When a new Chief Executive Officer (CEO) takes over, he or she usually wants to start off unencumbered by past management mistakes. The new boss’ first moves often set the stage, and just stabilizing the business can look like a significant achievement. It’s worth monitoring these CEO changes since, if the measures are taken effectively, the company’s shares usually react quite positively to any perceived accomplishment.
One of the first steps a new CEO usually takes is reducing expectations. Diminishing optimism for the near term is a way to lower the bar for future results, as well as buy time to implement new strategies. Reducing expectations also provides cover for a second step–taking significant charge-offs. These charges, readily blamed on prior leadership, typically clear the deck for better profits later. Finally, new CEOs often implement a cost reduction plan. The plan’s short-term expense is usually overlooked as a one-time thing amid the promises of better future results.
A recent case
Best Buy Co., Inc. (NYSE:BBY) is a recent example of this scenario. New CEO Hubert Joly, who started work in September 2012, gave initial guidance for free cash flow in the range of $850 million to $1.05 billion for the fiscal year 2013. This was a significant reduction from previous management’s range of $1.2 to $1.5 billion. In January 2013, Joly dropped expectations further to $500 million. When final fiscal year 2013 figures were reported in March 2013, adjusted free cash flow ended up being $965 million, beating the revised-revised guidance by $465 million.
The company also recorded fourth quarter 2013 pre-tax impairment charges of over $1 billion, primarily to reflect the write-offs of goodwill and store closures. Also included were some severance charges associated with the implementation of a comprehensive cost reduction plan. Since this earnings release, the market has greatly rewarded Best Buy as the company’s better than expected performance bolstered optimism about the company’s ability to stabilize itself.
Some interesting new CEO situations
Because this scenario is not unusual, it often pays to look into CEO changes. A couple of interesting ones are at Big Lots, Inc. (NYSE:BIG) and Safeway Inc. (NYSE:SWY).
Big Lots, Inc. (NYSE:BIG) is a large closeout retailer with around $5.4 billion in annual sales. Its new CEO, David Campisi, started on May 3 and could have already started to bring down expectations. On May 30, Big Lots cut its earnings outlook for the year to between $2.87 and $3.12 per share, from $3.05 to $3.25 per share, below analyst estimates.
The company’s guidance for the next quarter also seems pretty downbeat. They are expecting $0.17 to $0.27 per share, compared to $0.36 per share for the same period last year with net sales in the range of +1% to -1%, and comparable stores sales in the range of -2% to -4%. This is a seemingly sharp decline to their latest quarter’s reported adjusted income of $0.61 per share versus $0.68 per share in the prior year, and net sales are supposed to increase 1.3%, with comp sales for U.S. stores down 2.9%.
Big Lots, Inc. (NYSE:BIG) looks interestingly priced for any expectation beats. Based on estimated annual sales of $5.4 billion and cash earnings of $211 million, at the low end of guidance the company’s fair value would be around $37 to $44 a share at a fairly conservative market multiple of 10 to 12.
Safeway Inc. (NYSE:SWY) is a large supermarket operator with over $44 billion in sales. It named Robert Edwards as the new CEO in May. Like the rest of its industry, the company has been under intense competitive pressure. In the latest quarter ending March 23, the company reported decent earnings of $0.35 per share, compared with first quarter 2012 net of $0.30 per share. Identical-store sales increased 1.5% (excluding fuel), while total sales were $10.0 billion, essentially flat year-over-year. Safeway Inc. (NYSE:SWY)’s guidance for 2013 is $2.25 to $2.45 in earnings per share with free cash flow at $850 million to $950 million.