Things to ponder while waiting for first quarter earnings.....
ADP has completed the spin off of its brokerage services business. The new company, Broadridge, will trade under the symbol BR.
BEAS still hasn't issued financial statements for the quarters ending last July and October, never mind the fiscal year that ended this January. We naively believed that these reports would be filed in February, but June is the latest prediction. Perhaps we should add a new gauge for management (in)credibility.
BUD remains a part of Morningstar's Ultimate Stock-Pickers Portfolio. They evidently see something we don't.
COP's international holdings are becoming a concern, given the nationalistic (a nicer word than expropriation?) trends involving energy assets in places like Russia, where it owns a chunk of Lukoil, and Venezuela.
CSCO, a serial acquirer, recently entered into a deal to purchase WebEx for $3.2 billion in cash. This appears to be another step in their climb up the networking value chain for business customers. It echoes their earlier purchases of LinkSys and Scientific Atlanta to get a sturdier foothold in home networking.
EIX has recently been upgraded and downgraded.
HD is getting plaudits for putting the Nardelli debacle behind it. We're more concerned about whether the company can compensate for the cutback in new store openings by increasing the profitability of its current outlets.
INTC's new product line based on 45 nanometer technology is being viewed favorably relative to offerings from AMD.
KG's shares briefly set a new 52-week high of $19.86, which is still way below the historic high price. Recent upgrades have helped.
MSFT shares have retraced some the gains that anticipated Vista's launch. An order to pay $1.5 billion to Alcatel-Lucent for infringing on digital music technology probably didn't help.
NOK is battling with Qualcomm over patents. After losing market share to Motorola, new NOK products have been well received.
31 March 2007
29 March 2007
HD: Financial Analysis through Jan 2007
Home Depot (HD) is the largest retailer of hardware and other merchandise, including large amounts of lumber, for home construction and improvements. It sells to do-it-yourself homeowners and professional contractors.
Former CEO Robert Nardelli was forced out because of an uproar over his hefty compensation, the company's weak performance relative to principal competitor Lowe's, and Home Depot's long-stagnant stock price. The furor intensified after his dismissal when the world learned of his gargantuan golden parachute. To be fair, Mr. Nardelli also took actions -- share buybacks and dividend hikes -- generally considered to be investor-friendly. Nevertheless, conditions at Home Depot, and worries about how the company will handle the slowing of the housing market, morphed a premier growth company into a potential acquisition by a value-seeking hedge fund. More likely is the divestiture of the low-margin Home Depot Supply division, which serves contractors, and which was championed by Mr. Nardelli.
When we analyzed Home Depot after the quarter that ended in October 2006, the Overall score was a modest 34 points. Of the four individual gauges that fed into this overall result, Value was the strongest at 12 points. Cash Management and Growth were tied for weakest at 5 points.
In February, we updated the analysis to incorporate Home Depot's financial results for the quarter ending 28 January 2007, as reported in a press release. We have now refined the analysis to reflect the additional information (a cash flow statement, most notably) included in the company's recently filed Form 10-K for the full fiscal year. Our gauges now display the following scores:
Cash Management. This gauge has flat-lined at 5 points for the last 10 quarters. The Current Ratio moved up from 1.2 to 1.4. We would prefer to see it a little higher. Long-Term Debt/Equity surged to 47 percent, up from 24 percent the previous quarter. The debt ratio was only 10 percent one year ago. (The company claims the debt rise "Increased the efficiency of its capital structure by increasing its financial leverage." We suspect had something to do with $4.5 billion spent on acquisitions, including $3.5 billion for Hughes Supply and the undisclosed amount for twelve Home Way stores in China.) Inventory/Cost of Goods Sold is now 76 days. The inventory level was 83 days at the end of the pre-holiday prior quarter, when inventory levels are always high. The inventory level was 76.1 days at the end of January 2006, and the current inventory level is very much consistent with typical January level for this company. The consistency suggests sales met internal expectations. Accounts Receivable/Revenues are 13 days. This is a little better than recent levels, but actually a bit higher than typical values at the end of January. A sustained increase would indicate the company is having more trouble getting paid by its customers.
Growth. This gauge dropped two points from October. Revenue growth is now 11 percent year over year, down from 12 percent a year ago and 13 percent the year before that. (The fourth quarter was especially weak for Revenue, up only 4 percent from the previous fourth quarter.) Net Income growth didn't happen: Net Income declined by 1 percent, after having increased by 17 percent a year ago. Increased interest expenses and a 1 percent rise in the income tax rate hurt Net Income most. On the other hand, CFO growth was up a nice 16 percent, whereas CFO was flat from the year ending January 2005 to the year ending January 2006. Revenue/Assets is 174 percent; it is lower than after other January quarters. It indicates that the company is becoming less efficient at generating sales.
Profitability. This gauge increased 2 points from October. (The increase is counter-intuitive given the decline in Net Income, but it reflects the increase in CFO.) ROIC slipped to a still-healthy 17 percent. It was 19 percent a year ago. FCF/Equity jumped up to 16 percent from 10 percent. Operating Expenses/Revenue steadied at 89 percent. However, this masks a 1.2 percent decline in Gross Margin. The Accrual Ratio, which we like to be both negative and declining, fell from 7 to 3 percent. This tells us that more of the company's Net Income is due to CFO, in contrast to changes in balance sheet accruals.
Value. This gauge, based on the stock price of $40.74 on 31 January, dropped to a weak 6 points, compared to 12 and 9 points 3 and 12 months ago, respectively. The P/E at the end of the quarter was 14.2, about where it has been for the last year or so. The average P/E for the industry is 16. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is at a 13.5 discount to the average P/E, using core operating earnings) for stocks in the S&P 500. A 9 percent discount to the market has been more common in recent years. (When HD was a growth company, its P/E had a 100 percent premium to the market.) Since Net Income declined, the PEG ratio is not applicable. The Price/Revenue ratio has declined to 90 percent from 106 percent. The decrease suggests the shares have become less expensive. The average Price/Sales for the industry is 103 percent, which would tend to confirm this view.
Now at a disappointing 25 out of 100 possible points, the Overall gauge is towards the lower end of its range over the last 10 quarters. The score hit 62 points after the July 2004 quarter, when the stock price was below $34. The stock price rebounded above $40 in a mere three months, but never got any higher.
Former CEO Robert Nardelli was forced out because of an uproar over his hefty compensation, the company's weak performance relative to principal competitor Lowe's, and Home Depot's long-stagnant stock price. The furor intensified after his dismissal when the world learned of his gargantuan golden parachute. To be fair, Mr. Nardelli also took actions -- share buybacks and dividend hikes -- generally considered to be investor-friendly. Nevertheless, conditions at Home Depot, and worries about how the company will handle the slowing of the housing market, morphed a premier growth company into a potential acquisition by a value-seeking hedge fund. More likely is the divestiture of the low-margin Home Depot Supply division, which serves contractors, and which was championed by Mr. Nardelli.
When we analyzed Home Depot after the quarter that ended in October 2006, the Overall score was a modest 34 points. Of the four individual gauges that fed into this overall result, Value was the strongest at 12 points. Cash Management and Growth were tied for weakest at 5 points.
In February, we updated the analysis to incorporate Home Depot's financial results for the quarter ending 28 January 2007, as reported in a press release. We have now refined the analysis to reflect the additional information (a cash flow statement, most notably) included in the company's recently filed Form 10-K for the full fiscal year. Our gauges now display the following scores:
- Cash Management: 5 of 25
- Growth: 4 of 25
- Profitability: 9 of 25
- Value: 6 of 25
- Overall: 25 of 100
Cash Management. This gauge has flat-lined at 5 points for the last 10 quarters. The Current Ratio moved up from 1.2 to 1.4. We would prefer to see it a little higher. Long-Term Debt/Equity surged to 47 percent, up from 24 percent the previous quarter. The debt ratio was only 10 percent one year ago. (The company claims the debt rise "Increased the efficiency of its capital structure by increasing its financial leverage." We suspect had something to do with $4.5 billion spent on acquisitions, including $3.5 billion for Hughes Supply and the undisclosed amount for twelve Home Way stores in China.) Inventory/Cost of Goods Sold is now 76 days. The inventory level was 83 days at the end of the pre-holiday prior quarter, when inventory levels are always high. The inventory level was 76.1 days at the end of January 2006, and the current inventory level is very much consistent with typical January level for this company. The consistency suggests sales met internal expectations. Accounts Receivable/Revenues are 13 days. This is a little better than recent levels, but actually a bit higher than typical values at the end of January. A sustained increase would indicate the company is having more trouble getting paid by its customers.
Growth. This gauge dropped two points from October. Revenue growth is now 11 percent year over year, down from 12 percent a year ago and 13 percent the year before that. (The fourth quarter was especially weak for Revenue, up only 4 percent from the previous fourth quarter.) Net Income growth didn't happen: Net Income declined by 1 percent, after having increased by 17 percent a year ago. Increased interest expenses and a 1 percent rise in the income tax rate hurt Net Income most. On the other hand, CFO growth was up a nice 16 percent, whereas CFO was flat from the year ending January 2005 to the year ending January 2006. Revenue/Assets is 174 percent; it is lower than after other January quarters. It indicates that the company is becoming less efficient at generating sales.
Profitability. This gauge increased 2 points from October. (The increase is counter-intuitive given the decline in Net Income, but it reflects the increase in CFO.) ROIC slipped to a still-healthy 17 percent. It was 19 percent a year ago. FCF/Equity jumped up to 16 percent from 10 percent. Operating Expenses/Revenue steadied at 89 percent. However, this masks a 1.2 percent decline in Gross Margin. The Accrual Ratio, which we like to be both negative and declining, fell from 7 to 3 percent. This tells us that more of the company's Net Income is due to CFO, in contrast to changes in balance sheet accruals.
Value. This gauge, based on the stock price of $40.74 on 31 January, dropped to a weak 6 points, compared to 12 and 9 points 3 and 12 months ago, respectively. The P/E at the end of the quarter was 14.2, about where it has been for the last year or so. The average P/E for the industry is 16. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is at a 13.5 discount to the average P/E, using core operating earnings) for stocks in the S&P 500. A 9 percent discount to the market has been more common in recent years. (When HD was a growth company, its P/E had a 100 percent premium to the market.) Since Net Income declined, the PEG ratio is not applicable. The Price/Revenue ratio has declined to 90 percent from 106 percent. The decrease suggests the shares have become less expensive. The average Price/Sales for the industry is 103 percent, which would tend to confirm this view.
Now at a disappointing 25 out of 100 possible points, the Overall gauge is towards the lower end of its range over the last 10 quarters. The score hit 62 points after the July 2004 quarter, when the stock price was below $34. The stock price rebounded above $40 in a mere three months, but never got any higher.
18 March 2007
NT: Financial Analysis through December 2006
Nortel Networks (NT) is a Canadian-based supplier of products and services to telecom carriers, networking operators, and businesses.
Although it has been in business for over 110 years -- the first century as Northern Electric -- Nortel is one of the most spectacular casualties of the dot-com bust. Its stock price plunged from over $80 to $2, before a 1:10 reverse split late last year made the current price seem more respectable. Nortel has somehow managed to stay in business and even independent, unlike fellow fallen telecom Lucent. For most of this decade, huge losses have been the norm at Nortel, resulting in an unfathomable accumulated earnings deficit of $35 billion (U.S.). Tougher times also revealed shortfalls in the company's financial controls, and allegations of fraud, resulting in numerous restatements.
Nortel's recent 10-K provides current data and restated results for each quarter of 2006 and 2005. The auditors have expressed an opinion that the data fairly represent, in all material respects, the financial position of the company for these two years. Data for 2004 has also been restated; however, full quarter-by-quarter results were not included in 10-K. For our analysis of Nortel, we have warily used the financial statements included in some earlier (but not too much earlier) filings. Given the murkiness of historical data, we're not including numeric scores in the analysis summary below. Instead, we merely summarize the financial results that drive our gauges.
Cash Management. Given the extent of its losses, a Current Ratio just below 1.5 doesn't seem too bad. The recent upward trend in this parameter signifies improved credit-worthiness; however, it's only getting back a level attained a couple of years ago. Long-Term Debt/Equity is an extremely leveraged 397 percent, up from 345 percent in September and 320 percent one year ago. Inventory/Cost of Goods Sold dropped nicely to 104 days, from 114 days at the end of the prior quarter and 122 days at the end of December 2005. The percentage of Inventory that is product ready for sale (i.e., Finished Goods) is 37 percent, which is 2 percentage points fewer than a year ago. We don't trust the historical inventory breakout data, so we can't put this in historical perspective. However, the lower inventory figures seem to be suggesting that sales met, or even exceeded, expectations. Accounts Receivable/Revenue equals 89 days, which is a little less (a good thing) than recent levels. It might indicate the company is finding it easier to get its customers to pay their bills.
Growth. Revenue growth was 9 percent year over year, up from 7 percent a year ago. Net Income appears to have increased, but it declined if we ignore the last year's huge litigation charge. CFO, encouragingly, switched from a loss to gain, mostly because the final quarter generated a lot cash. Revenue/Assets seems to have stabilized at around 60 percent. It will be interesting to see how this indication of efficiency at generating sales changes in the next year or two.
Profitability. Since operating profit was slightly negative (i.e., a loss), ROIC was a little bit less than zero percent. FCF/Equity jumped up, if you can call it that, to minus 7 percent, from minus 57 percent a year ago. Operating Expenses/Revenue continue to hover around 100 percent, which tells us that core operating profitability is still lacking. There are some traces of pressure on Gross Margin, which are being compensated for by cutbacks in R&D expenses and, to a lesser extent, SG&A expenses. The Accrual Ratio, which we like to be both negative and declining, did both by moving from +2 percent to -1 percent. This tells us that more of the company's Net Income (Loss) is due to CFO, and, therefore, less is due to changes in non-operational balance sheet accruals.
Value. The stock price at the end of the year was $26.73. With negative earnings, the P/E and the PEG are not applicable. Therefore, our only measure of value is the Price/Revenue ratio. It was 1.02 at the end of the year, down form 1.26 in December 2005. It's ironic to say this about a company that has lost so much money, but the decrease suggests the shares have become less expensive. The average Price/Sales for the Communications Equipment industry is over 5.0.
In summary, an optimist can find some favorable aspects to Nortel's recent performance. Cash levels are reasonable, and Inventory control seems to be getting better. Revenue is increasing, indicating that the company's products are still succeeding in a very competitive marketplace. (Of 225 Communications Equipment firms, Nortel had the sixth-most sales in the last year.) A strong fourth quarter pushed CFO for the whole of last year into the black. And, the company is cheap compared to its competitors on a Price/Revenue basis. However, a pessimist won't have any trouble finding red flags. Long-Term Debt is too high: $2.7 billion of debt was rolled over into $3.3 billion of new debt in 2006. In an era of generally low long-term interest rates, the company has to pay 10.75 percent for senior fixed rate notes due in 2016. Even if the all non-recurring charges are ignored, Nortel's core operations generate small profits, at best, and often losses. The most recent quarter was good, but there have been other good quarters since the bubble burst. In addition, the company has said before that the restatements were complete, only to find additional errors that erased any remaining vestiges of credibility it had with the investment community. To top it off, new allegations of fraud could keep the black cloud above the company firmly in place.
Although it has been in business for over 110 years -- the first century as Northern Electric -- Nortel is one of the most spectacular casualties of the dot-com bust. Its stock price plunged from over $80 to $2, before a 1:10 reverse split late last year made the current price seem more respectable. Nortel has somehow managed to stay in business and even independent, unlike fellow fallen telecom Lucent. For most of this decade, huge losses have been the norm at Nortel, resulting in an unfathomable accumulated earnings deficit of $35 billion (U.S.). Tougher times also revealed shortfalls in the company's financial controls, and allegations of fraud, resulting in numerous restatements.
Nortel's recent 10-K provides current data and restated results for each quarter of 2006 and 2005. The auditors have expressed an opinion that the data fairly represent, in all material respects, the financial position of the company for these two years. Data for 2004 has also been restated; however, full quarter-by-quarter results were not included in 10-K. For our analysis of Nortel, we have warily used the financial statements included in some earlier (but not too much earlier) filings. Given the murkiness of historical data, we're not including numeric scores in the analysis summary below. Instead, we merely summarize the financial results that drive our gauges.
Cash Management. Given the extent of its losses, a Current Ratio just below 1.5 doesn't seem too bad. The recent upward trend in this parameter signifies improved credit-worthiness; however, it's only getting back a level attained a couple of years ago. Long-Term Debt/Equity is an extremely leveraged 397 percent, up from 345 percent in September and 320 percent one year ago. Inventory/Cost of Goods Sold dropped nicely to 104 days, from 114 days at the end of the prior quarter and 122 days at the end of December 2005. The percentage of Inventory that is product ready for sale (i.e., Finished Goods) is 37 percent, which is 2 percentage points fewer than a year ago. We don't trust the historical inventory breakout data, so we can't put this in historical perspective. However, the lower inventory figures seem to be suggesting that sales met, or even exceeded, expectations. Accounts Receivable/Revenue equals 89 days, which is a little less (a good thing) than recent levels. It might indicate the company is finding it easier to get its customers to pay their bills.
Growth. Revenue growth was 9 percent year over year, up from 7 percent a year ago. Net Income appears to have increased, but it declined if we ignore the last year's huge litigation charge. CFO, encouragingly, switched from a loss to gain, mostly because the final quarter generated a lot cash. Revenue/Assets seems to have stabilized at around 60 percent. It will be interesting to see how this indication of efficiency at generating sales changes in the next year or two.
Profitability. Since operating profit was slightly negative (i.e., a loss), ROIC was a little bit less than zero percent. FCF/Equity jumped up, if you can call it that, to minus 7 percent, from minus 57 percent a year ago. Operating Expenses/Revenue continue to hover around 100 percent, which tells us that core operating profitability is still lacking. There are some traces of pressure on Gross Margin, which are being compensated for by cutbacks in R&D expenses and, to a lesser extent, SG&A expenses. The Accrual Ratio, which we like to be both negative and declining, did both by moving from +2 percent to -1 percent. This tells us that more of the company's Net Income (Loss) is due to CFO, and, therefore, less is due to changes in non-operational balance sheet accruals.
Value. The stock price at the end of the year was $26.73. With negative earnings, the P/E and the PEG are not applicable. Therefore, our only measure of value is the Price/Revenue ratio. It was 1.02 at the end of the year, down form 1.26 in December 2005. It's ironic to say this about a company that has lost so much money, but the decrease suggests the shares have become less expensive. The average Price/Sales for the Communications Equipment industry is over 5.0.
In summary, an optimist can find some favorable aspects to Nortel's recent performance. Cash levels are reasonable, and Inventory control seems to be getting better. Revenue is increasing, indicating that the company's products are still succeeding in a very competitive marketplace. (Of 225 Communications Equipment firms, Nortel had the sixth-most sales in the last year.) A strong fourth quarter pushed CFO for the whole of last year into the black. And, the company is cheap compared to its competitors on a Price/Revenue basis. However, a pessimist won't have any trouble finding red flags. Long-Term Debt is too high: $2.7 billion of debt was rolled over into $3.3 billion of new debt in 2006. In an era of generally low long-term interest rates, the company has to pay 10.75 percent for senior fixed rate notes due in 2016. Even if the all non-recurring charges are ignored, Nortel's core operations generate small profits, at best, and often losses. The most recent quarter was good, but there have been other good quarters since the bubble burst. In addition, the company has said before that the restatements were complete, only to find additional errors that erased any remaining vestiges of credibility it had with the investment community. To top it off, new allegations of fraud could keep the black cloud above the company firmly in place.
17 March 2007
BUD: Financial Analysis through December 2006
For St Patrick's day, we'll discuss Anheuser-Busch (BUD), the well-known brewer and worldwide beer distributor. BUD also has an entertainment division that operates theme parks around the U.S.
It was big news in 2005 when Warren Buffett's Berkshire Hathaway (BRK-A) bought a large stake in BUD. We ran the numbers soon thereafter to determine if we could identify what led the Sage of Omaha to make this purchase. We couldn't: the numbers were lousy. Mr. Buffett later cut his stake, although his company still owns almost 5 percent of BUD. During this period, BUD has embarked on an ambitious expansion in China.
When we analyzed BUD after the quarter that ended in September 2006, the Overall score was a weak 21 points. [We bumped this up to 22 points when we factored in inventory data from the annual report; the effect of the inventory data was to increase the Cash Management score to 6 points.]
We have since updated the analysis to incorporate BUD's financial results, as reported in a Form 10-K, for the full year and last quarter of 2006. Our gauges now display the following scores:
Cash Management. This gauge dropped 4 points from 6 to 2. The Current Ratio is now 0.81, whereas it has more typically been between 0.9 and 1.0. We would prefer to see it higher. Long-Term Debt/Equity is a highly leveraged 194 percent, up from 170 percent the previous quarter. However, it is down from 217 percent a year ago and a five-year median value of 246 percent. Inventory/Cost of Goods Sold was steady at 25 days. The percentage of Inventory that is product ready for sale (i.e., Finished Goods) is 29 percent, which is up from 27 percent last year, but lower than the average level for the company. The inventory levels suggest sales met expectations. Accounts Receivable/Revenues equal 17 days. This is a couple days lower than the historic value, and it might indicate the company is finding it less difficult to get its customers to pay their bills.
Growth. This gauge increased a strong 8 points from September. Revenue growth was only 5 percent year over year, but up from a sickly 1 percent a year ago. Net Income growth was a modest 8 percent, but certainly better than the 19 percent decline in 2005's Net Income from the 2004 value. CFO, however, didn't grow in 2006, but this might seem like an improvement when compared to the 8 percent drop in CFO in 2005. Revenue/Assets is 96 percent, which is a fairly significant increase compared to last year's 91 percent. It indicates that the company is becoming more efficient at generating sales. A $750 million stock buyback, reducing assets, might also be a non-operational explanation for the increase.
Profitability. This gauge increased 1 point from the prior quarter. ROIC has been steady at a healthy 16 percent. FCF/Equity edged up to 48 percent from 46 percent last quarter and 43 percent a year ago. Operating Expenses/Revenue moved up in the last year from 82 percent to 83 percent. The change was primarily due to a 1 percent decline in Gross Margin. The Accrual Ratio, which we like to be both negative and declining, moved in the right direction, from 2 from 0 percent. This tells us that more of the company's Net Income is due to CFO, and, therefore, less is due to changes in balance sheet accruals.
Value. This gauge, based on the stock price of $49.20 at the year's end, dropped to a weak 1 point, compared to 3 and 5 points three and twelve months ago, respectively. The P/E at the end of the year was 19.4, up from 18.4 one year ago. The increase suggests the shares have become more expensive. BUD's P/E pretty much matches the average P/E for the alcoholic beverages industry. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is at a 19 percent premium to the average P/E, using core operating earnings, for stocks in the S&P 500. Historically, the company's P/E has had premium to the market, as expressed by this measure, at or below 10 percent. Companies tend to trade at a premium when their growth rates are greater than average, particularly when the growth rates seem more likely to be sustained. The PEG ratio of 2.5 is indicative of an expensive stock. The Price/Revenue ratio, which isn't affected by the one-time factors that cause wide swings in earnings, has increased to 240 percent from 220 percent. The increase suggests the shares have become more expensive. The average Price/Sales for the industry is 222 percent.
Now at a disappointing 23 out of 100 possible points, the Overall gauge has been stuck in the 20's for the last several years. The stock price took a dip down to $40, before recovering to $50, where it had been for years. We were surprised by the recovery.
It was big news in 2005 when Warren Buffett's Berkshire Hathaway (BRK-A) bought a large stake in BUD. We ran the numbers soon thereafter to determine if we could identify what led the Sage of Omaha to make this purchase. We couldn't: the numbers were lousy. Mr. Buffett later cut his stake, although his company still owns almost 5 percent of BUD. During this period, BUD has embarked on an ambitious expansion in China.
When we analyzed BUD after the quarter that ended in September 2006, the Overall score was a weak 21 points. [We bumped this up to 22 points when we factored in inventory data from the annual report; the effect of the inventory data was to increase the Cash Management score to 6 points.]
We have since updated the analysis to incorporate BUD's financial results, as reported in a Form 10-K, for the full year and last quarter of 2006. Our gauges now display the following scores:
- Cash Management: 2 of 25
- Growth: 15 of 25
- Profitability: 10 of 25
- Value: 1 of 25
- Overall: 23 of 100
Cash Management. This gauge dropped 4 points from 6 to 2. The Current Ratio is now 0.81, whereas it has more typically been between 0.9 and 1.0. We would prefer to see it higher. Long-Term Debt/Equity is a highly leveraged 194 percent, up from 170 percent the previous quarter. However, it is down from 217 percent a year ago and a five-year median value of 246 percent. Inventory/Cost of Goods Sold was steady at 25 days. The percentage of Inventory that is product ready for sale (i.e., Finished Goods) is 29 percent, which is up from 27 percent last year, but lower than the average level for the company. The inventory levels suggest sales met expectations. Accounts Receivable/Revenues equal 17 days. This is a couple days lower than the historic value, and it might indicate the company is finding it less difficult to get its customers to pay their bills.
Growth. This gauge increased a strong 8 points from September. Revenue growth was only 5 percent year over year, but up from a sickly 1 percent a year ago. Net Income growth was a modest 8 percent, but certainly better than the 19 percent decline in 2005's Net Income from the 2004 value. CFO, however, didn't grow in 2006, but this might seem like an improvement when compared to the 8 percent drop in CFO in 2005. Revenue/Assets is 96 percent, which is a fairly significant increase compared to last year's 91 percent. It indicates that the company is becoming more efficient at generating sales. A $750 million stock buyback, reducing assets, might also be a non-operational explanation for the increase.
Profitability. This gauge increased 1 point from the prior quarter. ROIC has been steady at a healthy 16 percent. FCF/Equity edged up to 48 percent from 46 percent last quarter and 43 percent a year ago. Operating Expenses/Revenue moved up in the last year from 82 percent to 83 percent. The change was primarily due to a 1 percent decline in Gross Margin. The Accrual Ratio, which we like to be both negative and declining, moved in the right direction, from 2 from 0 percent. This tells us that more of the company's Net Income is due to CFO, and, therefore, less is due to changes in balance sheet accruals.
Value. This gauge, based on the stock price of $49.20 at the year's end, dropped to a weak 1 point, compared to 3 and 5 points three and twelve months ago, respectively. The P/E at the end of the year was 19.4, up from 18.4 one year ago. The increase suggests the shares have become more expensive. BUD's P/E pretty much matches the average P/E for the alcoholic beverages industry. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is at a 19 percent premium to the average P/E, using core operating earnings, for stocks in the S&P 500. Historically, the company's P/E has had premium to the market, as expressed by this measure, at or below 10 percent. Companies tend to trade at a premium when their growth rates are greater than average, particularly when the growth rates seem more likely to be sustained. The PEG ratio of 2.5 is indicative of an expensive stock. The Price/Revenue ratio, which isn't affected by the one-time factors that cause wide swings in earnings, has increased to 240 percent from 220 percent. The increase suggests the shares have become more expensive. The average Price/Sales for the industry is 222 percent.
Now at a disappointing 23 out of 100 possible points, the Overall gauge has been stuck in the 20's for the last several years. The stock price took a dip down to $40, before recovering to $50, where it had been for years. We were surprised by the recovery.
15 March 2007
EIX: Financial Analysis through December 2006
Edison International (EIX) is the parent of Southern California Edison and other subsidiary companies that generate or distribute electricity or that provide financing for these activities.
Edison, which traces its roots back to 1886, is now one of the largest investor-owned electric utilities in the U.S. In the late 1990s, the State of California deregulated the industry, which, due to loopholes and questionable practices, led to the famous power crisis in the early years of this decade. Edison managed to skirt bankruptcy during the debacle, and its stock price has recovered from a low point in 2002 under $8.00 to close to $50 today.
When we analyzed Edison after the quarter that ended in September 2006, the Overall score was a relatively poor 15 points. Of the four individual gauges that fed into this Overall result, Growth was the strongest at 11 points. Value was weakest at zero points.
We have since updated the analysis to incorporate Edison's financial results, as reported in a Form 10-K for the full year and last quarter of 2006. Our gauges now display the following scores:
Cash Management. This gauge increased an improbable 13 points from 3 to 16. The Current Ratio is now 1.27. It has been stable at about this level for the last couple of years. We would prefer to see it a little higher. Long-Term Debt/Equity is a leveraged 106 percent, but it has dropped considerably since the worst days of the power crisis. The debt ratio was 120 percent one year ago. Accounts Receivable/Revenues equals 29.3 days. This is substantially less than the historic value for the company, and it might indicate the company is finding it less difficult to get its customers to pay their bills.
Growth. This gauge dropped 5 points from September. Revenue growth is now 6 percent year over year, down from 16 percent a year ago. Net Income declined 2 percent from a year ago. Net income would have rose had not the income tax rate increased from 29 to 35 percent. CFO growth is an eye-popping 62 percent, yet down from a fabulous 98 percent a year ago. Revenue/Assets is 35 percent; it has been holding steady.
Profitability. This gauge dropped 1 point from the prior quarter. ROIC slipped to a moderate 10 percent from 13 percent a year ago. FCF/Equity jumped up to 12 percent from 5 percent. Operating Expenses/Revenue moved up in the last year from 77 percent to 80 percent. The change was primarily due to a decline in Gross Margin of 3 percent. The Accrual Ratio, which we like to be both negative and declining, edged down to zero from +2 percent. This tells us that more of the company's Net Income is due to CFO, and, therefore, less is due to changes in balance sheet accruals.
Value. This gauge, based on the stock price of $45.48 at the year's end was zero points, compared to 0 and 3 points three and twelve months ago, respectively. The P/E at the end of the quarter was 13.7, up a little from recent quarters. The increase suggests the shares have become a bit more expensive. Reuters reports that the average P/E for the industry is 18.5, but Yahoo indicates a more credible value of 14.3. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is at a 16 percent discount to the average P/E, using core operating earnings for stocks in the S&P 500. One year ago, the company's P/E had a 20 percent discount to the market, as expressed by this measure. It's typical for slow-growth utility companies to trade at a discount. The PEG ratio is N/A because of the Net Income decline. Price/Revenue, which isn't affected by the one-time factors that cause wide swings in earnings, increased to 117 percent. However, it's down from 122 percent one year ago.
Now at a disappointing 20 out of 100 possible points, the Overall gauge has been below 30 points since the California power crisis passed. Yet, the stock price has moved up steadily, which sinks the Value score.
Edison, which traces its roots back to 1886, is now one of the largest investor-owned electric utilities in the U.S. In the late 1990s, the State of California deregulated the industry, which, due to loopholes and questionable practices, led to the famous power crisis in the early years of this decade. Edison managed to skirt bankruptcy during the debacle, and its stock price has recovered from a low point in 2002 under $8.00 to close to $50 today.
When we analyzed Edison after the quarter that ended in September 2006, the Overall score was a relatively poor 15 points. Of the four individual gauges that fed into this Overall result, Growth was the strongest at 11 points. Value was weakest at zero points.
We have since updated the analysis to incorporate Edison's financial results, as reported in a Form 10-K for the full year and last quarter of 2006. Our gauges now display the following scores:
- Cash Management: 16 of 25 (big jump)
- Growth: 6 of 25 (almost as big drop)
- Profitability: 6 of 25
- Value: 0 of 25 (no improvement)
- Overall: 20 of 100
Cash Management. This gauge increased an improbable 13 points from 3 to 16. The Current Ratio is now 1.27. It has been stable at about this level for the last couple of years. We would prefer to see it a little higher. Long-Term Debt/Equity is a leveraged 106 percent, but it has dropped considerably since the worst days of the power crisis. The debt ratio was 120 percent one year ago. Accounts Receivable/Revenues equals 29.3 days. This is substantially less than the historic value for the company, and it might indicate the company is finding it less difficult to get its customers to pay their bills.
Growth. This gauge dropped 5 points from September. Revenue growth is now 6 percent year over year, down from 16 percent a year ago. Net Income declined 2 percent from a year ago. Net income would have rose had not the income tax rate increased from 29 to 35 percent. CFO growth is an eye-popping 62 percent, yet down from a fabulous 98 percent a year ago. Revenue/Assets is 35 percent; it has been holding steady.
Profitability. This gauge dropped 1 point from the prior quarter. ROIC slipped to a moderate 10 percent from 13 percent a year ago. FCF/Equity jumped up to 12 percent from 5 percent. Operating Expenses/Revenue moved up in the last year from 77 percent to 80 percent. The change was primarily due to a decline in Gross Margin of 3 percent. The Accrual Ratio, which we like to be both negative and declining, edged down to zero from +2 percent. This tells us that more of the company's Net Income is due to CFO, and, therefore, less is due to changes in balance sheet accruals.
Value. This gauge, based on the stock price of $45.48 at the year's end was zero points, compared to 0 and 3 points three and twelve months ago, respectively. The P/E at the end of the quarter was 13.7, up a little from recent quarters. The increase suggests the shares have become a bit more expensive. Reuters reports that the average P/E for the industry is 18.5, but Yahoo indicates a more credible value of 14.3. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is at a 16 percent discount to the average P/E, using core operating earnings for stocks in the S&P 500. One year ago, the company's P/E had a 20 percent discount to the market, as expressed by this measure. It's typical for slow-growth utility companies to trade at a discount. The PEG ratio is N/A because of the Net Income decline. Price/Revenue, which isn't affected by the one-time factors that cause wide swings in earnings, increased to 117 percent. However, it's down from 122 percent one year ago.
Now at a disappointing 20 out of 100 possible points, the Overall gauge has been below 30 points since the California power crisis passed. Yet, the stock price has moved up steadily, which sinks the Value score.
04 March 2007
WPI: Analysis through December 2006
Watson Pharmaceuticals (WPI) develops, manufactures, and sells generic and, to a lesser extent, branded pharmaceutical products.
In November 2006, after resolving an FTC challenge, Watson completed an all-cash, $1.9 billion acquisition of Andrx Corporation. Andrx was both a maker of generic drugs (often controlled-release versions) and a distributor. Watson had been expanding beyond its roots a generic drug manufacturer into higher-margin branded pharmaceuticals. However, the Andrx acquisition increased Watson's concentration on generics, which are now responsible for over 75 percent of revenues. In addition, $497.8 million, more than 25 percent of the cost of buying Andrx, was classified as "in-process R&D" and expensed in its entirety during the fourth quarter of 2006.
When we analyzed Watson after the quarter that ended in September 2006, the Overall score was a weak 23 points. Of the four individual gauges that fed into this overall result, Cash Management was the strongest at 9 points. Value was weakest at 4 points.
We have since updated the analysis to incorporate Watson's financial results, as reported in a Form 10-K for the full year and fourth quarter, which concluded on 31 December 2006. Our gauges now display the following scores:
Cash Management. This gauge dropped 5 points from 9 to 4. The cash spent on Andrx cut the Current Ratio to 1.8, which isn't low enough to cause concerns, from over-stuffed values over 4.0. The acquisition also pushed Long-Term Debt/Equity to a leveraged 67 percent (the average for the industry is 49 percent), up from 26 percent the previous quarter. Inventory/Cost of Goods Sold soared to 153 days, from 111 days at the end of the prior quarter and 119 days at the end of December 2005. The percentage of Inventory that is product ready for sale (i.e., Finished Goods) is 65 percent, which is higher than the typical level for the company. If the acquisition hadn't made comparisons difficult, the inventory data would suggest sales were less than expectations. Accounts Receivable/Revenues equal 71 days. This is higher than the prior quarter, but a few days less than the figure from December 2005. There's no indication at the current time the company is finding it more difficult to get its customers to pay their bills.
Growth. This gauge increased 3 points from October. The last two months of the year, which included results from Andrx, pushed Revenue growth to 20 percent year over year, up from no growth a year ago. Net Income growth was N/A because the massive in-process R&D charge swung net income to a net loss. Net income was positive in 2005, but lower than 2004. CFO growth is now an impressive 45 percent, up from 6 percent a year ago. Revenue/Assets is 53 percent; it managed to hold steady despite the acquisition adding to the numerator and denominator. It indicates that the acquisition didn't affect the company's efficiency at generating sales.
Profitability. This gauge increased 4 points from the prior quarter. ROIC slipped to a weak 6 percent from 7 percent a year ago -- we need to calculate Watson's weighted average cost of capital to demonstrate the weakness of this result. Other hand, FCF/Equity jumped up to 25 percent from 12 percent. Operating Expenses/Revenue moved up in the last year from 93 percent to 85 percent. The change was primarily due to a substantial 10 percent decline in Gross Margin (acquisition expenses?), which was slightly ameliorated by other changes. The Accrual Ratio, which we like to be both negative and declining, plunged to an unbelievable -23 percent from -3 percent. However, the value isn't credible because of the large non-cash asset impairment charge.
Value. This gauge, based on the stock price of $26.03 at the year's end, edged up to a weak 6 points from an even weaker 4 points three months ago and 1 point twelve months ago, respectively. It is noteworthy that the score is entirely determined by Price/Revenue. This ratio, which isn't affected by the one-time factors that cause wide swings in earnings, declined to 134 percent from 171 percent in September and 230 percent in December 2005. The decrease suggests the shares have become less expensive. The average Price/Sales for the industry is 875 The P/E and the PEG ratio are not applicable because earnings were negative.
Now at a weak 29 out of 100 possible points, the Overall gauge tells a mixed story. Sales and CFO is strong, but Inventory levels are high and Net Income was torpedoed by acquisition expenses. The company appears cheap on the basis of Price/Revenue, but our other valuation metrics aren't applicable until real earnings are produced. Our greatest worry is that Gross Margin will remain weak because generic drugs are essentially commodities. The ROIC needs to be much higher to keep up with the company's expanded debt levels. We look forward to seeing future financial statements to determine how well the company is digesting Andrx and executing its business strategy.
In November 2006, after resolving an FTC challenge, Watson completed an all-cash, $1.9 billion acquisition of Andrx Corporation. Andrx was both a maker of generic drugs (often controlled-release versions) and a distributor. Watson had been expanding beyond its roots a generic drug manufacturer into higher-margin branded pharmaceuticals. However, the Andrx acquisition increased Watson's concentration on generics, which are now responsible for over 75 percent of revenues. In addition, $497.8 million, more than 25 percent of the cost of buying Andrx, was classified as "in-process R&D" and expensed in its entirety during the fourth quarter of 2006.
When we analyzed Watson after the quarter that ended in September 2006, the Overall score was a weak 23 points. Of the four individual gauges that fed into this overall result, Cash Management was the strongest at 9 points. Value was weakest at 4 points.
We have since updated the analysis to incorporate Watson's financial results, as reported in a Form 10-K for the full year and fourth quarter, which concluded on 31 December 2006. Our gauges now display the following scores:
- Cash Management: 4 of 25
- Growth: 8 of 25
- Profitability: 16 of 25
- Value: 6 of 25
- Overall: 29 of 100
Cash Management. This gauge dropped 5 points from 9 to 4. The cash spent on Andrx cut the Current Ratio to 1.8, which isn't low enough to cause concerns, from over-stuffed values over 4.0. The acquisition also pushed Long-Term Debt/Equity to a leveraged 67 percent (the average for the industry is 49 percent), up from 26 percent the previous quarter. Inventory/Cost of Goods Sold soared to 153 days, from 111 days at the end of the prior quarter and 119 days at the end of December 2005. The percentage of Inventory that is product ready for sale (i.e., Finished Goods) is 65 percent, which is higher than the typical level for the company. If the acquisition hadn't made comparisons difficult, the inventory data would suggest sales were less than expectations. Accounts Receivable/Revenues equal 71 days. This is higher than the prior quarter, but a few days less than the figure from December 2005. There's no indication at the current time the company is finding it more difficult to get its customers to pay their bills.
Growth. This gauge increased 3 points from October. The last two months of the year, which included results from Andrx, pushed Revenue growth to 20 percent year over year, up from no growth a year ago. Net Income growth was N/A because the massive in-process R&D charge swung net income to a net loss. Net income was positive in 2005, but lower than 2004. CFO growth is now an impressive 45 percent, up from 6 percent a year ago. Revenue/Assets is 53 percent; it managed to hold steady despite the acquisition adding to the numerator and denominator. It indicates that the acquisition didn't affect the company's efficiency at generating sales.
Profitability. This gauge increased 4 points from the prior quarter. ROIC slipped to a weak 6 percent from 7 percent a year ago -- we need to calculate Watson's weighted average cost of capital to demonstrate the weakness of this result. Other hand, FCF/Equity jumped up to 25 percent from 12 percent. Operating Expenses/Revenue moved up in the last year from 93 percent to 85 percent. The change was primarily due to a substantial 10 percent decline in Gross Margin (acquisition expenses?), which was slightly ameliorated by other changes. The Accrual Ratio, which we like to be both negative and declining, plunged to an unbelievable -23 percent from -3 percent. However, the value isn't credible because of the large non-cash asset impairment charge.
Value. This gauge, based on the stock price of $26.03 at the year's end, edged up to a weak 6 points from an even weaker 4 points three months ago and 1 point twelve months ago, respectively. It is noteworthy that the score is entirely determined by Price/Revenue. This ratio, which isn't affected by the one-time factors that cause wide swings in earnings, declined to 134 percent from 171 percent in September and 230 percent in December 2005. The decrease suggests the shares have become less expensive. The average Price/Sales for the industry is 875 The P/E and the PEG ratio are not applicable because earnings were negative.
Now at a weak 29 out of 100 possible points, the Overall gauge tells a mixed story. Sales and CFO is strong, but Inventory levels are high and Net Income was torpedoed by acquisition expenses. The company appears cheap on the basis of Price/Revenue, but our other valuation metrics aren't applicable until real earnings are produced. Our greatest worry is that Gross Margin will remain weak because generic drugs are essentially commodities. The ROIC needs to be much higher to keep up with the company's expanded debt levels. We look forward to seeing future financial statements to determine how well the company is digesting Andrx and executing its business strategy.
03 March 2007
KG: Analysis through December 2006
King Pharmaceuticals (KG) develops, manufactures, and sells branded, prescription pharmaceutical products. About 1/3 of King's net sales are due to Altace®, an ACE inhibitor, to treat patients with cardiovascular risks.
Over the last few years, KG has had its share of problems, including Medicaid overcharge allegations, hefty "intangible asset impairment charges" due to disappointing sales, inventory management challenges, financial restatements, and a proposed merger with Mylan Labs that fell apart after Carl Icahn raised objections. We first saw evidence in the second and third quarters of 2005 that King turned the corner. The scores shown on the Overall gauge were in the upper 70's at the conclusion of both of those two quarters, after having been in the 20's the three previous quarters. [The stock price on 30 June 2005 was $10.42, and it was around $17 most of 2006.] The scores then sagged through the first three quarters of 2006.
When we analyzed King after the quarter that ended in September 2006, the Overall score had dropped to a modest 39 points. Of the four individual gauges that fed into this overall result, Cash Management was the strongest at 17 points. Value was weakest at 7 points.
We have since updated the analysis to incorporate King's 10-K results for the full year and fourth quarter. With the data available through 31 December 2006, our gauges now display the following scores:
Cash Management. This gauge held steady at 17 points. The Current Ratio is now 2.7 It has been at this solid level for two quarters after having bottomed out at around 1.3. Long-Term Debt/Equity is an easily manageable 17 percent, down 1 percent the previous quarter. Inventory/Cost of Goods Sold is now 187 days. The inventory level was 179 days at the end of the prior quarter, and it was a warehouse-stuffing 252 days at the end of December 2005. The percentage of Inventory that is product ready for sale (i.e., Finished Goods) is 24 percent. This is much lower than the typical level for the company, and it suggests sales were greater than expectations. Accounts Receivable/Revenues are 49 days. It has been pretty steady at this level for the last couple of years, after having been much higher. There is no indication the company is finding it more difficult to get its customers to pay their bills.
Growth. This gauge dropped 2 points from September. Revenue growth is now 12 percent year over year, down from 36 percent a year ago when the company was rebounding from earlier problems. Net Income growth is an eye-opening 147 percent. The $171 million increase in Net Income, however, can be fully explained by a reduction in intangible asset impairment charges of $173 million (from $221 million to $48 million); a lower income tax rate (from 35 to 32 percent) also helped. Most notably, the Net Income increase was not due to improved profitability in the company's core operations (see below). Further evidence of this situation is that CFO growth was actually down 10 percent. Revenue/Assets is 60 percent; it has been steady for the last year after having been much lower. Since its problems a couple of years ago, King has becoming more efficient at generating sales.
Profitability. This gauge also dropped 2 points from the prior quarter. ROIC slipped to a moderate 15 percent. It was 18 percent a year ago. FCF/Equity fell to 18 percent from 24 percent. Operating Expenses/Revenue moved up in the last year from 66 percent to 72 percent. The change was primarily due to a decline in Gross Margin and increase in R&D expenses. Even here, we have to dig deeper: a $45 million arbitration charge was assigned to SG&A expenses and acquisition-related R&D expenses were substantial. The Accrual Ratio, which we like to be both negative and declining, went the wrong direction by soaring to -4 percent from -12 percent. This tells us that much less of the company's Net Income is due to CFO, and, therefore, more is due to changes in balance sheet accruals.
Value. This gauge, based on the stock price of $15.92 at year's end jumped remarkably to a strong 20 points, compared to 7 points and only 1 point three and twelve months ago, respectively. (The increase sure got the pulse rate up when we calculated the new reading of the Value gauge. We now understand that non-recurring gains and losses drove the result more than anything else.) The P/E at the end of the quarter was 13.4, down substantially from recent quarters. The decrease suggests the shares have become less expensive. The average P/E for the industry is a much more expensive 32. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is at a 17 discount to the average P/E, using core operating earnings) for stocks in the S&P 500. Historically, the company's price has been at a substantial premium to the market, as expressed by this measure. Companies tend to trade at a premium when their growth rates are greater than average, particularly when the growth rates seem more likely to be sustained. The PEG ratio of .09 is indicative of a bargain stock. The Price/Revenue ratio, which isn't affected by the one-time factors that cause wide swings in earnings, has declined to 190 percent from the 215-230 percent range. This decrease also suggest the shares have become less expensive. The average Price/Sales for the industry is a rather astounding 875 percent.
Having jumped to a very good 60 out of 100 possible points, the Overall gauge would appear to reflect, or even signal, a substantial increase in King's fortunes. However, of the four component gauges, only the highly weighted Value gauge actually increased. This increase was due, in large part, to the massive and seemingly wonderful 147 percent increase in Net Income. However, the analysis revealed that a reduced intangible asset impairment charge drove the earnings increase more than anything else. The drop in operational profitability might not be as bad as first appears because of non-recurring factors, but, when coupled, with the big drop in CFO, we see a red flag. We want to see how the gauges change in the next couple of quarters to figure out what is actually happening.
Over the last few years, KG has had its share of problems, including Medicaid overcharge allegations, hefty "intangible asset impairment charges" due to disappointing sales, inventory management challenges, financial restatements, and a proposed merger with Mylan Labs that fell apart after Carl Icahn raised objections. We first saw evidence in the second and third quarters of 2005 that King turned the corner. The scores shown on the Overall gauge were in the upper 70's at the conclusion of both of those two quarters, after having been in the 20's the three previous quarters. [The stock price on 30 June 2005 was $10.42, and it was around $17 most of 2006.] The scores then sagged through the first three quarters of 2006.
When we analyzed King after the quarter that ended in September 2006, the Overall score had dropped to a modest 39 points. Of the four individual gauges that fed into this overall result, Cash Management was the strongest at 17 points. Value was weakest at 7 points.
We have since updated the analysis to incorporate King's 10-K results for the full year and fourth quarter. With the data available through 31 December 2006, our gauges now display the following scores:
- Cash Management: 17 of 25
- Growth: 7 of 25
- Profitability: 8 of 25
- Value: 20 of 25 (up from only 7!)
- Overall: 60 of 100
Cash Management. This gauge held steady at 17 points. The Current Ratio is now 2.7 It has been at this solid level for two quarters after having bottomed out at around 1.3. Long-Term Debt/Equity is an easily manageable 17 percent, down 1 percent the previous quarter. Inventory/Cost of Goods Sold is now 187 days. The inventory level was 179 days at the end of the prior quarter, and it was a warehouse-stuffing 252 days at the end of December 2005. The percentage of Inventory that is product ready for sale (i.e., Finished Goods) is 24 percent. This is much lower than the typical level for the company, and it suggests sales were greater than expectations. Accounts Receivable/Revenues are 49 days. It has been pretty steady at this level for the last couple of years, after having been much higher. There is no indication the company is finding it more difficult to get its customers to pay their bills.
Growth. This gauge dropped 2 points from September. Revenue growth is now 12 percent year over year, down from 36 percent a year ago when the company was rebounding from earlier problems. Net Income growth is an eye-opening 147 percent. The $171 million increase in Net Income, however, can be fully explained by a reduction in intangible asset impairment charges of $173 million (from $221 million to $48 million); a lower income tax rate (from 35 to 32 percent) also helped. Most notably, the Net Income increase was not due to improved profitability in the company's core operations (see below). Further evidence of this situation is that CFO growth was actually down 10 percent. Revenue/Assets is 60 percent; it has been steady for the last year after having been much lower. Since its problems a couple of years ago, King has becoming more efficient at generating sales.
Profitability. This gauge also dropped 2 points from the prior quarter. ROIC slipped to a moderate 15 percent. It was 18 percent a year ago. FCF/Equity fell to 18 percent from 24 percent. Operating Expenses/Revenue moved up in the last year from 66 percent to 72 percent. The change was primarily due to a decline in Gross Margin and increase in R&D expenses. Even here, we have to dig deeper: a $45 million arbitration charge was assigned to SG&A expenses and acquisition-related R&D expenses were substantial. The Accrual Ratio, which we like to be both negative and declining, went the wrong direction by soaring to -4 percent from -12 percent. This tells us that much less of the company's Net Income is due to CFO, and, therefore, more is due to changes in balance sheet accruals.
Value. This gauge, based on the stock price of $15.92 at year's end jumped remarkably to a strong 20 points, compared to 7 points and only 1 point three and twelve months ago, respectively. (The increase sure got the pulse rate up when we calculated the new reading of the Value gauge. We now understand that non-recurring gains and losses drove the result more than anything else.) The P/E at the end of the quarter was 13.4, down substantially from recent quarters. The decrease suggests the shares have become less expensive. The average P/E for the industry is a much more expensive 32. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is at a 17 discount to the average P/E, using core operating earnings) for stocks in the S&P 500. Historically, the company's price has been at a substantial premium to the market, as expressed by this measure. Companies tend to trade at a premium when their growth rates are greater than average, particularly when the growth rates seem more likely to be sustained. The PEG ratio of .09 is indicative of a bargain stock. The Price/Revenue ratio, which isn't affected by the one-time factors that cause wide swings in earnings, has declined to 190 percent from the 215-230 percent range. This decrease also suggest the shares have become less expensive. The average Price/Sales for the industry is a rather astounding 875 percent.
Having jumped to a very good 60 out of 100 possible points, the Overall gauge would appear to reflect, or even signal, a substantial increase in King's fortunes. However, of the four component gauges, only the highly weighted Value gauge actually increased. This increase was due, in large part, to the massive and seemingly wonderful 147 percent increase in Net Income. However, the analysis revealed that a reduced intangible asset impairment charge drove the earnings increase more than anything else. The drop in operational profitability might not be as bad as first appears because of non-recurring factors, but, when coupled, with the big drop in CFO, we see a red flag. We want to see how the gauges change in the next couple of quarters to figure out what is actually happening.
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