NWL - Resideo Technologies: Another Disappointment

2023-09-11 11:11:30 ET

Summary

• Resideo Technologies' shares have been trading stagnant since late 2022 as investors are cautious.
• The company's earnings per share have been cut significantly, and its debt and complicated leverage remain concerns.
• Despite a share buyback program, the latest guidance cut gives no reason to be more optimistic about the company's performance.

Late in 2022, I wondered if smart home play Resideo Technologies ( REZI ) was a smart investment as well. This came after the shares had seen quite some tumultuous trading since its spin-off from Honeywell ( HON ) in 2018.

With results being volatile and long-term liabilities to Honeywell, an investment was not straightforward, even as valuations were non-demanding. Given the complexity and leverage, I was cautious to increase a minimal stake.

As the original 2023 guidance, which called for flattish sales and earnings, was decent enough given the modest valuation multiple, the issue is that both metrics are coming in short. This notably applies to the bottom line performance, making me quite frankly cautious, as I am not willing to buy the dip here.

Where Do We Come From?

Resideo provides residential security solutions, and following its spin-off, the business is essentially comprised out of two businesses under a single roof. This includes a larger, but lower margin distribution business, as well as a product business which is smaller, but posts higher margins.

Products being produced and distributed include items like cameras, heat control, freeze detection and (other) smart home applications. The company generated $4.8 billion in sales and EBIT of $420 million at the time of the spin-off, as this was after paying $140 million in indemnification payments to its former parent, a liability set to last 25 years into the future from the time of the spin-off.

Even after this payment the company earned about $2 per share, but I was fearful about the real performance post the allocation of corporate costs, as some other Honeywell spinoffs had seen tough times at the time as well. Such overhang and margin pressure made shares fall to the $10 mark in 2019, on the back of severe earnings declines as well. While revenues rose to $5.0 billion in 2019 and to $5.1 billion in 2020, earnings had stabilized at lower levels.

Early in 2022, the company announced a substantial $593 million deal to acquire the First Alert business from Newell Brands ( NWL ) , with a $395 million revenue contribution expected to provide a nice boost to the business, although the deal came at a big premium. Around the same time, the company posted 2021 sales at $5.85 billion on which operating profits were reported at $559 million, working down to a $1.63 per share earning number.

Amidst the impact of the First Alert acquisition and operating momentum, Resideo hiked the 2022 sales guidance to $6.55 billion with operating earnings seen up to $700 million, earnings which were needed as net debt rose to $1.2 billion following the First Alert deal.

After a modest increase, the company cut the full year guidance again alongside the third quarter earnings report. While earnings were seen around $2 per share, which worked down to a low multiple at $16, I failed to have conviction to increase a modest long position given the complicated leverage position.

Trading Stagnant

Since late 2022, shares of Resideo have been trading range bound, in fact, quite a tight range between $15 and $20 per share.

In February, it turned out that 2022 sales came in at $6.37 billion, up 9% on the year before. The company posted GAAP operating profits of $611 million, after a combined $70 million impairment and restructuring charge, with net earnings reported at $283 million, or $1.90 per share. Net debt ticked down to $1.09 billion, while EBITDA came in around three quarters of a billion. This net debt load excludes a $580 million obligations under indemnification agreements.

The 2023 guidance called for rather flattish performance with sales seen between $6.20 and $6.55 billion, with operating earnings seen at $650 million, plus or minus $25 million.

First quarter sales rose by 3% to $1.55 billion, although the company has seen strong margin pressure with profits of $0.38 per share down twenty cents, but nonetheless, the company maintained the full year guidance as well as $1.90 earnings per share number.

In August, Resideo posted a 5% decline in second quarter sales to $1.60 billion, with GAAP earnings down to $0.34 per share. On the back of this shortfall, the company cut the midpoint of the full year sales guidance to $6.24 billion, revealing that full year sales are seen down small. GAAP earnings are now seen a midpoint of just $1.25 per share, after earnings already came in at $0.72 per share in the first half of the year.

Net debt ticked down further to $1.03 billion as obligations under the indemnification agreements actually ticked up to $591 million, at least the reported liability on the balance sheet.

And Now?

With shares trading stagnant since late 2022, I understand why investors are cautious. The near $2 earnings per share number has been cut in a big way, and while a current 12 times multiple is still not demanding, the issues around debt and complicated leverage (with the indemnification payments) remain.

Management is apparently not too worried about these payments and the related liabilities (with EBITDA now seen at a midpoint of $558 million). This is evident as the board announced a $150 million share buyback program, sufficient to buy back nearly 7% of the outstanding shares here.

Given the latest cut in the guidance, I see no reason to get more upbeat. Shares trade flat compared to this time in late 2022, while leverage is rather flat, and earnings have been cut by over a third. While the resulting earnings multiple is still not too demanding, the situation remains quite complicated. This makes me cautious, as I hold onto a very small long position, with no reason to add to that.

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