IPO Analysis: Goodman Global (GGL)

| About: Goodman Global (GGL)

Story: Not our usual cup of tea (we usually like to have some insight into the growth prospects of a sector), Goodman Global Inc. makes HVAC (heating, ventilation, air conditioning) equipment marketed under the Goodman and Amana brand names.

We generally don't pay too much attention to industrial type companies as they are often slow growth and low margin in competitive industries, but GGL just came public (11Apr06), priced at the upper end of its expected range ($16-$18), and opened up on a very big deal ($423M). So somebody thinks they are worth a look, and because of that we'll do a quick scan of their numbers.

Company: They just issued Q1 2006 numbers. They had loses in Q1 2005 due to a non-recurring charge, without which they had nominal profits ($3.4M), and profits for Q1 2006 ($8.4M). Revenue increased 29% Y/Y ($381M/$296M). Costs of goods sold was 91% of revenue in 2005 ($268M/$296M), but only 77% in 2006 ($295M/$381M 2006).

All they do is build stuff, and the only thing in "costs of goods sold" is the prices they pay for the stuff that goes into the stuff that they build, so one wouldn't normally expect there to be much change in their gross margins, but a shift from 9% to 23% Y/Y is dramatic. It indicates that they must have found a new parts supplier -- or requires some other, clear explanation. Otherwise we would consider it a red-flag for mysterious book-keeping. But they plausibly explain it as due to a federally mandated shift to higher efficiency products (the 13 SEER minimum efficiency level, effective from 23 Jan 2006 forward) which are higher margin. So the new margins are probably sustainable going forward.

But then they explain that the 2005 "cost of goods sold" number has $39.6M in non-recurring charges and a $2M gain on commodity derivatives, and backing those out their 2005 margin would have been 78% ($268M-$39.6M+$2M/$296M). They claim their new margin is a 0.3% improvement over their old margin, but we find it 1% worse due to rounding errors. So 1) their margin improvement is a rounding error, and 2) any improvement due to product shifts is irrelevant.

At this point, we do not find their books at all transparent, and the red-flag is back. What are commodity derivatives transactions doing in costs of goods sold? We shouldn't have to read text to figure that out - it should be line-itemed on their P&L statement. They have about a Billion bucks in debt, so interest payments are material for them.

They have "...continued to leverage SG&A." But what they mean by that is 0.6% improvement Y/Y. Boring.

They are an IPO in an industrial area. There is always window dressing prior to an IPO, but industrial companies that have been around for a long time ought to be fairly transparent. Frankly, we don't trust that we can look at their numbers and really see what is going on.

At first blush, their gross margins seemed to have improved, but really they are flat. And at first blush their top line and bottom lines seem also to have improved, but again they are by such large quantities that it is mysterious. They claim 29% top line growth due to increased sales volume and a shift toward higher margin products. We've seen that that latter term is irrelevant, so somehow they managed to sell 29% more air conditioners Y/Y. Wow, that's a huge increase, and seems awfully implausible. But from their annual report, they have had 2001-2005 Y/Y top line growth rates of 5%, 5%, 10%, and 19% ($1.136B/$1.082B, $1.193B/$1.136B, $1.317B/$1.193B, and $1.565B/$1.317B), so maybe it is plausible.

At this point, we still don't see how there could be ca. 30% top line growth for a billion dollar air conditioning company. Maybe we could figure it out if we did a lot more reading (we would have to rule out channel stuffing and look for some international market share growth or other very significant change), but instead we're just going to Pass, despite the...

Stock: ...that has done ok so far: