2023-03-09 06:24:47 ET
Summary
- Newell Brands Inc. is a global company that designs, manufactures, and distributes consumer and commercial products worldwide.
- The company is feeling the current economic slowdown, with demand declining across its business segments.
- The company's financial performance has been poor, driven by rising costs and declining demand.
- Debt relative to earnings is creeping up and with a low cash balance, Fitch has downgraded the company.
- In the medium term, there is scope for upside with consistent FCFs regardless of stagnating revenues. Now, however, with only headwinds ahead, we rate NWL stock a sell.
Company description
Newell Brands Inc. ( NWL ) is a global company that designs, manufactures, and distributes consumer and commercial products worldwide. The company has five segments, including Commercial Solutions, Home Appliances, Home Solutions, Learning and Development, and Outdoor and Recreation.
Newell owns a range of household brands, such as the following.
Newell Brands
Newell Brands
Unlikely many of their consumer goods counterparts, the company operates across a wide variety of unrelated industries, giving the business far greater diversification but fewer scale benefits.
Share price
Newell's share price performance has not been great in the last decade. Gains were made going into 2017 but this quickly reversed as the market did not agree with a transaction it conducted. Following this, the share price began to trend down, with it now close to its decade-low level.
During this time, many consumer goods businesses have continued to grow, with Newell lagging behind. Despite this, the company owns some market-leading/recognizable brands, which should have no issue growing into the future. There is some potential here seemingly but the question is if it will ever be realized. Our objective is to assess the inherent quality of the business as a whole and any key trends impacting the industry. We will take a view of the current and expected future financial performance, which will help derive a fair value for the business.
Economic conditions
Many nations globally are currently experiencing inflationary pressures as a result of supply-side issues stemming from the end of lockdowns. This has contributed to a decline in consumer discretionary income as they see their cost of living increase. Interest rates, which have rightly increased in response, have only compounded the impact as borrowing costs rise. The net impact has been a downward trend in demand for many goods and a general pullback from the sky-high demand we saw post-lockdown. This has impacted Newell's brands as many of their products are discretionary in nature, such as home appliances and solutions. In FY22, Newell has seen a decline in demand across many segments, with Management citing softening conditions in most cases.
FY22 sales results (Newell Brands)
Not only is this impacting the demand side of the business but the supply side as well. As we have mentioned, much of this inflation is derived from supply-side issues, one such factor being energy prices following the War in Ukraine. Newell has experienced a 1.8% decline in GPM in FY22, with the company experiencing cost increases it has been unable to pass on to consumers.
Looking ahead, our view would be that economic conditions remain difficult, at least until late 2023. Inflation remains persistently high, suggesting rates may need to increase further or remain elevated for longer, regardless this is an issue for demand. It is still inconclusive as to whether we will experience a recession but our view is that things will be tough nonetheless. Management is assuming the following conditions.
Management FY23 assumptions (Newell Brands)
Working from home
The COVID-19 pandemic has contributed to a shift in working patterns, with many people now working from home for some portion of their working week. This has increased demand for home office products such as writing instruments and organizational products, as part of their creation of a WFH set-up. Not only this but many offices have been improving their office experience in order to entice employees to return. This has led to increased demand for both commercial solutions and learning & development. These are the only two segments of the business to grow, showing the strength of this factor. Our view is that this should continue long-term, as many employees find genuine benefits to their life from some degree of WFH.
Private label brands
Private label brands have been gaining market share in recent years, putting pressure on established consumer goods companies. This has been driven by consumers not necessarily seeing the value proposition to justify the price differential. This is especially the case with generic products, such as pens and containers, two products that Newell distributes. In response to this, Newell has been investing in product innovation and marketing to generate actual and perceived value. Our view is that the company has not done enough in this regard, relying too heavily on brand value.
FX
Similar to many other consumer goods businesses, Newell generates a material amount of revenue from its overseas operations. This exposes the company to FX risk, with the USD generally moving unfavorably during market downturns as capital flight moves towards the dollar. This could compound short-term woes as remitted revenues will record as lower dollars. This could mean market sentiment around the business is overly negative if performance does decline.
Financial performance
Newell Financials (Tikr Terminal)
Presented above is Newell's financial performance for the last decade.
Revenue has grown at a CAGR of 6%, with much of this occurring prior to the company's poor performance in FY18 and FY19. Since then, growth has stagnated, with the company unable to consistently post revenue at the $10BN level.
Despite the revenue growth, gross profits have not followed suit, only growing at 3%. The company has seen its GPM decline from 38% to 30%, as pricing pressures and rising costs in recent years have bitten. As we have mentioned, Newell's brands have faced stiff competition, with the company seemingly surrendering margins as a means of maintaining revenues. For this reason, the revenue growth is even more disappointing as it further disguises the poor performance.
Further, Newell has seen its operational costs sneaking up as Management have unsuccessfully invested in growing the business. Management is looking to restructure the operational aspects of the business, with investments in supply chain optimization, SKU reductions, and redundancies. This will assist in improving margins but realistically, Management needs to invest in the revitalization of its brands. This is a defensive move to improve margins rather than to get the company back on track.
This leaves the company will a pretty unattractive profitability profile. With only a 12% EBITDA margin and -2% FCF, the company lags far behind its peers. Our view of a normalized level would be 14%/3-5%. This reflects operational improvements but a declining level of pricing power.
Moving onto the balance sheet, the company is feeling the effects of market conditions weakening. Inventory turnover has declined 20% to 3.08x, suggesting inventory is becoming more difficult to sell. This has also contributed to the worsening of its CCC days. With more stock held than Dec21, it is likely that discounts will continue, driving down margins in FY23.
With only $287M in cash, the company may need to raise debt in the coming years. Newell will likely return to OCF positivity in FY23 but will need to shore up its liquidity. This is a major issue as our view is that the company is far too leveraged as it is. 3x ND/EBITDA is our default ceiling, with the company already past this level and will move further away in FY23. Fitch rate the company a BB , with a negative outlook in the business, deriving the same conclusion we have. We would argue Management has distributed far too much in recent years, with a sharp decline in dividends/BBs expected.
Overall, Newell could return to a reasonable profitability level should the operational changes succeed but growth beyond 1 or 2 percent looks very far away. Further, the company's capital structure looks very precarious on paper, with Management seemingly walking the company into a corner unnecessarily.
Outlook
Newell Outlook (Tikr Terminal)
Presented above are analysts' consensus forecasts for the coming 5 years. Analysts expect minimal growth from the business, with an almost 10% decline in 2023. This looks reasonable to assume as market conditions improve.
What looks far less likely, however, is the margins improvement forecast. Achieving a FCF margin in excess of 10% in the next 5 years is possible but an EBITDA Margin in excess of 14% does not seem within the company's remit. Newell has not achieved this since FY15 when it was a very different business.
Valuation
Newell is currently trading at 10.5x its LTM EBITDA, far below many of its consumer goods counterparts. With the problems the company is facing, comparing the company to its peers will do nothing but confirm the obvious that it is trading at a deep discount. Instead, we have conducted a DCF valuation on the assumption that the company navigates the coming years without needing to materially adjust its capital structure.
The key assumptions we have made are:
- A 10% decline in revenue during FY23, as the company struggles with weakening demand. This is followed by a 4% bounce back and subsequent growth between 1-2%. We believe demand will be mild due to the lack of observable improvement.
- An improvement of FCF conversion from the current levels to 8.5% by FY27, reflecting cost savings and improving cash take.
- An exit multiple of 10x, a perpetual growth rate of 2%, and a discount rate of 7%.
Based on this, we derive a current upside of 10%. This is similar to the consensus Street view of the business, with the target upside at 11% ( Source: Tikr Terminal ). Despite this, we see no reason for positive price action in the near-term, due to the difficult economic conditions ahead. Conversely, we actually see a reason for further negative movements as the company likely continues to post poor quarterly earnings and sees its liquidity position worsen.
Final thoughts
Newell is a case study example of how a single bad transaction can destroy a company's fortunes. Newell does own some valuable brands, many of which will perform well in the coming years, however, the business as a whole does not inspire confidence. Profitability is currently very poor, with improvements likely at least 18-24 months away. Further, we see some risk with solvency in the coming few years, which will only encourage further defensive measures. Investors are paying for the risks associated here, as we only see an upside of 10%. On a risk-adjusted basis, this stock is a sell.
For further details see:
Newell: Poor Performer Facing Headwinds