Annual Report Analysis

POSCO - Buy the steel business and get the hitech Engg and Power biz for FREE

2010-04-15T06:17:00.000-07:00

My Dad has been in steel business for fifty years in India.He has been part of the industry right from 1950s .He is currently consulting for steel companies that are expanding there operations to cater for increasing steel capacity in INDIA. One of the prime vendors that is assisting in expanding the cold rolling mills is none other than POSCO. In fact he had great praise for POSCO's engineering talent and said that they were in great demand when it comes to modernizing plants.

I then delved into POSCO's 20-F report and found that the company has greatly leveraged its Engg talent. Leveraging its technical know-how and track record of building some of the leading industrial complexes in Korea, POSCO E&C has also focused on diversifying its operations into construction of high-end apartment complexes and participating in a wider range of architectural works and civil engineering projects, as well as engaging in urban planning and development projects and expanding its operations abroad. One of its landmark urban planning and development projects includes the development of a 5.7 million-square meter area of Songdo International City in Incheon, which POSCO E&C is co-developing with Gale International, a respected real estate developer based in the United States. POSCO E&C also invested approximately Won 319 billion in April 2008 to acquire an 88.7% equity interest in Daewoo Engineering Company, a leading engineering company in Korea with expertise in chemical and petrochemical, energy, industrial plant and civil works.The company has also been active in setting up power plants in other countries.

Net sales of the Engg and Power business has doubled in last 5 years

YEAR       NET SALES TO EXTERNAL CUSTOMERS(In billions Korean WON)
====       ======================================================
2008                         3,672
2007                         2,710
2006                         2,121
2005                         2,148
2004                         1,689

Analysis of a fashion business - True Religion (TRLG)

2010-03-27T19:55:00.000-07:00

"Malibu hippy-bohemian chic" - is the main theme around which True Religion's products revolve.Its leading product is denim bottoms. Company's core competance lies in appealing fashion concious people and making them connect with there main theme. Fashion shows and celebrity buzz encompass a very significant portion of the company's advertising effects. The company was founded in 2002 by Jeff Lubell.He has played a very big part in the growth of the company.Right from designing the outfits to being on the fashion shows, he is always there.

The company also promotes MADE IN USA brand. Around 80% of the products are made locally. This gives them great speed and flexibility in getting the products out to the stores. Because of its brand value, the company can command very high prices for its products. The avg price for women's wear was $196 , for men's wear was $192 and for kids was $112.

INCREASED FOCUS ON :

1.CONSUMER DIRECT : As the brand is gaining stronghold presence, the company is more focussing
on selling its products directly.They are also reducing there offprice sales by $10mn in 2010.

2.INTERNATIONAL SALES : This increaed from $40mn to $54.4mn a 36% increase from 2008.The gross margin
  also has increased from 48 to 55%. It also has a great operating margin.The sales in 2009 was $54mn
  (17.3% of total sales).But the operating income was $25mn (32.4% of total operating income).

   REVENUES
SEGMENT             2009     2008     2007
US Wholesale       $123mn   $153mn   $111mn
Consumer direct    $129mn    $75mn    $29mn
International       $54mn    $40mn    $31mn 
other                $4mn    $1mn   - 


    OPERATING INCOME
SEGMENT            2009     2008    2007
US Wholesale      $30mn    $47mn    $36mn
Consumer direct   $44mn    $27mn    $11mn
International     $25mn   $16mn     $14mn
other            ($23mn) ($23mn)   ($15mn)

GROWTH IN COMPANY OPERATED STORES

They had 70 stores as of Dec-31/2009. In 2009 alone the company had opened 28 stores and 2010 they plan to open 27 new stores. Sales thru this channel in 2009 was $129mn.Averaging $1.84mn / store. One of the indications about any brand's popularity is the growth in sales / store. Last 4 years the company has done great by increasing its sales / store from $1.25mn to $1.84mn.

YEAR     NO OF STORES     SALES     SALES/STORE
2009.............70.......................$129mn.............$1.84mn
2008.............42.........................$75mn.............$1.78mn
2007.............15.........................$29mn.............$1.93mn
2006...............4...........................$5mn.............$1.25mn

YEAR    REV    NET INCOME   DILUTED EPS    STOCK PRICE (On Dec-31)      P/E
---------------------------------------------------------------------------------------------------
2009.....$311mn.............$47.3mn............$1.92......................$18.49...........................9.63
2008.....$270mn.............$44.3mn............$1.83......................$12.44...........................6.79
2007.....$173mn.............$27.8mn............$1.16......................$21.35.........................18.40
2006.....$139mn.............$24.4mn............$1.04......................$15.31.........................14.72
2005.....$105mn.............$19.5mn............$0.84......................$15.40.........................18.33
2004.......$27mn.............  $4.2mn............$0.20...................... $8.10.........................40.50

YEAR      CFO               CAP EXP             ACQUI           FCF
-----------------------------------------------------------------------
2009...$66.49mn..........$20.20mn.................$0...............$46.29mn
2008...$49.06mn..........$18.20mn.................$0.............. $30.86mn
2007.....$9.81mn............$8.90mn.................$0..................$0.9mn
2006.....$33.6mn............$4.41mn.................$0...............$29.19mn
2005.....$12,3mn............$0.75mn.................$0...............$11.55mn
2004.......$1.3mn............$0.46mn.................$0.................$0.84mn

YEAR   PAID IN CAP    BOOK VAL SHARES OUT   BOOK VAL/SHARE
---------------------------------------------------------------------------------------------
2009.......$49.8mn...........$197.85mn...........25.2mn....................$7.85
2008.......$38.50mn.........$142.25mn...........24.2mn....................$5.87
2007.......$26.49mn...........$95.24mn...........23.5mn....................$4.05
2006.......$19.55mn...........$67.48mn...........23.0mn....................$2.93
2005.......$11.57mn...........$35.29mn...........22.2mn....................$1.58

How is a stock valued?

2010-03-26T21:15:00.000-07:00

How is a stock valued??? This is the most basic question asked by any investor , especially if he is a newbie who is just cautiously putting his first $1,000 in stock market with the hope of applying the jargon "Let money work for me". There are zillions of books written about it and thousands make living selling there analysis in the form of research reports that would unearth the hidden gems and make you rich forever..... A basic formula that everyone applies to come up with a stock price is by multiplying a factor to the earnings per share (EPS) . This factor is commonly called as P/E. If its that simple then WHY :

1. The stock prices change every minute. Afterall we cant be that sloppy in our calculations.
2. Why the earnings multiple varies from stock to stock. For instance an insurance stock might be selling at 10 times the earnings , while a Tech stock might be selling at 40 times.

What is the easiest and least risky way of growing your money? Its by keeping your money with Uncle Sam. Yup, no kidding......Its not just Americans but the whole world's assumption that the least risky way of growing your money is by buying the Treasury Bills (T-Bills). But you can think yourself lucky if you can get an interest above 1% with this investment. So any investment product that will fetch greater than 1% is better than investing in T-Bill. But in order to get that one will need to take some risk. The excess return above 1% is called the risk premium.

Lending to Susie's Beauty Salon : So as an alternative to putting the money in T-Bill you decide to lend it to an upcoming local Salon called Susie's Beauty Salon. Its an upcoming place and its sole owner Susie is looking for extra capital to expand her shop. She promises the lender a 10% return. But there is a covenant to this deal, if the business goes bellyup the investor looses his capital. So the excessive 9% return is paid for the additional risk lender is taking by lending her the money.Because of her great managerial skills the business turns out good and all her lenders are paid in time. 5 years down the line her salon is ranked in top 10% in the county and creates a brand value recognized by young women. Her business becomes more predictable and less risky. So more lenders are ready to lend her now. Thus there is competition amongst lenders and the one that excepts the least interest rate gets to do business with her. Thus the new set of lenders have to settle for 5% rate because the less risk business is carrying

Investing in Susie's Beauty Salon : Next year she plans to go big and compete with the likes of Super cuts and create a national Beauty Franchise. She now invites investors to be her partners rather than just lenders and in return makes them eligible for there share of profits. The business issues 1 million shares of $10 each. The profits first year after going public is $1.2mn. This equates to $1.20 / share.A return of 12%. ($1.20 / $10).

Looking at these impressive numbers, new investors flock in and start approaching the present investors to sell the shares. Afterall who wouldnt like the gains of 12% in return of accepting a risk that is equivalent to 5% return.Its like heads I get 12 cents and tails I loose 5 cents.Thus the new investors offer a premium to the original $10 share price.

This premium keeps increasing till the earnings per share equate to 5% of the share price (Equivalent return a person can get by lending the money to a business with similar risk). Thus the share prices shoots from $10 to $24 . Making the P/E multiple as 20

This becomes hot news in the market.The Investors who missed the boat start following the business very minutely. They start monitoring the business closely and adjusting there estimates to Earnings per share accordingly .

On basis of its great brand value, Susie's Beauty Salon gets a lucrative deal of being a sole supplier of a leading beauty products company. The analysts estimate that the earnings would increase by 10%. The stock thus shoots up by 10% to $26.2. Making the current P/E as 22 with the assumption that the next year's P/E will be 20 because of 10% growth in earnings.

So now we know that the P/E multiple is made of two components :

1. Directly proportional to growth in future earnings.
2. Inversely proportional to return rate on bonds (debt instruments) on businesses with equivalent risk.

Following is another scenario that explains the above fact. As a growth strategy, Susie's Beauty Salon plans to acquire a hair restoration business. Hair restoration business seems to be more risky than her present one, Thus the lender demand an interest rate of 10%. The P/E multiple to match that will come down from 22 to 11 and the stock falls by 50% from $24 to $12.

RECAP OF THE CASE STUDY " SUSIE'S BEAUTY SALON":

1. When the business started the lenders demanded a 10% interest rate.

2. As the business grew and became more predictable and less risky , Susie got better deal and hence the interest rate dropped to 5%.

3. When the business opened up for new investors , the initial stock price was $10.

4. The first year's earnings per share was $1.20.

5. This was 12% return and the equivalent interest rate for the risk business possessed was 5%.

6. Thus to bring an equilibrium between interest rate and the multiple between the earnings per share and stock price, the stock goes up to $24.

7. The news of the company getting sole rights to market a leading brand of beauty poducts helps the stock go up by 10%, because the investors assume that this new development will increase the earnings per share by 10%. The stock price goes up to $26.2

8. With the acquisition of the hair restoration business, the original business becomes more risky and the interest rate for its debt shoots up to 10%. Thus the equilibrium for interest rate and P/E multiple is at 10.

9. The stock price thus falls 50% to $13.1.

The story goes on.....and Susie's beauty Salon becomes a highly traded stock in the market. Its stock price hovers around the news that changes one's assumption on the business risks and its future earnings potential.

Introduction to Financial statement standards

2010-03-24T14:33:00.000-07:00

The basis of Financial statements for GAAP is governed by FASB. Its details can be found at http://www.fasb.org/jsp/FASB/Page/PreCodSectionPage&cid=1218220137031#fas168 .

FASB has organized its material accordingly.

1. FASB statements - 1 to 168

2. FASB interpretations 1 to 48

3. FASB staff positions.

4. FASB Technical bulletins

5. EITF Abstracts.

What's the importance of financial statements?

2009-09-28T07:45:00.000-07:00

Financial statements give a quantitative picture about any business. For instance one can describe a particular car as "It’s a nice minivan that gives 22mpg and can fit in seven people". But that does not tell us much about the car. To get a clear picture we need to know the details about its Engine, Transmission, brakes, interior, wheels, steering etc. Similarly if one were to describe a state of the business then he has to start with its financial statements. Financial statements are a good starting point for fundamental analysis. The most important point to remember is that financial statements in vacuum are not of much use. They need to be understood with the context of the business. In other words one has to pay close attention as to how the numbers have been calculated. Two identical businesses can have exactly same operations, but there financial statements can differ if they used different accounting guidelines.

COMPARING THE BAKING SKILLS OF TWO WOMEN: If we are comparing Mary and Kathy on how fast they make cookies. Mary might say she takes 1 hr and Kathy may say she takes 45 minutes. In reality both might actually take the same time but the difference might be in the definition of cooking time. For Mary it might include the time to make the dough and for Kathy she might not count that time as cooking time.

Similarly each business has a decision of choosing there accounting processes, that one needs to understand in order to evaluate the numbers of its financial statements. All these details are usually in the notes that follow the financial statements in the 10-k report. The 10-k report for any publically traded company can be found at http://www.sec.gov . For foreign corporations whose securities trade in USA, the corresponding report is the 20-F report. And for Canadian businesses it’s the 40-F report.