Newell Brands Consolidating And Shedding

| About: Newell Brands (NWL)


Newell Brands recently released an update to its corporate strategy in which it plans to sell and consolidate a number of its businesses.

Newell has agreed to sell its tools business for $1.95 billion. We like its plans to use the proceeds of the deal for deleveraging.

Newell's new strategy bodes well for income investors, in our view, who should benefit from additional capital available and fewer business dragging on capital needs.

Let's take a look at the firm's investment highlights as we walk through the valuation process and derive a fair value estimate for shares.

By The Valuentum Team

Newell Brands' (NYSE:NWL) new strategy seems to be a familiar one. In a time fraught with concerns over the pace of global economic growth, some consumer brand entities are working to enhance value for shareholders via streamlining their operations or shedding underperforming brands in addition to those that may not fit their core strategies. Procter & Gamble (NYSE:PG) comes to mind as a prominent example. Newell Brands has adopted such a strategy following its merger with Jarden earlier this year, which has given its top line a boost, but has left its portfolio in a sprawled out state to say the least.

Newell Brands recently released an update on its strategy, in which it will consolidate its 32 business units into 16 operating segments. The strategy includes creating a global e-commerce division, selling a variety of businesses, and reducing financial leverage to pave the way for future M&A activity. The firm wasted no time in executing on the strategy, as it recently agreed to sell its tools business to Stanley, Black & Decker (NYSE:SWK) for $1.95 billion. Performance in the division has not impressed as of late, with sales falling 7% as reported in 2015. Management believes other areas of its business have better growth opportunity and "are responsive to innovation."

Generally speaking, we like the move for Newell in its post-merger state, though earnings per share dilution is expected as a result of the deal. Also on the selling block are its two winter sports units, its Heaters, Humidifiers, and Fans business, and its Consumer Storage business. The firm hopes to finalize all asset sales by the halfway point of 2017. In addition, we like management's decision to use the proceeds of the sale of its tools business to reduce leverage. All in, the moves appear to be Newell Brands executing soundly on the strategy it has laid out for investors.

While the reduction in leverage has been tabbed as geared towards future M&A activity, we also like what it does for the firm's future dividend potential. Newell Rubbermaid cut its dividend in 2009, but it has since nearly battled back to its pre-cut levels. The new Newell Brands has made its dedication to maintaining a payout at least at the level of legacy Newell's $0.76 per share annual dividend. Currency fluctuations and a changing retail environment have been cited by management as key threats to the health of its payout, and we like that it is addressing the latter in the form of its new e-commerce platform.

Though Newell's dividend yield is not all that compelling at current levels (~1.5%), its Dividend Cushion ratio (1.5) indicates that it is on solid ground and can handle reasonable ongoing increases. Deleveraging initiatives and potential upside to synergies have the potential to improve the firm's Dividend Cushion ratio moving forward, but it will be important to keep an eye on the M&A activity management engages in as it relates to future capital that could be used for dividend increases. But enough about the payout, let's dig into the remainder of the company's investment considerations!

Newell Brands' Investment Considerations

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Investment Highlights

• Newell Brand's products are marketed under a strong portfolio of brands, including Rubbermaid, Graco, Sharpie, Irwin (hand tools), and Lenox (band saw blades), among others. The company has changed from a holding company of 20+ business units to an operating company of 5 segments. The firm was founded in 1903 and is headquartered in Atlanta, Georgia

• Newell Rubbermaid recently acquired Jarden for over $15 billion in cash and stock, creating a branded consumer goods company called Newell Brands with ~$16 billion in annual sales. The transaction substantially scales the company's presence in key retailers, channels, and geographies

• Newell Brands is expected to generate $500 million in incremental cost synergies over the next four years, with the transaction being accretive to earnings immediately. The firm will have annual adjusted EBITDA of over $3 billion after synergies, and it anticipates maintaining an investment grade credit rating as it targets a leverage ratio of 3.0 to 3.5 times within 2-3 years.

• Newell Brands plans to maintain a dividend at or above the previous level of Newell Rubbermaid's annual dividend of $0.76 per share. The firm's capital allocation strategy will be focused on develeraging, and a disciplined approach to working capital and capital expenditures can be expected.

• The newly formed Newell Brands will be the combination of complementary portfolios that will accelerate Newell's existing business growth plans in Food & Beverage, Baby Products, Commercial Products, and Kitchenware & Appliances.

Business Quality

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Economic Profit Analysis

In our view, the best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital.

The gap or difference between ROIC and WACC is called the firm's economic profit spread. Newell Brands' 3-year historical return on invested capital (without goodwill) is 33.6%, which is above the estimate of its cost of capital of 10.3%. As such, we assign the firm a ValueCreation rating of EXCELLENT.

In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.

Image source: Valuentum

Image source: Valuentum

Cash Flow Analysis

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Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Newell Brands' free cash flow margin has averaged about 7.5% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG.

The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Newell Brands, cash flow from operations decreased about 7% from levels registered two years ago, while capital expenditures expanded about 53% over the same time period.

Valuation Analysis

We think Newell Brands is worth $43 per share with a fair value range of $34-$52.

The margin of safety around our fair value estimate is derived from an evaluation of the historical volatility of key valuation drivers and a future assessment of them. Our near-term operating forecasts, including revenue and earnings, do not differ much from consensus estimates or management guidance. Our model reflects a compound annual revenue growth rate of 29.1% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 0.1%.

Our model reflects a 5-year projected average operating margin of 7.6%, which is below Newell Brands' trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 2.5% for the next 15 years and 3% in perpetuity. For Newell Brands, we use a 10.3% weighted average cost of capital to discount future free cash flows.

Image source: Valuentum

Image source: Valuentum

Image source: Valuentum

Margin of Safety Analysis

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Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $43 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.

Our ValueRisk rating sets the margin of safety or the fair value range we assign to each stock. In the graph above, we show this probable range of fair values for Newell Brands. We think the firm is attractive below $34 per share (the green line), but quite expensive above $52 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.

Future Path of Fair Value

Image source: Valuentum

We estimate Newell Brands' fair value at this point in time to be about $43 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of Newell Brands' expected equity value per share over the next three years, assuming our long-term projections prove accurate.

The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.

The expected fair value of $56 per share in Year 3 represents our existing fair value per share of $43 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.

This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.

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.

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