This article is the second in the series of three articles about Alcatel-Lucent (ALU) - the first article was about the overall condition of the networking industry and ALU's position in the industry. In this article, I have tried to do a financial analysis of the company and in the third article I will try to put a value on the stock. In this article, I have used the last annual report of the company and the most recent 10-Q for the current year numbers.
Liquidity and Cash Position
First of all, I am going to talk about the liquidity and the cash position of the company. In order to gauge the liquidity of the company, I have calculated three ratios: Current Ratio, Quick Ratio and Cash ratio. The following table shows the trend in these three ratios.
The current ratio of the company has improved slightly over the past three years. Both current assets and current liabilities have fallen for the company over the past three years. However, short-term liabilities have fallen more than the current assets, which has resulted in a slightly improved current ratio. The ratio indicates that company has enough resources to meet its short-term cash needs. The second ratio is quick ratio, which has also improved marginally - quick ratio is calculated by adding cash or near cash assets (cash + marketable securities + receivables) and dividing by current liabilities. Cash and receivables have decreased over the past three years and marketable securities have increased. The third and the final ratio is cash ratio, which is calculated by adding marketable securities and cash and dividing them by current liabilities. Since the liquidity is needed to meet the short-term liabilities, all these ratios have current liabilities in the denominator, as we are trying to gauge the coverage from internal resources for short-term liabilities. Cash ratio has also improved indicating the liquidity position of the company is good.
Cash and cash equivalents for the company has come down during the current year - however, marketable securities have gone up. Moreover, the recent decision from the company to raise capital through capital markets will strengthen the cash position. As a result, we might not see any deterioration in the liquidity position of the company. For a company in trouble, ALU has impressive liquidity position. Other than the internal cash sources, the company has a credit line worth €2 billion ($2.7 billion). Furthermore, the increased confidence from lenders and customers will allow the company to further improve its liquidity. As a result, I believe ALU's liquidity does not face any immediate threat.
The networking equipment industry has been going through a tough time during the past three years - the industry has become extremely competitive and especially the competition from Chinese manufacturers has hit European manufacturers hard. ALU's profitability has not been impressive during this period, and the company has been recording losses from the operations. The table below shows some profitability metrics and the trend in the profitability of the company during the past three years.
Gross profit margin is the first ratio, which has deteriorated during the last three years. Margins have shrunk in the industry and it shows in the first three ratios - these ratios have been falling due to the falling profits. There was a temporary improvement during 2011; however, the company was not able to maintain these ratios due to falling margins. The return on capital and assets ratios also paint a gloomy picture for Alcatel-Lucent. However, the situation might change in the near future as the company is finally moving towards being profitable again. During the past two quarters, ALU has reported lower loss figures than expected, which has resulted in increased investor confidence. The cost cutting measures of Michel Comes are paying off and the losses are coming down.
Debt and Solvency
Finally I will talk about the debt and solvency position of the company. Michel Combes' policies are paying off for the company and the recent increase in the stock price has given the company to raise substantial capital from the capital markets. This cash inflow can allow the company to decrease its debt and supplement the cash position for the day to day operations. The company plans to raise $2.7 billion in new shares and debt offering - After the completion of these transactions, the net debt of the company will be close to zero. Total long-term debt at the end of 2012 was about $5.5 billion for Alcatel-Lucent and just above $5 billion at the end of the second quarter of the current year. The following table shows the debt metrics of ALU over the past three years.
The first ratio in the table is debt-to-assets ratio, which has been rising during the past three years. However, this ratio is still very manageable and currently only 25% of the assets are financed by debt according to the ratio. There is still a lot of room for the company and the ratio is manageable. The second ratio shows how the capital structure of the company has changed over the past three years. Debt as a percentage of the capital has increased from 51% in 2010 to 61% in 2012. The biggest reason for the increase is the decrease in equity due to losses and a decrease in retained earnings. For the same reason, debt-to-equity ratio has increased over the past three years. These both ratios are telling the same thing that how the capital structure has changed during the past three years. The last two ratios are calculated to show the ability of the company to meet its expenses through operating income. Interest coverage ratio is negative due to the operating losses faced by the company. Fixed charge ratio also includes lease obligations of the company, and this ratio is also negative due to operating losses. Alcatel-Lucent has a lot of facilities working on leases (both financial and operating leases) and lease expense is a significant expense for the company. The overall solvency position of the company is good and it does not face any immediate danger in my opinion.
The results of these ratios are not surprising - we know that Alcatel-Lucent was able to get cash to meet its operational needs from the loan market, and the recent increase in the confidence of the customers, financial institutions and investors will allow the company to further enhance its liquidity. The profitability of the company is under pressure and it will likely remain this way in the short-term. However, the cost cutting plans and a focus on lucrative segments will again take the company towards profitability. ALU does not have a cash issue now, which should allow it to compete better and bring in improved revenues. Finally, the net debt of the company will be close to zero once the new financing transactions are completed. Overall, the company looks in a much better position than one or two years ago, and I believe the recovery will continue.