Missed 1q14 EPS
TAL International (TAL) reported adjusted EPS of $0.92 per share for the first quarter of 2014, missing estimates by 4c. This is the third quarter in a row that TAL has missed consensus estimates, which were already revised lower.
Street analysts don't seem to "get" that something has changed. For example, consensus estimates for FY2013 adjusted EPS were approximately $4.65 per share going into the year -- TAL actually reported $4.15 per share.
A year ago, consensus estimates for FY2014 were approximately $4.80. Today, they stand at approximately $4.05, which I believe remains far too high.
Implicit EPS Guidance Below Street Estimates for 2q14
In TAL's press release, it also said "we expect our Adjusted pretax income to increase slightly from the first quarter to the second".
What does TAL mean by "increase slightly"? Let's check what it meant in the past...
Overall, we expect our pretax income will hold steady or increase slightly from the second quarter of 2013 to the third.
- 2q13 Adjusted Pretax Income: $55,942
- 3q13 Adjusted Pretax Income: $53,776 (-$2,166, whoops!)
As a result, we expect our Adjusted pre-tax income to decrease slightly from the third quarter of 2013 to the fourth quarter.
- 3q13 Adj. Pretax Income: $53,776
- 4q13 Adj. Pretax Income: $51,459 (-$2,317)
As a result, we expect our adjusted pre-tax income to decrease from the fourth quarter of 2013 to the first quarter of 2014.
- 4q13 Adj. Pretax Income: $51,459
- 1q14 Adj. Pretax Income: $47,544 (-$3,915)
So when TAL said "slightly", it either missed expectations or meant approximately $2 million. When it removed the "slightly", it meant closer to $4 million. Consensus estimates are $1.00 per share for 2q14, which would require a $4.5 million increase (35% tax rate, 33.776 million shares). Apparently, sell-side analysts are not taking TAL's hint (it's ugly out there!).
Dividend Increases Halted - First Step Towards Dividend Cut
For the first time in over two years, TAL did not increase its dividend. I believe this is the first step towards a dividend cut. Recall, I suggested in "Trouble Ahead For TAL" that the company would have to raise equity or cut its dividend if it was going to meet earnings expectations.
I continue to believe this is the case, particularly because of TAL's massive deferred tax liability ($371.6 million), which requires continuous growth of its container fleet. This is especially the case since TAL's earnings are falling, resulting in less cash flow to fund the required growth.
Additionally, the growth rate of TAL's Gross PP&E has slowed to 6.4% -- the lowest since the recession ended. During the recession, TAL's gross PP&E actually fell y/y by as much as 6%. Interestingly, TAL's argument that it won't have to pay cash taxes for several years never contemplates a decline in gross PP&E or a lack of growth for more than three years. Perhaps this is because the cash tax payments would start much sooner and be much larger.
Further Deterioration of Lease Rates
Based on TAL's comments, market lease rates fell 5-10% in the first three months of the year (from 10-15% below TAL's average lease rate to 20%). This only bolsters my confidence that earnings will disappoint and the dividend will have to be cut unless the company issues equity.
In addition to the pressure on disposal prices, market lease rates have been under pressure. At year end, we estimate that the current market lease rate a roughly 10% to 15% below our portfolio average reflecting low newbuild prices, widely available debt financing and aggressive competition.
(Note: this is what I said on January 6, 2014 before the company acknowledged the risk publicly or analysts spoke to the issue)
At March 31, we estimate that the current market lease rates are roughly 20% below our portfolio average, but the gap is even higher for our 2010 and 2011 vintage units reflecting the high prices of new containers purchased in those years.
Additionally, TAL said its average per diem rate fell approximately 4%.
The 5.2% growth in leasing revenue was driven by our ongoing fleet growth partially offset by a small reduction in utilization and an approximate 4% reduction in average per diem rates.
If average rates are falling 4% now, just think how significantly they will be falling when the even higher lease rates from the 2010 and 2011 vintages start re-setting in a more meaningful way beginning in 2015...
2015 & Beyond Looks Even Worse
While estimates are too high and lease rates are falling for 2014, the problem only grows in future years, as the company has acknowledged. Sell-side analysts suggest the market will recover by then, but this reflects a "head in the sand" approach to forecasting in light of the deterioration in lease rates during the first quarter.
With market lease rates 20% below TAL's portfolio average, the total headwind over the next few years is approximately $115.4m (annualized 1q14 leasing revenues * 20%) to lease revenues which have zero marginal costs. Therefore, the decline in adjusted pretax income will be the same -- 61% ($115.4m / $190.2m, $190.2m = annualized 1q14 adjusted pretax income)!!
The sell-side seems to be holding on to hope in spite of the reality that is clear from TAL's disclosures, which seem to have validated essentially all of my concerns.
With the P/E towards the high end of the company's historical range using consensus estimates that I believe are too high, I believe TAL continues to be a risky investment, and my price target remains $18.
Disclosure: I am short TAL. 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.