When Titan Machinery (NASDAQ:TITN) released its fiscal 2014 year end results on April 10, 2014, it forecasted or provided guidance for its operating cash flow. Titan stated that it was going to generate $60 million to $80 million in positive non GAAP operating cash flow for its current fiscal year ending January 31, 2015. It further stated that the method it would utilize for the company to generate positive operating cash flow, which would be the first time in six fiscal years, was the liquidation or reduction of its equipment inventories. Under Titan's inventories reduction guidance. total inventories would decline by $250 million from $1.08 billion as of January 31, 2014 to $758 million by January 31, 2015.
We are highly confident that Titan's reduction in its inventories to $758 million will result in a decline in the company's revenue and profits for fiscal 2016 as compared to fiscal 2015. Fiscal 2016 could potentially become the second consecutive year that Titan's revenues decline. Based on the guidance that Titan has already given, it will depart fiscal 2015 by reporting its first annual revenue decline since it's been a public company.
Those who are invested in Titan's shares are having a great time at the grand party that started as soon as its management concluded their conference call. During the call, which included a 23 page presentation, Titan's management provided details and highlights for its fiscal 2014 earnings report. It also provided guidance for fiscal 2015.
Great parties tend to end with a serious hangover. Expect one with Titan. As Titan moves through fiscal 2015, research analysts will need to begin to update their projections for its next fiscal year (2016) which begins on February 1, 2015. After the analysts and Titan's institutional investors begin to do their homework, we have no doubt that they will come to the same conclusion that we have come to. Doubts as to whether or not Titan can continue to be a growth company or even meet its EPS projections for 2015 will begin to surface. During 2013, Titan's management lowered it EPS guidance for its 2014 fiscal year three consecutive times.
Titan Machinery's EPS Guidance
for Fiscal Year (FY) January 31, 2014
There was one highlight at the bottom of page 19 of Titan's 23 page Q4 2014 Earnings Presentation that raised our eyebrows which Titan's management provided to the analysts and investors who attended its April 10th conference call. It was that the company had "$410.7 million available on $1.2 billion floor plan lines of credit". On November 14, 2013, Titan's Credit Agreement with Wells Fargo had been amended. Under the amended terms and conditions Titan's Net Leverage Ratio (Total Liabilities/Tangible Equity) was permitted to be a maximum of 3.5 for any fiscal period on or after January 31, 2014.
According to the Balance Sheet data published by Titan for its April 10th press release, its Total Liabilities were $1.15 billion on January 31, 2014. Titan's permitted Total Liabilities under the Credit Agreement that was amended on November 14, 2013 was $1.31 billion. Thus, the maximum net amount that Titan could have increased its Total Liabilities by, as of January 31st, was $160 million. Titan could only have used $160 million of the $410.7 million portion of its floor plan that it had represented as being available. The difference between the two amounts is $250.7 million.
On April 3, 2014, which was one week before Titan announced its fiscal 2014 earnings; the company's Credit Agreement with Wells Fargo was again amended. Under the most recent amendment, the company's Consolidated Net Leverage Ratio was decreased from 3.5 to 3.25 for quarters ending July 31st and October 31st 2014 and to 3.0 by January 31, 2015. The Total Liabilities permitted under the amended terms was $1.22 billion for Titan's 2nd and 3rd fiscal 2015 quarters and $1.12 billion for its 4th quarter and fiscal year ending on January 31, 2015. These amounts assume no change in Titan's tangible book value. Titan has already announced that it would take a $4.2 million pre-tax charge or loss associated with the company's realignment in its first quarter of fiscal 2015. Unless it reports a corresponding profit from its operations, its tangible book value would decline by $4.2 million.
Based on the recently amended Wells Fargo Credit Agreement, Titan's Total Liabilities for its fiscal quarters ending July 31st and October 31st 2014 can only increase by $70 million as compared to what its Total Liabilities were on January 31, 2014. For Titan to get down to its Total Liabilities permitted by Wells Fargo by January 31, 2015, its Total Liabilities will have to decline by $30 million from the $1.15 billion of Total Liabilities that it had on January 31, 2014.
It's obvious that Titan's decision to reduce its inventories was driven by Wells Fargo's steadily lowering of its Consolidated Net Leverage Ratio from 3.75 in October of 2013 to 3.0 in January of 2015. However, we believe that Titan's reduction in its inventories by $250 million to $758 million by January 31, 2014, is an overreaction.
A reduction in the company's inventories by 25% could potentially cause serious ramifications and repercussions for Titan for two reasons. The first reason is that there exists a historical correlation between Titan's revenue and its Inventories Growth Rates. The table below illustrates and compares the growth rates of Titan's inventories and revenue for its fiscal years 2010 through 2014. The decline in the growth rate of its inventories for 2014 to 8.5% from 24.2% resulted in a sharp decline in its revenue growth rate to 1.3% from 32.5%. The probability is high that a 25% decline in the company's inventories in fiscal 2015 will result in a greater decline for revenue than forecasted by Titan Machinery for fiscal 2015.
Growth Rates for Titan Machinery's Inventory
and Revenue for Fiscal Years 2010 through 2014
The second reason is that Titan's Revenue/Inventories Ratio has ranged between 2.06 and 2.53 over its past five fiscal 2010-2014 years. See table below. The decline in its inventories to $758 million from $1.08 billion by January 31, 2015 makes it highly probable that Titan's revenue for its fiscal year beginning February 1, 2016 will be lower than its revenue for its current fiscal year.
Titan Machinery's Revenue/Inventories
Ratios, Fiscal Years 2010 through 2014
Titan's historical Revenue/Inventories ratios and meeting of its goal to reduce inventories to $758 million by January 31, 2015 makes it easy for even a novice to project Titan's minimum and maximum revenue for fiscal 2016. It computes to $1.56 billion of revenue for Titan at the low end and $1.91 billion at the high end. The top end number for 2016 is below Titan's low end revenue number of $1.95 billion for fiscal 2015.
We do not believe that a potential decline in Titan's revenue for successive years has been discounted especially given the recent run up of its share price. It would be very difficult for most companies to increase revenue while significantly decreasing inventories.
As soon as the stock market begins to price in or to discount the increasing probability that Titan Machinery will have lower revenue in fiscal 2016 as compared to fiscal 2015, its share price will begin to erode. Titan could begin to be perceived by investors as a cyclical tractor dealership instead of a growth company. Its shares have the potential to be priced at a single digit price to earnings (PE) multiple or ratio. Based on Titan's minimum non GAAP earning per share projection of $.70 and maximum of $1.00, and its history of guiding forecasts down during prior fiscal years, we are projecting that its share price will be trading below $10 by the end of 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. I have no business relationship with any company whose stock is mentioned in this article.