THE CONTEXT: Its adjusted earnings beat Wall Street expectations, but revenue fell short as the company faced tough pricing competition during the quarter. The company has been working on a turnaround plan as it faces increased competition from online retailers and discount stores.
Uh, revenues fell short?
Remember, the issue is that the firm extended its "price match" guarantee against online retailers (read: Amazon) in the quarter.
Revenue was off 10%, which shouldn't be happening if the company's price-match was actually doing what they expect, which is to entice people to buy locally rather than over the Internet. (Note: Same-store revenues were down a much-smaller 1.1% -- but still down.)
This strongly implies that either they're not really price-matching in a form and fashion that consumers are willing to deal with or their stores suck, the retail experience sucks, and thus the customers are buying online even though it's not cheaper.
There are plenty of firms that will "price-match" if you catch them with a higher price than someone else. That sort of policy runs the risk of leaving a bad taste in the consumer's mouth if it happens all the time. What this says to the customer is that you believe they're a sucker in that you'll post a much higher price but take less if and only if challenged.
Some people think that's just fine, but others will think back about all the previous times they were in your store and presume you robbed them during those previous visits. If that's the take-away they get from your policy there is a very real risk they simply turn around and walk out.
The message being sent is similar to instructing your cashiers to short everyone who pays with cash by $5 in their change, but to immediately fork the $5 over if challenged. The first time I catch you and you immediately give me the remaining $5 I am going to think about the previous times I was in your store and wonder exactly how many of those times you stole $5 from me and got away with it. Think about it.....
It is my premise that treating customers like sheep to be shorn while deferring the shears if someone squawks is exactly the wrong thing to do and risks a severe and fatal customer backlash. You may get away with it with some percentage of the customers, maybe even most of them, but anyone who is offended by that sort of tactic is unlikely to come back and shop in your store again.
In any event, with revenues down 10%, what the company is doing is not working and, for today at least, the stock market agrees with me (the shares were off more than 4% at the close.)
Operating cash flow increased 39% to $4.25 billion for the trailing twelve months, compared with $3.05 billion for the trailing twelve months ended March 31, 2012. Free cash flow decreased 85% to $177 million for the trailing twelve months, compared with $1.15 billion for the trailing twelve months ended March 31, 2012. Free cash flow for the trailing twelve months ended March 31, 2013 includes fourth quarter 2012 cash outflows for purchases of corporate office space and property in Seattle, Washington, of $1.4 billion.
The problems don't lie there -- the top-line results look kinda ok and the bottom line isn't awful. But inside the report I find some rather disturbing "features." All of these must be taken in light of the net sales number, which is up 22%.
First, operating income was down 6% into that increase in sales. That's not so good and guidance is for flat to down revenues sequentially and a net loss as opposed to a profit last year in the same quarter.
The more-astonishing fact is that the company expects to book enough in stock-based compensation costs to create that entire loss -- that is, the firm is issuing stock to employees even though they're not making money!
It doesn't end there. Stock-based compensation is up 43% while sales are up half that. Depreciation is up 53% on a comparable-quarter basis. Inventories are down, which is good (better management of inventory is a good thing) and receivables and payables are comparable -- again, management efficiency looks ok.
PPE (purchases of property and equipment) skyrocketed 74% compared against last year as well.
I can't get excited over any of this. The only "maybe-good" is the PPE, if those purchases increase sales or improve efficiency. That's a big if when it's going up at this sort of rate. You'd expect PPE to rise at about the rate of sales; when it goes up three times as fast with a mature business model you start asking questions.
You also start asking questions when stock-based compensation expense goes up faster than does revenue. There's a fair argument to be had that you're overpaying -- maybe dangerously so.
I'm also rather jaded about the International business -- it ran a net operating loss. That's not good; it was profitable last year on the comparable period.
More to the point growth continues to slow. Worse, while North American efficiency improved, international continued to decline.
Media sales internationally appears to have flat-lined -- and if I had to guess I'd say that's where the profit was coming from. The loss of sales momentum internationally on media (e.g. books, electronic and otherwise) is a critical problem; commodity electronics and other merchandise is not going to get it done and calls into question whether Amazon is in trouble as an international media company.
The report isn't a disaster but it's a hell of a warning. Much of the Amazon bull case has rested on them being able to export their US model internationally and obtain the sort of growth numbers they got here.
If the high-margin part of their international business flat-lines the argument for paying nearly 400 times earnings goes up in a puff of smoke and the stock gets cut in half -- or more.
Disclosure: Lightly short but not materially so -- a technical break if anyone bothers to pay attention to the details in the report will cause me to get very interested on the short side.
I have long maintained that dividends are what companies that are doing well use to distribute the profits of operation to their shareholders, and form the only basis of long-term value in equity.
I have also long maintained that stock buybacks are what companies do when they have nothing productive to do with the funds they generate from operation. Companies that buy back their own shares are making a declaration that they are out of innovative ideas to grow their business and thus instead choose to machine their stock price.
There are legitimate exceptions to this general rule. A firm trading well below book value has an argument for buying back its own stock, because the market values the firm so poorly that it is able to reduce the outstanding equity for less than the market values it at. If a company is trading at 0.7x book, for example, but has cash, then choosing to buy back its own equity has a "free" 30% boost to the activity, which likely exceeds the gross margin it can earn from operations.
But note three things here, and how rare they are:
1. The firm has to have cash to do the buying with.
2. The firm must be trading well below book value.
3. The book value must be real; if there is any "cooking" of said "value" then this is an idiotic strategy as if that is exposed the share price (and quite-possibly the entire company!) will collapse.
Apple doesn't meet any of these tests. It is not buying the stock with cash, they are borrowing the money so as to evade paying taxes on overseas funds. This sort of corporate shenanigan is extraordinarily dangerous as you are now arbitraging two (or more!) national tax policies you do not control. It is trading (despite the fall in share price of late) at approximately 3x book value. And the alleged "book" value has a very large contribution from intangibles -- that is, things like intellectual property which are notoriously hard to put a true market number on and are usually both overstated and decaying assets.
A company with a cash hoard of some $40 billion on the balance sheet that decides to buy back shares is a firm that is telling you it has nothing in the oven that is revolutionary to drive future EPS with.
Reducing the share count boosts EPS and thus makes earnings "beats" look easier. But reducing the divisor is not "free"; it equally increases the amount of earnings misses and, if a loss is taken, magnifies those as well.
Borrowing to buy back shares is outrageously stupid. In a world of "cheap money" there is always an argument that one can obtain a "nice" return by doing so. But this assumes several things that are not knowns (and in fact are all risks):
1. Rates will stay low.
2. If they don't, the term of the borrowing is long enough that the firm will be able to pay both the coupon and retire the debt without materially impairing operations.
3. The firm's prospects are bright enough in new products and services that expansion of the firm's revenue and earnings will overrun the borrowing.
But wait -- #3 is in direct conflict with the statement coming from management through the act itself -- that the company has no better and higher use for its cash than to buy back stock in the first place!
In Apple's case the bigger problem the firm has is the enormous deterioration in margins. About a year ago I warned people that the margins they were reporting were utterly impossible to maintain, and that hardware companies all trend toward commodity status, which typically earns a 10% gross margin or less.
The only way to evade that outcome is to continually innovate so as to always be first and best. But once you start buying back shares you've declared that you can't do that anymore.
People on the earnings call appear to have figured this out rather quickly; the initial "pop" on the release of the plan to buy back stock and increase the dividend bled off through the call as the company failed to disclose anything new that would make the above formula work, closing in the after-hours session down somewhat.
On a fundamental basis the problem the firm has is that the $42/share the company currently claims in cash will be depleted and the reduction in operating margin means that re-filling that cache will become more difficult. Any attempt to move more product by coming up with "lower end" products will further erode margins and make the situation worse.
Apple is trapped without new fad products and drivers of their cult mania, in short, and the deterioration of margins plus issuance of debt adds leverage (read: risk) in execution.
I would not be surprised -- even a little -- to see the firm's stock trade down to $100 over the next couple of years. This sounds ludicrous given the current metrics but everything the company is doing right now damages the pillars on which the stock price rests -- cash on hand, margin, cachet among the "faithful" and innovation.
Put a fork in this company as a "market leader" -- they're done.
Disclosure: No position.
PEORIA, Ill., April 22, 2013 /PRNewswire/ -- Caterpillar Inc. (NYSE: CAT) today reported profit per share of $1.31 in the first quarter of 2013, down from first-quarter 2012 profit per share of $2.37. First-quarter 2013 sales and revenues were $13.210 billion, a decline from $15.981 billion in the first quarter of 2012. Profit was $880 million in the first quarter of 2013, compared with $1.586 billion in the first quarter of 2012.
Oops. The firm said:
"In our year-end 2012 financial release, we said the first quarter of 2013 would be challenging, and it certainly was. As expected, inventory changes were a major factor. Caterpillar and our dealers usually add inventory in the first quarter to prepare for higher end-user demand in the spring and summer. In the first quarter of 2012, we added about $2 billion to inventory, but this year, we cut inventory by about a half billion dollars. In the first quarter of 2012, Cat dealers added machine inventory of about $875 million, and this year, they reduced machine inventory by about $700 million. Those are significant year-to-year swings, and coupled with moderating end-user demand, resulted in sales and revenues being down 17 percent," said Caterpillar Chairman and Chief Executive Officer Doug Oberhelman.
Mining, in particular, is getting hammered; the decline expected is 50%. That's rather material, don't you think?
It also was foretold in the copper price, which has been on a relentless decline.
Of course the company continues to "machine" earnings with stock repurchases. They now expect to repurchase $1 billion of stock in the next quarter which decreases the divisor, amplifying both earnings and losses in terms of EPS.
The company is playing the spin game on CNBS as I write this; the truth is that the EPS was $1.31, off more than a buck from last year in the comparable quarter. They also missed on revenues by 17%, which is a monster miss against the same quarter last year.
IMHO their forward guidance is insanely optimistic; they believe that mining will pick back up in the next few months. If it doesn't then the firm's forward expectations are going to prove to be ridiculously optimistic.
Watch copper; if it continues to move lower in the next couple of months by the time the June quarter comes along these guys are going to be mewling about "terrible conditions" and their guidance is going to be ridiculously off with a miss of epic proportions.
Disclosure: No position.
First IBM last night, trading down more than $13, and now GE trading down 3.6%.
The common thread? Disappointment in the earnings department.
The problem is that buybacks of shares and squeezing suppliers, which I have noted for the last couple of years as the market has ramped, has a use-by date and is a short-term tactic that dramatically raises the firm's internal leverage.
If and when something goes wrong once you've done that you're caught -- big time.
This sort of crap sows the seed of a market collapse down the road when it is allowed to continue by shareholders and media pundits cheering on the "mothers' milk" nonsense.
Engineering earnings is never a good thing, but it's especially bad when it's done not by simply pulling forward next quarter's results into this quarter but worse, by adding leverage through reduction of the share count and playing with vendor payments.
Here it comes.
Where We Are, Where We're Heading (2013) - The annual 2013 Ticker
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