Eros International: No Positive Signs
Summary
- Eros International Plc. is facing a declining cash flow issue along with growth in operating expenses.
- Intense competition and unattractive movie library are adding to the problems that the company is already facing.
- There are no immediate signs of turnaround from its current fortunes.
Eros International Plc. (EROS) is a Mumbai-based company that specializes in the production and distribution of movies and music. Since its founding in the 1970s, Eros has emerged as a leading entertainment company in India and the wider East Asia region with a library of more than 12,000 titles. Besides distributing its content through conventional methods like theaters, Eros also launched Eros Now, which is an on-demand platform similar to what is offered by Netflix (NFLX) and other rivals. Nevertheless, intense rivalry has seen Eros’ fortunes decline significantly since 2017; five years since the launch of Eros Now. A subsequent evaluation of the company’s key financial metrics thus informs a sell suggestion.
Profit Margin
Figure 1 shows that Eros’ net profit margin has declined sharply from 4.53% recorded in 2017 to 2019’s loss of 151.95%. During this period, the company’s gross profits grew from $88.8 million in 2017 to $114.7 million in 2019. This infers prudent management of direct costs, efforts to market new films, and generate income from Eros’ diverse library. However, Eros recognized a $423.3 million impairment loss in 2019 that was attributed to the economic unviability of its library. This was caused by a change in market conditions, namely intensified competition, and technology. While the impairment loss is an exceptional item, it highlights the conditions to which Eros is subject. Other notable contributors to the company’s loss position include a $23.8 and $4.6 million growth in administrative and finance costs respectively. These indicate a decline in economies of scale where costs rise faster than revenues as an entity expands. They also highlight a growing appetite for debt. These conditions have become worse in the most recent quarter where Eros saw its revenues decline by 39% and net incomes by 687% as shown in Table 1.
Figure 1: Growth drivers
Source: Image created by author using data from SEC filings
Financial Leverage
As stated previously, Eros has shown a growing appetite for debt. This is indicated in Figure 1 where the equity multiplier increased from 152.04% in 2017 to 165.74% in 2019. However, these outcomes are attributed to the reduced role played by equity in the capital structure. Indeed, consequent losses and impairment charges have seen equity decline from $883.5 million in 2017 to $657.0 million in 2019, which is a 26% loss of shareholder value. During the same period, there was a 24% decline in operating cash flows. This further infers the volatile industry in which Eros operates. It also denotes the risks associated with excessive debt as declining operating cash flows mean fewer investments in capital assets that are critical for future growth. Of more immediate consequence is that a threat to operating cash flow makes it difficult or impossible for Eros to meet pressing debt demands. This is indicated in second quarter results where these inflows reduced by 95% amid a further depreciation in equity. This poses certain solvency risk for Eros as it might not have adequate cash to meet its debt contracts.
Asset Turnover
Eros’ management appears to have significantly improved asset efficiency with the asset turnover ratio rising from 18.83% to 24.81% in 2017 and 2019 respectively. It is necessary to note that this improvement was accompanied by a 19% asset impairment over a similar period and was only followed by a 7% increase in revenues. Further analysis shows that Eros has retained nearly the same amount ($10 million) of physical assets. This infers that the company has maintained the same studios, theaters, and similar assets since 2017. In other cases, this would mean that Eros was running a leaner and more efficient operation where fewer assets were used in generating incremental income. However, there is the significant impairment charge and accelerated amortization noted earlier. This infers that one reason behind the apparent asset efficiency is due to the reduced viability of Eros’ library. In turn, this is a cause of concern in the long-term should the company fail to realize adequate revenues from existing assets. This is highlighted in Eros’ second quarter results where asset efficiency declined from 8.44% recorded in 2018 to 7.09% seen in 2019. Further impairments, attributable to rapid technological changes and competitive forces, can be expected to have a sustained negative impact on Eros’ asset efficiency.
Table 1: EROS summary financial performance
2019 | 2018 | 2017 | |
'000 | '000 | '000 | |
Net Income | $ (410,453) | $ (9,745) | $ 11,455 |
Sales | $ 270,126 | $ 261,253 | $ 252,994 |
Assets | $ 1,088,902 | $ 1,410,319 | $ 1,343,365 |
Shareholder' equity | $ 656,985 | $ 1,003,417 | $ 883,548 |
Operating cash flows | $ 74,966 | $ 83,243 | $ 98,993 |
Debt | $ 431,917 | $ 406,902 | $ 459,817 |
Ratios | |||
Profit margin | -151.95% | -3.73% | 4.53% |
Asset turnover | 24.81% | 18.52% | 18.83% |
Equity multiplier | 165.74% | 140.55% | 152.04% |
ROE | -62.48% | -0.97% | 1.30% |
ROA | -37.69% | -0.69% | 0.85% |
2nd quarter ended September 30, | |||
2019 | 2018 | ||
'000 | '000 | ||
Net Income | $ (23,030) | $ 3,926 | |
Sales | $ 75,885 | $ 123,637 | |
Assets | $ 1,070,067 | $ 1,464,216 | |
Shareholder' equity | $ 701,535 | $ 1,055,858 | |
Operating cash flows | $ 817 | $ 16,825 | |
Debt | $ 368,532 | $ 408,358 | |
Ratios | |||
Profit margin | -30.35% | 3.18% | |
Asset turnover | 7.09% | 8.44% | |
Equity multiplier | 152.53% | 138.68% | |
ROE | -3.28% | 0.37% | |
ROA | -2.15% | 0.27% | |
Source: Table created by author using data from quarterly & annual reports
Return on Equity (ROE)
Growth in asset turnover and debt is conventionally associated with higher ROE. Asset turnover infers efficiency and higher revenues, while debt provides additional cash to fund production. However, these potential gains have been wiped out by Eros’ significant decline in profitability as shown in Figure and Table 1. Consequently, the company’s ROE has declined by over 4,900% from 2017’s 1.30% to 2019’s loss of 62.48%. Similarly, Eros has seen its return on assets fall sharply from 0.85% in 2017 to a loss of 37.69% in 2019. This denotes deterioration in shareholder value where equity is diminished and the company is unable to derive any profit from owned assets. This occurs at a time when Eros is facing intense competition with Walt Disney recently launching a similar platform to Eros Now. Netflix and a host of other companies already run popular digital demand platforms at competitive rates. These conditions mean that Eros has to purposefully scale its library and expand Eros Now to other regions. However, it is evident from preceding discussions that the company faces an enormous cash flow challenge and this hampers critical expansion efforts.
Figure 2: ROA and ROE trends
Source: Image created by author using Annual reports
Valuation
Figure 3: Eros' stock price trend
The market’s response to Eros’ financial troubles has been unfavorable. Figure 3 shows that the company has had 72% of its market value wiped out between 2017 and 2019. Additionally, Eros’ EPS has declined from $0.05 in 2017 to -$6 in 2019, which makes the price-earnings ratio irrelevant in making an investment decision. A more suitable tool is the price to book ratio where Eros has an outcome of 0.58. On itself, the low outcome would lead to a buy decision as it means that Eros is undervalued. However, the preceding discussions highlight Eros’ financial and market challenges. These make it difficult for the company to turn a profit even in the medium-term. Taking these other factors into consideration leads to the sell recommendation despite the undervaluation indicated by the price/book ratio.
This article was written by
Analyst’s 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.
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