Times of change can represent the opening of the new doors of opportunities for companies. But the uncertainty associated with these changes can also prove to be problematic. Very few companies over the past year or so have gone through as large a change as Spectrum Brands Holdings (NYSE:SPB) has. As I detailed in my last article on the company in November of last year, it sold off its Hardware and Home Improvement segment for a massive $4.3 billion. For a company that has a market capitalization as of this moment of $2.60 billion, that is a massive change.
That has not been the only change the company has gone through. Just recently, management decided to pay down a significant amount of debt while also issuing some new debt. This move should improve the company's bottom line. This move, combined with some recent improvements that we have seen on the bottom line, makes me remain confident in the company. This may seem odd to those who have followed my assessment of the company in the past. In each of the last two articles that I wrote about it, I have been bullish. However, my calls so far have fallen short of my own standards. From the time I rated the company a ‘buy’ in May of last year, shares are up 28%. While this is a good return, it does fall short of the 32.9% move higher seen by the S&P 500. And since reiterating my ‘buy’ rating on the stock in November of last year, the stock is up 16.6% compared to the 21.4% increase seen by the broader market.
To be very clear, we are still faced with a great amount of uncertainty. This is especially true as management looks to sell off its largest segment. And because of this, investors would be wise to bake in a lot of additional wiggle room in analyzing this company. However, with shares of the business trading on the cheap, both on an absolute basis and relative to similar firms, I think that this wiggle room certainly exists.
Recent developments
Over the past month or so, the management team at Spectrum Brands Holdings has been very active about making some rather interesting changes. I will spare you the step by step moves that the company has made to get to this point. However, the important thing to note is that, on June 4, management announced pricing terms and accepted tender amounts for a tender offer and consent solicitation that was launched prior to that point. Ultimately, the company has agreed to pay $1.16 billion to buy back a wide array of senior notes on its books. These have staggered maturities of between 2026 and 2031. Interest rates were actually not all that high, ranging between 3.875% and 5.50%.
In most cases when this kind of thing occurs, it is done with new debt that is issued. That would be a problem in this environment because of how high interest rates currently are. However, as of the end of the second quarter of this year, the company had cash and cash equivalents on its books of nearly $1.25 billion. I think one could argue that investing this capital elsewhere may have generated stronger returns. But for better or worse, management decided to take the safer route and reduce leverage. A very small amount of this debt is being bought back at a discount. This means that the company is actually buying back nearly $1.17 billion worth. This move alone will reduce annual interest expense by roughly $51.3 million.
Late last month, management also announced that they were issuing a private offering of exchangeable senior notes that would be due in 2029. The amount in question would be $300 million, with the initial purchasers having the right to buy up to another $50 million worth. I could not find a record of those purchasers deciding to go forward with this additional option. Normally, they would. But given that we don't have clarity on the matter, my analysis in this article will assume that they have not. These aren't just any notes though. For starters, they have a very low interest rate of only 3.375%. They can also be exchanged for common shares of the company, with an initial exchange rate of 8.2060 shares of common stock for every $1,000 worth of principal. This translates to a roughly 30% premium over where shares of the company were trading at as of May 20.
The management team at Spectrum Brands Holdings stated that the firm will receive net proceeds of $291.6 million from this issuance, assuming that the other $50 million option is not exercised. The firm has then decided to payout $21.6 million back to the initial lenders in what is called a capped call transaction. In short, Spectrum Brands Holdings will have the right, initially, to cap the price on the conversion of these exchangeable notes at an amount equivalent to $159.36 per share. This helps to reduce dilution in the event that things go really well. Management is also allocating $50 million toward buying back stock. But since we don't know the terms of that buyback, I am also not including this in my analysis for the company. Ultimately this debt issuance will reduce total interest savings for the company down to $40.1 million annually. But that's still an improvement over not paying the debt down at all.
The good and the bad
Given these most recent developments, our analysis of Spectrum Brands Holdings is complicated to some extent. However, we do understand what the historical financial performance of the business has been after removing from the equation discontinued operations. For starters, we should probably touch on financial performance for the 2023 fiscal year compared to 2022. In the chart below, you can see precisely that.
From 2022 to 2023, Spectrum Brands Holdings reported a 6.8% decline in revenue, with sales dropping from $3.13 billion to $2.92 billion. All three of the companies operating segments saw weakness during this time. This decline was in spite of $89.9 million of benefit driven by acquisition activities. And the largest hit came from the Home and Personal Care segment. This segment reported a 9.3% plunge in revenue, with sales falling from $1.37 billion to $1.24 billion. Lower consumer demand, the closing of the company's commercial operations in Russia, and (by management’s own admission) a ‘highly competitive landscape’ was responsible for this weakness. By comparison, the company’s other segments saw more modest declines. It also didn't help that foreign currency fluctuations impacted sales negatively to the tune of $51 million.
As much as I wish I could say that the bottom line was better, that's not exactly true. In some respects, it was. In other respects, it wasn't. The firm's net loss, for instance, worsened from $77 million to $233.7 million. Two of the company's three operating segments saw weakness during this time. Once again, the Home and Personal Care segment saw the worst of it, with an operating loss of $214.7 million compared to the $30.2 million gain reported in 2022. Lower volumes, material inventory write offs, the sale of higher cost inventories that the company had accumulated the year prior, as well as other factors, more than offset cost savings initiatives and reduced spending on operations. Total impairments during this time came in at $175.8 million. This isn't to say that everything was bad. The Global Pet Care segment actually saw its operating income grow from $78.3 million to $134.4 million. Management stated that they saved on distribution costs and improved operations at the fulfillment level. Increased pricing on its products, as well as the benefits from prior cost reduction programs, helped tremendously.
Other profitability metrics for the company were mixed. Operating cash flow in 2023 was positive to the tune of $8 million. This stacks up against the $231.5 million in outflows the company saw the year prior. But once we adjust for changes in working capital, we actually get a worsening of operating cash flow from negative $25.2 million to negative $69.2 million. The only bright spot for the company involved EBITDA. It managed to grow from $283.1 million to $303 million.
When it comes to the 2024 fiscal year, we now have data covering the first six months. Revenue for the company fell roughly 2.2% from $1.44 billion to $1.41 billion. The biggest decline came, once again, from the Home and Personal Care segment, with sales dropping by 5% from $643.6 million to $611.2 million. To be clear, total revenue for the company would have taken an even larger hit had it not been for a $12.9 million benefit that the company saw as a result of foreign currency fluctuations.
As painful as the top line was, management did report some improvements on the bottom line. The company went from generating a net loss of $74.6 million in the first half of the 2023 fiscal year to generating a profit of $90.2 million the same time this year. Operating cash flow did fall from $148.6 million to $80.7 million. But once we adjust for changes in working capital, we get an increase from negative $49.4 million to positive $164.4 million. Meanwhile, EBITDA for the business more than doubled, climbing from $90.8 million to $196.6 million.
The problem with analyzing Spectrum Brands Holdings is that the extreme volatility that the company has seen as of late, even after adjusting for its acquisitions and divestitures, makes it difficult to know what to expect moving forward. Perhaps the safest route is to value the company solely based on an EV to EBITDA basis since management has done well to remove a lot of the noise that shows up in other profitability metrics for the business in this metric. Management has been kind enough to forecast that EBITDA this year will be higher than what it was last year. They have not given a specific number. But they did say to expect growth in the low double digit range.
For the purpose of this article, I decided to take this as meaning a year over year increase of 12.5%. This would give us EBITDA this year of about $341 million. In the chart above, you can see what this means for the valuation of the business on a forward basis and you can also see how shares are priced using data from last year. Using the forward estimates, I then compared the company in the table below to five similar firms. And in this case, it ended up being the cheapest of the group.
Company EV / EBITDA Spectrum Brands Holdings 8.4 WD-40 Company (WDFC) 29.6 Energizer (ENR) 13.0 Central Garden and Pet Company (CENT) 10.5 Reynolds Consumer Products (REYN) 11.0 Clorox (CLX) 28.4
Takeaway
To be 100% straightforward with you, Spectrum Brands Holdings is not the kind of investment for those who cannot deal with uncertainty. The changes the company has made, and the changes it looks intent on continue making, can be unnerving. The good news is that leverage is improving, costs are dropping, and cash flows are rising. Shares of the firm also look attractively priced, both on an absolute basis and relative to similar firms. Given these facts, I think that keeping the company rated a ‘buy’ is logical, even though this rating has resulted in a modest amount of underperformance compared to the broader market.
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