the case as recent growth numbers turned negative following a challenging external environment.
The company anticipates that earnings will be diluted by $0.15 per share following the move, after taking into account the benefit of lower interest expenses. The company is quick to admit that other brands are for sale as well including sport brands, heaters, humidifiers and fans. If Newell would sell all these remaining businesses, sales could fall by another $700 million a year.
These divestments go a long way in reducing leverage. Total net debt of $12.4 billion will fall towards $10.5 billion following the sale of the tools business. Assuming that EBITDA will fall from $3.0 billion towards $2.85 billion, leverage ratios improve by 0.4 times towards 3.7 times EBITDA.
The Pro-Forma Business
Newell is pretty much a $16 billion business as it is looking to divest activities with $1.5 billion in sales. Beside the $2 billion proceeds from the tools business, the remaining activities might fetch another $1.5 billion in proceeds.
The remaining business generate $14.5 billion in sales on a pro-forma basis. Including synergies, Newell anticipates 20% EBITDA margins, for an EBITDA number of $2.9 billion a year. Depreciation & amortization charges run at a rate of $680 million in the second quarter. If we take into account the anticipated divestitures, depreciation & amortization charges could run at $600-$630 million going forwards. That suggests that EBIT comes in around $2.3 billion.
The good news is that deleveraging, following these divestments, could reduce leverage ratios towards 3 times. A net debt load of roughly $9 billion could result in net interest expenses of some $400 million, for an earnings before tax number of $1.9 billion. With a 25-30% tax rate, after-tax earnings might come in around $1.4 billion.
With 450 million shares outstanding that yields an earnings number just north of $3.00 per share. This seems realistic as this number includes anticipated synergies. Newell itself sees adjusted earnings for this year come in at $2.75-$2.90 per share, but this only factors in a fraction of the anticipated synergies, with synergies anticipated to run at an exit rate of $175 million by the end of this year.
I Require A Larger Earnings Yield To Be Appealed
Following a completion of the divestments, leverage ratios could fall towards 3 times which is elevated, but controllable. Using a $3 per share number, the current valuation of $52 per share translates into a 17 times forward multiple for a leveraged business. This could be rationalized by the 6% earnings yield which is appealing in this low interest rate environment, as well as the growth in core sales. That said, real appeal is hard to find as leverage remains an issue for the coming years, the long term growth record is modest and a 1.5% dividend yield is not particularly enticing.
While I understand the enthusiasm of investors given the full price received for the assets, this is priced in. Shares of Newell trade 2% higher, adding $500 million in market value in the process.
At these levels I simply fail to see a margin of safety. While deleveraging is to be applauded, I require a greater earnings yield to compensate for the leverage and modest growth in the past. If earnings yields would improve towards 7%, equivalent to a 14 times earnings multiple, I would be more compelled to own the stock, making me a buyer in the low-forties.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.