Exco Resources Inc.'s Profitability And Capital Analysis

| About: EXCO Resources, (XCO)

In this article, I will analyze EXCO Resources Inc's (NYSE:XCO) past profitability, debt, capital, and operating efficiency. In addition, I will take a look at which institutional investors have recently bought XCO in the last quarter. Based on this information, we will get an understanding of the company´s revenues, operating metrics and quality of earnings.

Profitability Analysis
Profitability is a class of financial metric used to analyze a business' ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, I will study several profitability metrics, such as return on assets, quality of earnings, cash flows and revenues. By analyzing these four metrics, we will be able to determine if the company is really making money.
When looking at the past 3 fiscal years, we can notice that EXCO Resources Inc´s revenues have decreased from $754 million in 2010 to $547 million in 2012. This equals a 37% decrease in revenues over the past 3 years. I do not like stocks that generate declining revenue growth. It is essential to study why that happened.
In addition, I always compare a company's revenue growth and operating cash flow growth. Operating cash flow is the cash generated from the operations of a company -or revenue- minus all operating expenses (depreciation charges not deducted).
Over the past three years, the company's operating cash flow has also increased. XCO's operating cash has increased by 20%. The company augmented its operating cash flow from $429M to $515M. I advise to look for companies with strong cash generation profiles.

ROA - Return On Assets = Net Income/Total Assets
ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. In simple terms, ROA tells you what earnings were generated from invested capital (assets).
I do not like the fact that EXCO Resources Inc's ROA decreased from 23.03% in 2010 to a current -45.57%. I am always looking to invest in companies that generate increasing ROAs. However, EXCO Resources Inc's ratio is evidence of the company generating less from its assets than it did in 2010.

Quality of Earnings
Quality of earnings is the amount of earnings attributable to higher sales or lower costs rather, than artificial profits created by accounting anomalies -such as inflation of inventory. In order to assess EXCO Resources Inc's quality of earnings, we will compare the level of income with operating cash flows.
XCO generated profits of $23M in 2010 and $23M in 2012, which translates into a growth of -39%. This growth surpassed that of the operating cash flow. This implies that earnings could have been created by inventory anomalies.

Total Liabilities to Total Assets Ratio
This metric is used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.
Over the past 3 years, EXCO Resources Inc has acquired more total liabilities than total assets. This indicates that the company has been financing its assets through debt, which is - sometimes- not a good signal. Over this time period, EXCO Resources Inc's total assets increased by $-1.153 billion, while the total liabilities increased by $237 million. It is always advisable to keep look at how a company finances its growth and check if that strategy is conservative.

Working Capital
Working Capital is a measure of both a company's efficiency and its short-term financial health. This ratio indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative W/C (working capital), while anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient.
In order to appreciate a company's working capital structure, we need to analyze its current ratio growth. XCO's current ratio has decreased from 1.82 in 2010 to 1.52 in 2012. This shows that the company's balance sheet was stronger in the past.

Gross Margin: Gross Income/Sales

The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor what percentage of revenue/sales is left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors -and overall industry- is more efficient. Investors tend to pay more for businesses that offer higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).
Over the past three years, the gross margin has decreased. The ratio shrank from 68.4% in 2010 to 62.0% in 2012. A decreasing margin indicates that the company has been becoming slightly less efficient year-after-year.

Asset Turnover
Asset turnover measures a firm's efficiency in using its assets to generate sales or revenue - the higher the number the better. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover, while those with high profit margins have low asset turnover.
The fact that the revenue growth has outpaced the assets growth (-4.96%) on a percentage basis, indicates that the company is making money on its assets.

Institutional Sponsorship
It is important to check which hedge funds bought the stock in the last quarter and at what price they did so. I assume that if a prominent institutional investor put money into EXCO Resources Inc, the stock will pass strict fundamental standards.
Prominent investors John Keeley and Prem Watsa bought the stock in the past quarter at an average price of $7.85-$7.90. As detailed in my blog, I believe that it is important to track hedge funds' purchases and sales in recent quarters.

Analyst Outlook

Currently, many analysts have a good outlook for EXCO Resources Inc. Analysts at MSN money are predicting that EXCO Resources Inc will retrieve EPS of $0.34 for FY 2013 and EPS of $0.21 for FY 2014. Analysts at Bloomberg are estimating EXCO Resources Inc's revenue to reach $663.71M million for FY 2013 and $745.49M million for FY 2014.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.