American Greetings (AM) released its Q3 earnings before the market opened yesterday morning and I have to say, they shocked everyone that follows this company and its stock. AM’s management is clearly testing investors’ patience and their reticence in the conference call to elaborate on certain items did little to assuage the shareholders.
Here are the key numbers in a nutshell:
|Income Statement||Revenues||Net Income||EPS||Operating Margin||SGA|
The revenue increased by 8%. From there, things go quickly downhill. For example, their cost of sales went up significantly, as a result the operating margin has been almost halved. The SGA expense ticked up 14%, which is quite an increase.
Balance sheet also saw deterioration. Cash on hand declined from $209.33 million in Q2 2011 to $85.66 million in Q3. This sequential decline was coupled with an increase in Accounts Receivable from $111.69 million in Q2, 2011 to $235.32 million in Q3. Incidentally, the Accounts Payable declined a little bit from $118 m to $108 m.
The Management Explanation
In the conference call yesterday, the management stressed the increase in revenues and failed to properly explain the reason for the decline in margins. They indicated that marketing and distribution expenses went up, and they are likely to remain high going forward. One of the reasons seems to be their push in the “value” cards category where they are trying to establish presence in the Dollar stores. This will be a low margin business, but one can’t fault the management to explore new revenue sources as the greeting card business remains in its multi year trough.
Some of the expenses in Q3 were one time expenses, although the management was not able to break it out. This makes it really difficult to judge the strength of its current operations, and hence the investors assumed the worst and the stock tumbled more than 20%.
There was some additional clarity added towards the new headquarters. The total expense is estimated to be $150-$200 million, bulk of it occurring in 2012. State of Ohio is offsetting part of this with a $93.5 million tax incentive spread out over 15 years. Additionally, sale of the existing building and the better economics of the new building is expected to bring the net cost down to $30 million.
This is still $30 million incremental for an expense that is unnecessary but I would rather them invest when the real estate markets are down than at the peak. It might end up with a good ROI.
Is There Still a Case for Owning AM?
I am not a fan of management that is not forthcoming on some key questions. However, the fact is that the company still has a book value of about $20/share. While the cash may have declined, it seems to have migrated to the Accounts Receivable, which means it will be collected at some time. Or at least a large portion of it. If there is an increase in bad accounts than that will be a cause for worry, as it seems that the company pushed out a lot of inventory to the retailers this quarter (much more than even seasonal trends would suggest).
The big question is whether the 7% operating margin a new normal. This is what investors are not able to figure out, and perhaps it will become clearer next quarter. This quarter is key as being the peak season for card purchases.
If you believe that the company will be able to maintain its 60 cents/share dividend, at a 10% required rate of return, the dividend is worth $6/share. The book value and the profitability should increase with an improving economy. This uncertainty does impair some value in the stock and I am going to bring my sell target down from $30 to $23. I am keeping my Buy recommendation but changing the buy price from under $20/share to under $16/share.
This is assuming that about 50% of increase in expenses were one time costs. If further information proves this to be inaccurate, the targets will be revised.