Q3 Earnings Quality: Expect a Variety of Hits and Misses

As earnings season begins in earnest we expect to see a wide variety of hits and misses. Alcoa (AA), one of the biggies, got the show rolling with a “beat” on their Q3 numbers.

However, CEO Klaus Kleinfeld made it clear that cost-cutting and other actions contributed heavily to cash positions and profits. In addition, the company cited improved aluminum demand by the auto makers.

But, in the aftermath of cash-for-clunkers, we expect car makers will be very careful with inventory build-up going forward.

While we are not surprised Alcoa topped the consensus estimates, there was nothing really to get excited about. Rather, it plays into our continuing “macro” concern that cost-cutting and not revenue growth is what props up the bottom-line.

Our dual cash-flow and accrual screens turned-up some interesting names in anticipation of Q3 earnings season. The list below is a mixed bag of earnings quality, industries and market caps, but we believe there is ample opportunity to make some money (or avoid trouble) if you keep an eye on the financial statements.

	Lindsay Corp.	LNN	Irrigation & Infrastructure Products
	Research In Motion	RIMM	Communication Devices
	International Business Machines	IBM	Computer Hardware and Services
	Wendy’s / Arby’s Group	WEN	Fast Food Restaurants
	Deluxe Corp.	DLX	Business Services
	Treehouse Foods	THS	Branded and Private Label Foods
	Allegheny Technologies	ATI	Industrial Metals
	Varian Medical Systems	VAR	Medical Equipment
	Apple Computer	AAPL	Computers and Devices
	Eastman Kodak	EK	Imaging and Digital Products

More information on these companies can be found at our website.

Lindsay Corp.’s fortunes are tied largely to farm income. Some analysts have been bearish on agricultural net income, hence a similar negative view of farm equipment makers. Yet, Lindsay produces healthy operating cash-flow and management doesn’t rely heavily on non-cash accounting tricks to make their numbers.

Research in Motion also produces quality operating cash-flows and we note use of balance sheet maneuvers have slowed in recent quarters. In contrast, rival Apple displays very high use of both accrual accounting and balance-sheet cash-flows in making their numbers.

Several companies on our list appear to be experiencing what we’d call “transitional” changes in earnings quality. IBM for example displays very thin spreads between operating cash and balance-sheet cash-flows. In addition, Goodwill levels (as a percent of stockholder equity, are over 100%). IBM is a great company, but at current prices, any good news is already priced in.

Management at fast-food chain Wendy’s / Arby’s appear to be turning the enterprise around, but they have more work to do. Although operating cash-flows are negative, the trend is improving in recent periods. The stock is cheap at $4-5, but income investors might want to look at their longer maturing bonds selling under par and dishing up tasty risk appropriate yields.

Industrial metals firm Allegheny Technologies displays accelerating balance-sheet cash-flows, higher use of accrual accounting and deteriorating capital productivity. As for Kodak, the grind of restructuring drags on. Today’s Kodak bears no resemblance to the good ‘ol days of traditional film photography or the fat margins that came with it.

Disclosure: None

Comments

[Ecomike:]

I have been bottom fishing this year, and done quite well with EK stock the last 3-4 months.

Oct 12 05:09 PM