DowDuPont and DOW Report Q1 Results; Maintain BUY on DWDP and DOW

• On May 2, 2019, DowDuPont Inc. (NYSE: DWDP) and Dow Holdings Inc. (NYSE: DOW) reported Q1 earnings results—the first following the DOW spin-off completed on April 1, 2019. DWDP is now comprised of DuPont Inc. (specialty products) and Corteva Inc. (agriculture business). The spin-off of Corteva from DowDuPont is expected by June 1, 2019.
• As background, DWDP negatively pre-announced Q1 results on March 28, 2019, owing to lower volumes, harsh weather conditions affecting its agriculture business, Q1 EPS of $0.84 was well ahead of pre-announced guidance and consensus of $0.70 (despite a 4% pricing decline), while revenues of $19.6 billion were slightly below consensus of $19.68 billion.
• 2019 guidance calls for DuPont sales to decline in the mid-single digits, per prior guidance; Corteva sales are expected to decline between 3-5% in the first half of 2019. Our estimates remain unchanged.
• DOW reported in-line Q1 results and guidance. For 2019, revenues are expected to decline in the low-teens percent; operating EBITDA is expected to decline in the mid-20s percent. While 2019 maintenance costs will increase by $200 million, earnings should benefit from improving oil prices. Management reaffirmed its target of $400 million in incremental cost savings.
• The fair value estimate for DOW remains $73. With DOW shares trading at over a 30% discount to our fair value estimate, we rate the shares as a BUY.
• The fair value estimate for post-spin DuPont and Corteva remain unchanged at $29 and $13, respectively.
• The fair value estimate for DWDP remains $42, implying an EV/2019E EBITDA multiple of 12x. With the DWDP fair value estimate representing 16% upside to the current share price we maintain our BUY recommendation, noting that DWDP should experience earnings leverage throughout the year despite fundamental weakness across multiple end markets.
• For more details, please refer to The Spin Off Report dated January 14, 2019 and UPDATE dated April 2, 2019.

On April 30, 2019, Ingersoll-Rand plc (NYSE: IR) announced that the company plans to spin off its industrial business, and merge it with industrial pumps and compressors manufacturer Gardner Denver Holdings, Inc. (NYSE: GDI). The merged company is to be named Ingersoll-Rand plc and will trade under Ingersoll-Rand’s existing ticker, IR. IR shareholders are expected to own 50.1% of the post-spin combined company. The transaction, which is tax-free to shareholders, is expected to be completed by the early 2020. 

Ingersoll-Rand, headquartered in Swords, Ireland, is a diversified industrial company with a current market capitalization of $29.0 billion. The company reports in two segments: (1) Climate (79% of revenue and 79% of EBITDA in 2018); and (2) Industrial (21% of sales and 21% of EBITDA in 2018).

Post-spin IR is an industrial company expected to generate 2019 pro forma revenues and adjusted EBITDA of $6.6 billion and $1.6 billion, respectively. Adjusted EBITDA includes expected annualized synergies of $250 million to be achieved by the end of year three following the close of the transaction. The company becomes the second largest manufacturer of pumps and compressors, with an estimated market capitalization of approximately $11.6 billion.

The post-spin parent company (which will have a new name and ticker) will be focused on climate control for the building, home, and transportation sectors, and includes heating, and air conditioning, and transport refrigeration solutions under the Trane and Thermo Brands. The company is expected to generate revenue and adjusted EBITDA of approximately $12.9 billion and $2.0 billion, respectively. The company will also receive $1.9 billion in cash (to be funded by newly-issued debt assumed by Gardner Denver in the merger), of which $600 million to $1 billion will be used for debt repayment and $900 million to $1.3 billion will be used for share repurchases and potential mergers and acquisitions.

From a strategic perspective, the transaction allows the post-spin climate company to focus on its larger, higher-margin business, while providing cash toward more targeted mergers and acquisitions. The potential combination of IR with GDI was reported yesterday by media sources.

ClimateCo (IR post-spin) is expected to generate 2019 sales and adjusted EBITDA of approximately $12.9 billion and $2.0 billion, respectively. Assuming revenue growth of 6%, roughly in-line with what the IR’s climate segment has averaged over the past five years, yet below the 10.5% increase in 2018, the company would generate revenue of $13.7 billion in 2020. Based on 2018 segment results, and including corporate costs, we estimate the standalone ClimateCo would have operated at an approximate margin of 15.3%. The company states that it will look to reduce approximately $100 million in stranded costs through 2021. Assuming a fully $100 million reduction, ClimateCo would have operated at an approximate 16% EBITDA margin.

Following the spin-off, ClimateCo can be compared with HVAC peers, including AAON Inc. (NASDAQ: AAON), Daikin Industries (6367 JP), Honeywell International (NYSE: HON), Johnson Controls (NYSE: JCI), Lennox International (NYSE: LII), and United Technologies (NYSE: UTX), which trade, on average, at a 2020E EV/EBITDA multiple of ~15x. Assuming a margin range of 15.3% – 16.0%, and applying the peer multiple implies and enterprise value range of $31.4 – $32.8 billion. Accounting for post-spin net debt of $1.3 billion (includes $1.9 billion cash payment from GDI), and 241.1 million shares outstanding, ClimateCo could be fairly valued between $125 and $131 per share. Our fair value estimate of $128 per share assumes $50 million in stranded costs are removed. Our ClimateCo fair value estimate implies approximately 5% upside to the current IR share price suggesting shares are fairly valued. It should be noted that shares of IR were up 6.5% yesterday as the Wall Street Journal began reporting of this possible transaction.

Following the merger, management states that IndustrialCo (GDI post-merger) is expected to generate approximately $6.6 billion in revenue and operate with an adjusted EBITDA margin of 21%, which does not include run rate synergies. The combined company is expected to generate $250 million in run-rate synergies, which would increase the adjusted EBITDA margin to 25%. Assuming revenue growth of 7%, roughly in line with GDI’s trailing twelve-month growth and IR’s industrial segment growth, IndustrialCo would generate sales of $7.1 billion in 2020. Assuming both no synergies and full synergy realization the company would earn between $1.5 billion and $1.8 billion in EBITDA in 2020.

Industrial-focused peers, such as Emerson Electric (NYSE: EMR), Eaton Corp. (NYSE: ETN), Flowserve (NYSE: FLS), Pentair (NYSE: PNR), Parker-Hannifin (NYSE: PH), Rockwell Automation (NYSE: ROK), Stanley Black & Decker (NYSE: SWK), and Illinois Tool Works (NYSE: ITW), as well as flow control focused peers such as SPX Flow Inc. (NYSE: FLOW) and Sun Hydraulics Corp. (NASDAQ: SNHY) trade at ~11.5x 2020E EV/EBITDA. Based on the peer multiple, pro forma net debt of $3.3 billion (includes $1.9 billion cash payment to ClimateCo), and 410.4 million shares outstanding (includes 210 million new shares issued to current IR shareholders), IndustrialCo could be valued between $34 and $42 per share. Our fair value estimate of $38 implies that half of the $100 million stranded costs are removed. Our fair value estimate for IndustrialCo implies 15.4% upside from the current GDI share price, suggesting meaningful value could be unlocked. Similar to IR’s recent share price performance, GDI shares were up 16% yesterday.

Reports Q1 softness, reduced Guidance; Fair Value Revised; Maintain HOLD

• On April 25, 2019, Brunswick Corp. (NYSE: BC) reported Q1 earnings results. Consolidated revenues of $1.3 billion were roughly in-line with consensus, driven primarily by softness in Marine OEM and aftermarket sales (delayed start of boating season, weather issues), lower revenue growth in Boat segment, and a 2% negative impact from foreign currency. Adjusted EPS of $0.99 was a penny ahead of consensus of $0.98, reflecting currency impacts as well we lower margins in the Fitness segment. Operating margin in the Boat segment declined 50 bps, owing to new product integrations and spending on profit improvement initiatives.
• As background, BC announced the intended spin-off its Fitness business in March 2018. Today, management noted its confidence that it is in a position to announce a sale of the business as expeditiously as possible, potentially in Q2.
• 2019 guidance calls for 8-10% revenue growth in the Marine Business–below our estimate of 10% and prior guide of 9-11%. Industry demand metrics remain mixed, with boat unit sales having experienced a 5% decline his quarter. Q2 Marine adjusted EPS guidance was adjusted downward $1.43-$1.50. Despite the quarter’s softness, management maintained its Marine operating earnings growth guidance of “high-teens percent” for the year. Fitness gross margins declined 50 bp, with operating earnings expected to be heavily back-end weighted.
• Overarching concerns are demand weakness, operating margin decline, and urgency of a Fitness separation.
• Our 2019 revenue estimates are revised downward slightly for lower growth in the Marine segment and reduced profitability across both segments. Our pre-spin sum-of-the-parts fair value estimate has been revised to $53 (versus $56), reflecting these revisions and updated balance sheet information. Shares are trading down approximately 8% intraday. With the fair value estimate implying 7% upside from current levels, we view the shares as fairly valued and maintain our HOLD recommendation.
• For more details, please refer to The Spin Off Report dated February 6, 2019.

• On April 25, 2019, before the market open, Wabtec Corp. (NYSE: WAB) reported Q1 earnings results. Revenues of $1.6 billion exceeded consensus of $1.5 billion, driven primarily by greater-than-expected contribution from the former GE Transportation, which experienced a strong quarter owing to timing of project deliveries. Adjusted EPS of $1.06 exceeded consensus of $0.84, by better-than-expected cost synergies. Q1 results included only 5 weeks 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
• WAB reaffirmed prior 2019 guidance of $8.4 billion in sales, $900 million in income from operations, adjusted EBITDA of $1.6 billion, and adjusted EPS of $4.00-$4.20. Product mix and revenue growth are expected to improve throughout the year, with a 14% EBITDA margin target expected for the year.
• Our 2019 estimates remain unchanged. The fair value estimate for WAB remains unchanged at $95.
• Shares are trading down approximately 5% intraday, owing largely to near-term concerns on locomotive deliveries, particularly in North America.  Q2 will be impacted by a greater portion of lower-margin OEM transit contracts; although margins are expected to improve sequentially throughout the year.  In Q4, WAB”s margins were negatively impacted by higher operating expenses resulting from integration of the GE Transportation business.
• Since the GE announcement, WAB shares have experienced considerable share weakness and insider selling, having declined from $114 in September. At 15x forward EBITDA, we view the shares as attractive, and near-term margin issues as short-lived. With the fair value estimate implying over 30% upside to the current share price, we maintain our BUY recommendation.
• For more details, please refer to The Spin Off Report dated January 14, 2019 and UPDATE dated February 26, 2019.

Withdraw recommendation of CSL with shares trading roughly in-line with our upwardly revised fair value estimate of $136 per share (previously $132) 

• CSL posted 1Q 2019 top-line growth of 9% to $1.07 billion with a 44.5% increase in EPS to $1.33 (compared with consensus of $1.04 billion and $1.10 per share, respectively).
• For full-year 2019, CSL maintained its guidance of consolidated sales growth in the high-single digit range, which is most notably driven by low-double digit growth at the core CCM (roofing) segment.
• Corporate expense is expected to be ~$80 million, with D&A expense of ~$200 million and cap ex of $110-$120 million.  Net interest is projected to be $55-$60 million and the tax rate is expected to be ~25% (see Exhibit #1).  Free cash flow conversion is anticipated to be more than 100% (of net income).
• Additionally, the company continues to execute against its previously articulated Vision 2025 plan, which calls for a doubling of revenues to $8 billion, consolidated margins of ~20%, ROIC of ~15% and EPS of $15 per share in 2025 (compared with $5.88 per share in 2018).
• In that pursuit, we expect CSL will continue to narrow its focus on the core CCM, CIT and CFT segments, which have comparably higher growth and margin profiles.  To that end, we see additional optionality in the CBF segment, which could be monetized to provide incremental growth capital to core businesses and/or be returned to shareholders.  (Recall, CSL, sold its CFS business for $750 million or ~12x 2018E EBITDA in 1Q 2018.)
• That said, with the shares trading roughly in-line with our revised fair value estimate of $136 per share (previously $132; see Exhibit #2) we prefer to maintain a disciplined approach and withdraw our recommendation, as of today’s close.
• Shares of CSL returned about 41% since our initial recommendation in late-July 2017 (compared with gains of ~18.5% and ~11% in the S&P 500 and Russell 2000 Indexes).

LB nominates two independent female directors and moves to implement additional governance improvements in an agreement with Barington Capital, which will serve as a special advisor

• LB nominated two independent female directors, Anne Sheehan and Sarah Nash, for election to its Board at the May 2019 Annual Meeting.
• Ms. Sheehan has a background in corporate governance with the SEC and CalSTRS while Ms. Nash was a long-time investment banker at JP Morgan who also has public company board experience (at, among others, Knoll and Blackbaud).
• If elected, LB’s Board would be comprised of 5 women and 7 men; as such, the percentage of female representation on the Board would increase to ~40% (from ~25%).
• As well, LB’s directors have unanimously recommended in favor of a vote, at the 2020 Annual Meeting, for the Board to be declassified (so that all directors will stand for election at the 2021 Annual Meeting) and for its supermajority voting requirements to be eliminated.
• Concurrently, the company entered into an agreement with Barington Capital, in which LB’s current director slate will be supported and the investor will begin to serve as a “special advisor” to the company toward the “shared goal of enhancing long-term stockholder value”.
• For context, on March 5^th, Barington issued a public letter to LB, which suggested a range of potential governance changes as well as operational and transactional initiatives, including a spin-off of VS or an IPO of B&BW.  Also, within the broader retail sector, we would note a recent trend toward the separation of divergent brands, including announced spin-offs at The Gap and VF Corp., as well as potential plans for an IPO of J. Crew’s Madewell brand.
• Our current base case fair value estimate of $36 per share reflects a blended multiple of less than 7x 2020E EBITDA (see Exhibit #1 on page 2).

Novartis Completes Alcon Spin-Off; Fair Values Revised

The spin-off of Alcon Inc. from Novartis AG (SIX: NOVN; NYSE: NVS) was completed on April 9, 2019. Shares of Alcon Inc. (SIX: ALC, NYSE: ALC) have performed considerably better than expectations in initial trading, and at approximately 30x consensus 2019 EPS estimates. Shares currently trade at a premium to eye care peers, which trade in the mid 20x range. Investors appear to be valuing the company based largely on its leading position in the $23 billion ophthalmology device market, and the potential for earnings improvement from current depressed levels.

The fair value estimate for Alcon has been revised to CHF 58 (from CHF 33 previously), reflecting a higher applied multiple of 22x 2020E EBITDA and 30x 2020E EPS (previously 14x and 18x, respectively); and a slight upward adjustment to operating margin. The fair value estimate for Novartis AG has been revised to CHF 96 from CHF 95 previously reflecting the recent rise in the USD to CHF exchange rate.

As background, the Alcon division currently comprises the firm’s ophthalmic surgical and vision care products—with the former group developing and manufacturing surgical products used by ophthalmologists and the latter manufacturing contact lenses and other eye-care products. The decision to commence a review of Alcon’s strategic options was likely triggered by the division’s lackluster performance under the Novartis umbrella.

With the fair value estimate approximating the current share price (CHF 58 as of this writing), we view Alcon shares as fairly valued, and reiterate our Hold rating. Alcon resembles a more classic pattern of spin-offs in that it may be able to improve revenue growth and profitability as an independent company—particularly if it can outgrow the market through new products and geographic expansion. That said, a key risk is increasingly competitive end markets, particularly in the growing addressable market for contact lenses, which could limit the pace of the company’s earnings expansion.

Post-spin Novartis offers more direct exposure to pharmaceutical growth assets while focusing the company’s US$5 billion share buyback program to drive stronger earnings growth. Novartis is expected to benefit from numerous key catalysts and events that, in our view, could offer upside to consensus estimates and valuation. These include approval and launch of key treatments as well as Phase III and Phase II data for over 10 products with greater than US$20 billion of peak sales potential. The company should experience double-digit earnings expansion (10% appears reasonable by 2020, in our view), driven by a transformation from a diversified healthcare company with weak cost control into a focused innovative biopharma story with a robust new product cycle.

With the fair value estimate for Novartis representing a 22% discount to the current share price (CHF 79 as of this writing), shares appear attractive– particularly given the new product cycle and potential for earnings expansion. Key risks for Novartis include an intensifying competitive environment—especially for Cosentyx, Novartis’s IL-17A inhibitor for the treatment of psoriasis, psoriatic arthritis, and ankylosing spondylitis. In addition, a key risk factor is the potential for a generic competitor to Novartis’ oral multiple sclerosis drug Gilenya, which would negatively affect 2019-2020 EPS.

EXP announces a strategic portfolio review as well as an increased share repurchase authorization and Board succession plans amid shareholder pressure

• Today, EXP disclosed it is working with Goldman Sachs to evaluate a range of potential strategic alternatives, including a separation of its businesses and the engagement of potential partners who may be interested in a transaction.
• As well, the company increased its share repurchase authorization by 10 million shares to 10.7 million shares (or ~25% of the outstanding share count) and announced that Mr. Mike Nicolais, currently the Vice-Chairman, would succeed Mr. Rick Stewart as EXP’s Chairman.
• Separately, the company indicated that sales in 4Q F2019 (March-ending) would likely be in the $283-$285 million range with adjusted earnings before taxes and EPS of $47-$50 million and $0.85-$0.89, respectively.  (Per Bloomberg, top- and bottom-line consensus estimates currently stand at $273 million and $0.77 per share, respectively.)
• For context, in late-March 2019, Sachem Head Capital Management disclosed an 8.9% stake in Eagle Materials with anecdotal indications that the investor would push for the divestment of EXP’s Oil & Gas Proppants (or frac sand) business and for the company to seek potential buyers for its Cement and Wallboard units.
• To that end, we would note that many of EXP’s end-markets have experienced consolidation in recent years and the company remains a relatively small player, by comparison, to competitors, including Buzzi Unicem, Cementos Argos, Cemex, CRH, Heidelberg, and LafargeHolcim as well as USG Corp., National Gypsum Co., Georgia-Pacific, Continental Building Products, Saint-Gobain, and PABCO Buildings Products.
• All told, it remains our view that EXP has a unique set of attractive assets and the shares remain undervalued relative to the sum value of its parts.  Our current fair estimate of $110 per share reflects a ~10x blended multiple on F2020E EBITDA.

CVET Now Rated at HOLD (previously SELL); Fair Value Revised to $25 (from $19) 

• Covetrus Inc. (NASDAQ: CVET) is now rated at HOLD (previously SELL) as the share price decline since initial trading limits further near-term downside.
• We increase our fair value estimate to $25 per share (previously $19) based on a revised valuation multiple of 13.5x (previously 11.0x).
• Shares of CVET, which was spun-off from Henry Schein Inc. (NASDAQ: HSIC) on February 7, 2019, have declined 31% from its closing high of $46.19 on February 6, 2019 (in when-issued trading) and 22% since the close of the first day of regular-way trading (February 8, 2019). (Shares of CVET had hit an intraday high of $50 per share in when-issued trading.)
• In CVET’s capital markets day presentation, the company stated that 2018 EBITDA should approximate $225 million, which includes around $25 million in standalone corporate expenses. Further, management highlighted the targeted $100 million of run-rate synergies by the end of year three. In 2019, revenue is expected to mirror market growth and EBITDA is expected to increase by “double digits off of underlying 2018E baseline of $225 million”. Longer-term high-single digit revenue and double-digit EBITDA growth is targeted.
• We acknowledge that Covetrus, which will have significant market share, bordering on a monopoly, has the ability to generate double digit earnings growth; however, recent trading multiples would suggest that the company is either a takeout target, receiving full credit for synergies, or valued similarly to drug manufacturers, as opposed to distributors, which we believe is more appropriate.
• We contend that CVET’s most applicable peers include PETS and PETQ (7.1x and 15.3x 2020 consensus EBITDA, respectively) and that MWI Veterinary Supply Inc.’s purchase price by AmerisourceBergen Corp. (NYSE: ABC) in 2015 (18.9x) is a relevant M&A comp.
• We think that our 2020E EBITDA estimate of $298 million, which incorporates high single-digit annual revenue growth, a 4.0% operating margin, and a 6.2% EBITDA margin, captures the company’s current growth prospects.
• Our margin assumptions equate to roughly $50 million in annual run-rate synergies being realized and results in 15% annual EBITDA growth. At a full $100 million run-rate of synergies, which the company expects to realize by the end of year three, the company would earn $346 million in EBITDA, which at 13.5x would equate to $31 per share, or roughly the current share price.
• For further information, please see The Spin Off Report on Henry Schein, dated January 15, 2019, and UPDATES dated February 7, 2019, and February 20, 2019.

DowDuPont Completes Spin-Off of Dow; Fair Values Revised, Maintain BUY on DWDP, Rate DOW at BUY

• On April 1, 2019, after the market close, DowDuPont Inc. (NYSE: DWDP) completed the spin-off of Dow Holdings Inc. Regular-way trading for Dow begins on April 2, 2019, on the NYSE under the ticker symbol “DOW”.
• DWDP is now comprised of DuPont Inc. (specialty products) and Corteva Inc. (agriculture business).
• The spin-off of Corteva from DowDuPont is expected by June 1, 2019.
• On March 28, 2019, DWDP announced a downward revision to Q1 guidance.
• DOW revenues are now expected to be down low-teens percent (versus previous guidance of down high-single digits percent) and operating EBITDA is expected to decline in the mid-20s percent (versus previous guidance of a decline in low-20s percent).
• The fair value estimate for DOW has been revised to $73 (from $80), reflecting Q1 guidance, and a balance sheet adjustment (debt includes pension liabilities), partially offset by recent multiple expansion among materials science comps (9.7x versus 8.0x).
• DOW shares closed trading in the when-issued market at $53.50 per share, implying 37% upside to our fair value estimate, thus we rate DOW shares as a BUY.
• The fair value estimate for DuPont has been revised to $29 (from $28) incorporating Q1 guidance, and revised EBITDA multiple of 12x (previously 11x).
• The fair value estimate for Corteva remains unchanged at $13.
• The fair value estimate for DWDP has been revised to $42 (from $67) reflecting the completion of the Dow spin-off, and DuPont fair value revision. DWDP shares closed at $36.81 in the when-issued market.
• With the revised DWDP fair value estimate representing 14% upside to the current share price we maintain our BUY recommendation.
• For more details, please refer to The Spin Off Report dated January 14, 2019 and UPDATE dated March 8, 2019.