Buy Newell's Equity, Not The Debt

| About: Newell Brands (NWL)

Summary

The market does not understand Newell because of all the M&A and debt.

Management is selling off divisions, paying down debt, and buying back shares.

Don't buy the debt because you have no idea who will end up owning each division.

I bought call options in my own account.

Newell Brands (NWL) is a way undervalued because the market doesn't quite understand the M&A occurring. The stock is a buy but be leery of the debt because of continued divestitures. On June 11, management announced a share buyback program of $3.6 billion in total. It plans to fund this program through $10 billion in after-tax divestments.

The stock trades for $29.45, there are 487.5 million shares, and the market cap is $12.38 billion. The dividend is 92¢ and the dividend yield is 3.1%. Pretty decent yield in today's markets. Earnings guidance is for $2.65 to $2.85 so that would put a PE of 11 on the low side.

Sales were down 7.6% in the first quarter in part due to the bankruptcy at Toy's R Us. Think of all the Graco baby products sold there. This and the balance sheet spook the markets. The balance sheet shows as the last quarter $459 million in cash and $2.346 billion in receivables. The liability side shows $1.398 billion in payables and $11.1 billion in debt. Yikes. We'll talk about the debt a little later.

Some of Newell's better known brands include: Paper Mate, Sharpie, Dymo, EXPO, Parker, Elmer's, Coleman, Jostens, Marmot, Oster, Sunbeam, FoodSaver, Mr. Coffee, Rubbermaid Commercial Products, Graco, Baby Jogger, NUK, Calphalon, Rubbermaid, Contigo, First Alert, and Yankee Candle. Since writing this article, I've noticed the company's mop buckets and trash can in commercial buildings.

On June 5, Newell sold off its Rawlings baseball division for $395 million, after tax proceeds will be $340 million. Rawlings put up $330 million in sales last year so it was sold for 1.2 times sales. This does add cash to the balance sheet which helps the cause. The company is also selling Waddington for $2.3 billion.

A presentation that management has put out clearly states the goals of the company. Rawlings was listed as a brand that was to be sold and sure enough, it was. Other brands on the block include: Jostens, Pure Fishing, Rubbermaid Commercial Products, Mapa/Spontex/Quickie, Process Solutions, Goody, Rubbermaid Outdoor/Closet/Refuse & Garage, and U.S. Playing Cards). The number of divisions under review represents $4 billion in sales. By 2020, management hopes to have a company with $11 billion in sales and operating margins of 15%. The last quarterly report changed the $11 billion in sales projection to $9 billion which is still good. Sounds about right. An S&P report notes that 71% of sales are U.S. based and that Wal-Mart (NYSE:WMT) accounts for 13.7% of sales. S&P has a target price of $32. I think they're being stingy.

Management puts 2018 guidance for revenues at $14.4 billion to $14.8 billion. Earnings per share of $2.65 to $2.85. Cash flow from operations of $1.15 billion to $1.45 billion. All this points to a cheap stock. If things work out and sales are $9 billion by 2020, then the price to sales ratio is only 1.37. That is cheap for a stock with so many strong brands and high potential profit margins.

Now let's talk about the bonds. I see a bond that matures in about a year and a half (12/1/19), with a yield to maturing of over 3%, BBB rated, and a cusip of 651229AP1. I see another with a maturity of maturity of five years (4/1/23), yielding of 4%, BBB rated, and a cusip of 651229AV8. Both are high yields for investment grade bonds. The bond market is smart and has sold these off. Why? No one knows who the parent company of these bonds will be when the above brands are sold off. Could it be private equity? A holding company? A sovereign wealth fund? A Chinese company with weak accounting? Don't know. There are many other maturities listed too.

In my own account, I bought a call option with a strike price of $20 (it's in the money) with an expiration of January 2020. I paid $8.30 for each contract. Riskier but it's my own money and not my clients'.

M&A deals are a great time to buy equities. The markets don't like uncertainty. I like what Newell is doing and have faith that it will pay down debt and buy back shares. When the dust is settled, the stock should trade for much more that it is at this point.

Disclosure: I am/we are long NWL.

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.