A. Schulman: Cashless Profits

A. Schulman (SHLM) is a supplier of plastic compounds and resins used in a variety of consumer, industrial, automotive and packaging applications.

Market cap: $630 million; Enterprise Value: $750 million

Next earnings date: Tomorrow morning, Wednesday July 2.

The company is estimated to earn $1.40 per share (pro-forma) this year (FY ending Aug ’08). At around $23, the stock doesn’t look expensive at 16x ’08 EPS. However, the earnings estimate looks high, considering the company earned only $0.82 per share last year. The company makes liberal use of pro-forma accounting. Last quarter, it converted a $0.13 EPS loss to a $0.29 EPS profit by excluding restructuring expenses, asset impairment, goodwill impairment, termination of an aircraft lease, CEO transition costs and other employee termination costs. Trailing twelve month free cash flow is negative, with substantial increases in accounts receivable and inventory. In spite of this, the company has been buying back stock by taking on more debt.

From a fundamental point of view, the continuing economic weakness in the global economy (particularly the automotive sector) could pressure revenues. The company’s raw materials are primarily petroleum based, so the recent increase in crude oil prices is a negative. The company is instituting some price increases, but these are unlikely to fully compensate for input cost increases.

The company’s guidance is for net income to exceed $36 million this FY, which translates to EPS exceeding $1.30. However, the company has qualified this with “unless global economic conditions become worse than anticipated”, which they certainly have since the company reported earnings three months ago. It is possible the company will still meet this target with deft use of pro-forma accounting involving liberal exclusions of expenses. However, cash generation is likely to continue on its downward trend.

Fair value for SHLM stock: $17 (12x multiple on FY08 adjusted EPS of $1.40).

Disclosure: Author has a short position in SHLM

Comments

[Jarret:]

Good call Ranjit. I will be keeping my eye on your future articles

Do you have any others coming up that you are bearish on.

2008 Jul 02 07:22 PM

[SinghisKing:]

Well said Ranjit but the beat earnings and outlook was negative and the stock is creeping up now. Are you short long term, or short like few days from ur post

2008 Jul 03 04:29 PM

[Ranjit Thomas:]

Thanks for your comments. I did write a follow up piece, where I said I could no longer recommend a short position after the stock came down post-earnings. I will periodically be writing about stocks I am bearish (or bullish) on. You can watch the space under my bio for new articles.

2008 Jul 07 06:05 PM