CTVA Provides Updated Financial Guidance; Fair Value Estimate Remains $36; Maintain BUY

• On August 15, 2019, Corteva Inc. (NYSE: CTVA) provided an investor update which included updated financial guidance. Recall that Corteva spun off from DowDuPont Inc. (formerly NYSE: DWDP) on June 3, 2019.
• CTVA reaffirmed its 2019 outlook originally provided on its 2Q earnings call on August 1, 2019. Revenues are expected to decline 3% Y/Y; operating EBITDA is expected at $1.9-$2.05 billion.
• Today’s announcement focuses on the company’s mid-term financial targets and includes an upward revision to 2020 guidance. For 2020, Corteva upwardly revised revenue guidance to 4% to 6% versus 3% to 5% previously, attributing the revised outlook to the expectation of higher pesticide sales. The company guided to 2020 EPS of $1.06-$1.31, broadly in line with consensus estimates.
• Last quarter’s downward revision to 2019 estimates appears to suggest Corteva’s weather-related impacts are largely behind it, and that management may have set the bar conservatively in its debut as an independent company. Given that Corteva is a 2020 growth story, one could argue that industry fundamentals are bottoming.
• Our 2019 estimates remain unchanged, and are based on EV/EBITDA and P/E multiples of 15x and 28x, respectively. The applied multiples remain conservative, in our view, in light of more diversified industrial chemical peer Syngenta AG (NYSE: SYT) trading at 14x 2019E EV/EBITDA. The fair value estimate for CTVA remains $36 per share.
• Shares of CTVA appear to have bottomed from recent $25 lows in June. We maintain our BUY recommendation. We continue to expect an improving demand outlook throughout the year and into 2020, and see long-term value in the shares as a pure-play agriculture science company—particularly amidst industry consolidation.
• For more details, please refer to The Spin Off Report dated January 14, 2019 and UPDATE dated August 2, 2019.

KAR Reports 2Q 2019 Results which Includes Margin Pressure from Trade Rev Rollout; Maintain BUY, Lower FVE to $29 (previously $33)

• On August 6, 2019, after the market close, KAR Auction Services, (NYSE: KAR) released 2Q 2019 results and maintained its full year 2019 outlook.
• KAR reported 2Q 2019 revenue of $719.1 million (15% year-over-year increase) and net income from continuing operations of $0.20 per share (a 27% year-over-year decline). The consensus estimate expected revenue of $692.2 million and EPS of $0.37.
• Notably, the company highlighted that it incurred a $16 million operating loss attributed to the rollout of its Trade Rev platform versus a $11.3 million loss in the prior year period.
• Investor concern over the ability of management to achieve profitability from Trade Rev remains a pivotal concern. For its part management has previously stated that it expects a lost of ~$60 million from Trade Rev this year before seeing losses narrow in 2020.
• Management reiterated its full year guidance, which includes adjusted EBITDA of $530-$550 million.
• We lower our fair value estimate to $29 per share (previously $33 per share), which is now based on 2020E EBITDA of $575 million (previously $604 million) at 9.5x, and incorporating $1.6 billion in net debt and 134 million shares outstanding.
• Based on current share price, and on 2019 guidance of ~$540 million in adjusted EBITDA, shares of KAR are currently trading at 8.9x 2019 EBITDA and 8.4x our 2020E EBITDA. For context, KAR’s closet peer Copart Inc. (NASDAQ: CPRT) trades at 19.4x 2020 consensus EBITDA estimate.
• We believe our heavily discounted multiple compared to CPRT accounts for differences in business models, lower margins (~20% versus ~30%), and uncertainty surrounding the timing of profitability at KAR’s Trade Rev.
• We maintain our BUY rating on KAR (with current trading representing nearly 20% upside to our revised fair value), however note that the market will likely need to see a narrowing of Trade Rev losses before it is willing to give credit to shares.
• KAR will hold a conference call this morning at 11am EDT.
• For further information please see The Spin-Off Report dated December 14, 2018, and UPDATE notes published on April 2, 2019, June 6, 2019, and June 21, 2019.

MNK Suspends Specialty Generics Spin-Off; Drop Coverage of MNK Effective Immediately

• On August 6, before the market open, Mallinckrodt plc (NYSE: MNK) announced that it plans to suspend the planned spin-off its Specialty Generics business, citing uncertainties surrounding recent opioid litigation. The company noted that it continues to actively consider a range of options intended to lead to the ultimate separation of the Specialty Generics business, consistent with its previously stated strategy.
• We are dropping coverage of MNK effective immediately. We will re-instate coverage should the company reconsider completing the separation.
• Our prior estimates and fair values should no longer be relied upon.

CTVA 2Q Results Suggest Bottoming Fundamentals; Fair Value Estimate Revised to $36 (from $37); Maintain BUY

• On August 1, 2019, Corteva Inc. (NYSE: CTVA) reported 2Q 2019 earnings results, its first following the spin-off from DowDuPont Inc. (formerly NYSE: DWDP), which was completed on June 3, 2019.
• While Corteva’s softer 2Q sales of $5.6 billion (-3% Y/Y) reflected weather-related impacts in North America, international markets outperformed expectations; 10% of sales were derived from markets outside of North America, with Latin America sales increasing 34%year over year.
• CTVA downwardly revised its 2019 outlook, modestly. Operating EBITDA is expected at $1.9-$2.05 billion (vs. $2.20 -$2.30 billion), owing to North America weather-related crop planting delays, reduced planting. and loss of early season crop protection business). 2019 sales guidance was revised to -3% Y/Y (vs. flat).
• The downward revision to estimates appears to suggest Corteva’s weather-related impacts are largely behind it, and that management may have set the bar conservatively in its debut as an independent company. Given that Corteva is a 2020 growth story, one could argue that industry fundamentals are bottoming.
• We adjust our 2019 estimates to reflect updated guidance and balance sheet information, and an upward adjustment to our EV/EBITDA and P/E multiples (15x and 28x, respectively). The applied multiples remain conservative, in our view, in light of more diversified industrial chemical peer Syngenta AG (NYSE: SYT) trading at 14x 2019E EV/EBITDA. Accordingly, the fair value estimate for CTVA is revised to $36 per share (from $37).
• Shares of CTVA have appreciated approximately 20% since recent $25 lows in June. We maintain our BUY recommendation. We continue to expect an improving demand outlook throughout the year and into 2020, and see long-term value in the shares as a pure-play agriculture science company—particularly amidst industry consolidation.
• For more details, please refer to The Spin Off Report dated January 14, 2019 and UPDATE dated June 3, 2019.

TIVO’s increases 2019E sales and adj. EBITDA guidance to $650-$655 million and $180-$190 million, respectively; IP/Products separation remains “on track” for 2H 2020 

• Last night, TIVO reported 1H 2019 sales down ~8% to $334 million while, by our calculation, so-called “core” sales declined just 1.5% to $330 million.  Adjusted EBITDA of $100 million compared with $111 million in 1H 2018.
• The company increased full-year guidance for the second time this year; current expectations call for full-year sales of $650-$655 million and adj. EBITDA of $180-$190 million (compared with current consensus of $646 million and $176 million, respectively, and initial guidance of $640-$654 million and $172-$178 million).
• The company expects cash taxes of $28-$29 million and a non-GAAP diluted share count of 127 million.
• During 2Q 2019, TIVO re-paid $50 million of convertible notes, ending the quarter with net debt of $618 million and a leverage ratio of ~3.4x.
• The company expects to repay the remaining $295 million of convertible notes by maturity (in March 2020) and refinance its Term Loan B prior to the impending IP/Products separation, which management indicates remains “on track” for 2H 2020.
• TIVO expects to receive a ruling on the tax-free status of the separation from the IRS in late-2019 or early 2020 and to file its initial Form 10 by 4Q 2019.
• Notably, TIVO indicates that it will continue to evaluate strategic transactions that could unlock value for shareholders even as it moves through the on-going separation process and that it remains actively engaged with interested parties.
• In terms of the on-going litigation with Comcast, we see the potential affirmation of the ITC’s June 4^th ruling scheduled for October 4^th as the most relevant near-term catalyst.
• Fair value remains $14 per share, reflecting 2020E adj. EBITDA of $190 million and multiples of 6.0x and 12.5x for Products and Licensing, respectively.

LNDC provides F2020E adj. EBITDA guidance of $36-$40 million (compared with consensus of $33.5 million and our ~$39 million estimate); nominates two new Board members and seeks to refinance debt

• For full-year F2019 (May-ending), LNDC posted consolidated top-line growth of almost 6.5% to $557.6 million with adjusted EBITDA growth of ~1% to ~$26 million.
• For full-year F2020, the company projects consolidated sales growth of 8%-10% with consolidated EPS and EBITDA of $0.28-$0.32 and $36-$40 million, respectively (compared with current consensus of $0.29 and $33.5 million).
• By segment, the company is expecting 8%-10% sales growth at Curation Foods with segment EBITDA of $19-$21 million.  Lifecore is expected to post top-line growth of 10%-12% with segment EBITDA of $21-$23 million.  Corporate expense is expected to be ~$4 million and cash flow from operations are projected to be $26-$30 million (versus $16 million in F2019).
• At year-end, LNDC’s leverage and fixed-coverage ratios were 3.7x and 2.2x (compared with covenants of 4.5x and 1.2x), respectively.  The company currently has borrowing capacity of ~$32 million (up from $28 million at the end of 3Q F2019). [Note: during 4Q F2019, LNDC exercised a put option to sell 70,000 Senior B preferred shares back to Windset Farms, which reduced the fair value of its investment to $61 million (from $68 million).]
• Notably, the company indicated it is currently in talks with existing and potential lenders to refinance its debt, which it expects will extend the duration (currently September 2021) as well as meaningfully reduce its interest rate (currently 5.25%).
• On the governance front, LNDC is nominating two new Board members, Craig Barbarosh and Charles Macaluso, for election at the Annual Meeting in October 2019.
• Fair value remains $14 per share although adjustments to our forecasts may be made following this morning’s conference call at 11 a.m. (ET).

WAB Reports Strong Q2 earnings, Increases EPS Guidance; Fair Value Estimate Revised to $90 from $95; Maintain BUY

• On July 30, before the market open, Wabtec Corp. (NYSE: WAB) reported Q2 earnings results which exceeded consensus expectations. Revenues of $2.2 billion were driven primarily by greater-than-expected contribution from the former GE Transportation, which allowed the company to offset a $40 million headwind from reduced organic sales and foreign currency-related losses (this is the first full quarter including GE Transportation). Importantly, transit sales increased 6% on a year-year-year basis, suggesting industry fundamentals have bottomed. Adjusted EPS of $1.06 reflected better-than-expected cost synergies associated with the integration of the GE business. As background, Wabtec is comprised of the transportation business of General Electric Company (NYSE: GE), which was spun off and merged with Wabtec on February 25, 2019
• While WAB’s 2019 revenue guidance was adjusted down slightly to $8.3 billion (from $8.4 billion previously), the company increased both the low end of adjusted EPS guidance to $4.10-$4.20 (from $4.00-$4.20) and its full-year cash flow guidance to $900 million (from $500-$600 million). 2019 EBITDA guidance was maintained at $1.6 billion. Product mix and revenue growth are expected to improve throughout the year, with a 14% operating margin target expected for the year.
• We maintain our BUY rating on WAB. Our fair value estimate is revised to $90 (from $95), reflecting a slight downward adjustment to 2019 revenues to $8.S billion (from $8.4 billion) and EBITDA margin of 18% (from 19%).
• Since the GE announcement, WAB shares have having declined over 30% from $114 in September. At approximately 10x forward EBITDA, we view the shares as attractive, particularly given that near-term margin issues associated with integration of GE appear to be behind the company. Shares are trading up approximately 9% intraday. With the fair value estimate implying 16% upside to the current share price, we maintain our BUY recommendation, noting that we expect continued operational improvements throughout the year.
• For more details, please refer to The Spin Off Report dated January 14, 2019 and UPDATE dated April 25, 2019.

NPO tightens full-year 2019E adj. EBITDA guidance to $225-$229 million (from $224-$232 million) and raises adj. EPS guidance to $4.45-$4.59 (from 4.25-$4.52), not including LeanTeq (4Q 2019 close)

• Last night, NPO announced 1H 2019 consolidated sales down 2% at $747 million with a 5.5% increase in adjusted EBITDA to $104 million and a near 31% rise in adj. EPS to $2.04.
• 1H 2019 results were primarily driven by strength in the Power Systems segment, which posted a 20% gain in 1H 2019 sales to $127 million with adj. segment EBITDA growth of almost 200% to $19.5 million.  Adj. EBITDA was up ~3.5% to $78 million at Sealing Products and down ~30% to $24 million at Engineered Products.
• The company ended 2Q 2019 with net debt of ~$304 million and a leverage ratio of 1.4x (compared with $335 million and 1.5x at year-end 2018).
• In terms of guidance, NPO tightened its full-year adj. EBITDA target to $225-$229 million (compared with the previous guide of $224-$232 million and $217 million in 2018) and raised its adj. EPS target to $4.45-$4.52 (compared with the prior guide of $4.25-$4.52 and $3.91 in 2018), implying year-over-year growth of ~3%-5% and ~14%-17%, respectively.  [Note: NPO’s current guidance does not include the impact of the recently announced LeanTeq acquisition (~$55 million in annual sales), which is expected to close in 4Q 2019.]
• As of yesterday, Mr. Marvin Riley officially took over as NPO’s CEO following the planned retirement of Stephen Macadam who served as the company’s chief executive for 11 years.  Mr. Riley was most recently NPO’s COO and was previously the President of NPO’s Fairbanks Morse division (i.e. Power Systems).
• Our fair value estimate remains $81 per share (see Exhibit #1 on page 2), reflecting a blended multiple of ~7.5x (unchanged) on 2021E EBITDA of ~$271 million (unchanged) and net debt of ~$391 million (previously $395.5 million).

Pfizer Inc. to Spin Off, Merge Upjohn Business with Mylan N.V.

On July 28, 2019, Pfizer Inc. (NYSE: PFE) announced that the company will separate Upjohn, its off-patent branded and generic established medicines business, and combine it with Mylan N.V. (NASDAQ: MYL). Under the terms of the agreement, which is structured as an all-stock, Reverse Morris Trust transaction, each Mylan share would be converted into one share of the new company. Pfizer shareholders would own 57% of the combined new company, and Mylan shareholders would own 43%. The Boards of Directors of both Mylan and Pfizer have unanimously approved the transaction.

The transaction, which is expected to be tax free to Pfizer and Pfizer shareholders and taxable to Mylan shareholders, is expected to close in mid-2020, is subject to approval by Mylan shareholders and customary closing conditions, including receipt of regulatory approvals. Upjohn will issue $12 billion of debt at or prior to separation, with gross debt proceeds retained by Pfizer. Upon closing, the new company, which will be renamed and rebranded by the close of the transaction, will have approximately $24.5 billion of total debt outstanding.

The new pharmaceutical company is estimated to generate pro forma 2020 revenues of $19 to $20 billion. Pro forma 2020 adjusted EBITDA is expected between $7.5 and $8.0 billion, including phased synergies of approximately $1 billion annually to be realized by 2023. Pro forma free cash flow for 2020 is expected to exceed $4 billion. The company expects to achieve a ratio of debt to adjusted EBITDA of 2.5x by the end of 2021. In addition, the new company intends to initiate a dividend of approximately 25% of free cash flow beginning the first full quarter after close and the potential for share repurchases once the debt to adjusted EBITDA target is sustained.

Mylan is primarily a generic drug company, which operates an active pharmaceutical ingredient manufacturer and runs a specialty business focused on respiratory, allergy, and psychiatric therapies. The combination with Upjohn will allow the new company to meaningfully expand the geographic reach of Mylan’s existing broad product portfolio and future pipeline into new growth markets where Upjohn has existing sales infrastructure and local market expertise. In addition, Upjohn brings several iconic brands, including Lipitor (atorvastatin calcium), Celebrex (celecoxib) and Viagra (sildenafil), and proven commercialization capabilities, including leadership positions in China and other emerging markets. Mylan offers a diverse portfolio across key therapeutic areas, such as central nervous system and anesthesia, infectious disease and cardiovascular. The generic-drug industry has been negatively impacted by declining prices—in part because fewer blockbuster drugs, such as Lipitor and Viagra, are losing their patent protection. In addition, pharmacies and wholesalers have combined to create larger purchasing groups, creating more leverage against generic drug companies. As a result, generic drug companies such as Mylan have struggled, leading some companies to divest their generics units or consolidate. For example, Novartis sold parts of its Sandoz generics unit to Aurobindo Pharma in September 2018. Accordingly, the new company should realize the benefits of scale and significantly expanded distribution. 

For Pfizer, the decision to separate its off-patent drugs business is not surprising given the company’s recent corporate activity around divesting its non-innovative pharmaceutical businesses and positioning for above industry average growth.. Pfizer has focused on drugs that are expected to maintain patent protections for some time, both those it has internally developed as well as through acquisitions. In addition, the company has focused on divesting lower-margin businesses. Last year, Pfizer agreed to combine its consumer health care unit, which includes products like Advil and Centrum multivitamins, with GlaxoSmithKline’s. At the same time, acquisitions have been focused on specialized growth areas, such as last month’s acquisition of Array BioPharma, a maker of specialized cancer treatments, for $10.6 billion.

PRELIMINARY VALUATION

We base our initial, preliminary valuation based on management’s targets for the combined Mylan + Upjohn and for post-spin Pfizer. Management estimates that the new combined company will generate $19 – $20 billion in revenue in 2020 and operate with an approximate 40% EBITDA margin. Shares of Mylan currently trade at 6.5x the 2020 consensus EBITDA estimate. Mylan’s peer group includes other generic drug companies such as Teva Pharmaceutical Industries Limited (NYSE: TEVA), Perrigo Co. plc (NYSE: PRGO), and Taro Pharmaceutical Industries Ltd. (NYSE: TARO), amongst others, which trade on average at 8.3x 2020 estimated EBITDA. It could be assumed that MYL will see multiple expansion to closer approximate the peer group following the merger. Assuming shares trade between the current multiple and the peer multiple, shares would be valued between $49.4 billion and $64.4 billion. Incorporating $25 billion in net debt (which includes $12 billion in debt issued by Upjohn in conjunction with the spin-off from Pfizer), and ~1.2 billion shares outstanding (including 667 million new shares issued based on a 0.12:1 share distribution ratio to PFE shareholders), shares of the new company could be valued between $21 per share and $35 per share. Our preliminary fair value estimate of $28 per share assumes the mid-point of guidance and equates to a 7.4x multiple. 

Post-spin PFE is expected to generate about $40 billion in revenue and operate with a mid-30s% EBIT margin. In 2018 PFE operated with an EBITDA margin of 46.9%. Assuming $40 billion in sales and a 50% EBITDA margin, which incorporates a 35% EBIT margin and ~$6 billion in D&A, post-spin PFE would earn $20 billion before interest, taxes, depreciation, and amortization. Shares of PFE currently trade at 11.0x the 2020 consensus EBITDA estimate. Peers to Pfizer include other large diversified pharmaceutical companies such as Merck & Co. Inc. (NYSE: MRK), Eli Lilly and Co. (NYSE: LLY), and Johnson & Johnson (NYSE: JNJ). This peer group trades on average at 12.3x the 2020 consensus EBITDA estimate, with a range of 11.4x – 13.9x. Applying the peer average to post-spin PFE’s estimated EBITDA of $20 billion, the company, ex-Upjohn, would be worth $246 billion on an enterprise value basis. Incorporating the $12 billion cash proceeds from the Upjohn debt issuance, and 5.6 billion shares outstanding, post-spin shares of PFE would be fairly valued at $40 per share.

On a pre-spin basis, incorporating the 57% ownership of the Mylan + Upjohn company, shares of PFE are fairly valued at $43 per share, roughly in line with current trading levels.

TFII’s increases 2019E EPS guidance to $3.90-$4.00 (from $3.80-$3.90) with free cash flow of ~$400 million, imply a greater than 10% FCF yield; conference call commentary suggests management still sees areas of undervaluation within the TFII portfolio

• For 1H 2019, TFII posted consolidated revenue growth (ex-fuel) of ~3% to $2.3 billion with adjusted EBITDA growth of ~35% to $425 million.  Adj. EPS increased 26% to $1.94.
• The company ended 2Q 2019 with net debt of $1.76 billion and a leverage ratio of ~2.2x (within the company’s targeted range of 2.0x-2.5x).
• For full-year 2019, TFII increased its adj. EPS guidance to $3.90-$4.00 per share (from $3.80-$3.90), while anecdotally indicating that the upwardly revised range remained “conservative”.
• Management also projects full-year free cash flow, including ~$50 million of one-time facility investments, will be ~$400 million (or ~$4.50 per share).
• On this morning’s conference call, TFII indicated its intent to remain aggressive on the share repurchase front at the current valuation (i.e. a greater than 10% FCF yield); to that end, the company authorized the repurchase of 7 million shares through October 2019.  As well, the company also hinted that a hike in the quarterly dividend to $0.27 (from $0.24) was likely during 2H 2019.
• Additionally, management commentary suggested an on-going contention that portions of the TFII portfolio (e.g. P&C and Logistics) remain undervalued. Most notably, the company pointed to the double-digit multiples garnered in recent deals, including Royal Mail’s (RMG LN) purchase of Golden State Overnight (in October 2016) and Dicom Canada (in September 2018).
• Our base case fair value estimate remains $49 per share, reflecting a blended multiple of ~7.5x on 2019E EBITDA of $766 million.