Personal Products Spectrum Brands Holdings, Inc. - SPB
Spectrum Brands Hlds – SPB
Buy – Target: $150.00
Current Price: $117.77
Company Introduction: Spectrum Brands Holdings, Inc. offers a suite of global consumer products in ~160 countries. They sell batteries, appliances, door locks, plumbing and hardware parts, pet food and supplies, auto care products,
insect and weed solutions. They recently sold their battery brands to Energizer for $2 billion in cash. Investment Thesis
• Strategic sale of a low margin business for $2 billion in cash. • 24% short interest, high likelihood they are about to get squeezed.
We believe the recent sale of their battery brands to Energizer is the start of a trend that will improve margins and growth rates. Their battery brands had some of the smallest growth rates in Spectrum’s suite of brand offerings, and management has stated that their intention is to use proceeds to improve leverage and pursue growth opportunities.
The Start of the Opportunity: 60% of SPB is currently owned by HRG Group, Inc. (HRG). This has made SPB much more volatile and too risky for many investors. On December 17th & 19th, HRG issued two v letters to SPB proposing an integration of the two Source: Bloomberg, JWC Research corporate structures and a payment of $200 million Weekly Chart from SPB in exchange for the use of HRG’s net operating losses of $1.5 billion and additional board representation. SPB replied with minor tweaks to the payments and no additional board representation.
On January 18, 2018, SPB postponed their shareholder meeting due to discussions with HRG “regarding a potential strategic transaction.” We believe a simplified structure is on its way with a lock up period for all parties. We also view the Energizer deal as the first indication of a “new” Spectrum Brands. We believe this will improve investor confidence. We also expect the 24.5% short interest to get squeezed as confidence is restored.
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What is the JWC Confidence Score
The JWC Confidence Score is an overweight/underweight scale designed to quickly give our clients key bullish and bearish points based on the JWC Research process - scoring the industry, operations, management team and valuation. The JWC Confidence Score utilizes 100 as a baseline score. The analyst then scores each segment of their analysis, decreasing it for bearish signs and increasing it for bullish
signs. The graph shows a recap of this analysis with the company score being an average of the four sections. The JWC Confidence Score is continually monitored and updates are released based on any changes to the JWC Confidence Score.
JWC Confidence Score JWC Confidence Score
Industry: 100 Bull: Non-discretionary household products are generally defensive and we expect to see more e-commerce presence and global market growth opportunities.
Bear: Retail sales have increasingly consolidated
and the competition can be intense. Margins are often compressed for companies to remain competitive.
Operations: 120 Bull: SPB’s various portfolio brands and geographic footprint provide diversification benefits to the business model. M&As can enhance long-term growth and margin expansion.
Bear: The international operations overseas exposes the company to international business risk and currency fluctuations.
Management: 120 Spectrum Brands Hlds – SPB 115 Bull: The leadership team focuses on transformative strategies to grow higher-margin Bull: SPB has a strong cash flow profile and businesses and selling less profitable divisions. business model poised to boost organic growth and margin expansion. They plan to use the cash Bear: As the business is investing heavily in from selling the battery brands to deleverage the operations abroad, it can be challenging for the company and position it for faster growth. leadership to manage and adapt to a rapidly changing market. Bear: The financial performance of the company relies heavily on a small number of key Valuation: 120 customers. It is important that SPB continues to Bull: The company has robust cash flow and develop its online presence to maintain a earnings per share over peers. In fiscal 2017, competitive position in the market. they refinanced to lower interest rate loans.
Bear: Our valuation assumes strong free cash flow and management’s ability to control debt through the restructuring with HRG.
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Spectrum Brands Holdings, Inc. - SPB
Company Description Figure 1. SPB Brands
Spectrum Brands Holdings, Inc. (NYSE: SPB), headquartered in Middleton, Wisconsin, is a diversified global branded consumer products company. The company manufactures, markets, and/or distributes its products in approximately 160 countries in North America, Europe, Middle East, Africa, Latin America and Asia-Pacific regions. They offer an expanding portfolio of leading brands providing superior value to consumers and customers every day (Figure 1). The five product segments they manage include: Global Batteries & Appliances, Hardware and Home Improvement, Global Pet Supplies, Home and Garden, and Global Auto Care. As of FY2017, the company has nearly 18,000 employees in 50 countries.
Source: Company Presentation Industry Overview Figure 2. Online Penetration Retail Environment: The retail environment has drastically shifted in the consumer products industry. Manufacturers and marketers for the major consumer brands seek to maximize market appearance, brand name recognition and sales margin through a variety of trade channels and distribution networks. Retail sales of consumer products has increasingly consolidated on a worldwide basis into a small number of mass merchandisers and e-commerce companies that generally have strong negotiating power with their suppliers, such as Amazon and Walmart. Retailer inventories are generally believed to be much healthier as manufacturers have gone to a more on-demand mentality. We expect to see more online presence of consumer brands as e- commerce proves to be a bright spot (Figure 2), Source: Company Presentation for example, SPB’s online growth of over 50% in their core U.S. market.
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Spectrum Brands Holdings, Inc. - SPB
Industry Overview Figure 3. Net Sales by Segment
(continued)
Competitive Landscape: A portfolio of non- discretionary household product equities can be a defensive investment and helps to offset external headwinds during the economic downturn. The household products sub-industry remains very competitive, and the diversification of products is a key characteristic to satisfy a broad customer base. As consumer confidence continues to increase and inflation picks up, we expect to see growth and margin expansion opportunities across global markets. As branded companies and private labels compete in the relatively stable developed markets; pursuing mergers and acquisitions can further create growth, operational synergies and cut costs, Source: Company Presentation which helps to maintain top-line and bottom-line growth. Historically, the return on shareholder Figure 4. Geographic Footprint-FY2017 Net Sales equity for companies with the strongest brand portfolios has consistently been in double digits. Additionally, we expect to see rising demand of packaged products in emerging markets over the next few years.
Source: Company Presentation
Figure 5. Fiscal Year-end Deleverage History
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Spectrum Brands Holdings, Inc. - SPB
A Quick Look at Operations
Segments Distribution: Spectrum manages its International Operations: As a manufacturer business model in five vertically integrated, of largely non-discretionary, non-premium product-focused segments: Global Batteries & priced, home-related, replacement packaged Appliances, Hardware and Home Improvement, goods used by consumers daily, Spectrum’s Global Pet Supplies, Home and Garden, and global market leader position and international Global Auto Care (Figure 3). footprint provide diversification benefits to the • Batteries & Appliances – See below business and can help the company hedge • Hardware and Home Improvement market risk in one area against others. SPB’s division manufactures security hardware, operations spread around 160 countries and four such as locksets and door parts, plumbing regions: NA, EMEA, LATAM and APAC (Figure 4). and hardware products. Each operation segment distributes in at least • Pet Supplies is comprised of aquatics and two regions. We expect that Spectrum will companion animal products, which sell continue to grow internationally, especially in consumer and commercial aquarium kits Latin America, Europe and Asia. and equipment, as well as other specialty pet products. 2017 Mergers & Acquisitions: In 2017, SPB • Home and Garden primarily produces made two major acquisitions: PetMatrix in June outdoor insect and weed control and GloFish in May. Both are bolt-on businesses solutions, household pest control that fall under Global Pet Supplies. PetMatrix is solutions and personal-use pesticides. the manufacturer and marketer of rawhide-free • Auto Care consists of two of the most dog chews, consisting of the DreamBone and recognizable brands in the automotive SmartBones brands. GloFish is the development aftermarket appearance products and and licensing of fluorescent fish for sale through performance chemicals/additives mass retail and online channels. The purchase categories – Armor All and STP. agreement includes Glofish branded operations and intellectual property. They pursue Batteries & Appliances: This was the largest acquisitions at attractive pre-synergy multiples division (40% of net sales, 33% of Adjusted that leverage pre-existing manufacturing EBITDA) and specialized in batteries, which capabilities, along with strategic benefits such as includes consumer battery and hearing aid new categories, channels or locations. batteries, personal care-grooming and styling products, and other small kitchen/home Improving Efficiencies: Project Alpha and appliances. On January 16, 2018, SPB Project Ignite are two projects that Spectrum announced the sale of the battery and lighting initiated and made good progress to improve brands. There have been limited details efficiency and support long-term growth. published on the specifics, but we believe this will According to management, both projects include the Varta and Rayovac brands for $2 streamline their supply chain, reduce operating billion in cash – the cash amount was announced, costs and inventory levels, and further improve the brands sold was not (to differentiate our customer service. Both projects will last multiple opinion from known facts). It appears that these years. brands generated $866 million in revenue. This will lower this division’s revenue from ~$2.1B to ~$1.2B. We expect this to be a long-term positive for SPB as these brands had some of the lowest margins and growth rates. We believe they are positioning the company for continued long term growth (deal expected to close at the end of 2018).
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Spectrum Brands Holdings, Inc. - SPB
Management JWC Valuation
Our View: The primary reason that we are Valuation: Our $150 price target is derived from recommending SPB is because of their our discounted cash flow (DCF) calculation experienced leadership team and their focus on (Figure 6). We utilized a 9% WACC and perpetual growth. They constantly seek strategic and growth rate of 2.5%. As of September 30, 2017, transformative acquisitions to complement their SPB has long-term debt of $3.8 billion. In fiscal core organic growth. On January 16, 2018, SPB 2017, they increased their revolving credit announced an agreement to sell Global Battery facility to $700 million and were opportunistic and Lighting Business to Energizer Holdings, Inc. several times during the year by repricing their for $2.0 billion in cash. This could help Spectrum U.S. term loans to lower interest rates. restructure their business and focus on faster- growing and higher-margin businesses. Capital Structure: Spectrum Holdings Group has a market cap of ~6.97 billion. Free cash flow The company plans to use the cash from the sale improved from $520 million in FY2016 to $550 to deleverage the company, as well as continuing million in FY2017. We believe that the company to look for strategic capital investments to is well positioned to take advantage of their strengthen core segments (Figure 5). The refinancing activities and funds from sale to company has always put protecting shareholder deleverage, make investments in core segments, value as the top priority. In fiscal 2017, they and benefit shareholders. increased the quarterly dividend rate to $0.42 per share and paid out $96.2 million of cash dividends to their shareholders. We expect this trend to continue as the company keeps demonstrating a strong ability to generate cash flows and earnings per share.
Figure 6. JWC Valuation
Source: JWC Research
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Spectrum Brands Holdings, Inc. - SPB
Risks
International Operations: SPB is operating in Figure 7. Estimates & Key Data 160 countries worldwide and approximately 36% of their net sales for the fiscal year 2017 was to non-U.S. customers. The company is subject to significant international business risks. As SPB continues to pursue growth opportunities and investments overseas, if the macro market conditions change drastically, currency fluctuates, or if SPB fails to comply with the laws and regulations of foreign countries, it would have an adverse impact on Spectrum’s cash flow and financial position.
Client Concentration: In recent years, retail sales and consumer trends have consolidated towards mass merchandisers and e-commerce companies. Spectrum’s success relies heavily on a few key customers. For example, Walmart accounts for approximately 15% of the consolidated net sales. If SPB fails to retain their key customers, the loss would result in less purchase orders and thus fewer revenue Source: Bloomberg, JWC Research streams.
Acquisitions: The core of our investment thesis is SPB’s ability to identify new and higher growth opportunities after the sale of the battery brands. If SPB falters in this plan and is unable to improve margins and spur additional growth, it will adversely affect free cash flow and ultimately our valuation.
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Spectrum Brands Holdings, Inc. - SPB
JWC Rating Systems
Buy: The stock’s total return is expected to outperform the S&P 500 over the next 12 months. Avoid: The stock’s outlook and drivers are too unpredictable. This stock should be avoided. Sell: The stock’s total return is expected to materially underperform the S&P 500 over the next 12 months.
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