This will be a technical article designed to help the reader understand the financial health of Newell Brands (NYSE:NWL). All the data I have assembled goes back to 2008 so we can have a decade of information. I will discuss the trends in Newell's financial health throughout the years which will paint us a picture of the innermost workings of the company. I will start with the negatives and then I will move on to the positives. Let's dive in.
Liquidity of Newell Health
Liquidity answers the question, "How quickly and easily can something be converted to cash?" Companies need assets which are easily converted to cash to be able to fund the short-term (and long-term) needs of the company. It goes without saying that if a company has a lot of short-term liabilities, but no cash or liquid assets on hand, it is going to find itself between a rock and a hard place. Let's see how good of a job Newell Brands does at managing its liquidity.
The cash ratio is a more stringent ratio than the current ratio, which is what many investors use. I prefer the cash ratio because it only includes cash/cash equivalents and not all current assets, which makes the cash ratio a much more conservative measure.
I have separated the compounded annual growth rates into three categories: CAGR for the decade, CAGR excluding Jarden (2008-2015) and CAGR with only Jarden (2016-2017). Yes, the data only spans two years for the Jarden comparison, but this truly allows us to see the quantitative impact of Jarden on the overall company.
Starting at 2008, we see that the CAGR for cash & cash equivalents is 6.53% compared to 7.75% for the current liabilities. These numbers are quite close, and that is a good sign. Overall, the cash ratio only decreased by a CAGR of 1.13% per year for ten years. This indicates that over the past decade, Newell has been able to cover its short-term obligations with consistency. If you are wondering why the cash ratio each year is less than one, that is a good question. The reason is because if a company were to simply keep an abundance of cash on hand to cover all or more of the current liabilities, then that would be an unproductive use of capital. Rather than earning a risk free return, we want the company to use some cash to expand and grow revenue, while also keeping some cash aside to cover short-term emergencies or liabilities.
Now, let's look at CAGR excluding Jarden (2008-2015). Here, we can actually see that there was no change in cash & cash equivalents while current liabilities fell by 1.47%. This improved the cash ratio by 1.49% showing that the company actually became slightly more liquid and healthier over those periods of years.
It is when we strip out those years and look solely at CAGR in reference to the Jarden years (2016-2017) that we can see big changes. Here, we can see that cash & cash equivalents fell by 17.35%, current liabilities rose by .58%, and the cash ratio deteriorated dramatically by 17.83%. The company clearly had much higher liquidity issues post acquisition than before. Now staying on the topic of liquidity issues, let's analyze the…
>As a company, accounts receivable is your most important source of cash. The collection period allows us to see how quickly (or slowly) a company is collecting cash from its customers. Standalone figures are typically unhelpful, however, looking at the past ten years in succession offers insight. Here, we can see that the CAGR over the past decade is .98% - meaning that it has taken Newell about 1% longer each year to collect cash from its customers. Now, that isn't a dramatic amount by any means. The dramatic amount occurs when the company acquired Jarden. There, we can see a 22% increase in the time it took to collect cash from customers. It is worth noting that the 2017 Collection period was still lower than 2015, which was pre-Jarden. We saw a substantial decrease from years 2015 to 2016, but then immediately reversed course from 2016 to 2017.
In the cash ratio, we saw some issues in regards to liquidity during the Jarden years. With the collection period, we see some issues in regards to cash flowing through the system at a slower rate. In other words, increasing collection periods is a drain of cash because it is cash you are owed, but do not physically possess. Perhaps the credit terms are too loose or customers are simply not paying. If that is the case, then the company would learn this over time, and using those historical numbers, increase what is called the…
Bad Debt Reserve
Bad Debt Reserve or Allowance for Doubtful Accounts is a provision for the estimated amount of bad debt, or cash that the company does not expect to receive from customers during the year based upon historical data.
Here, we can see that the allowance for doubtful accounts represented 4.06% of gross receivables in 2008 and then 2.27% in 2017. In other words, out of all the accounts receivable that Newell is owed, they expected to collect a higher percentage of it in 2017 than in 2008. Overall, the CAGR decreased 6.27% each year, meaning that Newell's customers either became more creditworthy or honest about paying. Since Newell's %ADA/GR decreased, but their collection period increases, it leads me to believe their customers have become more prone to paying, but simply take longer. This is good relative to the alternative which would have been if their %ADA/GR and collection period were both increasing - that would be a sign of trouble as that indicates their customers are becoming less and less creditworthy and taking longer to pay Newell back, if ever. However, since these forces are working in opposite directions, I believe this is not a big issue, but it is bad for liquidity because it is still a drain of cash (since the company should have more cash than it does but does not because they are not receiving as fast as they should from customers. Therefore, it is cash you should have, but don't, which in effect, is a drain of cash).
Sticking with the theme of liquidity and cash, I want to turn your attention to another piece of this puzzle. The accounts payable turnover ratio allows us to see how quickly (or slowly) a company is paying back its suppliers. I am sure the astute in the audience noticed that by using total supplier purchases without distinguishing between purchases made with cash verse credit, that I overstated the total supplier purchases. However, the breakdown of supplier purchases made with cash verse credit is typically not readily available on general purpose financial statements. Even if they were, the cash to the credit proportion is relatively small and therefore, modifying the supplier purchases to 'total' and not just 'credit' comes with negligible effects.
Ok, moving on. As we can see above, the CAGR of their payment period has decreased by 2.47% over the last ten years. That means each year, Newell pays their suppliers 2.47% slower. Furthermore, if we look at the CAGR in the Jarden years, we can see that the payment period decreased by a whopping 35.61%. This is a huge change that indicates for whatever reason, Newell took a long time to pay back suppliers. Perhaps going back to our earlier theme, there was not enough cash flowing through the business after having to pay for current liabilities and not enough cash flowing through because customers were taking a longer time to pay Newell back. This lack of liquidity probably forced the company to take longer to pay back the money they owed since they did not have enough on hand and were not collecting it fast enough.
Let's continue to stick to the theme of cash and take a look at the final piece in this puzzle which is…
Cash Flow from Operations
In this particular case, I have separated the CAGR of this ratio in two segments based upon performance rather than the typical pre-Jarden and post-Jarden theme this article has followed up until now. The reason is that there is a trend I want to point out. Therefore, we have CAGR from 2008 to 2012 and CAGR from 2013 to 2017.
Before I continue, I want readers to understand there are two definitions of an asset. One is a 'poor man's definition' which is typically taught by professors and economists and the other is a 'rich man's definition' which is what our idols who have succeeded in the real world use, and what we will use as well.
A poor man describes an asset as "something he owns."
A rich man describes an asset as "something he owns which produces cash."
The first thing to notice here is that from 2008 to 2012, cash flow from operations increased by 8% each year (using CAGR). Total assets fell by an average of 2.18%. The company had become more efficient in utilizing their assets to produce more cash from operations. Overall, the cash flow from operations as a percent of total assets rose by over 10% each year over those years (again, in terms of CAGR).
Starting in 2013, though, we can see a downward trend. One that is pretty steep as well. I want to point out that in 2017, the company had a $1.7 billion cash reduction due to deferred income taxes which is why the cash flow from operations is much lower than 2016. If we normalize this and then the cash flow from operations for 2017, as well as the 2017 %CFFO/TA, would be quite similar to 2016. Nevertheless, the %CFFO/TA fell from 9.97% in 2013 to 2.81% (or around 5.4% if we normalize the deferred income tax). In order words, Newell became less efficient at converting their assets into cash.
A lot of articles have been written about Newell and the associated divestitures although not many specifically discuss why is the company taking this route? Often times, I read that Newell is divesting to take focus on their core business or their essential operations or simply improve efficiency. Well, yeah… obviously. That is not specific at all. That is what analysts over at MarketWatch put out because they just want to superficially write an article to gain views in time. Even Newell lacks specificity. They wrote in their 2017 10K, "During 2016, the Company committed to plans to divest several businesses and brands, most of which were disposed of during 2017, to strengthen the portfolio to better align with the long-term growth plan." Wasn't the whole point of acquiring Jarden in the first place to improve efficiency and strengthen the portfolio for the long run? To become more cost effective due to higher economies of scale and earn higher revenues due to synergies?
I believe this M&A did not go the way Newell had hoped it would. The simple fact that Newell CEO Michael Polk and Jarden co-founder Martin Franklin did not see eye to eye put a further strain on the acquisition. I think these data points show that Newell was having liquidity issues and that their core operating performance was deteriorating. Cash on hand was hard to come by, cash from customers was hard to come by, Newell was taking longer to pay off suppliers and became less efficient in utilizing assets to produce cash. The synergies did not come forth, and I believe Newell must have thought they will not come forward in the immediate future either. And alas, perhaps that is the hidden reason as to why they decided to take this massive change in trajectory and apply their Accelerated Transformation Program. One of the covenants in that plan is to use the cash from divestitures to pay down debt and buy back stock. Newell expects to earn about $10 billion cash after tax from their divestitures. This influx of cash will improve the liquidity issues of the company, which I suspect was underlying cause and reason for Newell's decision to divest, refocus, and the improve operational inefficiencies.
This almost made my negative list because sometimes if you see decreasing reserves, combined with increasing inventory, it could be an issue that needs to be further investigated. Inventory reserves are contra asset accounts (these accounts offset their corresponding asset account) in which the company provides provisions for charges for the expected amount of inventory which they predict they will have to write down. By underreserving inventory, companies can decrease cost of goods sold, increase gross margin, and inflate their operating income.
At first glance, it looks like that might be a possibility. However, digging a little deeper, we can see above that in 2008, Newell actually over-estimated the amount they would have to write off. They set aside a provision for $79 million in 2008 and only had to write down $47.7 million. Perhaps the recession year was quite uncertain, and they were being safe in their allocations. Nevertheless, that caused the balance at the end of the year to be higher than it normally would have. Since the balance at the end of 2008 is the starting balance for 2009, that then caused the 2009 ending balance to be higher because the provision that year was $57 million and writeoffs were $58.4 million, effectively canceling each other out. Therefore, in 2008 and 2009, I believe the inventory reserve account was overstated and would have been around $60 million which is pretty similar to what Newell reported in 2017 ($52 million). As a result, I think Newell simply overvalued that account earlier, and it has simply fallen to the historically normal level, not to below the historically normal level.
Cost of Goods Sold & Revenue
Not everything I wanted to write about today was negative. If we analyze the CAGR of Newell's cost of goods sold, it comes out to be 9.27% higher each year. Revenue has grown at a CAGR of 9.83% each year. This is an awesome thing to see. Simply earning more revenue from products sold each year is not indicative of the whole story. An analyst has to also look at what is the cost that the company incurs to sell those products. If those costs are rising at a fast rate than revenue, it is only a matter of time before it catches up and laps sales. The big exception was in the year 2015 to 2016 where cost of goods sold increased 145.5%, but revenue only increased 124.21%. However, the next year, from 2016 to 2017, the business was back on track and in accordance with their historical normalcy where revenue rose faster than costs (11.14% verse 8.89%).
The fact that Newell is producing more revenue while simultaneously lowering their cost of goods sold is a wonderful sight to see and just goes to prove the point I wrote about in my last article that Newell passes on higher costs to their consumers. A lot of analysts believe higher inflation and tariffs are going to spell the death of Newell. Inflation certainly is not new, and if anything, these past ten years have shown Newell is not fazed by higher costs. They are still outpacing those costs with higher revenues. And furthermore, if Newell is affected by tariffs, so are all the other sellers who make the same product.
Note: I wrote in my last article, and I will write it here again - I am not suggesting I am a proponent of inflation or tariffs. I just wanted to demonstrate that Newell has the ability to succeed in either or both of those environments. For an interesting read on inflation, take a look at this piece I wrote in my blog.
On the subject of positives and revenue, I would also like to point out the evenly distributed earnings between the three segments of Newell's business. Obviously, there is substantial risk when a company is generating a majority of its revenue from one area of its business. This slide shows that Newell has a strong foothold in many markets and has done a great job in making sure they do not lean too heavily on any one area. This allows investors the reassurance that even if some segments are to struggle (such as Baby, Writing, and Appliances in early 2018), there are other profitable segments that help offset that blow.
So, now that we have a better understanding of the inside scoop of why the company has arrived at this point, let's focus on company guidance for 2018. A lot of damage was dealt during the first two quarters. However, the company's continuing operations are expected to stabilize pretty soon.
Newell Brands believes that margins will improve sequentially on a quarter by quarter basis due cost saving initiatives and price increases. Full year revenue is expected to be around $9 billion or slightly less. Cash flow from operations is expected to come in at $900 million to $1.2 billion. As far as debt repayments, Newell is working on decreasing that as well as they already paid off their term loan balance of $300 million.
I believe from analyzing the data that Newell probably has some liquidity issues boiling. That combined with operational inefficiencies left Newell without the synergies or cost savings they expected when they acquired Jarden. The positive takeaway here, though, is that the hardest battles of the company seem to be behind them, and they expect to sequentially improve operations in the following quarters. Revenue looks strong, and there is no denying the strong brand presence, market share, and demand for Newell's products that exists. Going forward, there should be less pressure on the liquidity issues due to the sale of assets. Obviously, this is not the ideal way to improve liquidity, but the fact is that is where we are at the moment. The company is looking to restructure itself and focus on improving its operations. At the end of the day, a bet on Newell is a bet on management. From analyzing the company, that is a bet I am considering taking, but not convinced quite yet. My valuation report will come soon. Thanks to everyone who made it this far. I know this was another long article, but I would never feel right about giving my readers an article which was "half baked". If you enjoyed, hit that follow button and join the DocShah Economics family.
Disclaimer: Neither this article nor any comment associated with it is taken as financial advice. Investors should always do their own research before executing any financial transaction.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NWL over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Source : https://seekingalpha.com/article/4207572-newell-brands-financial-health-analytics