NWL - Newell Brands: A Hold After The Q2 Earnings

2023-08-01 01:54:53 ET

Summary

• Newell Brands' stock price has gained attention recently despite underperforming the market, as investors analyze the latest 10-Q report.
• Net sales have declined significantly in the past three- and six-month period, indicating a lack of demand for the company's products.
• Factors like consumer confidence, inflation rate and the execution of the new strategic initiatives, along with the foreseen savings will play a crucial role in determining the company's future performance.
• Now, we rate the stock as "hold".

Newell Brands Inc. ( NWL ) engages in the design, manufacture, sourcing, and distribution of consumer and commercial products worldwide.

While the firm has been significantly underperforming the broader market year to date, the company's stock got the attention of many investors recently, as their stock price has jumped by more than 7% after the latest earnings release.

In today's article, we will be discussing several line items from the latest 10-Q and how they may be developing in the coming months and quarters.

Sales

NWL's net sales have declined significantly both in the past 3 months and also in the past 6 months. This is a clear indication that there has been a lack of demand for the firm's products.

In our opinion, the poor performance can be largely explained by the challenging macroeconomic environment. People have been relatively pessimistic about their financial outlooks in the previous quarters, leading to reduced spending on non-essential, durable items. In this low consumer confidence environment, NWL has been struggling to keep up the demand for the goods it is selling.

Let us consider here three important factors:

1.) Development of the consumer confidence in the United States

Consumer confidence is often treated as a leading economic indicator and helps investors define, how the spending behaviour of the people may be changing in the near future. High or improving confidence means that people are more optimistic about their financial situation and about the general health of the overall economy, which potentially leads to higher spending on non-essential, durable goods.

Sentiment in the U.S. has improved significantly in the past months. If such a development were to continue, it would have a positive impact on the demand for NWL's products and could potentially lead to higher sales figures in the second half of the year. We also need to mention that the inflation rate in the U.S. has been falling gradually since the 2022 highs, which could also provide tailwinds for the firm in the near future.

Management has been slightly more cautious about their outlook for the rest of the year:

"As we look toward the balance of the year, we expect top and bottom-line pressure to persist as consumers continue to wrestle with elevated levels of core inflation and the resumption of student loan repayments, [...]"

A higher demand could not only have a positive impact on revenue, but also on the inventory levels. And this takes us to our second point.

2.) Inventories

As a result of the softer demand, inventory levels have increased substantially, raising concerns whether they may become obsolete or need to be sold at significant discounts.

In the recent quarters, however, NWL has managed to bring the inventory levels down, which has been partially the reason for the sharp jump after the earnings report.

Looking ahead, we would like to see the inventory levels falling further to reach the historic norms. And in this sense, it is important to recognise that management remains committed to do so:

"Inventories declined nearly $700 million versus the prior year period and nearly $300 million versus the first quarter of 2023, as the company continued to make progress on inventory reduction."

Dividends

Many investors have been considering investing in NWL's stock because of its dividends. Currently the firm pays a quarterly common dividend of $0.07 per share, equivalent to an annual yield of about 2.5%. This is quite a decline compared to the dividends that the firm has been paying previously.

One key question that we have to answer here: Are the dividend payments now, after the reduction, sustainable, despite the macroeconomic headwinds?

On one hand, the firm's dividend payout ratio is below 100%, which means that the dividends are covered by the net income, at least as of now. But the ratio is around 87%, which is considered quite high, especially if we compared it to the firm's own five year historic average.

One reason, why it appears a bit troubling is because paying out 87% of the net income leaves little resources left for the company to fund its initiatives with internal financing.

We cannot rely on this one measure only, however. When calculating net income it also involves non-cash items, which may lead to a more pessimistic picture. Free cash flow payout may be a slightly more suitable measure in this case. The table below shows, how NWL's CFO and CAPEX has been varying over the past years. We can see that in the most recent quarter, NWL has generated more than enough cash to cover its CAPEX and also fund its dividends.

"Year-to-date operating cash flow was $277 million compared with outflow of $450 million in the prior year period, with the improvement primarily driven by working capital and a reduction in incentive compensation payments, which more than offset a decline in operating income and higher restructuring and related payments."

In the coming quarters, we would like to see operating cashflow further improving or at least remaining stable, after the highly volatile past months.

Profitability

When making an investment decision, the profitability of the firm plays a key role. Three measures that are commonly used to assess profitability are: gross profit margin, operating margin and net profit margin. The following chart presents that all these measures have been trending downward in most of 2022.

Before investing in NWL's business, we would like to make sure that this trend can be turned around. And there are several signs, which may be an indicator for that:

1.) The firm has defined a new corporate strategy

Building on the solid operational foundation we have already put in place, we are now focused on significantly strengthening the company’s consumer-facing capabilities while prioritizing the top 10 countries and top 25 brands, which represent about 90% of sales. Consistent with the new strategy, we are investing in consumer and customer understanding, brand building, brand communication, innovation and retail execution as part of our One Newell approach to unlock the full power of our leading consumer brands, create and leverage scale and drive operational excellence.

In our opinion, focusing on the business segments that are the strongest and contribute most to sales may have a positive impact on the profitability going forward. We like when firms recognise that focusing on the highest-value generating segments can have the most impact on the overall financial performance. These initiatives, however require investment and may lead to margin contractions in the near term, before returning to an expanding trajectory.

2.) Declining inflation rate

Inflation rate in the United States has been steadily declining in the past months. While the firm remains cautious, we believe that this may help to reduce expenses, potentially positively impacting the firm's profitability.

3.) Restructuring and savings initiatives

In January 2023, the company announced a restructuring and savings initiative, Project Phoenix, that aims to strengthen the company by leveraging its scale to further reduce complexity, streamlining its operating model and driving operational efficiencies.

The impact of these initiatives are likely to be visible from 2024 onwards, as the implementation is expected to last until the end of 2023.

Conclusion

NWL's business has been suffering in the past quarters from the significant macroeconomic headwinds, primarily generated by the poor consumer sentiment and the elevated levels of inflation. Looking forward, we believe that the environment has been and continues to improve, which may lead to better financial performance in the coming quarters.

Along with the revenue, earnings have been also volatile and downward trending in the recent past, partially driven by the deteriorating profitability. Looking forward, along with the macroeconomic improvements, the firm's new corporate strategy, and restructuring and savings initiatives should lead to improved profitability, in our view.

The improved cash flow from operations gives confidence that the firm generates enough cash to fund its CAPEX and dividends internally. However, the dividend payout ratio based on the net income appears to be too high, despite the recent dividend cut.

All in all, we would like to see the positive impacts of the new corporate strategy, along with the positive impacts of the cost savings and improving macroeconomic environment materialise, before we could issue a "buy" rating on the stock.

For these reasons, we issue a "neutral" rating on the stock today.

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