• Brett Schafer

Three Downtrodden Stocks Poised for a Turnaround

Classic value is not what I typically invest in. My bread and butter, or really, what I think I have an edge in, are growth names that I can hold for a long time period. These include stocks like Square, Spotify, and Yext, companies with rapid sales growth but low-profit margins. I like them because I think they can be highly profitable in the future, not for the cash they bring in now.

However, I have found a few names (possibly driven by the fact my portfolio sits at an average P/E of 52, who knows) that I like because I think Wall Street is overly discounting their current cash flows. This discount comes from fears of outside competition, changing industry landscapes, and poor capital allocation.

The three stocks are Altria Group (ticker: MO), Bed Bath and Beyond (BBBY), and Sprouts Farmers Market (SFM). All three are unique cases, with stocks down 30% or more in the past few years, and with terrible perception from industry analysts. Let’s go into detail on why I like them.

Altria Group

Listen to our podcast on Altria group here.

Altria is a sin stock that gets the majority of its revenue from smoking and adjacent products. These adjacent products include smokeless tobacco/nicotine, vaping (they have an investment in JUUL), marijuana (they have an investment in Cronos Group), and alcohol.

The stock has sold off because, quite frankly, the way they invested in JUUL was absurd. Altria put $12.8 billion into JUUL labs at a valuation of $38 billion. They’ve already had to write down $4.5 billion of the money, making it one of the worst corporate investments of all time.

I believe this negative catalyst is already baked into the stock. Shares are down 20% in the last year, and 25% in the last five. Here are what the current financials look like:

  1. EV/FCF of 14

  2. Dividend yield of 6.5%

  3. FCF margin of 30%

  4. EV/EBIT of 10

And this comes while the company is buying back almost a billion dollars worth of stock a quarter. Net revenues only decreased by 1% in 2019, mainly driven by decreases in cigarette sales, but every other part of the business was either neutral or growing by single digits. Margins are increasing, meaning they can keep their current cash flow numbers even with slowly declining sales. Nicotine addiction is real and isn’t going away anytime soon.

If you write off all non-tobacco businesses, I still believe Altria is trading at a steep discount to its future value. But the reason I bought shares is I think JUUL and Cronos, while overvalued before, are not zeroes. These are high growth industries, and great hedges to a cigarette business that is still throwing off $8 billion in cash flow a year.

Bed Bath and Beyond

Listen to our podcast on Bed Bath and Beyond here.

This is a deep-value pick. Like a Graham-style, Buffett in the 50’s type value play. And it has me excited, because this is territory I’ve never been to before.

Bed Bath and Beyond trades at a steep discount. Its $1.2 billion market cap is almost equal to the amount of working capital held at the end of the fourth quarter! The company must be in really dire straits then, correct?

Correct. Net income has gone down every year since 2013, and was actually negative in 2019. The stock is down over 80%, and the company has spent over $11 billion on share buybacks since the early 2000s. There is also a narrative that brick-and-mortar retail is dying, and that everyone is getting eaten by Amazon. Bed Bath and Beyond fell right into that crossfire and has probably lost more than a few customers to e-commerce over the past decade.

Here is what the valuation looks like, based on 2019 numbers:

  1. EV/FCF of 16

  2. EV/OCF of 7

  3. Dividend yield of 4.8%

  4. FCF margin of 2%

  5. Declining EBIT margins

It looks bad for Bed Bath and Beyond right now. However, I think the absolute floor (aka, liquidation value) is very close to the current price, and that the turnaround is coming soon. In October they named Mark Tritton as their new CEO. Tritton has experience at Target, Nike, and Nordstrom’s.

Tritton has come out firing, making quite a few changes in the past few months (go to the investor relations page to see everything). They sold PersonalizationMall.com for $252 million, and they plan on raising money to work on their omnichannel offering to try and reverse declining profit margins.

Bed Bath and Beyond is definitely not getting back to its heyday as a retail force anytime soon. But I do think that, if enough fat gets trimmed and they get back to positive operating margins, a $5 billion market cap is not out of reach. It is a lot riskier than these other two bets, seeing as they have quite a bit of debt, big competitors, and no profits. But the upside is quite large as well.

Sprouts Farmers Market

Listen to our podcast on Sprouts Farmers Market here.

This isn’t necessarily a “deep-value” pick, but really a company I think has sold off but is still poised for a long runway of growth.

Sprouts Farmers Market is a healthy grocery store chain that tries to be Whole Foods but at cheaper prices. They are big on fresh produce, supplements, and organic specialties. With 340 stores in 22 states, expansion is primed to continue with a strong base in the southwest. Their plan is to eventually be nationwide.

SFM went public in 2013 and has grown its free cash flow almost every year since. The problem is, it went public at a crazy valuation and is down by more than 50% since 2013.

Here are the current financials:

  1. EV/FCF of 21.5

  2. EV/OCF of 10.5

  3. P/E of 16

In 2019 SFM grew sales by 8%, had one-year comp sales of 1.5% and two-year comp sales of 3.8%. Their free cash flow numbers are not tremendous as they are opening about 20 stores a year, which is why I think EV/OCF is a better business indicator.

With 8% sales growth, already low margins (remember, they are the cheap healthy alternative), and an almost single-digit OCF multiple, I love SFM’s long-term potential. Shareholders aren’t getting any dividends or buybacks, but I think there is still a lot of growth left for this healthy grocer.

Maybe this is more of a growth/value play, but with the stock trading at these depressed levels, I feel Wall Street is way too pessimistic about SFM’s future.

Overall Feelings

These stocks are all “value” plays, but for entirely different reasons. One (Altria) is undervalued based on its declining future cash flows, another (Bed Bath and Beyond) is trading essentially at liquidation value, and the third (Sprouts Farmers Market) is trading at a discount to its potential long-term growth. I like all three and think they can outperform over the next few years.

Disclosure: The author is not a financial advisor, and may have an interest in the companies talked about.


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