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Jason Merriam is author and developer of the innovative Merriam Report www.merriamreport.com providing unique financial analysis based on the "dual-cash flow" methodology. An active investor for 35 years, he is also founder and president of Merriam Investor Services since 1990. MIS... More
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  • Q3 Earnings Quality: Dual Cash-Flow and Accrual Evaluation 0 comments
    Oct 10, 2009 09:17 PM | about stocks: LNN, RIMM, IBM, WEN, DLX, THS, ATI, VAR, AAPL, EK
    As earnings season begins in earnest we expect to see a wide variety of hits and misses. Alcoa, one of the biggies, got the show rolling with a “beat” on their Q3 numbers. 
     
    However, CEO Klaus Kleinfeld made it clear that cost-cutting and other actions contributed heavily to cash positions and profits. In addition, the company cited improved aluminum demand by the auto makers.
     
    But, in the aftermath of cash-for-clunkers, we expect carmakers will be very careful with inventory build-up going forward.
     
    While we are not surprised Alcoa topped the consensus estimates, there was nothing really to get excited about. Rather, it plays into our continuing “macro” concern that cost-cutting and not revenue growth is what props up the bottom-line.
     
    Our dual cash-flow and accrual screens turned-up some interesting names in anticipation of Q3 earnings season. The list below is a mixed bag of earnings quality, industries and market caps, but we believe there is ample opportunity to make some money (or avoid trouble) if you keep an eye on the financial statements.
     
    Lindsay Corp.
    LNN
    Irrigation & Infrastructure Products
     
     
    Research In Motion
    RIMM
    Communication Devices
     
     
    International Business Machines
    IBM
    Computer Hardware and Services
     
     
    Wendy’s / Arby’s Group
    WEN
    Fast Food Restaurants
     
     
    Deluxe Corp.
    DLX
    Business Services
     
     
    Treehouse Foods
    THS
    Branded and Private Label Foods
     
     
    Allegheny Technologies
    ATI
    Industrial Metals
     
     
    Varian Medical Systems
    VAR
    Medical Equipment
     
     
    Apple Computer
    AAPL
    Computers and Devices
     
     
    Eastman Kodak
    EK
    Imaging and Digital Products
     
     
    More information on these companies can be found at our website
     
    Lindsay Corp.’s fortunes are tied largely to farm income. Some analysts have been bearish on agricultural net income, hence a similar negative view of farm equipment makers. Yet, Lindsay produces healthy operating cash-flow and management doesn’t rely heavily on non-cash accounting tricks to make their numbers.
     
    Research in Motion also produces quality operating cash-flows and we note use of balance sheet maneuvers have slowed in recent quarters. In contrast, rival Apple displays very high use of both accrual accounting and balance-sheet cash-flows in making their numbers. 
     
    Several companies on our list appear to be experiencing what we’d call “transitional” changes in earnings quality. IBM for example displays very thin spreads between operating cash and balance-sheet cash-flows. In addition, Goodwill levels (as % of stockholder equity, are over 100%). IBM is a great company, but at current prices, any good news is already priced in. 
     
    Management at fast-food chain Wendy’s / Arby’s appear to be turning the enterprise around, but they have more work to do. Although operating cash-flows are negative, the trend is improving in recent periods. The stock is cheap at $4-5, but income investors might want to look at their longer maturing bonds selling under par and dishing up tasty risk appropriate yields.
     
    Industrial metals firm Allegheny Technologies displays accelerating balance-sheet cash-flows, higher use of accrual accounting and deteriorating capital productivity. As for Kodak, the grind of restructuring drags on. Today’s Kodak bears no resemblance to the good ‘ol days of traditional film photography or the fat margins that came with it.         
     
    Disclosure: None
    Stocks: LNN, RIMM, IBM, WEN, DLX, THS, ATI, VAR, AAPL, EK
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