Sirius XM: Does EPS Matter?

Aug.13.14 | About: Sirius XM (SIRI)

Summary

EPS is the metric by which many companies are judged at first glance.

Sirius XM has posted flat earnings per share recently, and should continue to do so for some time.

To the informed long term investor, this should not be a concern. Focus elsewhere.

When choosing an investment, individuals often flip through various metrics surrounding the companies that they are considering. What's the metric you most often hear mentioned when companies are discussed? If you answered 'earnings per share' or 'EPS' then I would say you are correct. But is this metric always a good measure of company performance? Does it always represent the capabilities of the company? Does it always accurately represent the big picture?

No.

Likewise, the P/E metric or price to earnings ratio, which is directly related to EPS, does not always accurately represent whether or not a stock is fairly valued. Address a room full of veteran, successful investors, and ask them how many give strong consideration to P/E or simply EPS and the silence will be deafening. Address a room of newbies to the market? The one guy that doesn't raise his hand just graduated and can head to the other room.

The truth here is that production of and growth in EPS is not always the best focus for a company to take. Are straight earnings important? Sure they are. But in some cases they are not as important as other things that are more deserving of the company's attention.

And that leads me into Sirius XM (NASDAQ:SIRI). A quick glance at the company shows that Sirius XM has a TTM P/E of 60 and EPS, other than when the company booked all of its NOLs, varying between a 0.01 and 0.02 tracing all the way back to late 2010.

Is the company really not doing any better than it was in 2010? When one looks at the 10Q, and it appears that earnings are relatively flat quarter over quarter or year over year, is this a concern? It could be, but it might not be, and that's why investors need to dig deeper into the 'why?' behind the numbers.

What is one of the reasons Sirius XM has posted flat earnings recently? Why will this likely continue going forward?

Interest expense.

With Sirius XM buying back shares at a significant rate, it continues to take on debt to finance the large scale share repurchase program it has set into motion. Buying back large percentages of the float costs a lot of money, and Sirius XM has taken on debt in order to finance part of the buybacks. This is most definitely slated to continue as Sirius XM will need to take on more debt to finance what is now a $6 billion authorization.

Is it a concern, though? Not really. There are a few things to consider here when looking at the drag on earnings that interest represents.

First, consider the rates that Sirius XM has borrowed at recently. The company has refinanced very high interest debt with very low interest debt that falls between 4% and 6% rates. On top of this it has borrowed significant amounts in the same range in order to fund its ongoing share repurchase program. It's reasonable to expect that the next debt offering will be on the higher end of the scale closer to 6%, because as the company increases leverage the cost on that debt also increases.

Because the company is using this debt to repurchase and retire shares, then it is using this debt to purchase an asset that it expects to appreciate in the future. It does drag on EPS as interest is deducted as an expense. But if one assumes the company will perform well and appreciate over the duration of the loan in excess of the cost of that loan, then it is a good long term move. With historically low debt costs today, it almost becomes a no brainer for Sirius XM to take on more debt to buy back more shares as quickly as possible.

It should also be considered that a debt cost of, say, 5%, does not actually translate into the same cost for the company. Interest is deductible, and if we assume a 40% tax rate on earnings for example purposes, the effective rate on the debt becomes only 3%.

Do you expect Sirius XM to appreciate at a rate greater than 3% per year over the longer term? Consider from $3.40 per share, only 3% appreciation would mean a 10 year target of $4.57. There are 1 year price targets currently higher than that by more than one analyst.

The interest drag on EPS, while it may appear concerning on the surface, actually makes sense from a long term perspective. Rapid reduction in shares coupled with historically low, and deductible, interest rates, are where the story currently lies. The company is not building cash to issue dividends.

Someone simply looking at EPS would pass Sirius XM over. 60 P/E? Flat EPS for years? Forget it. Similarly, those modeling Sirius XM's EPS and not taking into account the rapid pace of buybacks at present will overshoot on EPS and the company will underperform on estimates. If one chooses to look simply at EPS or EPS trends, I am of the opinion that they will repeatedly find themselves disappointed.

Truth be told, the less Sirius XM posts in earnings (to a point) the more it makes sense given majority holder Liberty Media's (NASDAQ:LMCA) attitude which is often stated as 'Liberty hates to pay taxes' or more simply 'John Malone hates to pay taxes.' Taking a deduction for an already low interest cost associated with increasing one's stake in the company? Sign me up.

Will a day come that EPS matters to Sirius XM? Perhaps. Investors should want debt to remain serviceable which means that debt cost will never exceed Sirius XM's ability to repay that debt, and that may mean that as time goes on and share count is reduced, that EPS begins to rise.

But I don't expect that to happen in the near term, and like I said above, I really don't care. What is important to me, now, is that Sirius XM takes advantage of low debt costs, and what is in my opinion a low share price, and buys back and retires as many shares as possible.

Another 'benefit' to lower earnings? Consider that in 2012 Sirius XM booked all operating losses or NOL's and currently any posted taxes come out of this amount which is now an asset on the books. This was the reason Sirius XM posted 0.48 EPS in Q3 of 2012. This tax benefit is finite and will run out over time, and the less that is subtracted from this benefit in the form of earnings each quarter, then the longer Sirius XM can go without paying income tax. Handled correctly Sirius XM may not pay taxes for the next 3 to 5 years or even more.

So does EPS matter? In some ways it does but it's only a first step. One should understand what goes into EPS, and the topics touched upon here only go into a single aspect. In a vacuum, EPS carries little to no weight as does the P/E metric which is based on it. First glance? New investors? These metrics may keep them away, scare them out, or cause some whisperings of misinformation. This can affect share price movement in the short term but over the longer term the 'real' story will play out.

If you are basing your expectations of Sirius XM on what you feel should be represented in an improving EPS metric, I think you will be sorely disappointed in the near term due to the interest expense drag associated with the buyback. Time will eventually change this, and investors need to look deeper to understand how the numbers work together to eventually produce exceptional returns. For those who are looking for the next quick flip or absolutely have to match or beat the market at all times, it may be best to look elsewhere.

Disclosure: The author is long SIRI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long SIRI January 2015 $2.50, $3 and $3.50 calls. I am long SIRI Aug 16th $3.50 calls.