HD: Financial Analysis through January 2008

We have analyzed Home Depot's (HD) preliminary report for the January 2008 quarter, and this post reports our tentative results. The financial statements in this report were not complete: the Balance Sheet was abbreviated and the Cash Flow Statement was omitted. We will update our evaluation after the company submits a complete 10-K report to the SEC.

2007 was a momentous year for the largest retailer of "do-it-yourself" merchandise, which includes building materials, home improvement supplies, and lawn and garden products. Robert Nardelli, now at Chrysler, was forced out as Chairman and CEO because of dissatisfaction with the company's operating performance, stagnant stock price, and bountiful executive compensation. His elephantine severance package became a cause célèbre. After Frank Blake took over, the company decided to sell the Home Depot Supply division, which served professional contractors. The purchase by a consortium of private equity firms closed on 31 August 2007 for $8.5 billion, which was $1.8 billion less than the figure originally negotiated. The company used the proceeds and other funds to complete a $10.7 billion Dutch Auction tender offer for its own shares. The offer is part of a larger $22.5 billion "recapitalization" plan, although there has been speculation that the further share repurchases will be delayed considerably.

A fund controlled by Sears Holdings chairman and successful investor Edward Lampert acquired 16.7 million Home Depot shares, valued at $541.3 million, during the third quarter.

We analyzed Home Depot after the October 2007 quarter. The analysis omitted gauge scores because we didn't have sufficient financial data representative of the new corporate structure.

Before we examine the metrics associated with each gauge, let's compare the latest quarterly Income Statement to our previously communicated expectations. Please note that the presentation format below, which we use for all analyses, may differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.

($ M)		Jan 2008 (actual) (1)	Jan 2008 (predicted)	Jan 2007 (actual) (2)
Revenue		17659	17125	17404
Op expenses
	CGS	(11605)	(11405)	(11554)
	Depreciation	(452)	(377)	(393)
	SG&A	(4353)	(3767)	(4000)
	Other	(0)	(0)	(0)
Operating Income		1249	1575	1457
Other income
	Investments	0	0	0
	Interest, etc.	(192)	(140)	(123)
Pretax income		1057	1435	1334
Income tax		(386)	(531)	(493)
Net Income		671	904	841
		$0.40	0.50/sh	0.42/sh
Discontinued ops				84 (0.04)

<sup>1. 14 weeks
2. 13 weeks and restated</sup>

Revenue in the January 2008 quarter was 1.5 percent more than in the year-earlier quarter and 3.1 percent greater than our prediction. However, Revenue increased only because the recent quarter included an extra, 14th, week. If we multiply $17.659 billion by (13/14), the equivalent 13-week revenue figure is $16.398 billion. On this basis, Revenue in the January 2008 quarter was 5.8 percent less than in the year-earlier quarter. Similarly, on a comparable week basis, Revenue was 4.2 percent below our prediction.

As for Operating Expenses, we thought the Cost of Goods Sold (CGS) would be 66.6 percent of Revenue, and the actual value was nicely lower at 65.7 percent. Depreciation expenses were 2.6 percent of Revenue, fractionally above our 2.2 percent estimate. Sales, General, and Administrative (SG&A) expenses were 24.7 percent of Revenue, significantly higher than our forecast of 22.0 percent.

The soaring SG&A costs outweighed the lower CGS. On the whole, Operating Expenses were 2.1 percent of Revenue greater than we expected. This led to Operating Income 20.7 percent below the forecast value.

Non-Operating interest expense was a substantial $52 million greater than we expected. The slightly lower than expected Income Tax Rate, 36.5 percent vs. 37.0 percent forecast, wasn't enough to compensate for the higher expenses. As a result, Net Income fell below our prediction by a dismal 25.8 percent.


Cash Management. We estimate the value of this gauge at 8 points.

The following measures contributed the most to the score:

• Days of Sales Outstanding (DSO) = 10.6 days, less than the 13.0-day level one year earlier
• Cash Conversion Cycle Time (CCCT) = 50.3 days, down from 51.9 days, for this measure of efficiency.
• Debt/CFO = 2.1 years (based on an estimate of CFO), up from 1.5 years in January 2007. Debt may be on the rise, but it appears to be affordable.
  

The following measures contributed the least to the score:

• Current Ratio =1.2; much weaker than we prefer, but not too much below the five-year median value of 1.3.
• LTD/Equity = 64.3 percent, up from 46.5 percent last year; the company has, intentionally, become much more leveraged as it borrows money to repurchase shares.
• Inventory/CGS = 87.3 days, compared to 84.2 days 12 months ago. The five-year median is much less at 77.4 days, which suggests that sales have been slower than expected.
• Working Capital/Market Capitalization = 3.0 percent, down from 5.4 percent in January 2007.
  

Growth. We estimate the value of this gauge at 10 points.

The following measure was the only one that contributed meaningfully to the score:

• Revenue/Assets = 174.5 percent, way up from 151.2 percent in a year; stock repurchases decrease assets, which create the illusion of improved sales efficiency.
  

The following measures contributed little to the score:

• Revenue growth = -2.1 percent year-over-year, compared to -3.1 percent previously
• Net Income growth = -20.1 percent year-over-year, compared to -9.8 percent
• CFO growth = -17.6 percent year-over-year (estimated), down from +15.7 percent.
  

Profitability. We estimate the value of this gauge at 6 points.

The following measures contributed the most to the score:

• FCF/Equity = 15.6 percent (estimated), down from 16.5 percent
• ROIC = 15.0 percent, down just a tad from 15.2 percent in a year
  

The following measures contributed little to the score:

• Accrual Ratio = 3.3 percent (estimated), up from 2.2 percent
• Operating Expenses/Revenue = 90.6 percent, up from 88.8 percent in a year
  

Value. Home Depot's stock price edged down from $31.51 on 31 October 2007 to $30.64 on 31 January 2008. Using January's closing price, we estimate the value of this gauge at 14 points.

• Enterprise Value/Cash Flow = 10.2 (estimated), down from 12.1 in January 2007 and a five-year median of 12.8.
• P/E = 12.2, down from 15.5 one year earlier. The five-year median P/E is 15.7 (when the company was growing)
  
• P/E to S&P 500 average P/E = 29 percent discount, compared to a five-year median of a 9 percent discount
  
• Price/Revenue ratio = 0.72, down from 1.0 last year and its five-year median of 1.07.
  

The average P/E for the Retail (Home Improvement) Industry is currently 12.8. The average Price/Revenue for the Industry is currently 0.72.

We need the full set of financial statements that will be in the 10-K report, but our initial assessment of the Overall Gauge score is 41 out of 100 possible points. The Cash Management, Growth, and Profitability Gauges are all rather weak -- and they might have been even weaker if not for the 14-week quarter -- but the punishment applied to Home Depot (HD) shares is perking up the Value Gauge.

ADP: Financial Analysis through December 2007 (Update)

We previously posted an analysis of ADP's (ADP) preliminary financial results on the quarter that ended 31 December 2007. The financial statements in this report were limited in that the Balance Sheet was abbreviated and the Cash Flow Statement was missing.

ADP subsequently submitted a more complete quarterly report in a 10-Q filed with the SEC. The 10-Q data changed some of the metrics that determine our gauge scores. The Cash Management gauge score increased by two points, and the Growth gauge score lost one point. However, these two minor differences canceled each other out, and the Overall gauge remained at a pretty good 49 out of 100 points.

For a review of the latest quarterly Income Statement and how it compared with our predictions for the quarter, see our earlier post.

ADP, which is one of a mere handful of U.S. companies with a AAA bond rating, is a top provider of payroll and other personnel-related IT services to corporate customers. It also publishes the monthly ADP National Employment Report(SM) that measures total non-farm private employment.

ADP has been restructuring. It spun off its Brokerage Services Group business on 30 March 2007. The divested company was renamed Broadridge Financial Solutions, and it now trades publicly under the ticker symbol BR -- see our initial analysis of BR here. On 6 July 2007, ADP sold an airline ticket-clearing business based in Spain, which had annual revenues of about $75 million. ADP also acquired three businesses during the second half of 2007, but the acquisitions were not material to the company's finances.

ADP has about $20.7 billion of corporate and client funds (the latter being the lion's share) invested in debt securities. Of this amount, $6.1 billion is in money market securities and other cash equivalents, and the remaining $14.7 billion is in available-for-sale securities. In the latest 10-Q, the company states:

At December 31, 2007 approximately 95% of the available-for-sale securities held a AAA or AA rating, as rated by Moody’s, Standard & Poor’s and, for Canadian securities, Dominion Bond Rating Service.

ADP’s investment portfolio does not include any asset-backed securities with underlying collateral of sub-prime mortgages or home equity loans, nor does it contain any collateralized debt obligations (CDOs) or collateralized loan obligations (CLOs). ADP’s investment portfolio does include senior tranches of AAA-rated, fixed rate credit card, auto loan, and other asset-backed securities.

The Company believes that its available-for-sale securities that have fair values below cost are not other-than-temporarily impaired since it is probable that principal and interest would be collected in accordance with contractual terms, and that the decline in the market value was due to changes in interest rates and not changes in credit risk. The Company currently believes that it has the ability to hold these investments until the earlier of market price recovery and/or maturity and currently intends to do so. The Company’s assessment that an investment is not other-than-temporarily impaired could change in the future due to new developments or changes in the Company’s strategies or assumptions related to any particular investment.

This wording did not change from the 10-Q for the quarter that ended on 30 September 2007.

With full 10-Q set of data for the December 2007 quarter, our gauges display the following scores:

• Cash Management: 16 of 25
• Growth: 18 of 25
• Profitability: 14 of 25
• Value: 8 of 25
  

• Overall: 49 of 100
  

Cash Management. This gauge increased from 14 points in September to 16 points now.

The following measures all helped the gauge:

• Debt/CFO = nil
• Current Ratio = 1.8; up slightly from 1.7 one year ago
• LTD/Equity = 0.7 percent; down from 1.2 percent last year. Both values are insignificant.
• Days of Sales Outstanding (DSO) = 51.5 days, well down from 62.4 days in December 2006, but up a little from 48.4 days at the end of September.
• Cash Conversion Cycle Time (CCCT) = 38.1 days, compared to 42.3 days last year and 35.0 days last quarter.
  

The following measure was the only drag on this gauge score:

• Working Capital/Market Capitalization = 5.7 percent, down from 6.3 percent one year ago
  

Growth. This gauge increased from 17 points in September to 18 points now.

The following measures all helped the gauge:

• Revenue growth = 13.8 percent year-over-year, more than making up for last year's -3.4 percent
• Revenue/Assets = 101.3 percent, up dramatically from 75.7 percent in a year; sales efficiency is improving. The spin off and share repurchases both helped reduce Assets.
• Net Income growth = 18.1 percent year-over-year, up from -4.9 percent
  

Net income for the year benefited from a change in the income tax rate from 37.9 to 36.1 percent

The following measure held the score down:

• CFO growth = -0.8 percent year-over-year, compared to -15.6 percent one year ago.
  

Profitability. This gauge was unchanged from September at 14 points.

The measures that helped the gauge were:

• ROIC = 26.9 percent, up from 17.9 percent in a year
• FCF/Equity = 23.5 percent, up from 20.6 percent in a year
• Operating Expenses/Revenue = 80.3 percent, down from last year's 81.5 percent
  

The measures that hurt the gauge were:

• Accrual Ratio = -1.5 percent, up from -3.1 percent in a year
  

Value. ADP's stock price inched down from $45.93 to $44.53 over the course of the quarter -- it has since fallen under $40. The Value gauge, based on the year-end closing price, moved up from 5 to 8 points.

The measures that helped the gauge were:

• Enterprise Value/Cash Flow = 16.0, down from 18.4 in December 2006, but just slightly above the 5-year median value of 15.7
• P/E = 21.7, quite a bit below the 5-year median of 26.4
  
• P/E to S&P 500 average P/E = 27 percent premium, nearly half its five-year median value
  
• Price/Revenue ratio = 2.8, compared to a five-year median of 3.3
  

The average P/E for the Business Services industry is currently 18. The average Price/Revenue for the industry is currently 2.14.

An Overall gauge score of 49 out of 100 possible points qualifies as a good score for ADP and the best in four years. Our only real concern is Cash Flow growth. The results need to be treated with some skepticism because the historical financial data we use for comparison might not be representative of the current corporate organization.

WPI: Financial Analysis through December 2007

We have analyzed Watson Pharmaceuticals (WPI) preliminary financial results for the quarter that ended on 31 December 2007. The Balance Sheet omitted various details, including those characterizing Watson's inventory, current liabilities, and stockholder's equity. Our evaluation will be updated after the company files a complete 10-K report with the SEC.

Watson develops, manufactures, and sells generic and, to a lesser extent, branded pharmaceutical products. In November 2006, Watson completed an all-cash, $1.9 billion acquisition of Andrx Corporation. [More than a quarter of this cost was later expensed as "in-process R&D."] Andrx made and distributed generic drugs, often controlled-release versions. Watson had been expanding beyond generic drugs into higher-margin branded pharmaceuticals. However, the Andrx acquisition reversed this strategy, and generics became responsible for over 75 percent of revenues.

Across the industry, it's clear that many branded pharmaceutical products will soon lose their patent protection. This situation increases the attractiveness of generic drug manufacturers.

When we analyzed Watson after the September quarter, the Overall score was a modest 41 points. Of the four individual gauges that fed into this composite result, Profitability was strongest at 15 points. Value was weakest at 6 points.

Now, with the available data from the December 2007 quarter, our gauges display the following scores:

• Cash Management: 15 of 25
• Growth: 13 of 25
• Profitability: 12 of 25
• Value: 13 of 25
  

• Overall: 51 of 100
  

Before we examine the factors that affected each gauge, let's examine the latest quarterly Income Statement to our previously announced expectations. Note that the quarter-to-quarter comparison below is skewed by the $500 million charge in the fourth quarter of 2006 for in-process R&D associated with the Andrx acquisition.

Please also note that the presentation format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.

($ M)		Dec 2007 (actual)	Dec 2007 (predicted)	Dec 2006 (actual)
Revenue		627	630	621
Op expenses
	CGS	(373)	(366)	(410)
	Depreciation	(44)	(44)	(42)
	R&D	(36)	(41)	(41)
	SG&A	(108)	(112)	(102)
	Other	(0)	(0)	(501)
Operating Income		66	67	(476)
Other income
	Investments	0	0	0
	Interest, etc.	(6)	(7)	(6)
Pretax income		60	60	(481)
Income tax		(21)	22	(8)
Net Income		38	38	(489)
		$0.33/sh	0.33/sh	(4.80)/sh

Revenue in the January 2008 quarter was 1.0 percent more than in the year-earlier quarter. It was just shy of our estimate, which was based on the company' guidance to expect Revenue of $2.5 billion for the entirety of 2007.

We expected the Cost of Goods Sold (CGS) to be 58.0 percent of Revenue, and the actual value was 59.5 percent for a Gross Margin of 40.5 percent. Depreciation was 7.0 percent of Revenue, in line with our forecast. Research and Development (R&D) expenses were 5.7 percent of Revenue, an iota less than our 6.0 percent estimate. Sales, General, and Administrative (SG&A) expenses were 17.3 percent of Revenue, compared to the forecast of 17 percent.

With both Revenue and Operating Expenses consistent with expectations, it's no surprise that Operating Income nearly matched the prediction.

The Non-Operating side was also free of surprises, although the Income Tax Rate was a little less than we expected. Our target was 37 percent, and the actual rate was 35.8 percent. The difference was not significant enough to throw off our Net Income estimate.


Cash Management. This gauge increased from 10 points in September to 15 points now.

The measures that helped the gauge were:

• Current Ratio = 2.6; up from 1.8 in December 2006
• Days of Sales Outstanding (DSO) = 47.6 days, much less than the 66.3-day level one year earlier
• Cash Conversion Cycle Time (CCCT) = 54.4 days, down from 93.7 days, for this measure of efficiency
• LTD/Equity = 48.6 percent, down from 66.9 percent last year in the wake of the Andrx deal.
• Working Capital/Market Capitalization = 17.8 percent, up from 14.7 percent (cash levels that were depleted by the acquisition have recovered)
• Debt/CFO = 2.1 years, compared to 2.5 and 2.6 years 3 and 12 months ago, respectively
  

The measures that hurt the gauge were:

• Inventory/CGS = 122.2 days, compared to 117.7 days in December 2006
  
• Finished Goods/Inventory = 67 percent (estimated), compared to 65 percent one year ago)
  

Growth. This gauge didn't change from 13 points in September.

The measures that helped the gauge were:

• Revenue growth = 26.1 percent year-over-year, up from 20.2 percent
• Revenue/Assets = 72.1 percent, up from 52.6 percent in a year; it's not surprising that more high-volume generic drugs in the product mix would improve sales efficiency
  

The measures that hurt the gauge were:

• CFO growth = -9.4 percent year-over-year, disappointing.
• Net Income growth was N/A because the enormous $500 million charge at the end of 2006 for in-process R&D causes net income for the trailing four quarters to be negative.
  

Profitability. This gauge decreased from 15 points in September to 12 points now.

The measures that helped the gauge were:

• FCF/Equity = 19.0 percent, down from 25.4 percent in a year
• Accrual Ratio = -6.1 percent, up from -23.2 percent in a year.
  

The measures that hurt the gauge were:

• ROIC = 6.1 percent, rather tepid up from 5.7 percent in a year
• Operating Expenses/Revenue = 90.0 percent, too high historically, but down from 92.6 percent in a year.
  

Value. Watson's stock price dropped over the course of the quarter from $32.40 to $27.14. The Value gauge, based on the latter price, rose to 13 points from only 6 points three months ago (and 11 points twelve months ago).

The measures that helped the gauge were:

• Price/Revenue ratio = 1.3, about the same as one year ago and lower than its median of 2.2.
• Enterprise Value/Cash Flow = 9.1, down from a five-year median of 11.4
• P/E = 22.6 (the median P/E is around 27)
  

The measure that hurt the gauge were:

• P/E to S&P 500 average P/E = 37 percent premium (the median is 44 percent premium)
  

The average P/E for the Biotechnology and Drugs industry is 28. The average Price/Revenue for the industry is 7.2.

With the acquisition of Andrx Corporation fading into the rear-view mirror, an Overall Gauge score over 50, and shares that have declined with the market, Watson is worthy of further attention. We would like to see lower Inventory levels, higher CFO, and better ROIC.

WMT: Financial Analysis through January 2008

We have analyzed Wal-Mart's (WMT) preliminary report on the quarter that ended 31 January 2008. This post reports our results.

The financial statements in Wal-Mart's report include enough data to estimate the GCFR gauge scores. We will scrutinize the company's future 10-K submission to the SEC to determine if the additional data in the formal report would alter the scores.

With annual sales over $350 billion, or about 10 percent of U.S. retail sales, Wal-Mart squeezed ahead of Exxon Mobil (XOM) to garner the top spot on the 2007 edition of the Fortune 500 list of America's largest corporations. Wal-Mart transformed retailing (for better or for worse, depending on your perspective) by using information technology to manage its supply chain and by pressuring manufacturers to squeeze every penny out of their costs. Wal-Mart's visibility and role in advancing globalization have made it a lightning rod for criticism.

All retailers are challenged by the slowing U.S. economy, in which consumers weakened by high food and energy prices are nervous about their jobs and homes. In this environment, super-efficient Wal-Mart has something of a competitive advantage. The company sells the merchandise consumers can't do without and it does so at prices hard for competitors to match. To bolster store traffic, Wal-Mart has shown it is willing to implement price reductions that trim already razor-thin profit margins.

When we analyzed Wal-Mart after the October quarter, the Overall score was 29 points. Of the four individual gauges that fed into this composite result, Value was the strongest at 12 points. Profitability was weakest at 3 points.

Now, with the available data from the January 2008 quarter, our gauges display the following scores:

• Cash Management: 7 of 25
• Growth: 5 of 25
• Profitability: 6 of 25
• Value: 7 of 25
  

• Overall: 26 of 100
  

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations. Wal-Mart's performance matched our estimates almost exactly. Please note that the presentation format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.

($ M)		Jan 2008 (actual)	Jan 2008 (predicted)	Jan 2007 (actual)
Revenue		106269	106330	98090
Op expenses
	CGS	(81323)	(81874)	(75565)
	SG&A	(19224)	(18608)	(17080)
	Other	(0)	(40)	(0)
Operating Income		5722	5808	5445
Other income
	Investments	(101)	(100)	(171)
	Interest, etc.	618	600	643
Pretax income		6239	6308	5917
Income tax		(2143)	(2208)	(1977)
Net Income		4096	4100	3940
		$1.02/sh	1.01/sh	0.95/sh

<sup>1. Revenue "predictions" for Wal-Mart are based on the company's publicly announced monthly sales reports.
2. The company includes some income in operating income that we treat as non-operating income.</sup>


Revenue in the January quarter was less than 1 percent below the predicted value, and it was 8.3 percent higher than in the January 2007 quarter. Year-over-year revenue growth is now 8.6 percent.

We thought the Cost of Goods Sold (CGS) would be 77.0 percent of Revenue, and the actual value was 76.5 percent. In other words, the Gross Margin, at 23.5 percent, was a 0.5 percent better than our expectation. Lower CGS were balanced out, however, by higher Sales, General, and Administrative (SG&A) expenses. SG&A costs in the quarter were 18.1 percent of Revenue, compared to our forecast of 17.5 percent.

We had set aside $40 million, per company guidance, for a special operating charge related to the restructuring of the Seiyu operations. We suspect Wal-Mart included this in SG&A costs, but we don't have any definitive information.

Operating Income was 5.1 percent above the value in the January 2007 quarter. However, Operating Income was 1.5 percent below the forecast value because of the slightly lower than expected Revenue and the higher SG&A expenses

Non-operating income was a tiny $17 million greater than expected. The Income Tax Rate was 34.3 percent, instead of the predicted 35 percent. As a result, Net Income matched the prediction almost exactly. Earnings per share were $0.01 better than estimated because there were fewer shares outstanding.


Cash Management. This gauge didn't change from 7 points in October.

The following measures pushed the score up the most:

• Cash Conversion Cycle Time (CCCT) = 10.0 days, down from 11.7 days in January 2007, for this measure of efficiency
• LTD/Equity = 46.1 percent, a manageable figure but up from 44.2 percent in one year
• Debt/CFO = 2.0 years; compared to 2.3 and 1.7 years 3 and 12 months ago, respectively
• Inventory/CGS = 43.9 days, compared to 50.8 and 45.3 days 3 and 12 months ago, respectively

The following measures held the score down:

• Current Ratio = 0.8; weaker than we like; just slightly below the five-year median
• Days of Sales Outstanding (DSO) = 3.2 days, longer than the 2.9-day duration one year earlier
• Working Capital/Market Capitalization = -4.4 percent, down from -2.2 percent
  

Growth. This gauge increased from 4 points in October to 5 points now.

The following measure pushed the score up the most:

• Revenue/Assets = 2.292, up slightly from 2.282 in a year; sales efficiency improved by a tiny amount.
  

The following measures held the score down:

• Net Income growth = 5.8 percent year-over-year, down from 7.5 percent a year ago.
• Revenue growth = 8.6 percent year-over-year, down from 11.0 percent
• CFO growth = 2.0 percent year-over-year, down from 13.2 percent
  

Profitability. Encouragingly, this gauge increased from 3 points in October to 6 points now.

The following measures pushed the score up the most:

• FCF/Equity = 8.4 percent, up from 7.0 percent in a year
• ROIC = 11.6 percent, not bad but down from 12.4 percent in a year.
  

The following measures held the score down:

• Accrual Ratio = 4.6 percent, down from 5.2 percent in January 2007
• Operating Expenses/Revenue = 95.3 percent, slightly above last year's 95.1 percent
  

Value. Wal-Mart's stock price rose over the quarter from $45.21 to $50.74. The Value gauge, based on the latter price, decreased to 7 points from 12 points three months ago.

All of the following measures made small positive contributions to the score:

• Enterprise Value/Cash Flow = 11.7, up from 11.3 in January 2007, but significantly below its five-year median of 13.7.
• P/E = 15.7, down from 16.3 a year ago, and below its five-year median of 18.5.
  
• P/E to S&P 500 average P/E = 8 percent discount, much lower than its five-year median of a 12 percent premium
  
• Price/Revenue ratio = 0.5, lower than its five-year median of 0.7.
  

The average P/E for the Retail - Department and Discount industry is currently 15.6. The average Price/Revenue for the industry is currently 0.56.

Now at a weak 26 out of 100 possible points, the Overall gauge fell back a couple of point with the fourth quarter results. This was mostly consequence of the run up in the share price during the last three months, which took a slice out of the double-weighted Value gauge. Growth is positive, but tepid. Profitability is somewhat encouraging.

TDW: Financial Analysis through December 2007 (Update)

We previously posted an analysis of Tidewater's (TDW) preliminary financial results for the quarter that ended on 31 December 2007, which was the third in the company's fiscal year.

Tidewater subsequently submitted a more complete quarterly report in a 10-Q filed with the SEC. The additional data in the 10-Q changed neither analysis results nor gauge scores. The Overall gauge remains at a modest 41 out of 100 possible points. For details, please see the earlier post.

A few tidbits from the Notes to the Financial Statements in the 10-Q.

1. During the last nine months, the number of common shares held in trust for an employee benefit plan dropped to zero from 1.2 million.

2. Of the $200 million authorized in July 2007 for share repurchases, $177.5 million has been put to use. Almost 66 percent of these purchases took place in the December 2007 quarter.

3. With an increasing proportion of earnings derived from non-U.S. operations, Tidewater's effective income tax rate has been reduced correspondingly. During the first three quarters of the current fiscal year, the rate averaged 18 percent.

4. The effective tax rate may change as uncertain tax positions are resolved. The company’s Balance Sheet for March 2007 included $13.1 million of tax liabilities for uncertain tax positions for the last seven years. This corresponds to only $0.04 per common share, which gives the impression that the company is relatively conservative in its tax accounting.

5. Tidewater has a tax-qualified and supplemental pension and retirement plans for certain employees. Together, they cost the company about $2.7 million per quarter. The assets behind these plans and the expected rate of return isn't clear from the 10-Q.

6. Tidewater contributes to a pension plan for UK merchant navy officers. The plan has a deficit, and participating companies have been subject to supplemental assessments, which can be paid in installments. The exact amount and Tidewater's share for each year is somewhat uncertain, but it seems to be in area of $3.5 to $4.0 million per year. Tidewater expenses the full amount for each year as soon as it is determined.

7. It's public knowledge that Tidewater and other oil service companies are having their operations in Nigeria scrutinized to assess compliance with the Foreign Corrupt Practices Act (FCPA). Tidewater's view is that "changes in local law and regulations are desirable, and may be necessary, in order to provide greater transparency and efficiency, as well as to give greater assurance as to compliance with applicable laws." The company notes that it might have to curtain or cease operations in Nigeria if a permanent solution isn't found and current interim procedures for obtaining import permits prove ineffective. However, it is planning to supplement its current 24-vessel fleet with three additional vessels.

PEP: Financial Analysis through December 2007

We have analyzed PepsiCo's (PEP) preliminary financial results for the quarter that ended on 29 December 2007. Our evaluation will be updated after the company formally submits a complete 10-Q report to the SEC.

PepsiCo is a leading global purveyor of beverages and snacks. The company is known for good management, steady growth, significant international exposure, and the defensive characteristics of the food and beverage industries. While famously locked in a battle with Coca-Cola for the soft-drink market, PepsiCo's snack food business results in a more diversified company. In the North American markets, the Frito-Lay division takes in more revenue and contributes more to operating profit than the Pepsi Bottling division.

When we analyzed PepsiCo after the September quarter, the Overall score was a modest 39 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at 23 points. Value was weakest at 3 points.

Now, with the available data from the December 2007 quarter, our gauges display the following scores:

• Cash Management: 8 of 25
• Growth: 5 of 25
• Profitability: 11 of 25
• Value: 0 of 25
  

• Overall: 22 of 100
  

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.

($M)		Dec 2007 (actual)	Dec 2007 (predicted)	Dec 2006 (actual) (1)
Revenue		12346	10951	10570
Op expenses
	CGS	(5784)	(4928)	(4830)
	SG&A	(4811)	(4271)	(4097)
	Amortization, etc.	(21)	(60)	(54)
Operating Income		1730	1692	1589
Other income
	Equity income	95	140	113
	Interest, etc.	(28)	(25)	(4)
Pretax income		1797	1807	1698
Income tax		(535)	(501)	(128)
Net Income		1262	1307	1826
		$0.77/sh	0.79/sh	1.09/sh

1. Restated


Revenue soared in the December 2007 quarter. The reported figure was 12.7 percent above our estimate and 16.8 percent greater than in the year-earlier quarter. Revenue growth at PepsiCo International was especially strong, up 26 percent. The weak dollar contributed to the sales surge, but the company also reported gains in both volume and pricing.

We thought the Cost of Goods Sold (CGS) would be 45 percent of Revenue, and the actual value was 46.8 percent. As shown in the figure, this is a relatively high percentage for PepsiCo; it probably reflects the rise in commodity prices. Sales, General, and Administrative (SG&A) expenses were 39.0 percent of Revenue, matching our prediction. SG&A costs are always higher in the fourth quarter than the others. One of these entries, CGS or SG&A, includes a $102 million restructuring charge. Amortization of intangible assets was $39 million less than we expected.

The Revenue and CGS values far above expectations nearly canceled each other out. Operating Income was only 2.25 percent above the forecast value.

Non-operating income was $48 million less than expected. The Income Tax Rate was 29.8 percent, instead of the predicted 27.7 percent. The higher rate was enough to pull Net Income below our prediction, despite the fabulous top-line Revenue figure, by 3.4 percent.


Cash Management. This gauge decreased from 13 points in September to 8 points now.

The measures that helped the gauge were:

• LTD/Equity = 24.2 percent, up from 16.6 percent a year ago, but an easily managed level
• Cash Conversion Cycle Time (CCCT) = -59.6 days, up from -64.3 days; we're not sure what to make of a negative value for this measure of efficiency.
• Debt/CFO = 0.6 years, easily affordable, although slightly higher than previous levels.
  

The measures that hurt the gauge were:

• Current Ratio =1.3; weaker than we like, but close to the norm for this company
• Inventory/CGS = 42.7 days, compared to 45.3 and 42.0 days 3 and 12 months ago, respectively.
• Finished Goods/Inventory = 47 percent, up from 43 percent last quarter (this increase had the greatest negative effect on the score.)
  
• Days of Sales Outstanding (DSO) = 37.5 days, greater than the 36.4 days calculated one year earlier
• Working Capital/Market Capitalization = 1.9 percent, down from 2.1 percent
  

Growth. This gauge decreased substantially, from 23 points in September to 5 points now.

The measures that helped the gauge were:

• Revenue growth = 12.7 percent year-over-year, up from 7.6 percent in a year.
• CFO growth = 14 percent year-over-year, up from 4 percent in a year
  

The measures that hurt the gauge were:

• Revenue/Assets = 114 percent, down from 117 percent one year earlier; sales efficiency is improving
• Net Income growth = 0.6 percent year-over-year, down from 38 percent in a year
  

Earnings growth was hurt by an increase in the income tax rate from 19.3 to 25.9 percent.

Profitability. This gauge slipped from 13 points in September to 11 points now.

The measures that helped the gauge were:

• ROIC = 26 percent, wonderful, but down from 32.3 percent in a year
• Accrual Ratio = +3.3 percent, down from +5.4 percent in a year. The Cash Flow contribution to earnings increased.
  
• FCF/Equity = 26 percent, unchanged from 2006
  

The measure that hurt the gauge was:

• Operating Expenses/Revenue = 81.7 percent, up from 81.1 percent.
  

Value. PepsiCo's stock price rose from the end of September to the end of December from $73.26 to $75.90. Given that the price was in the low $60's only a year ago, it's not surprising the Value gauge has bottomed out.

None of our measures helped the gauge:

• Enterprise Value/Cash Flow = 18.3, up from 17.3 in December 2006 and a five-year median of 17.8
• P/E = 22.1, up from 18.7 last year, but a little below the five-year median of 22.6
  
• P/E to S&P 500 average P/E = 30 percent premium, a little above than the five-year median premium of 28 percent
• Price/Revenue ratio = 3.2, above the five-year median of 3.0.
  

The average P/E for the Non-alcoholic Beverages industry is currently a more expensive 22.7. The average Price/Revenue for the industry is currently 3.8.

A rising stock price, increasing costs, and slowing income growth knocked down PepsiCo's Overall Gauge score to 22 out of 100 possible points. Last year had more substantial non-recurring tax benefits, which skews the comparisons. However, we're worried more about the decreasing Gross Margin, which swallowed up seemingly impressive (and hard to sustain) Revenue Growth.