Do We Have a Goodwill Bubble? Goodwill is an accounting concept that represents the amount an acquiring company pays for a target beyond that target’s identifiable assets.
More technically — goodwill is the premium the acquirer pays for the net assets it buys while acquiring the target. Goodwill might represent the target’s brand reputation among customers, the loyalty and skill of employees, the potential future growth in earnings thanks to those things, and so forth. It’s a proxy for the synergies the acquirer hopes to achieve from the acquisition and use of the target’s assets.
One important point: goodwill only appears on a company’s balance sheet when the company completes an acquisition. You don’t get to record goodwill assets for whatever brand reputation, employee loyalty, and the like that your company might generate naturally.
For the last 20 years, accounting rules have directed companies to record goodwill as an asset on their books and test it annually for impairment. Goodwill also tends to accumulate over time — because companies do more deals, which means more goodwill, added to whatever goodwill you were already carrying.
The practical result: over time, goodwill becomes a more and more significant part of the corporate balance sheet. The only time when goodwill might decrease is when the company decides that, oops, those expected synergies didn’t materialize like we expected, so we need to write off (that is, impair) part of the value.
So how much is goodwill accumulating on corporate balance sheets? We decided to investigate.
To do that, we examined goodwill as a percentage of total assets and of stockholders’ equity (net assets) for both the S&P 500 and all companies. To calculate the percentage, we summed up goodwill for all companies in each group, and then divided that number by the sum of total assets or shareholder equity.
As you can see from the chart below, goodwill represents about 5 to 10 percent of total assets, and 30 to 40 percent of equity. S&P 500 companies have more goodwill on their books, which is understandable because they engage in corporate acquisitions more often.
We can also see that goodwill is increasingly a more significant part of companies’ balance sheets; the lines fluctuate from year to year, but the trend for all four is unmistakably up.
Is this a bubble that may burst?
For all companies collectively, perhaps not. We’d need some widespread, long-term, cataclysmic economic event to trigger massive impairments, and even amid today’s tumultuous circumstances, that seems unlikely.
For specific industries, on the other hand, that’s much more possible. Consider how the pandemic hammered tourism, retail, and hospitality. Or perhaps rising interest rates would trigger an economic squeeze in a sector like real estate.
You get the idea. We might not be in the midst of one massive goodwill bubble, so much as we’re floating along numerous smaller, industry-specific bubbles. Which ones might burst? How much splatter would that generate?
Calcbench itself isn’t sure. But we do have the data to let you conduct your own investigation— and if you find something interesting, you’re always welcome to drop us a line at firstname.lastname@example.org.
(For additional analysis of goodwill, check out a comment letter sent by the CFA institute to the FASB here.)
Calcbench makes it easier for analysts to extract numbers from earnings press-releases. In this post we will focus on the Non-GAAP numbers, those numbers not in the income statement, balance sheet and statement of cash flows.
As an example we will get non-cash compensation expense allocated to research and development for software companies, i.e. stock options awarded to software engineers. This example assumes, that you have a Calcbench account, sign up for a free trial @ calcbench.com/join and have installed the Windows version of the Excel Add-in from calcbench.com/excel.
1. Open the Disclosure Viewer
2. Find the relevant Earnings Press Release in the Disclosure Viewer
3. Click on the piece of data you want. This will insert the formula for the fact
4. Parameterize the period arguments to the inserted formula
5. Add more periods and drag the parameterized formula over.
Non-cash compensation for the software industry is collected @ https://www.dropbox.com/s/8dtcoiea7conkvs/r%26d%20stock%20based%20compensation.xlsx?dl=0.
Faithful readers of the Calcbench blog know that we often talk about the importance of goodwill assets on the balance sheet, and how the potential impairment of goodwill is always something to keep in mind.
Today we have a great example of what we mean: circuit manufacturer Analog Devices ($ADI).
Analog came to our attention because we had been compiling a list of S&P 500 firms whose goodwill assets were a high portion of total assets. Analog placed near the top of that ranking, with $12.26 billion in goodwill against $21.4 billion in total assets — a ratio of 57 percent.
But wait, one of our interns said. Didn’t Analog do a big acquisition a few years ago? How much did goodwill account for that deal?
So we opened our Interactive Disclosures database, and researched what Analog has been reporting for business combinations disclosures. Sure enough, Analog had acquired Linear Technologies in 2016 for $15.7 billion. Buried in the disclosures was the purchase price allocation Analog reported for that deal. We shaded the goodwill item in blue:
So Analog is carrying $12.26 billion in goodwill on the balance sheet — and 86 percent of that amount is tied up in this single deal with Linear. That’s a mighty big bet to place on one acquisition.
Now let’s review quarterly revenue at Analog from the start of 2017 through Q2 2020:
Hmmm. Clearly revenue popped in the middle of 2017 as Linear’s business started showing up on Analog’s financial statements. We even found an old press release from that time where Analog said it expected Linear to add at least $160 million to Q2 revenue for 2017.
Since then, however, the trend has not been impressive. So was the $10.5 billion allocated to goodwill in that deal actually worth it?
It’s not Calcbench’s place to answer that question. We simply provide the data — and in this case, when you review the data, suddenly that question about Linear seems like a fair one to ask.
We also peeked at the balance sheet for Analog Devices. The firm has $8.1 billion in liabilities, and $11.77 billion in shareholder equity. In other words, almost all of Analog’s shareholder equity is tied up in the goodwill from that Linear deal.
That is, if the Linear deal turned out to be a disaster and the company had to impair the whole $10.5 billion, shareholder equity would pretty much evaporate. Yes, such an extreme example is unlikely — but even a more modest impairment would still result in a substantial reduction of equity.
Our point is simply that analysts following Analog need to consider its goodwill balances carefully. That line item is far more consequential to firm value than one might assume at first glance. Hence we obsess over goodwill and impairments all the time around here.
While we’re on the subject, let’s also give a shameless plug for our first-ever Calcbench webinar, happening on Tuesday, Oct. 20 at 12:30 pm ET — where an in-depth look at goodwill and impairment will be the subject. It’s free and will be a great time, so register today!
This blog will outline the importance of and the steps to getting data out of the press releases that Calcbench has been collecting for the past two years.
Corporate press releases are released ahead of the quarterly earnings call that the company has with analysts and investors. The press release has information that won’t necessarily get into the 10-Q / 10-K. For those reasons, it becomes important for users to get this data.
Historically, users only had access to this data by manually collecting the releases and then inserting data (hand keying information) into their spreadsheets/databases.
Today, that has changed.
Using Calcbench, a client can get this data in a few different ways.
First, they can simply view it online. They can collect data from the web by exporting it. Or, they can bypass the web and access this data DIRECTLY through our Excel Add In or the Calcbench API.
See below from the income statement section of Paychex 8-K that came in on the morning of October 6, 2020. Also, note that this information collection process pertains not only to the Income statement but also to the Balance Sheet and the Cash Flow statement. Calcbench also captures tables of data as well, including GAAP to NON-GAAP reconciliation tables.
Visit Calcbench disclosures page and retrieve the 8-K in full or read it online. Or, for more information on our earnigngs press release tools, go to: https://www.calcbench.com/home/earnings_release_data
Well here’s one firm living high on the hog: Conagra Brands ($CAG), which just reported solid quarterly results because people are still stuck eating at home. That sort of thing tends to help one of the largest food businesses around.
Conagra manufactures brands including Slim Jim, Healthy Choice, Duncan Hines, and Reddi Whip. Its largest customers include supermarket retailers Walmart ($WMT) and Kroger ($KR) which account for roughly 33 and 11 percent of sales, respectively.
So what do the numbers tell us? That people are eating — and eating enough to keep Conagra in a strong position, even with all the coronavirus uncertainty otherwise whipping around the economy.
First we looked at Conagra’s segment disclosures, which show a 12 percent increase in quarterly sales from the year-ago period. See Figure 1, below.
Every operating division saw better numbers this year than last, with the exception of foodservice — but that’s the division that sells to restaurants, catering services, and similar commercial customers, so one would expect that division to decline. The rest look good.
OK, that’s clear enough, but one impressive quarter does not a trend make. So we used the Multi-Company database page to study Conagra’s quarterly sales from the start of 2019 through Q3 2020 and compare them year over year. See Figure 2, below.
We can see a definite pop in sales from the second quarter of this year that continued to Conagra’s most recent quarter, which ended on Aug. 30. The pattern makes sense; everyone panicked in the spring and stocked up on food ahead of the corona-pocalypse; and then continued to buy more food over the summer as life reached a semi-stable state. Which still included vast numbers of us eating at home.
Will Conagra’s Q4 2020 show a similar trend? Circle back to the data in three months and see what you find.
But wait! Isn’t it also true that while revenue might be going up, costs are also rising? That’s definitely a thing for many firms. So what’s the scoop for Conagra?
We jumped over to the Interactive Disclosures page and pulled up Conagra’s Management Discussion & Analysis. As one would expect, the firm had a section devoted to pandemic concerns. There, we found this paragraph disclosing both the good and the bad about coronavirus and the company:
During the first quarter of fiscal 2021, our operating margins saw improvement largely due to favorable fixed cost leverage, reduced travel expenses, and lower trade promotional activity on certain brands. That benefit was partially offset by several factors including higher transportation and warehousing costs, temporary plant closures, employee safety and sanitation costs, and employee compensation costs, which accounted for an estimated $34 million of incremental costs in the first quarter.
So there you have it. Yes, the pandemic is pushing Conagra’s costs upward, but revenue is rising even higher. There are worse sandwiches life might force you to eat.
At least one business seems to be motoring along despite the pandemic: Thor Industries ($THO), maker of RVs and related motorhomes, which apparently are more popular these days since nobody is flying.
Thor filed its annual report on Sept. 28, and compared to 2019 the numbers on the income statement all seem respectable. Sales, gross profits, pre-tax income, and net income were all higher for Thor’s fiscal year that ended on July 31.
Meanwhile, the numbers in the footnotes (read the footnotes, people!) tell a somewhat quirky tale that offers plenty of food for thought.
Segment revenue. Yes, total revenue for Thor rose 3.8 percent, from $7.86 billion in 2019 to $8.17 billion this year — but North America sales actually fell, from $6.2 billion to $5.5 billion. Revenue growth came entirely from the European market, where sales soared by $1 billion. See Figure 1, below.
Also interesting to see that while sales rose year-over-year, 2020 sales were still considerably lower than what Thor saw in 2018. Moreover, that growth in Europe revenue comes from the acquisition of a large European RV maker, which Thor acquired in February 2019. So this isn’t a story of an RV firm prevailing over the pandemic; it’s the story of an RV firm trying to regain prior success after an awful prior year.
Dealers and inventory. Thor also tells an interesting story about the inventory of its RVs held by dealers. For example, earlier this spring Thor shut down its manufacturing plants during the pandemic. With no new RVs rolling out of the plants, the inventory dealers had on site then started to fall (because they had no new RVs to replenish old RVs they had sold).
The practical upshot: the backlog of orders for Thor RVs has soared. As the company describes it:
Thor’s North American RV backlog as of July 31, 2020 increased $3,063,316, or 265.9%, to $4,215,319 compared to $1,152,003 as of July 31, 2019… In recent periods, dealer inventory levels have decreased materially based on recent production interruptions from March through May 2020 due to the COVID-19 pandemic, coupled with strong retail demand for RVs given the perceived safety of RV travel during the COVID-19 pandemic, a strong desire to socially distance and the reduction in commercial air travel and cruises.
Thor then goes on to cite rosy predictions for industry sales in 2021. The RV trade association projects unit shipments (that is, wholesale RV sales to dealers) to rise as much as 19.5 percent next year.
So far, so good. Then we noticed…
Repurchase obligations. Along with those shipments and sales to dealers, Thor also extends repurchase agreements for unsold inventory if a dealer goes into default with its bankers.
Hmmm. Now we’re into contingent liability territory.
Thor first mentions that concern in its disclosure of Risk Factors, blandly stating: “We may incur larger-than-average repurchase obligations if there is an increase in the number of financing defaults by our independent dealers.”
Well, what does that mean? How large a potential liability are we talking about?
Thankfully, the disclosures also include a section for contingent liabilities. There, we can see that those liabilities have trended downward over the last year:
The Company’s total commercial commitments under standby repurchase obligations on dealer inventory financing as of July 31, 2020 and July 31, 2019 were $1,876,922 and $2,961,019, respectively. The commitment term is generally up to eighteen months.
Thor goes on to explain that it covers such liabilities by deferring a portion of each sale and stashing that money in a reserve account. As of July 31, 2020, that reserve had $7.7 million, down from $9.5 million the prior year.
So there you have it: a respectable income statement from Thor, but also a much more complex picture once you start digging into the data. Perhaps we’ll send an update as the Calcbench team drives cross-country in our company Airstream.
Calcbench has been taking a deep look at the retail sector lately, and how firms in that line of business have weathered coronavirus and recession. We reviewed the filings of 45 large, well-known retailers to see what they’ve been disclosing, how their financial performance has fared, and more.
For a quick summary of what we reviewed, see below:
Overall, the picture for retailers this year is mixed. Some, such as Apple ($AAPL), Walmart ($WMT), and Lululemon have performed deftly and admirably. Others, less so. We’ll revisit major players in this sector from time to time, especially next spring as annual reports for 2021 start hitting the streets.
Meanwhile, we’re always eager to hear from you about what else we should examine: other sectors to review, or specific disclosure items (supply chain finance, accounts receivable, cash from operations) regardless of industry. Drop us a line at email@example.com any time.
We continue our look at the retail sector today with a dive into one of the most painful facts of life in corporate reporting: impairments.
Nobody likes them; they can ruin net income for the quarter, and in extreme cases can leave the balance sheet reeling. But with coronavirus lockdowns and recession ravaging the retail sector, impairments were inevitable.
How inevitable, exactly? We took a look.
Among the 40+ large retailers we’ve been examining for Retail Week, impairments totaled $2.19 billion for second-quarter 2020.
The good news is that $2.19 billion is actually lower than the $3.54 billion those same firms reported in the first quarter of this year. The bad news… well, take a look at Figure 1, below. That’s what these firms have been reporting for impairments since the start of 2018.
Like, wow. No other quarter in the last two years comes remotely close to what our retail sample reported in the first two quarters of this year. That bump in the middle of 2019? The amount was $469.8 million for all 46 firms we examined, in the second quarter of 2019. Macy’s ($M) and Walgreens Boots Alliance ($WBA) both have declared asset impairments larger than that amount individually this year.
OK, so impairments soared earlier this year. Next question: how much have those impairments hammered the retailers’ balance sheets?
Not that much, thankfully. Total assets for this sample group grew rather nicely over the last 10 quarters, from $1.06 trillion at the start of 2018 to $1.253 trillion in Q2 2020. So even though impairments spiked this year, they still didn’t nick assets to any material degree.
On the other hand, as you can see in Figure 2, below, impairments as a percentage of assets still — soared? Spiked? Shot up? We’re running out of verbs to describe it.
For context, we didn’t even include prior quarters because the percentage was essentially zero.
Individual impairment charges happened in numbers great and small.
For example, Macy’s took a $3.15 billion charge in Q1. Almost all of that ($3.07 billion) was an impairment of goodwill, stemming from the unprecedented disruption of coronavirus. As the company said in its disclosure:
The Company determined the fair value of each of its reporting units using a market approach, an income approach, or a combination of both, where appropriate. Relative to the prior assessment, as part of this current assessment, it was determined that an increase in the discount rate applied in the valuation was required to align with market-based assumptions and company-specific risk. This higher discount rate, in conjunction with revised long-term projections, resulted in lower fair values of the reporting units.
More interesting is the disclosure from Walgreens-Boots Alliance. Yes, the firm did record a $2 billion impairment in Q2, as seen in this table reconciling adjusted net income of $919 million to an actual, GAAP-approved net loss of $1.58 billion.
Except, Walgreens doesn’t give a clear sense of where that number came from. In the Goodwill section of disclosures, it identifies a $1.67 billion impairment in the goodwill of its retail pharmacy brand — but that’s all it says. Nothing further to explain how you get from that $1.67 to the $2 billion actually recorded.
Only when you crack open Management Discussion & Analysis and search “impairment” do you find this meager statement:
In addition, due to the significant impact of COVID-19 on the financial performance of the Retail Pharmacy International division, the company completed a quantitative impairment analysis for goodwill and certain intangibles in Boots UK, which resulted in the recording of non-cash pre-tax impairment charges of $2.0 billion.
Uh, thanks, guys. Glad to see you’re so sparing with electrons to type out that data.
So we look forward to what Q3 will bring the retail sector, and what other trends might emerge as we analyze the many more retail firms that submit Q2 filings over the weeks to come.
We continue our look at the retail sector this week with a review of an important performance metric for this sector: inventory turnover.
Inventory turnover measures how many times a company has sold and restocked inventory during a given period. More simply: it measures how quickly a retailer is moving goods off its shelves. Generally speaking, the higher the number, the better.
Coronavirus has hammered operations for large retailers, with store closures, supply chain disruptions, and a recession that has left millions of consumers with fewer dollars to spend. So we wondered: have those forces shown up in inventory turnover?
We reviewed two years’ worth of quarterly filings among 40 large retailers — from Abercrombie & Fitch ($ANF) to Walmart ($WMT), with lots more high-profile brands in between — to see what we could find.
The short answer is: drawing broad conclusions about the whole sector is messy. Financial analysis will need to do a firm-by-firm review to see what’s really going on.
Figure 1, below, shows average inventory turnover among our 40 sample retailers for Q2 2018 through Q2 2020.
The zig-zag nature of this chart shows how much inventory turnover in the retail industry depends on the specific quarter. For example, inventory turnover is typically higher in calendar Q4 because that’s holiday season, when retailers design their operations to churn out sales as quickly as possible.
What struck us was the low inventory turnover for Q1 2020 — an average of 5.34, and a median of 3.61; compared to 5.54 and 3.99 in Q1 2019. Then note the sharp rebound in Q2 2020, to levels above Q2 2019.
That makes sense; if stores were suddenly closing earlier this year in Q1, sales would stall. Then stores reopened in Q2, and perhaps pent-up demand led to a spike in buying.
Then again, those are just broad averages across 40 firms. When you look at specific retailers to see how inventory turnover has fared this year, a more varied picture emerges. Numerous firms saw their inventory turnover decline from Q1 to Q2, meaning their ability to get goods off the shelves slowed. See Table 1, below.
What’s interesting here is that Apple ($AAPL) and Casey’s General Stores ($CASY) have markedly higher inventory turnover to begin with. For Apple, that probably is a manifestation of the firm’s e-commerce prowess: you can jump online, place an order, and within a few days your iWhatever is at your doorstep. (We wrote about the importance of e-commerce in our previous Retail Week post.)
Casey’s, meanwhile, sells small-dollar items that people need all the time. Perhaps it’s little surprise that other firms with lots of convenience items — CVS Health Corp., Rite Aid, and Walgreens Boots Alliance, for example — all have inventory turnover well above 10, too.
Calcbench subscribers can research inventory turnover and several other notable performance metrics themselves. We have a few options for you.
First, you can use the Multi-Company database page. Create the peer group of companies you want to research, and then enter any of several performance metrics we track in the “Standardized Metrics” field in the upper left portion of your screen. You might want to track:
You can also find these metrics on our Bulk Data Query page, which lets you research all sorts of data for large groups of firms — either individually or as a group; including by average or total amounts. Performance and liquidity metrics are listed at the bottom.
Today Calcbench kicks off another of our occasional in-depth looks at a business sector, this time examining the retail industry.
Retail firms have taken it on the chin in 2020 with the double-whammy of pandemic and recession. So what have those pressures meant for business operations and financial disclosures? That’s what we want to explore.
First up: in-store sales versus e-commerce.
We selected this subject after reading the latest quarterly filing for Lululemon Athletica ($LULU), the sporting apparel business that mostly sells yoga pants. Lulu filed its second-quarter report on Sept. 9, and the gap between store sales and e-commerce is just striking.
In-store sales fell by 55 percent in Q2 2020 compared to the year-earlier period. That shouldn’t be a surprise, since vast swaths of North America (which accounts for roughly 80 percent of Lulu sales) had shut down retail stories or otherwise told people to stay home.
But what were those prospective customers doing while stuck at home? Apparently ordering yoga pants online, because e-commerce sales jumped by 154 percent for Q2 2020. In fact, e-commerce sales rose so much in Q2 that they more than made up for declines from in-store sales.
See Figure 1, below. Total Q2 sales figures are high-lighted in blue.
Now, if you do the math, it’s clear that e-commerce sales have not been enough to keep revenue moving in the right direction for the first half of 2020 — which means that the numbers must have been worse in Q1. So we used our handy “Add Previous Period” feature to see what those numbers were. They are in Figure 2, below.
So Lululemon had begun a pivot to e-commerce in Q1 2020 when the pandemic arrived, and then ramped up that pivot dramatically in Q2. Net income is still down sharply from the year-earlier period ($86.8 million in second-quarter 2020 versus $125 million in second-quarter 2019), but the segment disclosures suggest an impressive bit of repositioning, all things considered.
Intrigued by Lululemon’s disclosures, we looked for other retailers’ disclosure of e-commerce revenue, too.
Specifically, we assembled a list of more than 40 large, high-profile retailers; everyone from Abercrombie & Fitch ($ANF) to Walmart ($WMT). We then strolled over to our Segments, Rollforwards, & Breakouts database to see which ones report e-commerce.
Spoiler: not many.
If you search for “commerce” in the operating segments filter, only four reported any data: Walmart, Party City ($PRTY), Tilly’s ($TLYS), and Signet Jewelers ($SIG). Applause goes to Signet for also breaking out e-commerce revenue by geography; and to Walmart for breaking out e-commerce revenue by major operating brand.
Still, four out of 48 major retailers ain’t much. We also looked under “online” and “direct” (for direct to consumer, as Lulu describes the segment) and found none others.
Walmart’s disclosure of e-commerce is tricky. Yes, the company does report those numbers — but not in table format. You either need to read the footnotes closely, where Calcbench does find the numbers because they are tagged; or search in our Segments disclosure database, where we present the tagged numbers.
See Figure 3, below, for what we mean. You’d need to read that written passage high-lighted in blue, below, to see that Walmart essentially doubled its e-commerce revenue from Q2 2019 to Q2 2020.
Still, the pivot to e-commerce revenue is going to be crucial for retailers — especially if they want to compete against Amazon ($AMZN), which has been building e-commerce expertise for 25 years. So the more retail firms disclose about this operating segment, the better.
Not long ago the Securities and Exchange Commission adopted new rules to reduce the amount of disclosure that firms need to make about business risks, legal proceedings, climate change, and other issues.
Those changes go into effect within 30 days of their being published in the Federal Register, which typically happens within a few weeks. So on a practical basis, companies could start filings disclosures according to this new, slimmer standard by the end of this year.
That poses an immediate question for financial analysts: How do you figure out exactly what has changed from one filing to the next?
Like, sure, you could easily see that overall disclosure was reduced from one quarter to the next — but the devil is always in the details. So how do you pinpoint exactly what has changed, to determine what has happened to some point you consider telling or important?
As always, Calcbench has your back. Here’s how you do it.
Start on our Interactive Disclosures page. Pull up the relevant filing for whatever company you’re researching. Figure 1, below, shows the commitments and contingencies disclosure for Apple ($AAPL) in its second-quarter 2020 filing from earlier this summer.
These are the disclosures Apple provides about various lawsuits it is facing, from consumers, regulators, investors, or others. (We chose Apple to demonstrate our search features only because it’s a high-profile name, and have no idea how significant the disclosed matters actually are.)
Notice the third tab on the top, “Compare to Previous Disclosures.” Click on that, and you see a three column display akin to Figure 2, below.
The column on the left is the original disclosure you were looking at; in this case, Apple’s Q2 2020 report. The column on the right is the prior period: Q1 2020.
The column in the middle shows what text has changed between the two periods. Text that was removed from the prior period is shaded in red; text that was added to the current disclosure is shaded in green.
That’s how you can identify textual changes in disclosure quickly and easily.
In this specific case, we zoomed into civil litigation over Apple’s iOS operating system. If you squint, you can see that in February 2020 Apple agreed to settle this litigation, and will ultimately pay somewhere between $310 million to $500 million to plaintiffs. That’s the paragraph shaded in green.
You can use our Compare to Previous Period feature for any disclosure a company makes: MD&A, risk factors, contingencies, segment disclosures, or whatever else you want to research. So however disclosures might change under new SEC reporting rules, Calcbench remains ready to help you find the information you need.
We hadn’t noticed this until now, but if you want a fascinating glimpse of how coronavirus leaving some firms trapped in a game of three-dimensional chess, you might want to read the latest quarterly filing from meal kit delivery service Blue Apron ($APRN).
Let’s start with the numbers. Blue Apron filed its Q2 earnings report on July 29, and in a startling break from historical norms, printed its net income number in black ink.
Revenue rose 28.6 percent from the prior quarter to $131 million, and while cost of goods sold also rose by a comparable amount, the company cut spending in other line items enough that operating income was $2.67 million and net income was $1.11 million. That was the first quarterly profit Blue Apron had turned in years. See Figure 1, below.
From the income statement alone, those numbers look good: a young e-commerce subscription service making money. You don’t see that too often.
Moreover, the numbers also seem sensible. The pandemic has forced tens of millions of people to work from home. Restaurants have been closed. Why wouldn’t some portion of us try to sharpen our cooking skills with a meal kit delivery service?
That analysis isn’t wrong per se, but it’s also far from right. When you start digging into Blue Apron’s footnote disclosures, a much more complex picture emerges.
In the Management Discussion & Analysis, Blue Apron provides several non-GAAP performance metrics to give a better sense of business activity. As you can see in Figure 2, below, those metrics all trended in the right direction for the first half of 2020, although the total number of customers was still lower than one year ago.
Then comes the narrative disclosure from Blue Apron.
Yes, management says, demand has risen thanks to a hungry, idle public looking to do something other than watch Netflix and attend Zoom meetings — but, management adds, it doesn’t know how long that higher demand will last.
This increased demand may not continue at current levels, if at all, depending on the duration and severity of the COVID-19 pandemic, the length of time stay-at-home orders and restaurant and other restrictions continue to stay in effect to a significant extent and for economic and operating conditions, and consumer behaviors to resume to levels prior to the COVID-19 pandemic and numerous other uncertainties.
It’s a valid concern: as recession drags on, consumers might look to cut spending; and subscription services such as Blue Apron are one easy target for most households. Meanwhile, if the pandemic does recede quickly, that means more restaurants returning to full operations, which means more competition for Blue Apron.
Then Blue Apron talks about the challenges of meeting the current demand surge, and it’s fascinating…
During the COVID-19 pandemic, we have also seen higher than normal rates of absenteeism among our fulfillment center workforce and, at times, we have experienced difficulty in hiring a sufficient number of employees to adequately staff our fulfillment centers. As a result, we have also closed, and may again in the future close, some weekly offering cycles early to cap orders as we continue to increase headcount to meet demand.
So sometimes manpower problems have been so great, Blue Apron maxed out on its ability to take orders.
There’s more. Surging demand did allow Blue Apron to cut its marketing spending in Q2 (and look at Figure 1 again; that $4 million cut to marketing spend was the difference between net profit and net loss), but more marketing spend resumed in Q3:
[W]e increased our marketing spend at the end of the second quarter and we expect to re-engage in additional marketing spend as part of our previously announced growth strategy to retain existing and attract new customers.
And then a warning about future growth opportunities, which might be constrained because Blue Apron is spending so much time and money on immediate operational needs:
As a result of the challenges we have seen from time to time in hiring a sufficient workforce to adequately staff our fulfillment centers and in order to manage increased demand, we also made a decision to delay certain new product offerings that are part of our growth strategy, which may negatively impact net revenue in future periods.
Phew! That’s a lot of caveats to income statement numbers that seem good at first glance. There’s much more to the picture if you read the footnotes.
Which, as we always say, every analyst should do.
Amid the many ways the world is going to pieces this year, one small but steady stream of anxiety is this: perhaps all those over-extended commercial real estate businesses will default on their loans and spark a banking crisis.
Calcbench wondered how one might quantify this particular unease, so we decided to hit the data. What are big banks reporting about delinquent commercial loans?
As usual, all the good data is buried in the footnotes. Most large banks include a disclosure section called “Loans” or “Outstanding Loans & Leases” or something similar. (This is not to be confused with “Allowance for Credit Losses,” which appears nearby but doesn’t contain the same information.)
In that Loans section, the bank will usually include a table that breaks out consumer, commercial, and credit card banking; with columns that denote total loans, current loans, and loans delinquent by 30, 60, or 90-plus days. Figure 1, below, is an example from Capital One ($COF) in second-quarter 2020. We colored the commercial banking line blue.
So if you do the math in that commercial line, Capital One had $77.49 billion commercial loans as of June 30, and $76.98 billion of that amount was current — which means a delinquency rate of 0.66 percent.
OK, now the next questions. Has that amount increased over, say, the last year or so? And is it wildly out of step with other banks?
To find those answers, Calcbench reviewed the delinquency data for six other banks, looking back over the last five quarters:
In each case, we looked at commercial loans only, and kept the math simple: total loans minus current loans, and the difference must therefore be the delinquent loans.
The results are Table 1, below.
Two points jump out to us right away.
First, no bank seems to have a huge problem with commercial loan delinquency in absolute terms. Even the worst, Citigroup ($C) still has 98.1 percent of commercial loans currently paid up. Its delinquent loans totaled $7.5 billion, measured against assets of $2.23 trillion.
The relative increase in delinquent commercial loans, however, is another matter. Citigroup’s commercial loan delinquency rate more than doubled in the last four quarters — although, the rate for Q2 2020 wasn’t that much above Q2 2019. So is the relative increase alarming? You tell us. Wells Fargo’s ($WFC) rate also nearly doubled over the last year. Hence we shaded both firms in red (Wells in a darker shade because its increase seems more dramatic).
Our analysis is simple, and we have no illusions that much more loan data is necessary to get a true picture of any greater risk to the financial system. But clearly commercial loan performance is changing. If that’s an issue you monitor in your financial analysis, Calcbench has all that data in our Interactive Disclosures page — just find the banks you want to analyze, and start digging.
Uber filed its latest earnings report last week, and as expected, the numbers looked as ugly as a 1970s AMC Gremlin with two flat tires. That said, the report did give an excellent example of one thing Calcbench loves to look at: adjusted earnings.
To be clear, adjusted earnings are a perfectly fine concept. One-time costs, stock grants, restructuring expenses, interest payments — those things happen, and a firm can argue that such costs don’t accurately reflect fundamental business activity. Hence the adjusted earnings.
Adjusted earnings are also perfectly fine to include in earnings releases and quarterly reports, so long as the firm provides a reconciliation from those adjusted earnings to actual earnings as defined under U.S. Generally Accepted Accounting Principles.
So nothing Uber ($UBER) reported for Q2 adjusted earnings is improper under SEC rules, but the company did take the idea of adjusted earnings on a wild ride.
First, the company presented a metric it calls “adjusted EBITDA.” That’s unusual right there because EBITDA itself is adjusted earnings — so adjusted EBITDA is what, exactly? Adjustment squared?
Uber says adjusted EBITDA is net income with an additional 13 adjustments for various expenses:
Uber also devised a metric it calls Segment Adjusted EBITDA, and we’ll just let Uber speak for itself on this one:
We define each segment’s Adjusted EBITDA as segment revenue less the following direct costs and expenses of that segment: (i) cost of revenue, exclusive of depreciation and amortization; (ii) operations and support; (iii) sales and marketing; (iv) research and development; and (v) general and administrative. Segment Adjusted EBITDA also reflects any applicable exclusions from Adjusted EBITDA.
So Segment Adjusted EBITDA is earnings before, well, everything, we guess. Uber does put that metric to use in a table that assigns Adjusted EBITDA to six operating segments. The tale it tells is that ride-share adjusted EBITDA plummeted, but the delivery segment grew, as did the other four segments. See said table, below.
And finally, on the 18th page of Uber’s 18-page earnings release, we find the reconciliation from the $837 million loss in adjusted EBITDA to an actual loss of $1.77 billion for the second quarter. See Table 2, below.
The craziest part is that for all the pandemic havoc that Uber has endured this year, its many, many adjustments to EBITDA were even more beneficial to Uber last year, when its actual $5.2 billion loss (for one quarter!) was adjusted to an adjusted EBITDA loss of a mere $656 million. That’s mostly thanks to a stock-compensation expense of $3.9 billion last year that didn’t hit this year.
Here’s an interesting item: the SEC has asked Coca-Cola ($KO) about a supply chain financing program the company has apparently launched, and how that program might affect Coke’s cash flows and financial metrics.
The questions came in a comment letter the SEC sent to Coke on June 2. Per SEC policy, comment letters aren’t posted publicly until a few weeks after they’re sent, so this particular item only came to our attention recently.
The comment letter notes that Coke’s accounts payable increased $1.1 billion in 2019 due to extension of payment terms with Coke’s many suppliers; and that “we further note from external sources that it appears you have in place a supply chain finance program.”
So, the SEC asked…
To the extent supply chain finance arrangements are reasonably likely to affect your liquidity in the future, please disclose the following:
- The impact the arrangements have on operating cash flows;
- The material and relevant terms of the arrangements;
- The general risks and benefits of the arrangements;
- Any guarantees provided by subsidiaries and/or the parent;
- Any plans to further extend terms to suppliers;
- Any factors that may limit your ability to continue using similar arrangements to further improve operating cash flows; and
- Trends and uncertainties related to the extension of payment terms under the arrangements.
In addition, please consider disclosing and discussing changes in your accounts payable days outstanding to provide investors with a metric of how supply chain finance arrangements impact your working capital.
This comment letter caught our eye because it’s not the first time the SEC has recently asked a large consumer products manufacturer to say more about its supply chain financing program. Last fall the SEC sent a similar inquiry to Procter & Gamble ($PG), also asking about possible effects to cash flows and days payable outstanding.
For corporate financial executives, what’s interesting is that the SEC isn’t asking just asking simple questions about what Coke’s supply chain financing does. The SEC is outright telling Coke to say more about the program in future quarterly reports (“please disclose the following…”).
To that extent, Calcbench can help other firms in similar situations. You can visit our Data Query Tool, which lists all sorts of data points you can research. DPO is one of the liquidity ratios listed at the bottom.
In fact, when we wrote about Procter & Gamble’s change in days payable outstanding, we compare P&G to peer firms — including Coca-Cola, which actually saw more of an increase in DPO from 2018 to 2019 than Procter & Gamble.
So nobody should be surprised that the SEC is asking Coke about its supply chain financing now. And if your firm also dabbles in supply chain financing, you may want to look at what P&G and others are disclosing about their programs, so you can get ahead of the SEC sending its next comment letter to you.
We have another study from the crack Calcbench research team, this time looking at the giant tech firms and whether their sky-high market valuations really do overshadow all other firms in the S&P 500.
As you may have seen in the Financial Times and other business press, one idea making the rounds these days is that the five tech giants — Microsoft, Apple, Google, Amazon, and Facebook — have seen such gigantic run-ups in their market valuations that they are pushing up the overall S&P 500 index to artificial highs, and therefore masking weaker performance among the other 495 firms.
That concern isn’t without merit. Apple ($AAPL), for example, has seen its market cap increase by $1 trillion in the last 11 months. Amazon’s ($AMZN) market cap has gone from $887 billion one year ago to $1.596 trillion today. Those are huge spikes in valuation.
So our research note tried to understand: What’s driving this momentum? Are there any metrics that might suggest the over-performance of these five firms — which we’ve dubbed “the MAGAF Group” — could actually be justified?
Well, maybe. Hear us out.
First, the market cap of the MAGAF Group does account for an outsized portion of the S&P 500’s total market cap: roughly 22.1 percent at the end of July. But in first-quarter 2020 they also accounted for 16.1 percent of all net income, 13 percent of operating cash flow, and 13.1 percent of operating income. See Figure 1, below.
Corporate finance theory says that share price is a function of expected net income. So is that outsized financial performance worth the 22.1 percent outsized market cap? You tell us. The numbers aren’t that far apart.
But wait! Corporate finance theory specifically says share price is a function of expected future earnings, and the table above reflects prior earnings.
Our research note tried to address that too, by examining prior growth in net income for the last several years — using those numbers to approximate momentum in earnings growth, if you will.
So if you could “invest” in $1 of net income in the MAGAF Group (we know you can’t do that in the real world, it’s a thought experiment), that $1 would be worth $1.57 today. But $1 of net income in the S&P 500 overall, or the S&P 495 without that MAGAF firms would actually be worth less than $1 now.
That could explain the runaway growth in market cap for the MAGAF firms: because their earnings have been running away from the rest of the S&P 500 firms, too.
Do other factors contribute to the market cap growth? Most likely. For example, the poorer net income growth among the S&P 495 really took a turn for the worse only this year, when the pandemic struck.
So are the MAGAF firms doing so well because they’re relatively immune (no pun intended) to the pandemic’s pressures? Or are they doing so well because so many other firms were hammered by the pandemic, so investors just dumped their money into the only stocks still doing well?
Again: you tell us. We’d be eager to hear your theories; email us at firstname.lastname@example.org.
Our research note is simply one interpretation of the data. We have plenty more data to test your own hypothesis.
Fashion house Ralph Polo Lauren ($RL) filed its latest quarterly report on Tuesday morning. Suffice to say, coronavirus has left the company’s financial performance looking more than a little tattered.
Let’s start with the income statement numbers. Revenues in Q2 2020 was $487.5 million, a 62 percent plunge from Q1 and down 66 percent from the year-ago period. The firm also posted a net loss of $127.7 million for the quarter.
If you want to get academic about it, one could say at least Q2’s declines in operating income, net income, and EPS weren’t as bad as what RPL reported in Q1 — and indeed, those numbers were all worse in the first quarter. See Figure 1, below.
More alarming, however, is this item from the Statement of Cash Flows: net cash generated from operations swung from $754.6 million in Q1 to a loss of $70.3 million in Q2.
That is never a good thing. Yes, RPL still conjured up more cash from financing and investing activities, so it has enough money to keep the bills for now, but negative cash flow from operations can quickly lead trouble for a firm’s ability to continue as a going concern. Any time a firm posts negative numbers like that, management needs to act quickly to right the ship.
So what is going on with Ralph Polo Lauren, exactly? Let’s open the Interactive Disclosures database and take a look at what executives had to say.
Management gives a summary of how COVID-19 has affected business, and Ralph Polo Lauren is getting hammered from numerous directions at once:
This paragraph captures the grim state of affairs:
In connection with the COVID-19 pandemic, the Company has experienced varying degrees of business disruptions and periods of closure of its stores, distribution centers, and corporate facilities, as have the Company’s wholesale customers, licensing partners, suppliers, and vendors. During the first quarter of Fiscal 2021, the majority of the Company’s stores in key markets were closed for an average of 8 to 10 weeks, resulting in significant adverse impacts to its operating results. Although nearly all of the Company’s stores were reopened by the end of the first quarter of Fiscal 2021, the majority are operating at limited hours and customer capacity levels in accordance with local health guidelines, with traffic remaining challenged.
So what has management done in response? The COVID-19 summary lists several measures, most of which we’ve already seen other firms taking, too — suspension of cash dividends and share repurchase programs; employee furloughs; pay cuts for senior executives; stretching out payments to vendors; and so forth.
The company also issued $1.25 billion in new debt to cover general operating expenses while RPL figures out what to do next.
Another point worth pondering: many retail firms like RPL will need to embrace direct-to-consumer e-commerce sales even more if they want to weather the pandemic. Ralph Polo Lauren already does offer such sales on its website.
But when you look at the company’s segment reporting, one finds that RPL only reports geographic segments — not wholesale sales to other stores, sales from RPL stores, or e-commerce. So we have no idea how well any embrace of e-commerce might fare.
At least, there are no such disclosures yet. Maybe that’s a point financial analysts could raise on the next earnings call.
Well here’s news to ponder next time you’re sitting on the throne at home: Kimberly-Clark Corp. ($KMB) reports that its sales of toilet paper spiked in the second quarter.
Revenue from “consumer tissue” (because that’s what we call it in polite circles) rose 12 percent compared to the year-ago quarter, to $1.645 billion. Meanwhile, revenue from its K-C Professional segment, which targets corporate buyers stocking office bathrooms, fell 12 percent to $724 million.
The numbers arrived last week in the firm’s Q2 filing. See Figure 1, below.
Also notable is that operating profit from the Consumer Tissue segment nearly doubled to $428 million. We have to say it: the toilet paper segment is really cleaning up.
This should be no surprise. As coronavirus forced untold millions of people to spend less time at work and more time at home, that had profound implications for the, um, personal sanitation business.
First, everyone stocked up on more toilet paper than usual, leading to a demand spike estimated as high as 845 percent. Second, toilet paper used in the home is different from what we all use in the office, school, or shopping mall; it comes from different paper pulp, and uses different manufacturing processes.
Hence we all saw bare shelves in the tissue aisles of our local stores earlier this spring. That shortage seems to have receded as toilet paper manufacturers retooled their processes (“I feel confident to eat a Burrito Supreme,” our intern said, when we dispatched him to the local supermarket for a spot-check), although even now some stores still impose caps on how much tissue a customer can buy at one time.
Anyway, back to Kimberly-Clark. It’s one of the few toilet paper manufacturers that discloses such sales as an operating segment. Technically the Consumer Tissue segment also includes other types of tissue such as napkins and paper towels; plus “a wide variety of innovative solutions,” which makes us wonder how R&D works in this field — but regardless, the segment is a reliable barometer for revenue derived from this most basic function.
Another firm that sells toilet paper and discloses financials is consumer giant Procter & Gamble ($PG). Procter & Gamble hasn’t filed numbers for its second quarter 2020 yet (they are likely to arrive this week), but we can glean a few clues from its first-quarter filing.
First, P&G rolls up its TP numbers into a segment called Baby, Feminine, and Family Care. That segment includes many other products such as baby wipes, baby diapers, adult diapers, and more, although we do know that all P&G revenue in the first quarter totaled $17.214 billion.
In the Segments disclosures, however, the firm splits out the percentage contribution that each segment contributed to the total — so we can see that Family Care specifically contributed 9 percent of Q1 sales, up from 8 percent in the year-earlier period.
Nine percent of $17.214 billion is $1.55 billion, so that’s a rough estimate of P&G tissue paper sales. See Figure 2, below.
First-quarter 2019 sales were $16.462 billion. So if Family Care accounted for 8 percent of that number, that’s $1.317 billion — which means that product line’s sales rose $233 million for first-quarter 2020, a jump of 17.7 percent.
The details are always in the data.
Commodities can be a risky business, as demonstrated by egg producer Cal-Maine Foods ($CALM). The company filed its latest 10-K report on July 20, and it tells quite a tale of egg prices volatility in the last year. Let’s try to unscramble this.
First, some background on the volume of egg output Cal-Maine produces. The company is the largest producer and distributor of eggs in the United States, with sales mostly across the South and Midwest. Cal-Maine sold 12.84 billion eggs in its fiscal 2020, about 19 percent of total “shell egg” consumption in the U.S.
Turns out, however, that the egg business is rather volatile. That’s true in any given year, but it was especially true this year thanks to Covid-19 — where egg prices were depressed in the first three quarters for Cal-Maine, and then soared in the last quarter as everyone started cooking at home more often.
Figure 1, below, is one snapshot of Cal-Maine’s financial performance over the last three years. Net sales edged down 0.7 percent in 2020, largely thanks to an oversupply of eggs, which depressed egg prices, which depressed net sales even though Cal-Maine actually sold 2.9 percent more eggs last year.
Notice that gross profit also declined for fiscal 2020, by 19.4 percent. As Cal-Maine states in its Management Discussion & Analysis: “The decrease resulted primarily from lower selling prices for conventional eggs through the first three quarters in fiscal 2020.”
So that egg depression really rolled Cal-Maine for the first nine months of its year. Then came the great price spike of Q4 — but alas, it was not enough to turn Cal-Maine’s fortunes sunny side up.
We went to the USDA website for more data on egg prices, and found this chart, below. That giant red spike is egg prices in March and April of this year.
Or to frame the spike another way, Cal-Maine tracks its egg prices to a benchmark known as the UB Southeastern Large Price Index. That index ranged from a low of $1.02 per dozen to $3.18 within second-quarter 2020. Volatility like that would be hard for any firm to manage.
On the bright side, lower commodity prices for feed grains pushed down Cal-Maine’s costs, although said costs had risen appreciably in fiscal 2019, so even the lower costs in 2020 were still above what Cal-Maine was paying in 2018.
Meanwhile, SG&A costs rose a bit, and one big item for disposal costs rose from $33 million to $82 million. So all in all, Cal-Maine’s operating income almost evaporated, from $45.7 million last year to $1.27 million for 2020.
Here’s hoping next year’s numbers have more sizzle.
We all know that airlines have suffered mightily since coronavirus grounded international travel at the start of this year. Now Delta Airlines ($DAL) has filed its report for Q2 2020, and we discovered a secondary crisis: investments Delta made in other airlines, which have since fallen apart and led to more than $2 billion impairments.
Tucked away in the Investments portion of its quarterly report, Delta detailed its three investments in smaller airlines: Virgin Atlantic, LATAM ($LTM), and Grupo Aeroméxico. The latter two filed for bankruptcy reorganization earlier this spring, essentially wiping out Delta’s influence over either one.Virgin Atlantic averted its own bankruptcy with emergency funding arranged by Richard Branson, but is still sputtering so much that Delta had to impair that investment too.
What happened, exactly? Let’s take a look.
LATAM. Delta acquired 20 percent of LATAM for $1.9 billion in January to forge a strategic alliance with the Chilean airline. The company also promised to give LATAM $350 million in “transition payments,” including $200 million paid in 2019 and the remaining $150 million delivered in quarterly payments from September 2020 through 2021.
Alas, LATAM filed for Chapter 11 bankruptcy in May. That prompted Delta to terminate a deal to buy four A350 aircraft from LATAM, with Delta paying a $62 million termination fee. That fee is recorded as a restructuring charge on the income statement.
Moreover, Delta recorded an expense of $1.1 billion in impairments and equity method losses. That item is folded into the $2.06 billion in impairments and equity method losses Delta reported as “Non-Operating Expense” on the income statement. See Figure 1, below; the impairments line is shaded grey.
Grupo Aeroméxico. Delta also has a 51 percent ownership stake in Grupo Aeroméxico, but thanks to a quirk of Mexican corporate law Delta’s voting control is limited to only 49 percent. Hence Delta still reports for its Aeroméxico holding using equity method accounting.
Anyway, Aeroméxico filed Chapter 11 in June. As a result, Delta says, “We no longer have significant influence over Grupo Aeroméxico” and Delta is now accounting for its holding using the fair value method — which included a $770 million impairment.
Virgin Atlantic. Delta had long had a 49 percent investment in Virgin Atlantic, and as recently as Q4 2019 had valued that holding at $375 million. Then came coronavirus, and “Virgin Atlantic has incurred significant losses during 2020,” as Delta so blandly described the situation.
That prompted Delta to record a $200 million impairment for its Virgin Atlantic investment, and to reduce the basis in its investment to zero dollars going forward.
Add up those three impairments, and you get a total of $2.07 billion — which is actually more than the $2.058 billion listed above in Figure 1, thanks to a few other investments that increased in value.
Delta also lost $4.8 billion from its regular operations, for a total pretax loss in Q2 of (gulp) $7.014 billion. The impairments on its investments in other airlines account for 29.3 percent of that loss.
For comparison purposes, Delta had equity investment impairments of only $17 million in second-quarter 2019, and no such losses in the three intervening quarters. The it coughed up (no pun intended) this $2.058 billion impairment monster.
Coronavirus! For some firms, it’s shaping up to be a long-term illness.
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