DJ Bed Bath & Beyond is Ready to Rally Under a New CEO, Meryl Witmer Says -- Barrons.com
By Meryl Witmer
It's time for the rubber to meet the road. In the latest installment of Barron's annual investment Roundtable , five of our panelists give -- and defend -- their views on specific stocks and other investments.
The Roundtable members spend half of their daylong meeting each January proposing stocks, bonds, and funds that they believe will race ahead or fall on their faces, and this year was no different. There was a clutch of compelling picks, some persuasive pans, and even what one of our newest panelists views as a couple of likely 10-baggers. See the other picks here, and check in next week for the picks and pans of our other five panelists.
Weighing in below is Meryl Witmer of Eagle Capital Partners.
So Meryl, what do you have for us today?
Meryl Witmer: I don't have a lot. It's pretty slim pickings for the value investor these days. We look at many companies, and the current stock prices are as high -- or higher -- than our target prices a couple of years out.
Yet you still found stocks to recommend, including Bed Bath & Beyond.
Witmer: Bed Bath (ticker: BBBY) was really poorly run. I can't stress that enough. I have some knowledge of what happened there from prior employees and people who worked at competitors. It was really poorly managed. But it has a new CEO, a fantastic CEO at the helm. They've brought in Mark Tritton from Target, and the thesis says he'll implement operational improvements following the successful road map he had at Target.
What's so great about Tritton?
Witmer: This is a guy who knows how to build a strong omnichannel retailer. When he went to Target as chief merchandising officer -- the second most important job at a retail company -- Target was not doing so well. His first year, same-store sales went up 1%. The next year, they went up about 5%. And the next year, they went up about 5% again. Before he was at Target, he was at Nordstrom, where he was in charge of the private-label business, and did an absolutely fantastic job. Revenue went up dramatically in that area. He has a real focus on improving merchandise and reducing the cost of private label.
A key part of the whole analysis is, when he negotiated his pay package at Bed Bath, he took a base salary of about $1 million to $1.2 million, with a target bonus of $750,000. And he took the rest of his compensation in equity, about $7 million to $10 million in equity, depending on how well he does. So, he came in, and he didn't say, "Oh, pay me $10 million to $15 million in cash." He said, "Pay me a million or two, and give me the rest in stock." He thinks he can do what's needed and sees upside in owning shares.
How much improvement do you expect at Bed Bath & Beyond?
Witmer: They have estimated they would make $2 a share this year, which gives them margins around 3%. He should be able to bring the margins up to 6% over the next few years, just from better sourcing, cost-cutting, and getting sales moving a little. If he does that, earnings should grow to about $4 to $5 a share. We think the stock would get at least a nine or 10 multiple, probably higher if it is on a growth track. So, we have a shot at, from $16 today, getting to about $45 a share in three years. It could be a three-bagger.
Bed Bath is reporting earnings this week, and I expect the stock to trade down, so hopefully Barron's readers will be able to buy this stock more cheaply. I want to stress that this will likely not be an overnight success, so it makes sense to buy it on dips.
What's your next stock?
Witmer: LafargeHolcim (LHN.Switzerland and HCMLY in the U.S.), a maker of cement and lime aggregates. I mentioned it in the midyear Roundtable. It's up a little, but it's so good I want to mention it again. Lafarge Holcim is the product of a very difficult merger. It was very, very poorly managed before. And now we have a dynamic duo running it -- Jan Jenisch, who's the former CEO of Sika, and Geraldine Picaud, the former CFO of Essilor. They came in to turn it around and reduce the bloated overhead. They focused on getting the balance sheet into shape, and sold assets to shore it up. And they continue to improve operations by pushing management down to the local level, fostering a more entrepreneurial climate, and upgrading where needed. They're very, well, almost ruthless about doing this, and I mean that in the best of ways.
What kind of results is Lafarge producing?
Witmer: For 2019, they should report 3.40 to 3.50 Swiss francs of earnings per share. And with their typical growth rate of 4% to 5% and getting debt paid down with free cash flow, we see earnings growing to about CHF4.30 a share in 2021. The company has depreciation and amortization well above its maintenance capital-spending needs. So, if you add in the excess of about CHF560 million to earnings, it yields free cash flow per share of CHF4.75 in 2019, growing to CHF5.66 in 2021. With a range of after-tax free cash flow of CHF5.65 to maybe CHF6.55 if things go right in that 2021-22 time frame, we see the stock trading to at least $70 or CHF67.50 within the next year or two, and it has a 3.85% yield as an added incentive to own it. This is the base case.
There's potentially more upside?
Witmer: We see the potential for 50 cents to a dollar per share of incremental EPS, and free cash flow, coming from better cement pricing in Europe, due to changes the European Union is making in the CO(2) allowances and requirements. We think that many of the mom-and-pop producers in Germany and Spain will eventually shut down, taking capacity out of the market, rather than make the needed investments to meet the CO(2) -reduction requirements. And the resulting consolidation will move pricing upward toward 90 euros to 100 euros per ton from about EUR70 to EUR80 now.
In addition, it's very difficult to build a new cement plant. Europe doesn't need them. In the U.S., it takes 10 years, if you can even get it done. In the U.S., capacity utilization should increase, and that should help on the pricing front, which isn't in our numbers. That could ultimately take pricing $10-plus per ton higher.
And for your last pick?
Witmer: It's Lanxess (LXS.Germany and LNXSY in the U.S.), a specialty-chemical producer based in Germany that I recommended last year, and I'm recommending it again. It was up nearly 50% in 2019. Now it's about EUR59, has a market cap of about EUR5 billion. Over the past year, the company has hit its numbers, despite very, very weak macro conditions in Europe and elsewhere. And they've continued to improve the quality of their business mix. They've divested noncore, low-performing businesses, and they're bringing in some money from that.
Is there more to the story than good management and debt pay-down?
Witmer: In the past year -- and this is just a new thing that came up on their investor day -- they created a company called CheMondis. It's an online chemical distributor, which has gone from start-up to EUR150 million in transaction volume in less than a year. It's basically business-to-business, small-transaction chemicals. It's a very complicated business. You need all the chemical manifests, and the like. And they have a niche in there, and it's just growing dramatically. It's not contributing to earnings yet, but if it keeps growing like this, it will be quite an asset.
That sounds promising.
Witmer: And while they continue to execute extremely well in a challenging global economy, we're really excited about the cash war chest they're building. Lanxess currently has about a billion euros of cash on the balance sheet, and they'll receive an incremental EUR600 million from the sale of their stake in Currenta, a chemical-park operator. The company has put a strategic-acquisition target list together and is being very disciplined with the prices they're willing to pay. They have a strategy, and they've done some very successful acquisitions in the past.
What does that mean for the stock?
Witmer: Without any acquisitions, they should make about EUR4 per share in 2020 and, adding the excess depreciation and amortization, have about EUR5.65 in sustaining free cash flow. After the sale of Currenta, we think there's about EUR1.5 billion of excess cash, which is $17 a share. We trust the terrific management team to deploy it strategically. If they can get a 12% after-tax return, that earnings power would increase by EUR2 per share. At 12 times, that would add an incremental $24 of value to our current price target of $70 a share. We see something close to $100. And if they don't deploy the capital, $70 to $80. And it's about $60 today. So, a free call on the upside.
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January 17, 2020 17:15 ET (22:15 GMT)
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