Over the last few weeks, I have had several interviews with prospective Investment Management Academy candidates. After retelling my last few years, I remember how impactful reading has been to my development as an investor. There is still much to learn for me, but, as a result of reading The Intelligent Investor, The Margin of Safety, and The Psychology of Money, an econ kid with zero accounting and finance experience became the president and portfolio manager of an investing organization. Inspired by the youth, I returned to my reading ways and met Peter Lynch through One Up On Wall Street. Mr. Lynch describes six different situations, including asset plays. It reminded me of my summer internship stock pitch: Spectrum Brands Holdings (SPB).
In Short, Not a Short
In all honesty, I was looking for a short. I was told that: “If you want to get a hedge fund job, you need to have a long and a short”. Well, I do not tend to look at situations from the shorting lens. However, I saw the end of summer stock pitch as an opportunity to try the short-view out.
As I began to comb through the statements, I thought I was looking at a dumpster fire. I saw 15x net debt to EBITDA, negative earnings, and building inventory. It made me feel like I found a real winner, or should I say loser.
My short thesis came to a brisk halt when its outstanding bonds did not look like bankruptcy was imminent. I had been curious why such a terrible-looking situation was trading near a 52-week high. How could an amateur short analyst find this so easily?
I began looking at SPB in late June 2023. As of early November 2023, SPB has zero net debt and around $10 net-cash per share while it trades at $77 per share (as of 11/10/23).
How did this situation change? SPB became an asset play.
Spectrum Brands Holdings, Inc (SPB)
Key Financials (as of 11/10/2023)
- Market Cap: $2,773.3 mm
- Enterprise Value: $2,021.4 mm
- NTM P/E: 21x
- NTM EV/EBITDA: 6x
- Net Cash/Share: $10
- Current Stock Price: $77
Quick Company Overview
Spectrum Brands Holdings (“Spectrum”, “Spectrum Brands”, or “the Company”) produces, sells, and manufactures licensed and owned consumer product brands.
The Segments
Its portfolio of brands and products are separated into three different segments: Home & Personal Care (“HPC”), Global Pet Care (“GPC”), and Home & Garden (“H&G”).
HPC – 38% of FQ3 sales & 4.1% Adjusted EBITDA Margin
HPC products include small kitchen appliances like grills, toasters, and coffee makers and hair dryers, flat irons, and electric trimmers. Some notable brands are Black & Decker, George Foreman, Toastmaster, and Remington.
GPC – 37% of FQ3 sales & 19.7% Adjusted EBITDA Margin
GPC products include dog treats, cat and dog food, and aquatics like tanks and filters. Some notable brands are 8IN1, Dingo, IAMS, Tetra, and Instant Ocean.
H&G – 25% of FQ3 sales & 20.7% Adjusted EBITDA Margin
H&G products include pest control, weed killer, insect repellent, and household cleaning. Some notable brands are Hot Shot, Spectracide, Cutter and Repel, and Rejuvinate.
Business Model
Spectrum sells and distributes its brands to large retailers, online retailers, warehouse clubs, and drug store chains. Some of its largest customers are Walmart, Amazon, Home Depot, and Lowes.
The Company primarily manufactures through third party manufacturers around the world.
In addition, the Company has a history of acquiring and selling brands as another source of income.
Recent history: Debt to the Moon
In 2020, Spectrum benefited from the outbreak in COVID-19. Consumers turned their intention to home improvement, adopting pets, and spending time outside. All of these trends resulted in the Company having a strong year.
In anticipation of continued strength, the Company continued to acquire brands and grew its inventory through large debt issuances. However, as interest rates began to rise and consumer spending shifted away from the home, SPB had excess inventory and crippling debt.
Net Cash Position?… HHI Divestiture
How did the company go from 15x net debt to EBITDA to positive net cash? On September 8th, 2021, management announced the sale of its Hardware and Home Improvement (HHI) Segment to ASSA AMBLOY for $4.3 billion in cash.
However, on September 22nd, 2022, the Department of Justice blocked the divestiture due to some of ASSA AMBLOY’s holdings. On December 2nd, 2022, ASSA AMBLOY sold off the assets in question.
As of June 20, 2023, the deal went through, which saved Spectrum’s balance sheet. The Company netted $3.8 billion, which was above the $3.6 billion expected after taxes and fees. Immediately, management paid down $1.1 billion of its most expensive debt, received authorization for a $1 billion share repurchase plan, and funded a $500 million accelerated share repurchase program. These moves left the company with around $2.9 billion in cash and $2.1 million in debt.
From deal announcement to close, SPB had to dedicate a significant amount of resources to pushing the deal, and the business itself was deteriorating given the elevated inventory, lacking demand, and suffering profitability.
The Problem Child = HPC
The HPC segment has been the worst performing part of the Company during the special situation. Throughout the offloading of HHI, HPC’s revenue has had the largest percentage of the mix but the worst margin profile.
GPC is the most consistent in profits and growth while H&G suffers from seasonality with overall solid performance.
What does it look like without HPC…NET-NET? (AMENDED 12/20/23)
Management admits that they are already in the process of trying to separate HPC as its own entity to eventually spin it off or sell it just like HHI, so that SPB can become a “pure pet and garden play.” Given that the segment has only a 4% EBITDA margin (up from around 1% a year ago) and stale inventory, management wants to improve it before making the transaction.
In Spectrum’s Q4 2023 earnings call, CEO David Maura discussed HPC’s potential sale. He described it as a $1.2 billion business with a 10% EBITDA margin. Maura could be signaling to buyers that these are the numbers that he would be looking to base a sale on. Eventually, he stated that this would be more likely to happen in late 2024, 2025, or 2026, but, based on his annual transaction track record, maybe it happens sooner.
Let’s say a transaction happens, it will leave Spectrum Brands with a doubled EBITDA margin and a potentially stronger cash position. Currently, the company’s working capital is 2,161.1 or $55 per share. If HPC can hypothetically sell for $1.5 billion (1.25x rev multiple), then its working capital per share will increase to $93.
SPB would turn into a NET-NET!
Note: It is pretty rare to find NET-NETs these days. If you are curious about what a NET-NET is, use this link to learn (basically a company selling bellow its net current asset value)
Context – this is still not a very good business
Before you go out and make a reckless decision, please understand this: Spectrum Brands is still not a fantastic business compared to other places you could put your money.
Its products are sold to the biggest big box retailers out there. There is intense competition in its end markets, and its customers are not known for sharing much margin. The Company does not own most of its manufacturing, which means there is not much control over its costs. Even though the CEO specializes in special situations and distressed debt, it does not mean you want the company you own to get into special situations constantly and have distressed debt.
That being said, there is a pathway to becoming an okay business. The Company can improve its ROIC as a pure pet and garden play through getting rid of its diworsification. A better EBITDA margin could lead to more consistent positive free cash flow, which will grow its cash balance organically. The pet market is growing, and SPB could eventually become a good acquisition target for the bigger players.
At the end of the day, this is an asset play…for now.
Asset play?
Think about it like this:
- SPB has $10 net cash per share ((Cash – Long Term Debt) / Shares Outstanding)
- Investor buys one share at $77 at a 21x forward P/E
- Investor essentially buys the share for $67, which slashes the valuation to around 18x forward P/E
I feel better about this Company at $67 per share and a 18x P/E. I would feel great if…
- HPC sells for $1.5B in cash = $38 per share (Total cash per share = $48)
- Investor essentially buy the $77 share for $39, which slashes the valuation to around a 11x forward P/E
Continue the Research
To follow an asset play story, we will pay attention to earnings and company performance, but we will be focused on what the Company is doing with the cash: more share buybacks, debt pay-down, and hopefully no M&A. In addition, big stock movement will probably be as a result of what the Company does with HPC and when. Best not to get involved until a legitimate buyer surfaces.
To stay on top of the story, you will need to continue the research beyond what I have told you so far. Go learn more about the individual brands, too. Do you use them?
Something I am trying to do is get more primary research. For example, I started looking at Nathan’s Famous hot dogs, but I have never bought hot dogs on my own. It was dad’s weekend at UIUC, so I asked my dad if he had ever heard of them. He said, “Yea, Nate’s are great, pretty sure they are supposed to be healthier.” Now, NATH is going to get a second and third look.
You can do this for Spectrum Brands, too. If you do, please reach out to me via twitter, instagram, or shoot me a text to let me know what you find.
Employ your curiosity.
-Maximus Beach
Learn more about Maximus Beach’s background here.
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