Performance and Valuation Prime™ Chart
The PVP chart above reflects the real, economic performance and valuation measures of Ferrellgas Partners, L.P. (NYSE:FGP) after making many major adjustments to the as-reported financials. The four panels explain the company's corporate performance and valuation levels over the past 10 years plus best estimates for forecast years based on quarterly financials and consensus estimates.
The apostrophe after ROA', Asset', V/A', and V/E' is the symbol for "prime" which means "adjusted." These calculations have been modified with comprehensive adjustments to remove as-reported earnings, asset, liability, and cash flow statement inconsistencies and distortions. To better understand the PVP chart and the following discussion, please refer to our guide here.
The problem with Generally Accepted Accounting Principles (GAAP) is that they create inconsistencies when comparing one company to another, and when comparing a company to itself from year to year. By making adjustments, we aim to remove the financial statement distortions and miscategorizations of GAAP. Some of these can be automated through consistently applied formulas; however, many must be made manually. Manual adjustments that cannot be automated include mergers and acquisitions accounting, special charges, business impairments, and others. The practice of creating consistent, apples-to-apples comparable measures of financial performance is often considered either tedious or overly complex by even seasoned financial analysts.
Under GAAP, the as-reported financial statements and financial ratios of FGP do not reflect economic reality. The traditional ROA computation understates the company's profitability by incorrectly including certain items. The distortion of both profitability measures and valuation metrics of FGP are primarily driven by the inclusion of the firm's goodwill ($479mn), which inflates the firm's asset base, and by incorrectly expensing stock option payments ($51mn) and operating leases ($45mn), rather than treating them as part of the company's investments.
After adjusting for similar issues and a host of other GAAP-based miscategorizations, Valens calculates FGP's Adjusted Return on Assets as 9% in 2015. In contrast, most financial databases show a traditional ROA of only 5%. Additionally, our analysis shows that FGP has an Adjusted Forward P/E of 18.4x, compared to the firm's traditional forward P/E of 27.3x. The profitability of FGP's operations and their equity's true value are therefore not what traditional metrics originally indicate.
Adjusted Return on Assets - ROA'
The top panel of the chart shows the firm's Adjusted ROA (a.k.a. ROA', or ROA Prime). This measure is comparable from year to year and across peers as it "cleans up" the aforementioned GAAP accounting issues to provide consistent analysis.
Ferrellgas Partners' Adjusted ROA was 9% in 2015. This is not only greater than the U.S. average cost of capital, it is also almost twice that of the traditional 5% ROA being reported for the firm. The spread between FGP's Adjusted ROA and its traditional ROA is driven by an understatement in the company's Adjusted Earnings From Operations (the numerator, Earnings'), and an overstatement of their Adjusted Total Operating Assets (the denominator, Asset').
Earnings are understated because the traditional calculation of net income does not recognize operating leases ($45mn) as part of the company's operating investments, and incorrectly deducts stock option expenses ($51mn). The incorrect deduction of these items makes it near-impossible to objectively compare the firm to its peers and even to its own historical performance. Our adjustments resolve the accounting issues between the expensing and capitalization of certain expenses.
Furthermore, by adjusting for the firm's goodwill of $479mn, the returns earned by FGP through its operations can be identified. This adjustment provides better investment analysis because it separates the firm's profitability into: 1) organic Adjusted ROA, which indicates how well management executes the business, and 2) acquisitive Adjusted ROA, which shows how well management does when they acquire a business.
With everything considered, FGP appears far more profitable than what traditional metrics suggest. That is a major difference in context and concept for evaluating the firm's situation.
Growth in Adjusted Business Assets - A'
In the second panel of the chart, Asset' growth stands for "Asset Prime Growth" (or Adjusted Asset Growth) and is the real annual growth rate of the cleaned-up and properly adjusted asset base of the company. This metric shows the management team's propensity to reinvest or divest over time. When viewed in context of the Adjusted ROA, the growth rate explains a lot about management's intended strategies and even performance incentives.
Historically, FGP has seen limited-to-no Adjusted Asset growth. However, FGP's Adjusted Asset base grew by 42% in 2015 as a result of their acquisition of Bridger Logistics, LLC for $839mn, which will contribute to the buildout of FGP's midstream crude operations.
Valuation Relative to Adjusted Assets - V/A'
The third panel shows the Adjusted Value to Assets ratio (V/A'), a "cleaned-up" Price-to-Book metric that compares the Adjusted Enterprise Value (V') of the company to its Adjusted Asset level (A'). The Adjusted Enterprise Value is the market capitalization of the company plus the total debt of the company, including off-balance sheet debt, and less excess cash (or non-operating cash balances). Meanwhile, the Adjusted Asset level reflects the total operating assets of the firm, necessarily adjusted for problematic accounting standards for reporting of the balance sheet. The Adjusted Asset level is the same as the denominator of the Adjusted Return on Assets calculation and the Adjusted Asset growth panel.
FGP is trading at the low end of historical valuations relative to asset values with an Adjusted Value to Assets ratio of 1.9x. Moreover, it is much lower than the firm's traditional 14.7x P/B.
The classic P/B figure is distorted because the traditional calculation utilizes the firm's book equity value as the denominator, as opposed to the total operating assets of the company. By dividing the company's Adjusted Enterprise Value by the company's net operating assets (as opposed to the book equity value), Valens' Adjusted Value to Assets (V/A') metric is able to provide a more comprehensive view of the company's true valuation.
However, even though traditional metrics are overstating the firm's valuation relative to assets, this does not necessarily imply that FGP is cheap. Considering that the firm's Adjusted ROA of 9% actually warrants a V/A' closer to 1.4x, the firm's equity may still be overvalued relative to its assets.
Valuation Relative to Adjusted Earnings - V/E'
In the fourth panel, we have another perspective of valuation to help triangulate the market's embedded expectations for company performance. We always want to know what is "priced in" to the stock price. In this case, Valens evaluates the Adjusted Enterprise Value (V') of the firm relative to their expected Adjusted Earnings (E') for the next year. Adjusted Earnings are earnings resulting from the company's core business operations, regardless of how it is financed, and adjusted to its current dollar value. This is adjusted to eliminate accounting distortions and shenanigans, and to enhance comparability across different companies, industries and geographies, to determine potential mispricings. The Adjusted Enterprise Value (V') numerator is the same as that in the Adjusted Value to Assets ratio.
FGP's as-reported forward P/E is at 27.3x, making their equity appear overvalued by the market. However, our analysis finds that FGP is trading at the middle of historical valuations with an Adjusted Value to Earnings ratio of 18.4x. The traditional P/E calculation distorts equity valuation because of the aforementioned understatement of the firm's true profitability. FGP's stock may therefore not be as expensive as markets perceive.
As-reported financial statement information and financial ratios, which make up most of the publicly available financial databases, do not consider the extent to which distortions, miscategorizations, and misclassifications cause as-reported financial statements to depart from economic reality. Even the venerable "statement of cash flaws" - pun intended - is horribly distorted, as many items in the statement of cash flows are actually non-cash related. What is deemed cash flow from operations, investing, and financing activities are inconsistently booked from company to company and even just from year-to-year at an individual company. The distortions are material and directionally changing, and the mis-measurements that result are decision-changing issues.
A far better picture of the economic reality of Ferrellgas Partners, L.P. can be seen once those distortions are removed. The firm is generating returns almost twice what most financial databases report, and is actually generating returns above the cost of capital. However, adjusted valuations relative to assets indicate that FGP's stock may already be slightly overvalued by the market. That said, while FGP's stock may be slightly overvalued in terms of its assets, it is not as expensive as markets perceive. With that context of corporate performance and market valuation, we have a far better means for evaluating FGP's stock price prospects.
Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article along with the lead analyst, Joana Halcon. Professor Litman is regarded around the world for his expertise in forensic accounting and "forensic fundamental" analysis, particularly in corporate performance and valuation.
Disclosure: I/we 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.