What to Expect From an Investment in Spectrum Brands

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Despite struggling for some time now, shares of Spectrum Brands (NYSE: SPB) have performed very well this year and are up 77.55% from a year ago. Management appears to be focused on returning value to shareholders while tackling the company's mounting debt load at the same time. This is positive news, but I’m starting to be a little skeptical and wondering whether or not the business would be better off paying down debt before returning anything to its investors.

Profits were up year-over-year this last quarter, but a larger interest expense brought earnings per share down 38.9% to $0.69 per share. This is the company’s third fiscal quarter, and interest expenses alone have eaten up 81% of operating income year-to-date. The total debt responsible for this charge now stands at $3.226 billion, up 76.5% from the same time last year.

On the same day as the earnings announcement, management announced that Term Debt has been reduced by $100 million so far this year, and that the company is targeting a reduction of $200 million total for fiscal year 2013. This works out to $100 million more debt reduced over the next three months. This is a small amount in terms of the total debt load, but it is definitely a step in the right direction. The only thing I wonder is where this money is going to come from.

Cash on hand currently stands at $99 million, and net trade receivables are at $479.3 million. Remember that interest charges in the most recent quarter alone were up to $61.5 million, however. The cash flow statement has yet to be turned in for the current quarter, but net cash from operating activities was a negative $197.8 million in the second quarter and the third quarter release only shows forecasted net cash from operating activities of $310-320 million. Needless to say, that’s a pretty big swing.

It's also a curious one, when coupled with an announcement to repurchase $200 million common shares and a recently-instated dividend payout. Both of these things are good, but both are also questionable since tackling the debt load should be a higher priority. Or at least it should, in my opinion.

A look at the company’s peers

Spectrum Brands has many large competitors, but two if its main market peers are Procter & Gamble (NYSE: PG) and Energizer Holdings (NYSE: ENR).

On a valuation basis, Procter & Gamble looks like a steal compared to Spectrum Brands. Its margins have faced pressures as well, however, with the most recently reported earnings showing gross margins down 60 basis points to 47.5% and operating margins down 250 basis points to 12.7%. In February of last year, the company responded to this trend by announcing a five-year $10 billion cost-saving initiative that includes a significant reduction in overhead and marketing costs. This quarter, Procter & Gamble’s earnings per share came in at $0.79, good for a 2.6% surprise.

Energizer had a bigger surprise when it reported adjusted net earnings per diluted share of $1.57 for the quarter, which was 18.9% better than analysts’ estimates. Energizer has also been working on cutting costs, which has been improving its margins. Top-line pressure continues to be a challenge, though, and will be even more of one as competitors have been cutting prices to gain market share.

This will be a definite issue for each of the companies highlighted in this article going forward. This is because the market continues to be saturated with items that have a large number or substitutes, while at the same time the companies' input costs continue to rise.

Bottom line

Spectrum’s management has the right idea, but the buyback doesn't make sense at the moment. Right now, there is absolutely no tangible equity in the company and its shares appear to be trading at a premium price. Such a situation typically signals that it’s a better time to sell rather than purchase shares. Time will tell, of course, but the company's debt issues look like a very long-term challenge that could potentially hold shares back.

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joshua kubiak has no position in any stocks mentioned. The Motley Fool recommends Energizer Holdings and Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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