Earnings vs Earnings power

26Apr10

I ran some screens and company called “Goodricke Group” turned up. I got pretty interested with the numbers.

Sales: 380 crores

PAT: 42 crores

Asset base: 120 crores

ROA: 35%

Networth: 110 crores & Debt: 10 crores (-> Debt:Equity = 1:11)

CFO: 57 crores and CFI: Negative 17 crores

Market Cap – 300 crores

For a company with hardly any debt, with ROE in excess of 35% and good cash flows, I thought it is a good deal at P/E of 7 and dug further.

Their 10 year record:

Total Sales: 2200 crores

Total PAT: 70 crores

Average ROA: 6%

The company was dealing with a commodity “non branded tea” for export markett and it had no pricing power. Prices were decided based on auctions and after a gap of 8-9 years the tea prices have reached previous pre 1998 levels. The great numbers for this year is just because of higher tea prices. A cursory look at few of their ARs and one will realize the same theme and story in MD&A. “Sorry, tea prices were less in auctions, we lost money” and “Great, tea prices have rebounded and we have made money”.

I realized that it is extremely important to take a 10-20 year view of the financials to get the real picture. Its earnings was 40 crores this year but this was not sustainable into the future and its earnings would drop the moment prices crash. I have no competence in determining the tea prices in next 1-2 years and so let this investment pass. Even otherwise it was not a great investment at the present market cap. It is important to distinguish between earnings and earnings power. In terms of P/E the stock may look cheap but it wont be able to maintain the “Earnings” generated. This is a reason why stocks of commodity companies do not have very high valuations, rarely going beyond single digit P/Es.

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2 Responses to “Earnings vs Earnings power”

  1. 1 vinvestor2010

    Hi cheked your blog, it is an interesting start, all the best
    The Goodricke Price rise was because of a drought in Kenya last year, there are 3 large tea producers globally India, Sri Lanka and Kenya
    this year with peace in Lanka and OK production in Kenya and normal monsoon tea prices will be lower
    ideally therefore you should look at normalized earnings
    also check the capital allocation record of this company. Do they waste it in dividend etc, because last year’s boom earnings will give them extra cash this year, how are they likely to spend it. If they spend it well , even with lower earnings but decent cash it might be a good buy , also please adjust for earnings seasonality
    Cheers

    • Thanks for the encouragement. 🙂 Those were good points. I will try looking at the capital allocation record but as of now I am trying not to look at commodities unless they are really cheap on normalized earnings basis.


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