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Emerge Energy Services LP (EMES) Making Money Out Of Sand?

January 8th, 2016 Posted by Deep Analysis No Comment yet

Emerge Energy Services LP stock deep analysis on five-year historical data.

Emerge Energy Services LP

Emerge Energy Services LP’s stock has fallen since the announcement of dividend suspension in October 2015. The lowest stock price was on October 27, 2015, at $3.87 per share. Because of economic slowdown, the oil and gas industry has suffered a setback and so the frackers. Consequently, if the oil industry recovers, the frackers will progress again. Although Emerge is generating more revenue year over year, the company’s debt is also increasing year over year. Emerge is using borrowed funds more than the investor’s investment for their business operations.  Furthermore, the company’s cash and cash equivalent represents 1.5 percent of the total assets.

A Question of Liquidity

First of all, the company’s liquidity is a concern and the question asked, “Would Emerge be able to pay its obligations in due date in the future? The balance sheet shows that Emerge has good liquidity ratios hence, it has a sound balance sheet. The income statement has not seen any negative earnings from 2012 to 2014. Emerge Energy Services LP has an incredible yield of 73.96 percent and also payout ratio of 432.4 percent. As a result, the valuation shows that Emerge is worth a lot more than its current market price today. Probably, this is the right time to buy.  Let’s find out.

Problem

As a result of fracking, Emerge is involved in a legal dispute.  They use hydraulic fracturing or fracking to extract oil and natural gas from deep under the earth. Hydraulic fracturing or fracking is the process of drilling and injecting fluid into the ground at high pressure in order to fracture shale rocks to release natural gas inside. Furthermore, the environmentalist believed that this process creates environmental and also health risks.  

Effect

The fracking process could be dangerous to the environment and therefore, may contribute to health risks within the community. The process may affect groundwater and rather can cause pollution hazards according to the book, “What’s the fracking problem? Hydraulic fracturing, silica sand, and issues of regulation”, page 639. On the other hand, although, the extraction of the silica sand can provide employment and also has economic benefits.

The Process

  • To the site. Each gas well requires an average of 400 tanker trucks to carry water and supplies to and from the site.
  • Heavy Load. It takes 1 to 8 million gallons of water to complete each fracturing job.
  • Fracturing Fluid. Up to 600 chemicals are used in fracking fluid, including carcinogens and also toxins such as uranium, mercury, ethylene glycol, methanol, hydrochloric acid and also formaldehyde.
  • Down 10,000ft, the fracking fluid is then pressure injected into the ground through a drilled pipeline.
  • The Math.

500,000 active gas well in the US x 8 million gallons of water per fracking x

18 times a well can be fracked 

= 72 trillion gallons of water and 360 billion gallons of chemicals that are needed to run the current gas wells.

Characteristics in Fracking

  • Shale fracturing. The mixture reaches the end of the well where the high pressure causes the nearby shale rock to crack, hence creating fissures where natural gas flows into the well.
  • Gravity.
  • Contamination. During this process, methane gas and toxic chemicals leach out from the system and therefore contaminate nearby groundwater. Furthermore, Methane concentration is 17 times higher in drinking water wells near fracturing sites than in normal wells.
  • Drinking Water. Contaminated drinking water is used for drinking water for nearby cities and towns. In addition, there have been over 1,000 documented cases of water contamination next to areas of gas drilling and also cases of sensory, respiratory and neurological damage due to ingested contaminated water.
  • Left Behind. Only 30-50 percent of the fracturing fluid is recovered, while the rest of the toxic fluid is left in the ground and is not biodegradable.
  • The waste fluid is left in the open air pits to evaporate, releasing harmful VOC’s (volatile organic compounds) into the atmosphere, hence creating contaminated air, acid rain, and ground-level ozone.
  • In the end, hydraulic fracking produces approximately 300,000 barrels of natural gas a day, but at a price of numerous environment, safety, and health hazards.

Source: quote from Dangerous of Fracking

Solutions

Emerge has adopted measures to guard the safety of their employees, and quoted as follows:

“We adhere to a strict occupational health program aimed at controlling exposure to silica dust, which includes dust sampling, a respiratory protection program, medical surveillance, training, and other components. We designed our safety program to ensure compliance with the standards of our Occupational Health and Safety Manual and U.S. Federal Mine Safety and Health Administration (“MSHA”) regulations. For both health and safety issues, extensive training is provided to employees. We have organized safety committees at our plants made up of both salaried and hourly employees. We perform annual internal health and safety audits and conduct semi-annual crisis management drills to test our abilities to respond to various situations. Our corporate health and safety department administers the health and safety programs with the assistance of plant environmental, health and safety coordinators”.

Source: SEC Annual filings 2014.

Company History of Emerge

Company Profile

Emerge Energy Services LP (Emerge) is a Delaware limited partnership. The company was formed by Insight Equity, a private company based in Southlake, Texas in 2012. In addition, Insight Equity managed a portfolio of companies that own more than $800 million capital. Furthermore, Emerge Energy Services LP is the leading manufacturer of Northern White Silica Sand.

Emerge operates in fuel processing and distribution, and also the sand mining. The company wants to create a diversified portfolio of critical energy service operations.

Significant Company Events

July 25, 2014, The company completed the acquisition of mineral reserves and also related assets to help manage the supply and cost of raw sand to the company’s Wisconsin sand processing plants.
May 14, 2013, Emerge completed the acquisition of Direct Fuels’ net assets for $98.3 million. Direct Fuels operates a motor fuel terminal and transmit processing facility in Texas, in which it expands the company’s geographic presence in the Dallas-Fort Worth, Texas market.
May 2013 Emerge Energy Services was combined with Superior Silica Sands (SSS), Allied Energy Company (AEC), and Direct Fuels (DF) in a series of transactions which developed in the initial public offering of Emerge, stated on the company’s website.
2011 SSS expanded to Wisconsin with the construction of the new Auburn facility, which provides direct access to the highest quality frac sand in the industry.
2010 The company opened a second industrial sand plant in Kosse dedicated to processing sand mined at the Kosse quarry.
2009 SSS built a new state-of-the-art processing plant at Kosse, Texas, with the support of Insight Equity. The facility has the capacity to supply over 900,000 tpy of quality proppant (frac) sand from high-quality Wisconsin feed.
2008 Insight Equity acquired Superior Silica Sand.
Insight Equity acquired AEC, a wholesale distributor of renewable and petroleum-based refined products, with fuel distribution representing a majority of revenue. AEC was founded in 1962.
2003 Insight Equity acquired Direct Fuel (DF), the largest independent regional fuel distributor and specialty processor in North Texas. DF was established in 1997.

Place/Head Office

The corporate headquarters was located at 6000 Western Place, Suite 465 Fort Worth, TX 76107, telephone numbers 817.841.8070, office 888.446.5677, fax info@sssand.com

Company Sector/ Industry

Sector:  Energy Minerals

Industry: Oil Refining and Marketing

Branches

The company has four major plants.

  1. Clinton, WI – located in the township Clinton, WI, directly on a second class 1 railroad, the Canadian National.
  2. New Auburn, WI – located on the Progressive Rail Short Line that connects to the Union Pacific Railroad.
  3.  Kosse, Texas mine and dry plant.
  4. Arland, WI – Superior Silica Sands’ newest state-of-the-art, the all-weather facility is a close replica of Clinton, WI.

Date of IPO

On May 14, 2013, the company completed its initial public offering (IPO) and became a publicly traded partnership. The net proceeds from IPO were $116.2 million, in which the price was $16.55 per share.

Other significant company information

  • The company has a total of 100 employees.
  • The business was operational since 2008.
  • According to the company’s SEC filings, there are several factors that contributed to the increase in demand for frac sand in the past years and in the future. In addition, the increased drilling of horizontal wells over vertical and directional wells increased drilling efficiencies and also the increased use of sand per well, have forced demand for frac sand. Furthermore, the demand will remain strong in 2015 compared to 2014 as the technological technique will continue to be applied.
  • The company expects said that the demand for frac sand will continue to grow, however, in the first half of 2015 will be a period of relative growth stagnation for the industry due to lower rig count.

Material events affecting the Numbers

  • The sand revenue from 2013 to 2014 increased by $174.1 million or 104 percent, as a result of a 62 percent increase in total volumes sold.
  • The company has a lower cost of goods sold which consist primarily of direct costs. In addition, the cost of goods sold is the purchase of sand, transportation to the plant to trans-load facilities, mining processing costs, plant wages and also repairs and maintenance.

Run Rate

Frac sand production facilities as of December 31, 2014.

Wet Plant Location 2014  Production (thousands of tons) Plant Capacity (thousands of tons) Proven Recoverable Reserves(millions of tons)
New Auburn 1,332 2,000 27.8
Thompson Hills 322 1,600 49.6
FLS Mine 1,189 1,200 13.7
Church Road 378 1,200 7.0
LP Mine 1,005 1,000 7.4
Kosse, TX 306 1,600 27.8
Dry Plant Location 2014 Production Volumes (thousands of tons) Plant Capacity (thousands of tons)
Arland 124 2,500
Barron 2,224 2,400
New Auburn 1,394 1,400
Kosse, TX 299 600

EMES Reserves

The wet plant shows the proven recoverable reserves in millions of tons. Emerge reserves will supply them with 15 years of Northern white frac sand and 17 years of native Texas sand, according to the annual financial statement filed with SEC. Furthermore, Emerge own 100 percent of their mineral reserves in Texas and 6.6 percent in Wisconsin, with the remainder of the reserves.

Emerge leases from third-party landowners with leases expiring in different times between 2036 to 2038. In addition, as of December 31, 2014, the mineral reserves under the property, plant, and equipment was $30.18 million. The table above presents the production report of Emerge as of December 31, 2014, on its wet and dry plant locations. Furthermore, the report also shows the plant capacity and the production volumes in thousands of tons.

Beneficial Owner

EMES Beneficial owner

Facts:

  • Insight Equity has 7.2 million common units ownership.
  • Another, Goldman Sachs Asset Management LP has 3.0 million common units ownership.
  • Susquehanna Financial Group LP has 1.3 million common units ownership.
  • Also, Ted W. Beneski has 563 million common units ownership.
  • In addition, all directors and officers as a group of 11 persons have 8 million common units ownership.
  • The following persons have less than one percent ownership:
    • Rick Shearer
    • Victor L Vescoso
    • Warren B. Bonham
    • Robert Lane
    • Richard DeShazo
    • Kevin McCarthy
    • Francis J. Kelly III
    • Kevin Clark
    • Eliot E. Kerlin Jr.
    • Peter Jones

Explanation

  • The controlling equity owners of Insight Equity were Ted W. Beneski and Victor Vescovo. In addition, Insight Equity has 30.2 percent equivalent ownership.
  • Goldman Sachs Asset Management, LP has shared voting power and also shared dispositive power with respect to 3,011,858 units. In addition, the company has 12.7 percent equivalent ownership.
  • Susquehanna Financial Group, LLLP has shared voting and also shared the dispositive power of 1,340,225 units. Another, the company has 5.7 percent equivalent ownership.
  • Out of Ted Beneski’s beneficial ownership, 27,522 units are held in an irrevocable trust account in favor of his sons, in which he is the trustee of each trust account. In addition, Ted Beneski has 2.4 percent equivalent ownership.
  • Kevin McCarthy’s ownership includes unvested restricted units granted to the company’s independent directors. In addition, McCarthy has less than 1 percent ownership.

Interpretation

The percentage of units beneficially owned is based on a total 23,718,961 common units outstanding as of the Ownership Reference Date as stated in the company’s SEC Filings.

MAIN ACTIVITY

How the company makes money?

Emerge Energy Services LP is a diversified energy services company. The sand subsidiary of Emerge produces silica sand that is a key input for the hydraulic fracturing of oil and gas wells. Furthermore, the company’s sand facilities are located in New Auburn, WI, Barron County, WI, and Kosse, TX, with headquarters in Fort Worth, TX.

Products

Silica sand and also fuel segment.

Emerge

Operations

Fuel Processing and Distribution and Sand Mining

EMES products2

Source: Emerge website

 Superior Silica Sand (SSS)

EMES SSS

Source: Superior Silica Sand (SSS)

The image above presents how the superior silica sand is the leading supplier of the highest quality frac sand available in North America.

Properties of Silica sand:

  1. 16/30 Northern White Sand
  2. 20/40 Northern White Sand
  3. 30/50 Northern White Sand
  4. 30/70 Northern White Sand
  5. 40/70 Northern White Sand
  6. 100 Mesh Northern White Sand
  7. 40/70 “Native Star” Sand
  8. 100 Mesh “Native Star” Sand

Demand Trends Illustrated

EMES Proppant demand

Source: Emerge Energy Services LP Prospectus, page 127

The image above presents the forecasted historical demand trend for Proppant and Raw Frac Sand in the United States. Furthermore, the factors that drive the demand for frac sand is the level of horizontal drilling activity by exploration and production companies and also the level of hydraulic fracturing services.

Who is running the business?

The person in charge of the company

Rick Shearer, Chief Executive Officer (CEO) and Director

EMES - CEO

Mr. Rick Shearer was elected by the General Partners as the Chief Executive Officer in April 2012. In addition, on May 2014, he was appointed to the Board of Directors of General Partner.

Education

  • Bachelor of Science Degree at Alderson-Broaddus College
  • Masters of Business Administration degree from Eastern Michigan University.
  • A graduate of the Executive Management Program at Harvard University.

What did Mr. Rick Shearer work in the past and leading up to the present position?

Present Chairman of the Board of Black Bull Resources.
May 2010 to Present He served as President and Chief Executive Officer of SSS.
March 2007 to May 2010 President and Chief Executive Officer of Black Bull Resources, an entity that specializes in the mining, processing, and marketing of industrial minerals, a publicly traded company on the TSX Venture Exchange.
January 2004 to March 2007 Member of the Board of Directors of Excell Minerals, a global stainless steel metals recovery company based in Pittsburgh, Pennsylvania, prior to its acquisition by Harsco Corporation in February 2007.
August 1997 to January 2004 President and Chief Operating Officer of US Silica Company Inc., a silica sand supplier.
2003 to 2004 Founding Chairman of the Industrial Minerals Association of North America.
Vice Chairman of the National Industrial Sand Association of Europe.

 Joseph “Jody” C. Tusa, Jr., Chief Financial Officer (CFO)

EMES CFO

May 2015 to Present Served as Chief Financial Officer at Emerge Energy Services LP.
January 2008 to January 2015 Chief Financial Officer of USA Compression Partners, LP
2001 to December 2007 He was Chief Financial Officer of Comsys IT Partners, Inc., an IT staffing company and an affiliate of Metamor.
1997 to 2001 Served as Senior Vice President of Business Operations for Metamor Worldwide, Inc., an IT services company listed on NASDAQ.

Key Executive Compensation

EMES earnings and compensation

Facts:

  • The total revenue was $377 million in 2011 and year over year it is increasing at a rate of 27 percent. In addition, the growth rate is 194 percent at $1.1 billion in five years.
  • The total key executive compensation was $812 thousand, $17.7 million and $3.6 million in 2012, 2013 and 2014, respectively.
  • Rick Shearer, CEO has a total compensation of $455.6 thousand, $14 billion and $1.4 billion in 2012, 2013 and 2014, respectively.
  • Robert Lane, former CFO has a total compensation of $81.7 thousand, $431 thousand and $1.2 million in 2012, 2013 and 2014, respectively.
  • Richard Deshazo has $560 thousand total compensation in 2014.
  • Warren Bonham, VP has a total compensation of $274.6 thousand, $3.3 million and $439 thousand in 2012, 2013 and 2014, respectively.

Explanation

  • Emerge total revenue was trending up, however, its costs of revenue were averaging 90 percent.
  • Based on net income, the total executive compensation was 4.72, 50.46 and 4.05 percent in 2012, 2013 and 2014, respectively.
  • The total compensation of Robert Lane based on net income were 0.47, 1.23 and 1.38 percent in 2012, 2013 and 2014, respectively.
  • Compensation of Richard Deshazo was 0.63 percent in 2014.
  • Warren Bonham has the compensation of 1.60, 9.43 and 0.49 percent in 2012, 2013 and 2014, respectively.
  • Rick Shearer’s compensation based on net income was 2.65, 39.80 and 1.54 percent in 2012, 2013 and 2014, respectively.

Interpretation

Emerge is capable of generating more revenue year over year, however, the cost of revenue was high and the bottom line was below 10 percent, hence 5, 50 and 4 percent were distributed as compensation.

Key Executive Compensation

The graph below presents the distribution of the total key executive compensation in 2014.

EMES compensation piechart

The graph presents the three years historical key executive compensation. In 2013, the company paid a higher compensation to the key executives compared to 2012 and 2014.

Facts:

In 2014, out of the total key executive compensation,

  • Rick Shearer has a total compensation equivalent to 56.1, 78.9 and 38.1 percent in 2012, 2013 and 2014 percent, respectively.
  • Warren Bonham has a total compensation equivalent to 33.8, 8.7 and 12.2 percent in 2012, 2013 and 2014, respectively.
  • Richard Deshazo has a total compensation equivalent to 15.5 percent in 2014.
  • Robert Lane has a total compensation equivalent to 10, 2.4 and 34.2 percent in 2012, 2013 and 2014, respectively.

Explanation

  • Rick Shearer’s basic salary were $245, $313 and $425 thousand in 2012, 2013 and 2014, respectively.
  • Robert Lane’s basic salary were $34, $256 and $270,6 thousand in 2012, 2013 and 2914, respectively.
  • Richard Deshazo’s basic salary is $234,000 in 2014.
  • Warren Bonham’s basic salary were $150, $137 and $200 thousand in 2012, 2013 and 2014, respectively.

Interpretation

Finally, the basic salary of the executives was approximately 50 percent of their total compensation and the remaining percentage were non-equity compensation.

NUMBERS ANALYSIS

Equity and Shares Outstanding

EMES SHE

The graph presents the historical partners’ equity and also the share outstanding of Emerge.

Facts:

  • From 2010 to 2012, the partner’s equity was increasing yearly up to $20 million.
  • On the date of IPO in 2013, the partners’ equity soared to $170 million at approximately 650 percent.
  • In 2014 and the trailing twelve months the partners’ equity decreased by 9 and 46 percent, respectively.
  • The number of shares outstanding from 2010 to 2012 was zero since the company IPO was in 2013.
  • As a result of Emerge IPO in May 2013 the net proceeds was $116.2 million and also non-recurring charges of $11 million.
  • Furthermore, Emerge had a secondary offering made on June 2, 2014, with 3,515,388 common units at a price of $109.06 per common unit.

Explanation

  • The net income of $13,1 million from January 1, 2013, to May 13, 2013, was added to the total partners’ equity resulting to an increase in 2013.
  • Another reason for an increase in equity is the income of $22,0 million from May 14, 2013, to December 31, 2013.
  • A further reason for an increase in the proceeds from IPO, net of offering costs of $116.2 million in 2013.
  • Common units issued for the business acquired of $53.7 million was also added to the total partners’ equity in 2013. therefore the equity increase.
  • Distribution payments were deducted in the total partners’ equity in 2013 at $49.5 million, as a result, the total decreases.
  • A net income of $89.1 million in 2014 was added to the total partners’ equity, therefore the equity increase.
  • Equity-based compensation of $9.2 million in 2014 was added to the total partners’ equity.
  • Total distributions of $113.8 were deducted from the total partners’ equity in 2014, so the total decreased.

Interpretation

In 2013, the total partners’ equity had increased by 650 percent because of the proceeds from IPO and also the company’s net income. The partners’ equity decreased in 2014 due to significant distribution payments made, and yet the net income was added.

Cash Flow Graph Analysis

EMES CF2

The graph above presents the historical cash flows of Emerge Energy Services LP from 2011 to the trailing twelve months presented in a graph. In addition, this graph will show us the trend of cash generated and used year-over-year.

Facts:

  • The operating cash flows were positive and also increasing year over year from 2011 to 2014.
  • And, the cash from investing activities was negative due to investments.
  • Also, the cash provided by financing activities was positive due to debt issued.

 Explanation

  • Cash flow from operating activities is the money that the company brings in for the regular business activities.
  • Investing activities show the changes as a result of gains and losses in investments. In addition, the purchases of property, plant, and equipment at $77,884,000 and also the business acquisition at $11 million is significant.
  • Financing activities show the external activities of the company. Also, Emerge has proceeded from the line of credit borrowings of $371,657,000. In addition, there was a repayment of the line of credit borrowings of $243,603,000 in 2014. Furthermore, Emerge also has a distribution to unitholders at $113 million and payment of capital lease obligations at $5.8 million also, payments of financing costs at $2.3 million in 2014.

Interpretation

Emerge has a significant amount of purchases of properties and acquisitions in 2014. In addition, the company is also using the proceeds from the line of credit borrowings in financing activities. Furthermore, Emerge also made repayments of the line of credit borrowings and distributions to unitholders.

Valuation

EMES Value

Facts:

  • The book value in 5 years was $0.97.
  • The average return on equity was 74.13.
  • ROE ratio deteriorates 79 percent in 2015.
  • The return in book value in 5 years was $0.72.
  • Further, stock price in 5 years was $4.60. Another, the yield was 63 percent.
  • Moreover, the risk used was 15 percent.
  • Current price as of December 7, 2015, was $6.06 per share.
  • As a result, the intrinsic value of the stock is $30.93.

Interpretation

The stock price of Emerge is undervalued.

Return on Earnings Analysis

Du Pont Analysis on Return on Equity (ROE)

The DuPont extended analysis concludes whether a company can make a higher yield on equity.  In this analysis, the Return on equity (ROE) is divided into two parts, the net profit margin, and also the equity turnover ratio. Therefore, the equation for this analysis was:

ROE = (net income / sales) * (sales / assets) * (assets / shareholders’ equity)

This formula breaks the return on equity into three components, such as the net profit margin, the asset turnover, and the equity multiplier.

ROE = (net profit margin) * (asset turnover) * (equity multiplier)

The Three-Step DuPont Calculation

EMES DuPont1

This the first step in the DuPont extended Return on Equity analysis. The return on equity is broken down into two components, the net profit margin, and also the equity turnover ratio.

Facts:

  • The net profit margin shows an upward trend from 2012 to 2014, however, in the trailing twelve months, the trend fall by more than 50 percent.
  • Further, the net profit margin was averaging 4.45 percent, however, it has an erratic movement.
  • Return on equity means the return on shareholders’ investment.
  • Furthermore, the equity turnover ratio was erratic in its movement in the last 4 years, furthermore, it is averaging 12.43 percent.

Explanation

  • The equity turnover is a measure of how well a company uses its equity to generate revenue.
  • As a result, DuPont equation provides a wider picture of the return on the company’s earnings on its equity. In addition, it tells where the company’s strength lies. Furthermore, it tells where there is room for improvements.

The Three-Step DuPont Analysis in Graph

EMES 3 step DuPont graph

Facts

  • Return on equity was erratic in movement with an average ratio of 45.98 percent.
  • Asset turnover was averaging 2.61.
  • Therefore, it means that EMES is generating an average of $0.26 of profit for every $1 of assets.
  • The equity multiplier was averaging 4.57.
  • Moreover, the return on equity was erratic in movement in the last 4 years, with an average of 45.98.

Explanation

  • ROE is broken down into three components, the net profit margin, the asset turnover, and the equity multiplier.
  • Net profit margin is also called the bottom line profit.
  • Asset turnover tells us how effective the company is utilizing its assets.
  • The return on equity measures on how much the shareholders earned for their investment in the company.

Interpretation

Now, it’s getting clearer, it broadens our understanding of the company’s ROE. If the ROE increase because of the company’s net profit margin or either due to an increase in asset turnover, it is a positive sign for the company. On the other hand, if the equity multiplier is the cause of the increase in ROE, consequently it could mean that the company is already leverage,

Conclusion

Emerge Energy Services LP is an emerging growth company. It is worth more than its current market price today. The company has a sound balance sheet and also the income statement has not seen any negative earnings. In addition, cash from operating activities is positive in the last four years. Emerge has an incredible yield of 73.96 percent and also a payout ratio of 432.4 percent.

The oil and gas industry had suffered a setback because of the economic slowdown, if the oil and gas industry recovered, frackers will be more profitable. Furthermore, the demand for silica sand will continue to rise. Therefore, the potential for growth is high for Emerge. In conclusion, the stock of Emerge Energy Services LP is best for a Buy.

CITATION

Emerge Energy Services, company website

Form 10K, 10-K 1 a10k141231-q4.htm 10K

https://www.sec.gov/Archives/edgar/data/1555177/000162828015001343/a10k141231-q4.htm#s8219e3567cc74c0d8d878bcebad2e86f

Prospectus, 10-Q 1 a10q15930-q3.htm 10-Q

https://www.sec.gov/Archives/edgar/data/1555177/000162828015008914/a10q15930-q3.htm

Form 10-Q 1 a10q15930-q3.htm 10-Q

http://www.sec.gov/Archives/edgar/data/1555177/000104746913005885/a2215166z424b4.htm#ck13401_historical_financial_and_operating_data

http://www.dangersoffracking.com/

Research and Written by Criselda

Twitter: criseldarome

michael kors

Michael Kors: Does Investors Need To Be Fashionable In Life And Portfolio?

October 15th, 2015 Posted by Deep Analysis No Comment yet

Michael Kors Inc  (KORS) is a luxury lifestyle brand, company around the globe.

Michael Kors (KORS) Company Research

KORS Logo2

KORS Company Profile

Michael Kors Inc  (KORS) is a luxury lifestyle brand, company around the globe. KORS operates its business through three segments namely, the retail, wholesale and licensing. The company has a distribution network in other parts of the globe of company-operated retail stores, leading department stores, specialty stores, and select licensing partners. The company’s retail segment contributed nearly 50 percent of their total revenue in their Fiscal 2015. The company’s retail segment includes 343 North American retail stores, including concession and their U.S. e-commerce site. And, the 183 international retail stores, including arrangements in Europe and Japan.

Significant collections

KORS offers two significant collections, the Michael Kors luxury collection and the MICHAEL Michael Kors accessible luxury collection. The company has also collections that offer accessories, footwear, and apparel. The licensing segment is committed to providing licenses to third parties, which include some production, sales, and/or distribution rights. The company also sells fragrances in its retail stores and by Estee Lauder to wholesale customers. In addition, the company also sells beauty products like nail lacquers, lip products, powers and a collection of body and sun products.

KORS PRODUCTS

The company’s products are accessories, apparel, footwear, and licensed product. Accessories include handbags and high quality and exotic skins small leather goods. “The Company has engagement with Fossil Partners, LP, (Fossil), which help them create a line of watches and jewelry. The company’s product licensees, in addition to “Fossil”, are the “Aramis” and Designer Fragrances division of The Estee Lauder Companies Inc. (Estee Lauder) for fragrance and beauty, and Luxottica Group (Luxottica) for eyewear, among others. Fossil has been the company’s exclusive watch licensee since April 2004, which is sold in the company’s retail stores.

Jewelry, Eyewear

In addition, Fossil has been the exclusive fashion jewelry licensee since December 2010. Moreover, Luxottica became the company’s exclusive eyewear license in January 2015. It is sold in the company’s retail stores, which serve as the key category. Prior to January 2015, “Marchon” was their exclusive eyewear license. The jewelry product line is bracelets, necklaces, rings, and earrings.

Beauty Products

In addition, the company also sells beauty products like nail lacquers, lip products, powders and a collection of body and sun products. Through its retail and wholesale sections, KORS sells its products in three principal geographic markets: North America, Europe, and Asia. Through its licensing section, KORS enters into agreements that license to third parties. They used the company’s brand name and trademarks, other production, and sales and/or distribution rights. Moreover, revenues generated in these agreements are initially earned in North America and Europe.

Competitors

The Company competes with:

  • Coach, Burberry,
  • Ralph Lauren,
  • Hermes,
  • Louis Vuitton,
  • Gucci,
  • Marc Jacobs,
  • Chloe,
  • Tori Burch,
  • Prada.

2. Date of Incorporation

Michael Kors Holdings Limited (MKHL and its subsidiaries, the Company) was incorporated in the British Virgin Islands (BVI) on December 13, 2002.

3. Place/Head Office

The corporate office of Michael Kors Holding Limited is in 33 Kingsway, London, WC2B 6UF, United Kingdom.

Phone: 44 2076 328 600

Website: http://www.michaelkors.com

4. Founder/Founding

In 1981, Michael David Kors, an American designer established Michael Kors Holdings Ltd., known for handbags and accessories and is based in London, United Kingdom.

5. Company Sector/Industry

Company Sector:    Consumer Discretionary

Industry:                 Textiles, Apparel, and Luxury Goods

Sub-industry:          Apparel, Footwear, and Accessory Design

6. Date of IPO

The company’s initial public offering (IPO) was on December 15, 2011, with its ordinary shares traded on the New York Stock Exchange (NYSE) under the symbol “KORS”. During IPO the stocks were then traded at $24.20 per shares.

7. Other Significant Company Information

  • The company has a total of 9,184 employees.
  • And the company has no unresolved staff comments.
  • On March 28, 2015, there were 199,656,833 common shares outstanding at a closing sale price of $66.97. Further, the company has 303 common shareholders at the record as of March 28, 2015.
  • During fiscal 2013, KORS completed its secondary offerings of 25,000,000 ordinary shares at $47.00 per share. An additional 3,750,000 shares at $47.00 per share were offered because the underwriters exercised their additional shares purchase option.

More Information

  • In September 2012, KORS completed its secondary offering of 23,000,000 ordinary shares at $53.00 per share. An additional 3,450,000 shares at $53.00 per share were offered in October 2012 because the underwriters exercised their purchase option.
  • And on February 2013, completed a secondary offering of 25,000,000 ordinary shares at $61.50 per share.
  • The company did not receive proceeds from the sale of the secondary offerings, which they incurred $1.7 million fees and were charged to selling, general and administrative expenses in Fiscal 2013.

8. Material Events Affecting the Numbers

Ms. Cathy Marie Robinson, executive officer of Michael Kors Holdings Limited was reappointed on August 27, 2015, as executive officer of Michael Kors Holdings Limited with a new title of Senior Vice President of corporate strategy and Chief Operations Officer, after her resignation on the same date, August 27, 2015.

Moreover, Ms. Robinson will receive a grant of restricted share units valued at around $1.5 million under the Michael Kors Holding Limited Amended and Restated Omnibus Incentive Plan. Likewise, the employment agreement was effective May 12, 2014, between Ms. Robinson and Michael Kors (USA), Inc. and it remains in effect without modification.

KORS MAIN ACTIVITY

How Does the Company Make Money

Michael Kors Ltd is a global luxury lifestyle brand led by a world-class management team and an award-winning fashion designer.  The company’s products are handbags, footwear, accessories, apparel, watches, and others.

Products

KORS ProductsA1

The Market

As of March 29, 2014, the company managed 405 retail stores, including concessions. In addition, the store sales growth increased by 26 percent from fiscal 2013 due to increases in sales on accessories line and watches during fiscal 2014. Further, the sales in a comparable store had increased by $255.3 million in fiscal 2014 due to an opening of 101 new stores since March 30, 2013.

What do People Think about the Company’s Products or Services?

Here is one of the comments from the customers of Michael Kors Holding Limited.

What is this lawsuit about?

The lawsuit alleges that Michael Kors deceptively and misleadingly labeled and marketed merchandise that it sells at its Michael Kors Outlet Stores, including by using allegedly misleading price tags on its Michael Kors Outlet Products, which Plaintiffs claim resulted in damages to Plaintiffs and the Settlement Class. Michael Kors maintains that its marketing and labeling is not deceptive or misleading and is entirely proper and permitted by law. (source: https://www.michaelkorsoutletsettlement.com/Content/Documents/Long%20Form%20Notice.pdf )

Who is running the Business?

Person-in-charge of the Company

Michael David Kors, Honorary Chairman and Chief Creative Officer of MKHL

KORS Michael Kors

Michael Kors is a New York-based fashion designer of American sportswear. He was the first women ready-to-wear designer for the French house Celine, from 1997 to 2003. He was born Karl Anderson, Jr. on August 9, 1959, in Long Island, New York, USA. Kors was married to Lance LePere on August 16, 2011. His parents were Karl Anderson and Joan Hamburg, a former model. His mother remarried Bill Kors when he was five and choose to change his name to Michael David Kors.

Further, Michael Kors graduated from John F. Kennedy High School and studied at Fashion Institute of Technology in New York City. Michael Kors started from a small-time sportswear designer to the head of the company.

Employment

On May 20, 2015, Michael Kors (USA), Inc. (the Company) and Michael Kors Holding Limited (MKHL) has entered into an amended and restated employment agreement with each Michael Kors, the Honorary Chairman, and Chief Creative Officer (“the Kors Agreement”), and John D. Idol, Chairman and Chief Executive Officer (“the Idol Agreement”), as required under the terms thereof.

The Kors Agreement is a continuation of terms in prior agreements. The Mr. Kors’ employment agreement will terminate upon his death, permanent disability or for “Cause”, defined in Kors Agreement. The Kors Agreement gives Mr. Kors imaginative and artistic control over the products produced and sold under the MICHAEL KORS trademarks and related marks, including exclusive control of the design of such products, so long as the control is commercially reasonable. Source: SEC filings

Intellectual Property

All intellectual property generated by or at Mr. Kors’ order in the course of his employment is the exclusive property of the Company. Mr. Kors is obliged to retain the confidentiality of the Company’s proprietary information. In addition, the Company has agreed that they will not enter into any new line of business without Mr. Kors’ consent, if he is reasonable, determines that such line of business is detrimental to the company’s trademarks.

Benefits

The Company provides health and medical insurance to Mr. Kors at its own cost without contribution from him. The whole life insurance premium policy and the $500,000 term life insurance policy. The Company provides automobile and chauffeur for transport to and from the Company’s offices and for other business purposes. Upon termination of the agreement, he will be allotted to a pro-rate of his bonus, however, if Mr. Kors terminates his employment without the consent of the Company, he will be an independent and exclusive design consultant for the Company with an annual fee of $1.0 million and will not challenge with the Company, for the remainder of his lifetime. Source: SEC filings

KORS Salary

In addition, Kors was entitled to a salary of not less than $1.0 million annually, under the new Agreement. Mr. Kors’ total basic compensation in the last fiscal year was $15.13 million USD, out of which, 17 percent were the total annual compensation and 32 percent was restricted stock awards.

Special events:

He was discovered by Dawn Mello, Fashion Director of Bergdorf. He turned the fashion house with successful accessories and a critically acclaimed ready-to-wear line. The MICHAEL line includes women’s handbags and shoes and ready to wear apparel. The KORS line is footwear and jeans. He was honored by the Couture Council of The Museum at the Fashion Institute of Technology (FIT) with the 2013 Couture Council Award for Artistry of Fashion.

As a teen, He starts designing clothes and selling them.
1977 He enrolled at Fashion Institute of Technology, after dropping out after nine months, got a job in Bergdorf Goodman boutique and was able to sell his design in a small space given to him.
1981 Kors launched Michael Kors womenswear line at Bloomingdale’s, Bergdorf Goodman, Lord & Taylor, Neiman Marcus, and Saks Fifth Avenue.

1984 – 1999

1984 Michael Kors first runway show for the Michael Kors fall collection and was successful in making the Company into a global luxury lifestyle brand.
1993 Forced him to discontinue the Kors line because of bankruptcy.
1997 He was able to recover and launched a lower-priced line and was named the first women’s ready-to-wear designer for French house Celine.
1998 – 2004 Serve as Creative Director of Celine, the French luxury brand.
1999 Mr. Kors was the recipient of numerous industry awards, including the CFDA Womenswear Designer of the year 1999 and Menswear Designer of the Year 2003.

2003 – 2009

2003 Kors left Celine
2002 Kors launched his menswear line.
2004 The MICHAEL Michael Kors and KORS Michael Kors lines were launched.
2006 Awarded as the Accessories Council ACE Award for Designer of the Year 2006.
2009 Fashion Group International’s Star Honoree at its annual Night of Stars Awards in 2009.

2010 – 2013

2010 The CFDA acknowledge Mr. Kors with their most prestigious honor, the Lifetime Achievement Award.
2010 At age 50, Michael Kors became the youngest person ever to receive a lifetime achievement award from the Council of Fashion Designers of America.
2011 Marked Kors thirtieth year in business. He received the Award of Courage from the American Foundation for AIDS Research (amfAR).
2013 Kors was selected for The Time 100, the magazine’s annual list of the 100 most influential people in the world.

2014 – Present

January 2014 Forbes reported that KORS has a personal fortune of more than $1 billion, making him the latest fashion industry billionaire.
Present Michael Kors has full collection boutiques in New York, Beverly Hills, Palm Beach, Manhasset, and Chicago

Further, Mr. Michael Kors is a renowned award-winning designer and is instrumental in defining the brands and designing the company’s collections. His unique role as the founder, Chief Creative Officer and the namesake behind the brand provides the Board of Directors with valuable leadership and insight into the company’s design, marketing, and publicity strategy.

John D. Idol, Chairman of Michael Kors, and Chief Executive Officer (CEO) and a Director

December 2003 to Present

KORS John Idol

 

 

 

 

 

Special events:

July 1, 2001 – July 2003 Chairman and Chief Executive Officer and a director of Kasper ASL, Ltd., whose lines included the Anne Klein brand.
July 1997 – July 2001 Chief Executive Officer and a director of Donna Karan International Inc.
1994 – 1997 Ralph Lauren’s Group President and Chief Operating Officer of Product Licensing, Home Collection, and Men’s Collection.

Employment Agreement

It is required in the terms, John D. Idol has entered into an amended and restated employment agreement with Michael Kors Holding Limited, (“the Idol Agreement”). The conditions under the Idol Agreement extend Until March 31, 2018, and will be automatically renewed for an additional one-year term, unless there is an advance written notification of non-renewal by either Mr. Idol or the Company. Mr. Idol will serve as Chairman and Chief Executive Officer of the Company and MKHL, reporting to MKHL Board.

Regarding Retirement and Fringe Rights

Mr. Idols’ employee retirement and fringe rights remain the same under the Idol Agreement. The company will pay the premium up to a maximum of $50,000 per annum, for his $5.0 million whole life insurance policy. He was likewise supplied with an auto and driver for transportation to and from the Company’s offices and for business purposes as provided in the Agreement.

Idol Agreement

The Idol Agreement will terminate upon a change of control and upon his death or total impairment. Mr. Idol can terminate the agreement without good reason upon 10 days advance written notice, subject to his having certain rights to meet with the MKHL Board, and a majority of the MKHL Board approves his dismissal. Moreover, a pro rata portion of his bonus will be given upon the termination of the agreement. Plus severance equal to double the sum of his current base salary and the annual bonus paid or payable to him during the last fiscal year. And payable in a single lump sum within 30 days after the termination.

New Agreement

Mr. Idol agreed, that all rights to the Company’s intellectual property will remain the sole and sole property of the Company and he will remain bound to preserve the confidentiality of the Company’s proprietary information. Under the new agreement, Mr. Idol is entitled to receive not less than $1.0 million annual salaries. Likewise, John D. Idol totals basic compensation was $15.01 million USD, of which 17 percent were the total annual compensation and 32 percent was restricted stock award.

Special Events:

July 3, 2007, President 2007, Secretary of Global Brands Acquisition Corporation
Since September 2011 Chairman of Michael Kors Holding Limited.
January 2003 Chief Executive Officer of Michael Kors Corporation
Since December 2003 Chief Executive Officer and Director of Michael Kors Holdings Limited.
July 2001 to July 2003 Chief Executive Officer of Kasper ASL Ltd.
July 1997 to July 2001 Chief Executive Officer and Director of Donna Karan International, Inc.
1994 to 1997 Group President and Chief Operating Officer of product licensing, home collections and men’s collection at Ralph Lauren.
1984 to 1990 Vice President at Ralph Lauren
July 2001 Chairman of Kasper ASL Ltd.
1980 Mr. Idol began his career at J.P. Stevens.

Key Executive Compensation 2015

KORS Executive compensation graph

The graph above shows the compensation for fiscal 2015. It shows the total amount of compensation for each executive from the highest to the lowest with the percentages against the total key executive compensation. Also, it includes all other benefits received by the executives.

The Historical Key Executive Compensation

KORS Executive compensation

Facts:

  • The key executive compensation in Fiscal 2015 was $39 million and it represents 3 percent of the total sales, general and administrative expenses.
  • Michael Kors’ total annual compensation was $15.1 million in Fiscal 2015, it represents 39 percent of the total key executive compensation.
  • And also, John D. Idol has $15.08 million total annual compensation in Fiscal 2015 and it represents 38.8 percent of the total key executive compensation.
  • In addition, Joseph B. Parsons has a total annual compensation of $3.0 million and it represents 8 percent of the total key executive compensation.
  • Moreover, Cathy Marie Robinson, Senior Vice President Global Operations has a total annual compensation of $3.6 million, equivalent to 9 percent of the total key executive compensation.
  • Finally, Pascale Meyran, Senior Vice President, and Chief Human Resources Officer have total annual compensation of $$2.0 million and it represents 13.6 percent of the total key executive compensation.

 Explanation

  • The composition of the total compensation was: salary, restricted stock award, securities options, non-equity compensation, and other compensation.
  • Moreover, Mr. Michael Kors and Mr. John Idol have the same amount of salary, restricted stock award, securities options, and non-equity compensation as follows, $2.5, $4.9, $2.6 and $5 million, respectively.

KORS Numbers Analysis

1. Equity and Retained EarningsKORS Historical SHE REFacts:

  • Shareholders’ equity growth in 5 years was 1,567 percent, from $125 million to $2.1 billion, Fiscal 2011 until the trailing twelve months.
  • The year over year growth was increasing or trending up yearly at an average rate of 97 percent.
  • And the retained earnings growth in the last five years was 2,783 percent.
  • The year over year growth was increasing at an average rate of 107 percent.

Explanation

  • In the fiscal year 2015, a net income of $881 million was added to the shareholders’ equity.
  • And the foreign currency adjustments of $91 million were deducted from stockholders’ equity.
  • A net gain on derivatives amounting to $31 million was added.
  • The exercise of an employee share option, equity compensation expense, and tax benefit on exercise of share options in the amount of $15, $49 and $45 million recorded as additional paid-in capital were added, respectively.
  • Also, the purchase of treasury shares in the amount of $495.3 million of 6,800,101 shares was deducted in 2015.

Interpretation

The shareholders’ equity had increased by 24 percent due to an increase in net earnings by 33 percent in the fiscal year 2015 from the fiscal year 2014.

The Equity and Retained Earnings Graph

KORS SHE RE Graph

The graph above shows that the shareholders’ equity and the retained earnings are trending upward from fiscal 2011 to fiscal 2015. In addition, the trailing twelve month shows that retained earnings have a slight increase, no more than 10 percent. Nevertheless, the shareholders’ equity falls down by no more than 10 percent.

Shares Outstanding

The number of shares outstanding is the company’s stock currently held by all its stockholders.

KORS Shares outstanding

Facts:

  • Fiscal 2015 and the trailing twelve months shares outstanding was 206 and 196.4 million shares.
  • And the growth from Fiscal 2011 to Fiscal 2015 was 10 percent.
  • The trailing twelve months shows a decreased of 5 percent or $9.55 million.

Explanation:

  • The number of shares increases year over year due to an issuance of restricted shares at 18,541, 250,654 and 413,108 shares in 2013, 2014 and 2015, respectively.
  • And the exercise of employee share options at 8.7, 2.6 and 1.8 million shares in 2013, 2014 and 2015, respectively.
  • In addition, in the trailing twelve months, there was a forfeiture of restricted shares at 8,252 shares which were deducted from the total number of shares.
  • Likewise, the exercise of employee share options in the trailing twelve months was 706,343 shares.

Interpretation

The company’s outstanding shares were increasing year over year due to the exercise of employee share options and the issuance of restricted shares.

Details on Share Repurchase Program

  • On October 30, 2014, the Board of Directors of KORS authorized a $1.0 billion shares repurchase program.
  • While, on May 20, 2015, The Board of Directors authorized an additional $500 million under the existing share repurchase program and extended the program through May 2017.
  • In the three months ended June 27, 2015, the company repurchased 6,960,352 shares at a cost of $350.0 million through open market transactions.
  • As of June 27, 2015, the remaining available under the repurchase programs was $658.1 million.

Share Repurchase Program

  • The company has also a “withhold to cover” repurchase program, which allows the company to withhold common shares from certain executive officers to satisfy maximum tax withholding obligations relating to the vesting of their restricted share awards.
  • Moreover, in the three month period ended June 27, 2015, and June 28, 2014, KORS withheld 22,500 shares and 11,022 shares, respectively at a cost of $1.1 million and $1.0 million, respectively, in satisfaction of maximum tax withholding obligations relating to the vesting of restricted share awards.

2. The Valuation Model

Using the valuation model, the following results were summarized in the table below.

KORS Value Model

Facts:

  • Book value growth rate in 5 years was 47 percent.
  • And the book value in 5 years is $74.29 per share.
  • Also, the average return on equity is 45.62 percent.
  • In addition, the return on book value in 5 year period was $33.89.
  • While stock price in 5 years is $335.51.
  • The present value of the stock was $145.05.
  • Dividend yield was zero percent.
  • On the other hand, the risk that was used was 15 percent.
  • Current price as of October 1, 2015, was $43.53
  • Intrinsic value was $87.03 per share.
  • A share price of Michael Kors Holdings Limited was undervalued by 50 percent.

Explanation

Using the Value Model, the market price of KORS as of October 5, 2015, was undervalued 51 percent because the intrinsic value or the true value of the stock was higher than the market price.

Detailed Financial Analysis

A. BALANCE SHEET

Financial Health Ratios

KORS Liquidity

Facts:

  • The current ratio was averaging 4.66 and the trailing twelve months ratio was 5.35.
  • And the quick ratio was averaging 2.96 and the trailing twelve months ratio was 3.19.
  • While the financial leverage was averaging 1.59 and the trailing twelve months ratio was 1.22.
  • Moreover, the debt to equity ratio was averaging 0.16 and there was zero debt to equity ratio from 2013 to the trailing twelve months.
  • And debt to assets ratio was averaging 0.05 and there was zero debt to assets ratio from 2013 to the trailing twelve months.

Explanation

  • The current ratio is a financial health ratio that proves the ability of the company in meeting its financial current obligations using its current assets. KORS is very capable of meeting its current obligations using its current assets because the current assets are 5 times more than its current liabilities. Cash represents 45 percent of the total current assets for the trailing twelve months.
  • While the quick ratio is a financial health ratio, which tests the ability of the company in paying its current financial obligation using only its quick assets. Quick assets are current assets minus inventory. KORS has the ability to pay its current obligations using its quick assets because its quick assets are three times greater than its current liabilities.

Further,

  • Financial leverage is the total assets divided by the total shareholders’ equity. For every $1 in equity that was invested, KORS had $1.59 in total assets.
  • While the Debt to Equity ratio is a measure of how much is financed by debt or creditors compared with its owners. KORS has zero debt to equity ratio of 2013 for the trailing twelve months, meaning, the operation of the business is financed solely by the stockholders.
  • Moreover, the Debt to Assets ratio is a measure of how much of the total assets are financed by creditors. KORS has a zero debt to equity ratio of 2013 to the trailing twelve months, meaning, the company’s total assets are financed by the stockholders.   

Interpretation

The liquidity and solvency ratios tell us that KORS is capable of meeting its current and long-term financial obligations on its due date using its current assets. In addition, the company is capable of paying its current financial obligation using only its quick assets.

Efficiency Ratios

KORS Efficiency

Facts 

  • The day’s sales outstanding were averaging 31.97 or 32 days in a period.
  • And the day’s inventory was averaging 105 days in a period.
  • While the payables period was averaging 36 days in a period.
  • On the other hand, the cash conversion cycle (CCC) was averaging 101 days in a period.
  • The receivables turnover was averaging 12 times in a period.
  • Likewise, the inventory turnover was averaging 4 times in a period.
  • Similarly, the fixed asset turnover was averaging 9 times in a period.
  • The asset turnover was averaging 2 times in a period.

Explanation

  • Days sales outstanding or average collection period or days sales in receivables, measure the average number of days a business takes to collect its average receivables in a period. It measures the liquidity and efficiency of sales collection activities.
  • The day’s inventory is the average number of days that it took to sell the average inventory in a period.
  • Payable Period measures the number of days the company takes to pay its suppliers, or it is the average payment period that the company set in making payments to its creditors.
  • The cash conversion cycle (CCC) measures the number of days, cash is tied up in the production, in the sales process of its operations and the benefits, it gets in payment terms from creditors.

More Explanation

  • Receivables turnover measures how many times a firm collects its average accounts receivable balance during a certain period. In other words, it measures the efficiency of the business to collect credit sales. Higher results are favorable and a lower result is unfavorable.
  • While the inventory turnover is the number of times per year that inventory turns over.
  • In addition, the fixed assets turnover ratio or the sales to fixed assets ratio. This ratio measures how efficient is the company in utilizing its fixed assets to generate revenue. The ratio is calculated by dividing net sales over average fixed assets.
  • Moreover, asset turnover measures the management efficiency in utilizing its average total assets in generating sales or revenue.

Interpretation

  • The day’s sales outstanding tells us that, it will take an average of 32 days for the sales or services to be converted into cash.
  • And the days’ sales in inventory tell us, that, it will take 105 days for the average inventory to be sold during a period.
  • Moreover, the payable period indicates that the average period for the company to pay its suppliers is 36 days from the date of purchase.
  • Likewise, the cash conversion cycle (CCC) indicates, that it takes 101 days for the company to turn assets into cash. It also indicates that the company is efficient in managing its working capital and the ability to pay off its current liabilities.

More of Interpretation

  • The receivables turnover ratio shows that the company collects its average accounts receivables 12 times in a year.
  • Likewise, the fixed asset turnover tells us that the company generates $9.28 of revenue for every $1 investment in net fixed assets over the year.
  • And the asset turnover ratio, tells us, that KORS is generating $2.02 of sales for every $1 invested in average total assets. In other words, net sales of KORS is equal to average total assets. This ratio looks at revenue and not profit.

Condensed Balance Sheet

KORS Condensed BSFacts:

  • In the trailing twelve months,
    • Total cash was 32 percent of the total assets, a decreased of 4 percent in 2015.
    • And the current assets were 71 percent of the total assets, a decreased of 4 percent in 2015.
    • On the other hand, current liabilities represent 13 percent of the total liabilities and stockholders’ equity.
    • Similarly, total liabilities represent 18 percent of the total liabilities and stockholders’ equity, a one percent increase from 2015.

Explanation

  • Cash was increasing year over year at an average rate of 167 percent in five years. Cash and cash equivalents are highly liquid investments with original maturities of three months or less.
  • And the total current assets were increasing year over year at an average rate of 57 percent in the last five years.
  • Moreover, net property, plant, and equipment were increasing year over year at an average rate of 40 percent in the last five years. The property is stated at cost less accumulated depreciation and amortization.
  • Total assets increased year over year at an average rate of 50 percent in the last five years.
  • On the other hand,  current liabilities are increasing year over year at an average rate of 25 percent in the last five years.
  • Likewise, the total liabilities increase year over year at an average rate of 15 percent in five years.
  • Lastly, stockholders’ equity increases year over year at an average rate of 97 percent in the last five years.

Interpretation

Michael Kors Holdings Ltd is a fast developing company. The company has seen 3,738 percent growth in cash, its total assets have seen 540 percent growth and the shareholders’ equity has seen 1,567 percent growth in the last five years.

 

B. INCOME STATEMENT

Profitability Ratios

KORS Profitability

Facts:

  • The gross margin was averaging 59 percent and the trailing twelve months ratio was 60 percent.
  • Operating margin was averaging 25 percent and the trailing twelve months ratio was 28 percent.
  • Net margin was averaging 16 percent and the trailing twelve months ratio was 20 percent.
  • Return on assets was averaging 31.07 percent and the trailing twelve months ratio was 36 percent.
  • Return on equity was averaging 46 percent and the trailing twelve months ratio was 42 percent.

Explanation

  • Gross profit margin is the percent of profit after deducting the cost of sales from the total sales.
  • Operating margin is the percent of profit after deducting the operating expenses from gross profit.
  • Net margin is the percent of profit after deducting interest, income tax expenses from the operating income.
  • Return on assets ratio is the ratio of net income to average total assets. It measures the efficiency of the management in using the company’s assets in generating net earnings. It indicates the number of cents for every dollar of average total assets.
  • Return on equity or return on capital is the ratio of the company’s net income over its stockholders’ equity during a period. It evaluates the profitability of the stockholders’ investment to the company. A higher ratio is better.

Interpretation

The company generates revenue in its divisions or segments around the world. In the 2015 fiscal period, KORS generated $2.13 and $2.1 billion, and $172 million in retail net sales, wholesale net sales, and licensing revenue, respectively. Its highest sales were in North America, followed by Europe.

The gross, operating and net margin increases in 2013 has remained stable going forward at a rate of 60, 29 and 20 percent, respectively. Return on assets tells us that the management is efficient in managing its assets. The return on equity ratio indicates that the company is capable of generating a decent return on the shareholders’ investment in the company.

The Profitability Graph

KORS Profitability Graph

Facts:

  • The graph shows that the gross margin was between 50 to 60 percent in the last five years.
  • Operating margin was ranging from 15 to 30 percent in the last five years.
  • Net margins have not seen negative and it was ranging from 7 to 20 percent in the last five years

Explanation

  • The company’s gross margins remain stable in the last five years.
  • Operating profit of KORS had increased by 52 percent in 2013 and remain stable at an average 29 percent going forward.
  • Net income had increased by 61 percent in 2013 and remain stable at 20 percent going forward.

Interpretation

The graph above shows that the management is efficient and capable of generating decent revenue year over year.

The Earnings Growth Rate

KORS Profitability and Growth

Facts:

  • Gross profit growth in the last five years was 452.5 percent, or from $803 million to $4.4 billion.
  • Growth in the trailing twelve months was 2 percent from 2015.
  • Operating income growth in the last five years was 798 percent, from $137 million to $1.2 billion.
  • The trailing twelve months growth was negative 2 percent from 2015.
  • Net earnings growth in the last five years was 1,097 percent, from $72 million to $868 million.
  • The trailing twelve months growth was negative 2 percent from 2015.

Explanation

  • Gross profit increases year over year at an average rate of 43 percent in the last five years.
  • The net sales from retail stores in Fiscal 2015 represent 49 percent of the total revenue, at $2,134,578,000, a 34 percent increase from Fiscal 2014.
  • The net sales from wholesale in Fiscal 2015 represent 47 percent of the total revenue, at $2,065,088,000, a 31 percent increase from Fiscal 2014.
  • Revenue from licensing in Fiscal 2015 represents 4 percent of the total revenue, at $171,803,000, a 22 percent increase from Fiscal 2014.
  • Total revenue in Fiscal 2015 was $4, 4 billion, compared to the total revenue of $3.3 in Fiscal 2014, having a 32 percent increase.

Interpretation

The company’s revenue was running in three segments, which is the retail, wholesale and licensing. In Fiscal 2015, Accessories contribute the highest sales equivalent to 68 percent of the total sales, Apparel had total sales equivalent to 13 percent, and footwear had total sales equivalent to 11 percent of the total sales. The total revenue from licensed products was equivalent to 8 percent of the total sales.

The Earnings Growth

KORS Earnings Growth Graph

The graph indicates that the earnings of Michael Kors Holdings Limited were trending up from 2011 for the trailing twelve months. Nevertheless, in the trailing twelve months, the development remains stable from Fiscal 2015. The operating income and the bottom-line show that earnings are getting higher year over year.

C. STATEMENT OF CASH FLOWS

KORS Statement of Cash Flows

Facts:

  • The cash from operating activities has a growth of 730 percent in the last 5 years, from $110 million to $915 million.
  • The capital expenditures were $421 million in the trailing twelve months.
  • Free Cash Flows have a growth of 841 percent in the last five years, from $52.47 million to $494 million.

Explanation

  • The cash from operating activities was increasing year over year at an average rate of 67 percent.
  • Capital expenditures are investments in property, plant, and equipment and it is increasing year over year.
  • The free cash flow is trending up year over year at an average rate of 158 percent. The growth rate in 2013 was 841 percent.

Interpretation

The cash from operating activities and the free cash flows were impressive. The management has the capability of generating sufficient cash from the company’s resources to be utilized for the business operations and for future investments and for paying dividends to its stockholders.

INVESTMENT VALUATION

The Enterprise Value (EV) Approach

Enterprise Value (EV) is the present value of the whole company. EV takes into account the balance sheet, so in my own opinion, it is a much more definite measure of a company’s true market value than market capitalization. It assesses the value of the productive resources that are capable of producing products or services, both equity capital (market capitalization) and debt capital. Market capitalization is the value of the whole company’s equity shares.

EV is a company’s presumed takeover price because the buyer would have to purchase all of the stock and pay off existing debt while taking all the remaining cash. This gives the buyer a strong case for making its offer.

The table below shows us the summary of the historical enterprise value.

KORS EV

Facts:

The trailing twelve months show that,

  • Market capitalization was $8.4 billion USD.
  • The share price as of October 5, 2015, was $43.53.
  • Total debt was zero.
  • Cash and cash equivalent were $809 million.
  • Calculated enterprise value was $7.6 billion.
  • Calculated enterprise value per share was $39.35.
  • Total shares outstanding were 193,421,990 million shares.

Explanation

  • Market capitalization growth of KORS was 64 percent in the last five years.
  • The company has zero debt from 2013 to the trailing twelve months.
  • Cash and cash equivalent represent 11 percent of the enterprise value for the trailing twelve months.

Interpretation 

In purchasing the entire business of KORS as of October 5, 2015, the investor would be paying t $7.6 billion at $39.35 per share. The equation in buying would be 100 equity and zero debt.

 

The Discounted Cash Flow (DCF) Approach on KORS

Discounted cash flow (DCF) is a valuation method used to estimate the value of the entire company today based on future cash flows. DCF calculates the present value of the future cash flows using a discount rate. A present value estimate is then used to evaluate a potential investment. It is described as “discounted” cash flow because of the principle of “time value of money”. In other words, the amount of cash that the company will receive today is worth more than the dollar in the future.

DCF Formula

Where:

  • Vo is the value of the equity of a business today.
  • CF1 to CFn represent the expected cash flows (or benefits) to be derived for periods 1 to n. The discounted cash flow model is based on time periods of time of equal length. Because forecasts are often made on an annual basis in practice, we use the terms “periods” and “years” almost interchangeably for purposes of this theoretical discussion.
  • r is the discount rate that converts future dollars of CF into present dollars of value.

The Historical Cash Inflows

KORS Historical CF

The EBITDA growth was 759 percent in the last five years, from $162 million to $1.4 billion. In addition, the EBITDA was increasing year over year at an average rate of 75.69 percent.

The Projected Cash Inflows

KORS Projected Cash Inflows

Facts:

  • The projected cash inflows in Year –
  • 1 or in the year 2016 was $1,534,937,800 billion.
  • 2 or in the year 2017 was $1,688,431,580 billion.
  • 3 or in the year 2018 was $1,857,274,738 billion.
  • 4 or in the year 2019 was $2,043,002,212 billion.
  • 5 or in the year 2020 was $2,247,302,433 billion.
  • The calculated terminal value was $13,829,828,353 billion.
  • The estimated present value discounted using the calculated required rate of return in Year –
  • 1 or in the year 2016 was $1,312,374,785.
  • 2 or in the year 2017 was $1,234,291,275.
  • 3 or in the year 2018 was $1,160,853,567.
  • 4 or in the year 2019 was $1,091,785,248.
  • 5 or in the year 2020 was $1,026,826,346.
  • The present value of the terminal value was $6,319,056,975.
  • The future enterprise value was $12,145,188,196 at $62.79 per share.

Explanation

  • The current growth rate of cash inflows in Fiscal 2015 was 28 percent, however, this is less than the growth in fiscal 2014 by 31 percent. And, from 2013 to fiscal 2014, the growth diminished by 81 percent.
  • The present value of the projected cash inflows was calculated utilizing the required rate of return (RRR) (shown in the table below), with the following formula:

 Present Value = Projected Cash Inflows ^n / (1+ discount rate) ^n

  • The enterprise value was the sum of the present value at year 1 to year 5 plus the present value of the terminal value. In other words,

Enterprise Value = PV^1 + PV^2 + PV^3 + PV^4 + PV^5 + PV (terminal value)

Interpretation

The present downswing of the luxury wholesale and retail sales globally might continue in the coming more years, due to this, the historical current cash inflow growth rate is not applied.

The Terminal Value

KORS Terminal Value

Facts:

  • The calculated Terminal Value using the Gordon Growth model was $13.8 billion.
  • The final projected year cash flows of $2,247,302,433.
  • The long-term cash flows growth rate of 0.61%.
  • And the calculated discount rate or the required rate of return of 16.9588 percent.

Explanation

Terminal value or continuing value is the value of the firm beyond the projected period. In other words, it is the future discounted value of all future cash inflows beyond a given date.

Interpretation

It needed to come up with a terminal value of cash inflows after projecting the future cash inflows at year 5. If the terminal value or the value of future long term value is not considered, it will be assumed that KORS stopped operating at the end of 5 year projection period.

The Fair Value or Intrinsic Value and the Margin of Safety

KORS Fair Value

Facts

  • Intrinsic Value or Fair Value was $11.17 billion at $57.73 per share.
  • The net debt was -$978,922,000.
  • Net Debt = Short term liability + Long term liability – cash and cash equivalent
  • Share price as of October 5, 2015, was $43.53.
  • The margin of safety was $14.20 per share or 25 percent of the intrinsic value.
  • The stock of KORS is undervalued.

The Discount Rate or the Required Rate of Return (RRR)

KORS RRR

Facts:

  • The calculated required rate of return or the discount rate was 16.9588 percent.
  • The risk-free rate was 7.17 percent.
  • The long-term cash flow growth, which is the average long term Gross Domestic Product (GDP) in the United Kingdom was 0.61 percent from 1955 until 2015.

Explanation

  • Risk-Free Rate is the rate of return from an investment with zero risks over a specified period.
  • Market Risk Premium is the return expected over and above the risk-free rate.
  • Beta is a measure of the stock volatility in the stock price fluctuations in the overall market.
  • GDP Growth Rate represents the overall market value of all the goods and services that a country produces over a specific time period – you can think of it as the size of the economy.

Interpretation

The required rate of return (RRR) is the minimum annual return that an investment must provide to support or justify the purchase of an investment. The investor’s decision to invest in a new project depends on their risk tolerance.

Present Value

This method of valuation tries to work out the value today of the projected cash flows in the future, now let us walk through the calculation of the present value of the projected cash inflow in year 5.  I will walk you through by the following formula:

PV

or PV = FV (1+r) n

Where:

PV = Present Value

FV = Future Value

r    = Rate of Return

n   = Number of Periods

Present Value at year 5:

PV = $2,247,302,433 / (1 + 16.9588%) ^5

= $2,247,302,433 / (1.169588) ^5

= $ 1,026,826,346 

Therefore:

PV = $1,026,826,346

FV = $2,247,302,433

r    = 16.9588%

n   = 5

Present Value of Terminal Value

PV = $13,829,828,353 / (1 + 16.9588%) ^5

= $13,829,828,353 / (1.169588) ^5

= $6,319,056,975

Therefore:

PV = $6,319,056,975

FV = $13,829,828,353

r    = 16.9588%

n   = 5

The present value of the future projected cash inflows at year 5 is $1,026,826,346. On the other hand, the present value of the terminal value was $6,319,056,975.

KORS Monthly Stock Trends

What is the stock trends? Stock trends are the general direction in which a market is heading, it is the movements of the highs and lows.  The stock trend is a significant factor in technical analysis.

KORS Stock Trend

Facts

  • The chart above illustrates a descending price movement from September 30, 2014, until April 30, 2015.
  • Then followed by a horizontal or sideways price movement from May 31, 2015
  • Until the trailing twelve months. The sideways pattern has a small price move.
  • As a result, a break of a trendline usually indicates a strong trending characteristic either up or downwards.
  • Moreover, the chart shows a little price movement in either direction and the chance to get an opportunity for profit is little, for a short term investor.

Explanation

The trend line shows a descending one-year movement from September 30, 2014, until the trailing twelve months at an average of negative 3.8 percent. Further, the one-year price growth of KORS is negative 40 percent, from $71.39 to $43.07, therefore, the price has a descending trend in a period of one year.

Historical Market Data

KORS Historical Market Data

Facts:

  • The Price to Earnings in the trailing twelve months was 10.63.
  • Earnings per Share for the trailing twelve months was $4.24 and it has a growth of 1185 percent in the last five years. Likewise, EPS is increasing year over year at an average rate of 77 percent in the last five years.
  • Price to Book value in the trailing twelve months was $4.10 per share.
  • Book Value per share in the trailing twelve months was $10.80 and it has a growth of 588 percent in the last 4 years.
  • EV/EBITDA in the trailing twelve months was 6 times.
  • The Share Price in the trailing twelve months was $45.12 and it has a growth of 60 percent in the last five years.
  • EV/EBITDA in the trailing twelve months was 6 times.
  • Market capitalization in the trailing twelve months was $8.4 billion and it has a growth rate of 63 percent.
  • The computed price target of KORS using the Price to Earnings was 45.84.

Explanation:

  • Price to Earnings (P/E) is the most popular metrics in stock analysis. It calculates the market value of the stocks relative to the earnings of the company. Likewise, it tells us what the market is willing to pay for the earnings of the company. The higher the P/E, the more the market is willing to pay for the earnings of the company.
  • In addition, Earnings per Share is a measure of profitability and how the management is handling the business operation. Moreover, it is a number of profits that accrue to each shareholders’ based on a number of shares they owned.
  • Moreover, Price to Book ratio is a financial ratio that compares the market price to the book value of the stock.

More Explanation

  • Book Value per share is the amount of shareholders’ equity over the number of outstanding shares, it is an indicator of the value of the company’s stock.
  • While the Enterprise Value/Earnings before Interest, Tax, Depreciation, and Amortization (EV/EBITDA), determines the value of the company.
  • Price Target forecast what the company is worth and compare to market price. It is a function of risk tolerance and the length of time in holding the security.

Interpretation

The financial ratios of KORS were improving year over year and the increase was acceptable. It indicates, that the management was efficient in handling the operation of the business.

In conclusion,

The stock trend graph has a descending trend and has a little movement. It is either up or down and a chance for a profit is small, for a short term investor. Hence, KORS stock is a good BUY for a long-term asset.

CITATION

https://www.sec.gov/Archives/edgar/data/1530721/000119312515201923/d900571d10k.htm#tx900571_13

http://www.michaelkors.com

https://www.michaelkorsoutletsettlement.com/Home/FAQ

https://www.michaelkorsoutletsettlement.com/Content/Documents/Long%20Form%20Notice.pdf

https://en.wikipedia.org/wiki/Michael_Kors

Researched and Written by Criselda

Twitter: criseldarome

itt-educational-services-esi

Is there a future for ITT Educational Services Inc (ESI) in US Education?

July 21st, 2015 Posted by Deep Analysis No Comment yet

ITT Educational Services Inc (ESI) is one of the largest publicly traded for-profit educational institution, headquartered in Indianapolis, USA

On May 12, 2015, the US Securities and Exchange Commission announces fraud against ITT Tech and Kevin Modany, the Chief Executive Officer. And Daniel Fitzpatrick, the Chief Financial Officer. The Securities and Exchange Commission affirmed that ITT Tech, who is running the for-profit colleges and its two executives. Mr. Modany and Mr. Fitzpatrick, has fraudulently hidden the poor performance of the threatening financial impact of the two private student loan program, the PEAKS, and the CUSO, which ITT Tech had financially guaranteed.

About ITT Educational Services Inc (ESI)

ESI established and provide the two student private loan programs after the breakdown of the private student loan market.  ITT Tech provides a limited risk of loss to attract investors to invest in these two private student loans programs. The two executives made various material distortion and eliminations in the disclosures to hid the default in the performance of the two student loan programs, stated on the Sec’s complaint.  Further, for-profit colleges are run by companies that operate under the demands of investors and stockholders.  Moreover, private loan programs are privately operated to earn money for their investors. Howbeit, for-profit colleges can get up to 90 percent of their revenue from federal student aid.

On the other hand, according to Kevin Modany in August he would be stepping down as Chief Executive Officer effective February 2015, further, he said that he would remain until the company has found somebody to replace him. Moreover, Daniel Fitzpatrick said, that he planned to retire October 29, 2015, from his position.

ESI Current Problems the Company is Facing  

  • The company was charged with fraud by the US Securities and Exchange Commission by concealing actual situation of the PEAKS and CUSO private loan program, and not telling the whole truth to the investors and its auditors. The company has misinformed the auditors repeatedly, therefore, the financials need to be restated.
  • Moreover, ESI has to face a federal lawsuit which was filed last year by the Consumer Financial Protection Bureau by exploiting students of predatory lending by pushing students in a private loan that cost higher than other private loans that may have a tendency to end in default.
  • In addition, after the announcement made by the SEC, the share price of ESI has nose-dive right after the publication at 44 percent, however, right after the filing of its financial statement ending December 31, 2014, to the SEC, the price started to rise to $4.37 from $2.41 per share. The stock price still remains unstable.
  • Moreover, ESI has been receiving punches from the regulators and could not defend themselves in a public arena because no evidence has been presented yet to the charges.

More about ESI’s concerns

  • One legislator is calling on the Department of Education to further investigate ITT Educational Services and its two executives, for not revealing the problems in the two private student loan program which could create a great impact on the financials.
  • Moreover, California Rep. Jackie Speier wrote a letter to the Department of Education demanding an investigation of alleged deceptive and predatory lending practices by the company.
  • In addition, the two programs were poorly run in 2012, which pushed the ESI’s guarantee obligations. Instead of telling the truth to the investors, the operators made a variety of actions that would appear that the company’s exposure was more limited, according to the Sec’s complaints.

Regarding Accounting Issues

  • Further, the SEC disclose complicated accounting issues that the company published years ago. The company affirmed in covering up losses by making payments on delinquent accounts to avoid exciting millions in guaranteed payments, which they have settled in 2011 and continued until 2013. According to SEC Enforcement Director Andrew Ceresney, the senior-most executives made a number of material misstatements and omissions in its disclosures to cover up poor performance of student’s loan programs that ITT created and guaranteed.

Statement from the SEC:

 “The SEC alleges that the national operator of for-profit colleges and the two executives fraudulently concealed from ITT’s investors the poor performance and financial impact of two student loan programs that ITT financially guaranteed.”

ITT formed both of these student loan programs, known as the “PEAKS” and “CUSO” programs, to provide off-balance sheet loans for ITT’s students after the collapse of the private student loan market. To induce others to finance these risky loans, ITT provided a guarantee that limited any risk of loss from the student loan pools.”

Issues that ESI is facing

  • ESI claimed that the US Securities and Exchange Commission had mistaken decision to bring an enforcement action against ESI. In addition, the company claimed that the evidence does not support the Sec’s claims.
  • Another problem of the company is the delay in the submission of the 2014 financial statement, which is one reason for the share price to decrease. However, recently, after the company had filed their 2014 financial statement with the SEC, the price immediate went up, unstable.
  • Moreover, the company have decided to consolidate the financial result of the PEAKS Trust program, beginning February 28, 2013, the Company’s Audit Committee concluded that the Company will need to restate the unaudited financial statements in its Quarterly Reports for each of the quarters ending March 31, 2013, June 30, 2013, and September 30, 2013, and the previously submitted annual report ended December 31, 2013, and the quarter ending March 31, 2014, as these were no longer reliable.

What are the Effects? 

  • Initially, the company’s future was placed into uncertainties and the reputation was affected.
  • The market price has dived at 44 percent from $4.02 to $2.27 per share, after the announcement of fraud against the company, Kevin Modany, Chief Executive Officers and Daniel Fitzpatrick, Chief Financial Officer.  However, after the filing of its 2014 financial statement, the price rise by 44.85 percent, but the price was still unstable.
  • Moreover, these private student loans program and the default rates have expanded in the US during recent years, which cause worries that it could trigger the next financial crisis.

From ITT’s Financials, quote:

“The level of student loan debt hit a record high of almost $1.2tn in the first quarter of 2015, with delinquencies of 90 days or more reaching about 11.1 percent, according to a report by the Federal Reserve Bank of New York released on Tuesday” 

If the allegations of Congresswoman Jackie Speier is true,  “ITT Educational Services has engaged in deceptive and predatory lending practices, pushing students into high-interest loans they know cannot be repaid, at costly taxpayer expense,” Speier wrote.These students become saddled with unforgivable debt, and their inability to repay it ruins their future job prospects while harming taxpayers who are stuck with the bill,” a statement gathered from the website of Congresswoman Jackie Speier.

ITT’s PEAKS PROGRAM

From ITT, quote,

In order to meet the price of tuition fees in addition to Federal loans and grants, ITT partnered with a Wall Street investment bank to create a lending program that, through an impressively complex series of financial transactions, may meet the definition of a “private” loan that ITT may count toward the 10 sides of the 90/10 calculation.”

ESI PEAKS flowchart

From ITT, quote:

“The program has begun with Liberty Bank, who issued $346 million in loans to ITT students. ITT took a 28 percent discount on these loans and received $246.7 million in cash from Liberty Bank. The loans were then sold to a trust that then issued a $300 million in senior debt to a group of Wall Street investors. In exchange for their discount on the loans, ITT received a subordinated note from the trust and additionally guaranteed the senior debt holders payment of principal interest, certain call premiums, and administrative fees and expenses, regardless of whether the loans are repaid.”

The PEAKS program has an interest rate ranging from 4.75 to 14.75 percent.

ITT’s CEO describes the PEAK’s program as, quoted:

“A third party private student finance where our students apply for private lending to fill the gap financing need that they have, if a student gets a loan, for example, for a thousand dollars, there’s less than that amount that is transferred to the company, so some amount of that loan stays behind to provide excess of collateralization for the performance of the portfolio. And then in addition to that, the company provides guarantees on the performance of the program, and to the extent that the excess of collateralization would not be sufficient to cover the return on the investment that the senior notes that the investors put into the trust to fund the program.”

Further,

“As of June 30, 2011, ITT has exhausted the lending capacity of the PEAKS program and it’s no longer originating additional PEAKS loans, although the company has indicated they are interested in reinstituting a similar program. Between January 2010 and June 2011, in addition to Federal loans and grants, approximately $345 million in loans were made to ITT students. In 2009, the year before PEAKS funding was available, ITT’s 90/10 ratio was 70 percent. For 2010, this ratio fell to 60.8 percent. While it is unclear as to the extent PEAKS is responsible for this drop, the program is likely responsible for at least a portion of this decline.” 

Partnering with Wall Street

The adviser and creator of the two private student loan program were ITT Technical Institute and ESI, who partnered with Wall Street investment bank or group of Wall Street investors. The company has the sole decision whether to extend credit to its students and is independent of the Originating Lender’s evaluation of prospective borrowers in accordance with the underwriting criteria established under the PEAKS Program.  Moreover, the Trust Equity Holder is the Administrator of the Trust, is responsible for identifying to the Trust the private education loans eligible for purchase under the PEAKS Program.  Therefore, the Trust Equity Holder has the power to direct the activities that are essential to ensuring that loans purchased by the Trust are of the quality specified under the PEAKS Program, which ultimately impacts the economic performance of the Trust.

Comments and Response from SEC gov:

Comment:

Please tell us whether the Trust is contractually required to use Liberty Bank as an exclusive underwriter and lender for the PEAKS program.  If not, which party would make the determination to use a different underwriter/lender?

Response:

“Pursuant to the applicable contractual provisions between the Trust and Liberty Bank, the Trust has agreed to purchase private education loans made by Liberty Bank to the Company’s students, if originated in accordance with the program guidelines and to the extent of available funds in the Trust.  The Company further understands that the Trust was established by the Trust Equity Holder and the owner trustee of the Trust (an entity AFFILIATED with the Sponsor) as a limited purpose trust to purchase and own private education loans originated by the Originating Lender under the PEAKS Program.

Liberty Bank is the designated Originating Lender (i.e., underwriter and lender) for the PEAKS Program pursuant to an origination and sale agreement (the “Origination and Sale Agreement”) among the Trust, the Originating Lender, the Origination Agent, an AFFILIATE of the Sponsor who serves as the lender trustee (“Lender Trustee”) of the Trust and the Company.  The Origination and Sale Agreement can be terminated only in limited, non-discretionary circumstances, which generally include:

The following:

  • a party’s failure to timely observe or perform its obligations under the Origination and Sale Agreement in any material respect and such failure remains uncured and materially adversely affects the value of the private education loans originated under the PEAKS Program:
  • a party’s representations, warranties, and covenants made in connection with the Origination and Sale Agreement or any sale of private education loans under the PEAKS Program are materially and adversely incorrect and the value of the private education loans is materially adversely affected; and
  • Changes in the laws or regulations that make the performance of obligations under the Origination and Sale Agreement impractical or unlawful.

“If the Origination and Sale Agreement is so terminated, the non-terminating parties have agreed to negotiate in good faith for the continuation of the origination and sale activities under the PEAKS Program on substantially the same terms with one or more additional parties.”

Quote from ITT Educational Services Internal Email, November 18, 2009, re PEAKS (ITT 00147688), ITT Educational Services, Private Education Loan Application and Solicitation Disclosure by Liberty Bank (ITT 00080791)

Solutions 

In the quarter ending September 30, 2014, filings, the following statement was gathered.

“The assets of the PEAKS Trust consist primarily of cash and the PEAKS Trust Student Loans. The liabilities of the PEAKS Trust consist primarily of the PEAKS Senior Debt. The assets of the PEAKS Trust serve as collateral for and are intended to be the principal source of, the repayment of the PEAKS Senior Debt. Moreover, the carrying values of the assets and liabilities related to the PEAKS Program that had been included as balance sheet items related to our Core Operations and consisted of the Subordinated Note, a guarantee receivable. In addition, the contingent liability, were eliminated from our Condensed Consolidated Balance Sheets as of September 30, 2014, and 2013.”

Primary Beneficiary of PEAKS Trust

Another statement gathered from ITT’s Q3 2014 financial statement:

Based on our analysis, we concluded that we became the primary beneficiary of the PEAKS Trust on February 28, 2013. This was the first date that we had the power to direct the activities of the  PEAKS  Trust that most significantly impact the economic performance of the PEAKS Trust, because we could have exercised our right to terminate the servicing agreement that governs the servicing activities of the PEAKS Trust Student Loans (the “PEAKS Servicing Agreement”), due to the failure of the entity that performs those servicing activities for the PEAKS Trust Student Loans on behalf of the PEAKS Trust to meet certain performance criteria specified in the PEAKS Servicing Agreement.

Further,

We have not, however, exercised our right to terminate the PEAKS Servicing Agreement. As a result of our primary beneficiary conclusion, we consolidated the PEAKS Trust in our consolidated financial statements beginning on February 28, 2013 (the “PEAKS Consolidation”). Prior to February 28, 2013, the PEAKS Trust was not required to be consolidated in our consolidated financial statements, because we concluded that we were not the primary beneficiary of the PEAKS Trust prior to that time. “

Furthermore,

“Our consolidated financial statements for periods as of and after February 28, 2013, include the PEAKS Trust because we were considered to have control over the PEAKS Trust beginning on February 28, 2013, under ASC 810, as a result of our substantive unilateral right to terminate the PEAKS Servicing Agreement. We do not, however, actively manage the operations of the PEAKS Trust, and the assets of the consolidated PEAKS Trust can only be used to satisfy the obligations of the PEAKS Trust. Our obligations under the PEAKS Guarantee remain in effect until the PEAKS Senior Debt and the PEAKS Trust’s fees and expenses are paid in full. See Note 13 – Commitments and Contingencies, for a further discussion of the PEAKS Guarantee.”

Another solution to the existing problems of ESI is to clear the charges made by the US Securities and Exchange Commission against the company, as the company is claiming, that, the evidence does not support the Securities’ charged.

What would be the results if they take options above? 

If the company is cleared of all the charges made by the SEC against them, the following results may happen.

  • The Company’s financials may start to rise again. One reason why the net earnings of the company drop by 119 percent in 2013 are due to the consolidation of the financial statement that includes the PEAKS Trust and the 2009 Entity.
  • Recently, the company had released its 2014 financial statement and made filings with the SEC, immediately after, the share price of the stock had risen by 44.85 percent.

Company History

Company Profile 

ITT Educational Services, Inc. (ESI) provides post-secondary degree programs in the United States.   Further, the Company provides master, bachelor and associate degree programs and short-term information technology and business learning solutions. In 1965 until 1994, ITT Tech was a fully owned subsidiary of ITT Corporation (as “ITT/ESI”). ITT’s Initial Public Offering was in 1994, with a ticker symbol of ESI under the New York Stock Exchange (NYSE). The company has 3,120 employees.

Key Dates

  • 1963: Textbook publisher Howard W. Sams opens Sams Technical Institute in Indianapolis, Indiana.
  • 1966: Sams is purchased by New York-based ITT Corp.
  • 1968: ITT incorporates its education subsidiary as ITT Educational Services.
  • 1981: ITT creates its new Business Division.
  • 1984: Employer Services Division is created.
  • 1992: ITT initiates Vision 2000, a growth strategy plan aimed at offering more degree programs and adding more colleges to the system.
  • 1994: Parent company ITT Corp. spins off 17 percent of ITT Educational in a public offering.
  • 1998: ITT Corp. is purchased by Starwood Hotels and Resorts Worldwide Inc.; ITT introduces its information technology program.
  • 1999: Starwood sells off all remaining ITT Educational stock in a public offering.

Incorporation/Head Office 

  • In 1968, ITT incorporates its education subsidiary as ITT Educational Services.
  • ESI’s head office was located at 13000 North Meridian Street, Carmel, IN 46032-1404, United States.

Company Sector/Industry 

ITT Educational Services was operating under the following category:

  • Sector: Consumer Discretionary
  • Industry: Consumer Services
  • Sub-Industry: Educational Services

Founder/Founding 

ITT Technical Institute was founded in 1946 as Educational Services Inc. ITT Technical Institute is a wholly owned subsidiary of ITT Corporation.

Senator Dianne Feinstein’s husband, California Regent Richard C. Blum has been a significant shareholder of the stock despite allegations of conflict of interest. Board member Vin Weber has also been a key political operative for the company since 1994.

The company’s first President, William Renner, late in 1969, however, he drops the position and replaced in 1970 by Burton Sheff. Sheff resigned in May 1972 and was replaced by Neil Cronin, who stayed only for a short period.

The next leader

In 1974, Richard McClintock became the next leader. McClintock, who had been employed by ITT Corporation and its subsidiaries since 1957. He had served previously as the company’s comptroller and treasurer. On the onset of his leadership in 1974, he immediately set about implementing new administrative structures and procedures. Moreover, two of his first initiatives were to establish an executive committee for the company and to begin establishing curriculum advisory committees for each region. On the other hand, Richard McClintock served ITT for 10 years, until his death in October 1984. In addition, the company’s executive committee took over the governance and operation until Rene Champagne took over the position in September 1985.

Other Significant Information 

  • After the conference call on June 2, 2015, the price went down by 12.42 percent, from $4.67 to $4.09 per share. Although the earnings meet investors’ expectations.
  • Moreover, ESI has a financing agreement dated December 4, 2014, with Cerberus Business Finance LLC as collateral agent and administrative agent. Further, ESI borrowed a principal amount of $100.0 million senior secured term loan. The loan is intended to be used as collateral for the $89.2 million letters of credit that are outstanding.
  • Large institutional investors in the company include Blum Capital Partners (which owns 15.8 percent of the company), Wellington Management Company (13.99 percent), Select Equity Group (6.5 percent), and Providence Equity Group (5.6 percent).

Material Events Affecting the Numbers 

Key Executive CompensationESI compensation

Facts:

  • The key executive compensation in 2013 and 2014 were $6 and $7.36 million, respectively.
  • While Kevin M. Modany’s total compensation in 2013 and 2014 were $3 and $3.2, respectively.
  • In addition, Daniel M. Fitzpatrick’s total compensation in 2013 and 2014 were $1.0 and $1.1 million, respectively.

Explanation:

  • The executive compensation in 2014 had increased by 23 percent from 2013.
  • While Kevin M. Modany’s total compensation in 2014 had increased by 8 percent from 2013.
  • In addition, Daniel Fitzpatrick’s total compensation in 2014 had increased by 13 percent from 2013.

Interpretation:

  • The total executive’s compensation had a growth of 41 percent in the last five years.
  • Moreover, Modany’s total compensation had a growth of 58 percent in the last five years.
  • While Fitzpatrick’s compensation has a growth of 37 percent in the last five years

MAIN ACTIVITIES

1. How Does the Company Make Money? 

ITT Educational Services, Inc. (ESI) offers post-secondary education in master, bachelor’s and associate degree program. It provides technology-oriented undergraduate and graduate degree programs through its accredited post-secondary institutions, ITT Technical Institutes, and Daniel Webster College. The Company owns and operates more than 130 ITT Technical Institutes and Daniel Webster College. ESI serves approximately 55,000 students in 39 states and online.

2. What do People Think of the Company’s Services? 

Here are some of the consumer’s complaints and reviews for ITT Educational Services:

  • Frank of Antelope, CA on May 11, 2015

Satisfaction rating (one star)

All I can say is that I owe $33,000 and it’s going down the drain for no real reason. The school hasn’t helped me get my real career together. I have just been laid off from a job that I looked for on my own. I got a 2 year Associates degree graduated in December 2013 and ever since I’ve been nothing but positive attitude looking for work. I’m not paying anyone for this mess. NEVER EVEN GOT MY GRADUATION PICTURES!!!

  • Michael of Towson, MD on May 9, 2015

Satisfaction rating (one star)

I graduated in 2013. CST was my major. They promised me a well-paying job. Did NOT fulfill their promise! Now I have a job but not even close to my major. They refuse to help me anymore. They won’t even return my phone calls. I have been calling just about every day!

  • Daniel of Sandiego, CA on May 5, 2015

Satisfaction rating (one star)

I was returning back to school at ITT Technical Institute. When I was trying to sign into my student portal I did not have access to it. I went to the dean’s office and 1 guy told me that the dean said that I am NOT allowed back at the school and I am NOT allowed back on the premise so I asked him why and he said something I did in the past. Then I asked him what did I do and he said I don’t know.

Further, I tried to contact the Dean, so I sent emails to the Dean and the Dean ignores me and never give me a response or a dismissal letter or anything, so I lost a lot of educational time for looking for another school. I should have graduated this year, but ITT Technical Institute causes me to fall back and waste a gap in my career.

  • Andrew of Tamarac, FL on April 29, 2015

Satisfaction rating (one star)

ITT Technical Institute in Fort Lauderdale, Florida tricked me into signing up for high-interest private student loans that were never explained to me. Private student loans were never once mentioned to either me or my mother and father. They rushed us through the entire sign up process and I was just an excited 18 years old fresh out of high school thinking I was doing the right thing. I don’t think I passed the entrance exam but the ITT Technical Institute salesman told me that I did anyway. I wanted so badly to believe him and so I did. All I ever wanted to do was go to college and get a decent education and a great paying job. I had no idea that it was all smoke and mirrors.

More of the Story

I attended between 2004 and 2006 and here is my experience of that time there. What they offered me was absolutely in no way what was described or advertised. My grades and GPA were artificially inflated by the administration in order to keep the school’s average GPA up, they were actually caught doing this. The classrooms were completely outdated, the computers were outdated by at least 6 years and software such as Photoshop was always at least 5 versions behind the current version.

Management

Most of the instructors knew less than a lot of the students in each classroom. Instructors were fired and hired at least a few times per course per semester. The new instructor would never know exactly where the previous instructor left off and it was just a complete disaster. Some instructors would just read directly from the book, some would just sit around and try to make friends with the students and let everyone does whatever they wanted.

This is not a way to run the school and I feel absolutely scammed that I am going to be paying $117,000 with interest on a $60,000 loan for a degree that most employers seem to shun. That being said, I would like a refund for the absolute lack of education I received. The fact that ITT Technical Institute is currently being sued by the CFPB for predatory practices is exactly why I am here. Predatory lending is exactly what I experienced among myriad other disasters and major shortcomings that a major “college” chain should have a standard.

  • Christina of Grand Rapids, MI on April 17, 2015

Satisfaction rating (one star)

itt-education-esi

I made the worst mistake of my life by signing up. When I first started things seemed pretty good. Class size was around 50 students per class. Many of them were Army Veterans that, gave me a sense or the illusion that I did not make the wrong decision in deciding to attend this school. By the second quarter, half of the students enrolled had to drop out and never returned. I just thought Maybe College was not for them and I continued to stick it out. Then I started noticing things like labs don’t ever work, teachers changing grades, passing people that were putting very little effort into their studies and never getting my books on time.

Further,

Then when I entered my second year in my Associate’s program in Computer Network Systems I was pulled out of class to meet with the finance department about financial aid. The school had told me that I was out of funding and I would have to take out loans to a different lender in order to continue my program. The financial aid adviser told me that the school offers a “Temporary Credit” where the school would fund me the money I needed at 0% interest until the loan was paid in full. Sounded as though, a good idea instead of trying to find a private lender to finance through.

I continued my program and graduated then I signed up to do the bachelor’s program but before signing up I asked the financial aid department if I had all the funding available that I needed to finish the program without needing to find alternate sources. I was assured I had plenty of funding available.

Furthermore,

So I started the bachelor’s program and by then the class size was no larger than 8 people and sometimes I was the only student in my class. Any times I was forced to take online classes even though I was told that online was an option. I continued on and at the last 4 quarters of my program, I get pulled out of class again by financial aid to advising me that I have run out of funding for my program and I would have to find other funding in order to complete my degree.

At this point, I was extremely angry and they offered to give me more money on the “Temp Credit” account so for me to graduate. I was too far into the program to just give up on it all so I agreed to add to the temp credit. A week after meeting with financial aid I get a letter in the mail saying that I have to start making payments on my temp credit account.

More of the Story

I called the school to verify this because when I sign up for the temp credit and was told I did not have to start making payments until 6 months after graduation. The financial aid adviser then told me that if I wanted to return to school I would have to set up a payment arrangement because I cannot just go to school for free. And had already invested too much time and money in this school I was not about to quit now so I set up a payment arrangement of $75.00 a month to stay enrolled.

Finally,

I ended up completing my bachelor’s degree program and have no assistance at all with career services or any help with internships, never getting any responses back on job prospects. I started getting statements in the mail about my temp credit. They sent 2 different statements that said different amounts on them. I called financial aid again to get verification and she said: “one statement was wrong and the other was right.” I then asked her “what happened to the balance that I had to my temporary credit when I first signed “up” and she said, “those loans were sold to private lenders.” And the nightmare continues. Stay away from this school. Also, if you are a victim of the predatory lending and abuses that ITT-Technical Institute has caused, please join us in the fight to get our loans forgiven. We are building a movement. Hope to see you there.

Who is Running the Business? 

The two officers that are directly responsible for the business operations of ITT Educational Services Inc. (ESI) were, Mr. Kevin M Modany, Chief Executive Officer (CEO) and Mr. Daniel M. Fitzpatrick, Chief Financial Officer (CFO).

Mr. Kevin M. Modany, Chief Executive Officer

ESI Modany

Mr. Kevin M. Modany has been the Chief Executive Officer of ITT Educational Services Inc. since April 1, 2007.   Mr. Modany served as the Chairman of the Board of ITT Educational Services Inc. from February 1, 2008, to August 4, 2014, and as its Director from July 25, 2006, to August 4, 2014.

History

  • April 26, 2005 – March 2009 – served as the President of ITT Educational Services Inc.   April 26, 2005 – April 1, 2007 – served as Chief Operating Officer of ITT Educational Services Inc.
  • And on  January 2003 – June 6, 2005 – served as its Chief Financial Officer from
  • While in July 2002 – April 26, 2005, – served as Senior Vice President
  • In addition, in June 2002 to December 2002 – he served as Director of Finance at ITT Educational Services Inc.
  • Moreover, in October 2000 – May 2002 – served as Chief Financial Officer and Chief Operating Officer of Cerebellum Software, Inc., a software development, and professional services company.
  • Also in October 1998 – September 2000 – served as President of USA Clean, LLC, a specialty chemical division of Gemini Holdings, Inc. and a distributor of products and chemicals for the textile care industry,
  • February 1995 – September 1998 – served as Executive Vice President, Chief Financial Officer, Director of Finance and Controller of Consolidated Products Systems, Inc., a food distribution and retail services merchandising company.

Modany’s Career

  • Modany began his career with a National accounting firm where he worked in the audit/financial consulting division and was consistently rated as one of the top performers in the local office. During his tenure, he served as the Sr. Auditor-In-Charge for the two largest audit engagements of the Pittsburgh office.
  • In addition, he obtained his Bachelor’s degree in Accounting (with an additional program focus in Finance) from Robert Morris University (formerly Robert Morris College-Pittsburgh, PA) and is a Certified Public Accountant.
  • Moreover, the annualized base salary as of February 10, 2014, was $824,076
  • Dollar increased over the prior year was $24,002 (3.0 percent)

Mr. Daniel M. Fitzpatrik, The Chief Financial Officer

ESI Fitzpatrick

Mr. Daniel M. Fitzpatrick has been the Chief Financial Officer and Executive Vice President at ITT Educational Services Inc. since April 2009 and served as its Principal Accounting Officer since September 2005.

  • June 6, 2005 – March 2009, Mr. Fitzpatrick served as Senior Vice President and Chief Financial Officer of ITT Educational Services Inc.,
  • Until June 2005 – served as Senior Vice President and Controller of Education Management LLC (alternate name: Education Management Corporation).
  • Prior to Education Management LLC, Mr. Fitzpatrick worked for Arthur Andersen LLP as an Engagement Manager providing audit, accounting, and business advisory services.
  • Annualized base salary as of February 10, 2014, was $412,000.
  • Dollar increase over prior year $12,000 (3.0 percent)

What do people think about the person or what do people say about the person?  

Here are some comments gathered from consumers affairs.com/education/itt

  • March 27, 2014                                                                                  

“Extremely greedy CEO-Kevin M. Modany has ruined the quality of an ITT Technical Institute education.”

Former Employee – Student Representative in Phoenix, AZ

Pros

Employees that care
Some students are a perfect fit for the ITT model.

Cons

Forcing, coercing, manipulating students to enroll is the unspoken mantra of HQ. Companywide Senior Student Reps were let go almost entirely due to not forcing enough students to enroll. The company has nearly eliminated all full-time teaching positions (sans Nursing, most state boards will not allow them too) so adjunct teachers make same teaching 10 students as they get for teaching a section of 30 plus students. Students forced into online classes that came to ITT to get classroom teacher instruction and attention. The Nursing programs are the only thing keeping some of the campuses open. The one program that state oversight keeps HQ from gutting the quality.

Advice to Management

  • Local campus management has their hands tied by HQ.
  • The abject greed and tone deaf “leaders” of HQ will be the downfall of this company. Very sad as there are some very dedicated educators and employees at the various campus.
  • Greed and arrogance ruined a very good company. Truly a perfect example of why the “for profit” education companies are under fire.
  • March 26, 2014                                                                          

“Educational Recruiter”  

Former Employee – Admissions Representative

I worked at ITT Technical Institute full-time (More than 3 years)

Pros

The people in the recruitment department were easy to get along with. My coworkers were the best part of working there. We had to bond with each other to make it through such a toxic environment.

Cons

Let me start by saying I am not a disgruntled employee. I was not fired. I do not have a personal vendetta against the school or anyone who works there. The truth is that ITT is a sham of a college. Prospective employees AND prospective students should research thoroughly before starting at ITT.

ITT is more like a factory than a school. Students’ needs are always second to company profits. From an admissions perspective, students are numbers, not people. They will enroll anyone who can breathe. I have personally witnessed people who cannot read/write be admitted into this school. They will take ANYONE as long as they qualify for federal student loans. The company is cheating the students AND ripping the government off at the same time. ESI specifically target low income, low information individuals and convince them that a 45k associate’s degree will somehow solve all their problems. More often than not what happens is that students sign up for loans, never graduate (because they had a slim chance from the start) and get stuck with debt and no degree. The facilities and equipment appear to be from the 80s, yet the commercials depict a high technical, state of the art environment.

They have an ‘any means necessary’ method of recruiting. Every day in the recruitment department was a struggle between maintaining my personal integrity and successfully doing my job. Admissions reps are taught to LIE and sell dreams to people who don’t know any better. It’s a sad situation to be in.

Advice to Management

Have some integrity. Do not force employees to work mandatory 6 days of work weeks.

Numbers Analysis

1. Equity and Retained Earnings Analysis

ESI SHE RE10yrs

Facts:

  • ITT’s stockholders’ equity growth in 10 years was negative 34.55 percent.
  • And the retained earnings growth for 10 years was 233.48 percent.
  • The shareholders’ equity in 2004 and the trailing twelve months of 2015 were $235 and $154 million, respectively.
  • Moreover, retained earnings in 2004 and the trailing twelve months were $294 and $980 million, respectively.
  • In addition, shareholders’ equity is deteriorating year over year except in 2008 where it shows a 166 percent increase.
  • The retained earnings are increasing year over year except in 2010 where it shows a 27 percent decrease.

Explanation:

  • A net income of $139 million was added to retained earnings in 2012, which cause an increased in the retained earnings.
  • Equity award vesting and exercises amounting to $4.8 million were deducted in retained earnings in 2012.
  • Issuance of shares for directors’ compensation amounting to $1 thousand was deducted in retained earnings in 2012.
  • A net loss of $$27 million was deducted in retained earnings in 2013.
  • Net income of $29 million was added to retained earnings in 2014.
  • Issuance of shares for directors’ compensation amounting to $32 thousand was deducted to retained earnings in 2014.
  • Common shares repurchased of $208 million and shares tendered for taxes of $1.45 million were deducted to shareholders’ equity in 2012.
  • And the net loss of $27 million, tax benefit from equity awards of $5.4 million and shares tendered for taxes of $395 thousand, were deducted from shareholders’ equity in 2013.
  • Other comprehensive income of $11 million and stock-based compensation of $11.6 million were added to shareholders’ equity in 2013.
  • Net income of $29 million and stock-based compensation of $10 million were added to shareholders’ equity in 2014.
  • Other comprehensive loss of $1.9 million, tax benefits from equity awards of $4.4 million and shares tendered for taxes of $914 thousand, were deducted from shareholders’ equity in 2014.in 2012

Interpretation:

The retained earnings growth in the last 10 years shows impressive at 233 percent, however, the shareholders’ equity has a negative growth of 35 percent. The decline in the stockholders’ equity was due to common shares repurchased in the amount of $208 million.

1.1 The Trend Graph

ESI trend graph

The shareholders’ equity was high in 2004 and 2005, however, it falls down in 2006 at 66 percent and down again in 2007 at 32 percent, then rise at 166 percent in 2008. From 2009 to 2014, the equity is moving stable at an average of $140 million.

On the other hand, retained earnings are moving upward from 2004 up to 2009, then it fell down in 2010 at 27 percent and the following period, it starts to rise up again until 2014. The movement of retained earnings is quite impressive.

2. Valuation

ESI Value model

Facts

  • Using Totem’s value model, the book value growth was 7 percent in the last 5 years.
  • The calculated book value in 5 years was $9.30
  • The average return on equity in the last 5 years was 98.59 percent.
  • While the calculated return on book value in 5 years was $9.17.
  • And the calculated present value of the stock was $27.36.
  • ITT has a zero percent yield.
  • Percent of risk that was used was 15 percent.
  • In addition, the current stock price as of July 21, 2015, was $4.46 per share.
  • On the other hand, the calculated intrinsic value of the stock was $16.42. 
  • Therefore, compare the current market price to the intrinsic value, the stock price of ITT was undervalued.

Detailed Financial Analysis

A. BALANCE SHEET

1. Condensed Consolidated Balance Sheets as of March 31, 2015, December 31, 2014, 2013, 2012 and 2011. ESI condensed

Facts:

  • The cash and cash equivalents were $146 and $136 million as of March 15, 2015, and December 31, 2014, respectively.
  • The total current assets were $293 and $291 million as of March 31, 2015, and December 31, 2014, respectively.
  • Total assets were $737 and $749 million as of March 31, 2015, and December 31, 2014, respectively.
  • And the total current liabilities were $316 and $323 million as of March 31, 2015, and December 31, 2014, respectively.
  • In addition, the total long-term debts were $82 and $125 million as of March 31, 2015, and December 31, 2014, respectively.
  • On the other hand, the CUSO secured borrowing obligations, excluding the current portion, were $96 and $100 million as of March 31, 2015, and December 31, 2014, respectively.
  • In addition, the total liabilities were $583 and $601 million as of March 31, 2015, and December 31, 2014, respectively.
  • Shareholders’ equities were $154 and $148 million as of March 31, 2015, and December 31, 2014, respectively.

Explanation:

  • There was an increase of $10 million in cash and cash equivalent as of March 31, 2015. The increase was due to, net cash flows from operating activities of $33.5 million, partially offset by repayment of the following principal, $15.6 million related to PEAKS senior debt, $4.0 million related to CUSO secured borrowing obligation and $2.5 million under the financing agreement.
  • The working capital as of March 31, 2015, and December 31, 2014, were negative $23.8 and negative 31 million, respectively.
  • Current assets were lesser by 8 and 11 percent against current liabilities as of March 31, 2015, and December 31, 2014, respectively.  It represents 40 and 39 percent of the total assets as of March 31, 2015, and December 31, 2014, respectively.
  • The property and equipment represent 21 percent of the total assets as of March 31, 2015, and December 31, 2014, respectively.
  • The total current liabilities represent 43 percent of the total liabilities and shareholders’ equity as of March 31, 2015, and December 31, 2015.
  • Total liabilities represents 79 percent of the total liabilities and shareholders’ equity.
  • Shareholders’ equity represents 21 percent of the total liabilities and shareholders’ equity.
  • ESI had a treasury stock of $1.0 billion as of March 31, 2015, and December 31, 2014.

Interpretation:

The company will have a hard time paying its current liabilities when the due date comes because they have negative working capital, in other words, its current assets is lesser by 8 percent against its current liabilities.  Moreover, the company is utilizing 80 percent of borrowed funds from creditors and only 20 percent of the shareholders’ equity in the operation of the business. Furthermore, the debt to equity ratio was 1.75 or 175 percent, it tells us that ESI is high leverage.

2. Financial Health

2.1 The Company’s Debts

2.1.1 The Assets and Liabilities of PEAKS Trust and CUSO secured borrowing obligations ESI CUSO assets and liabilities

Facts:

  • In 2013, the total assets of PEAKS were $87.4 million compared with its total liabilities of $242.7 million.
  • In 2014, the total assets of PEAKS were $68.6 million compared with its total liabilities of $76.4 million.
  • The total assets of PEAKS were $65.8 million compared with its total Liabilities of $62 million in the trailing twelve months.
  • Moreover, in 2014, the total assets of CUSO were $26.6 million compared with $122 million in total liabilities.
  • And in the trailing twelve months, the total assets of CUSO were $25 million compared with its total liabilities of $119 million.

Explanation:

  • In 2013, the total assets of PEAKS represent 36 percent of its total liabilities, in other words, total liabilities was 278 percent of its total assets.
  • In 2014, the total assets of PEAKS represent 90 percent of its total liabilities, in other words, total liabilities was 111 percent of its total assets.
  • And in the trailing twelve months, total assets of PEAKS represents 106 percent of its total liabilities, in other words, total liabilities were 95 percent of its total assets.
  • Moreover, in 2014, the total assets of CUSO represent 22 percent of its total liabilities, in other words, total liabilities were 460 percent of its total assets.
  • The total assets of CUSO represent 21 percent of its total liabilities, in other words, total liabilities were 477 percent of its total assets in the trailing twelve months.

Interpretation:

The PEAKS Trust senior debt was improving year over year when it comes to its assets versus its liabilities, however, its total assets are deteriorating year over year.  The liabilities of PEAKS have decreased by $180 million at 74 percent from 2013 to the trailing twelve months. The assets of the PEAKS Trust is used only for payment of the obligations of PEAKS Trust. Payment of the administrative fees and expenses; the principal and interest owed on the PEAKS senior debt are guaranteed by the company under the PEAKS Guarantee. In 2014, the company made payments totaling $170.3 million, relating to PEAKS and CUSO program.  The company projected that they will be able to make payment of $30 million under PEAKS guarantee within 2015.

The assets of the CUSO can only be used for the obligations of the CUSO. The Company made payments under the CUSO RSA of approximately $9,139 in 2014. ESI projected that they will make payment of $11.6 million under the CUSO RSA within 2015. The company was limited in making payments to PEAKS and CUSO by $45 million under the Financing Agreement.

2.1.2 The Revenue and Expense of the PEAKS Trust, 2015 Q1

ESI PEAKS revenue and expenses

Facts:

  • The revenue for three months ended March 31, 2015, and March 31, 2014, were $2.4 and $3.1 million, respectively.
  • The revenue had decreased by 30 percent at $720 thousand.
  • Total expenses were $4.6 and $7.5 million for the three months ended March 31, 2015, and March 31, 2014, respectively.
  • Student services and administrative expenses were $541 thousand and $1.4 million in the three months ended March 31, 2015, and 2014, respectively.
  • Provision for private education loan losses were $803 thousand and $0 in the three months ended March 31, 2015, and 2014, respectively.
  • On the other hand, interest expenses were $3.3 and $6 million for the three months ended March 31, 2015, and 2014, respectively.
  • Moreover, the losses were negative $2.1 and negative $4.4 million for the three months ended March 31, 2015, and 2014, respectively.

Explanation:

  • The revenue consists of interest income on the PEAKS Trust student loans.
  • The servicing, administrative and other fees incurred by the PEAKS Trust were included in the Student services and administrative expenses under the Condensed Consolidated Statement of Income. Student services and administrative expenses represent 12 and 19 percent of the total expenses for the three months ended March 31, 2015, and 2014, respectively.
  • Moreover, the provision for private education loan losses represents the increase in the allowance for loan losses that occurred during the period.
  • Provision for private education loan losses represents 17 and zero percent of the total expenses for the three months ended March 31, 2015, and 2014, respectively.
  • Allowance for loan losses related to the PEAKS Trust Student Loans represents the difference between the carrying value and the total present value of the expected principal and interest collections of each loan pool of the PEAKS Trust Student Loans, discounted by the loan pool’s effective interest rate as of the end of the reporting period.
  • Interest expense represents interest expense on the PEAKS Senior Debt, which includes the contractual interest obligation and the accretion of the discount on the PEAKS Senior Debt.
  • Interest expense represents 71 and 81 percent of the total expenses for the three months ended March 31, 2015, and 2014, respectively.
  • And the losses before provision for income tax were negative $2.2 and negative $4.4 million for the three months ended March 31, 2015, and March 31, 2014, respectively.

Interpretation:

The company made payments on Q4 2012 through January 2014, on behalf of certain student borrowers under the PEAKS Program to the PEAKS Trust to avoid defaults by those borrowers on their PEAKS Trust Student Loans (“Payments on Behalf of Borrowers”), which defaults would have triggered much larger contractually required payments by ESI under the PEAKS Guarantee, according to ESI.

“At the time we made Payments on Behalf of Borrowers, we believed that those payments were contractually permitted and a form of payment to the PEAKS Trust that would satisfy obligations that were contractually required. Since that time, however, we have determined that Payments on Behalf of Borrowers are not permitted or required to support the PEAKS Trust. If we had not made Payments on Behalf of Borrowers, we would have had to make contractually required payments under the PEAKS Guarantee in greater amounts.”

Moreover,

Prior to the PEAKS consolidation, payments on Behalf of Borrowers were reflected in the financial statements as a reduction to the company’s contingent liability after the PEAKS Consolidation. Payments that were made on Behalf of Borrowers were not reflected in the company’s financial statements. Since those payments were inter-company transactions that were eliminated from the company’s financial statements as a result of the PEAKS Consolidation, stated in the ESI filings.

2.1.3 PEAKS Guarantee Payments and Payments on Behalf of Borrowers

ESI PEAKS guarantee payments

Facts:

  • The company’s payment under the PEAKS guarantee for the three months ended March 31, 2015, and March 31, 2014, were $13.6 and $40.7 million, respectively.
  • Moreover, the payments made on behalf of borrowers were $0.00 and $1.8 million for the three months ended March 31, 2015, and March 31, 2014, respectively.
  • In addition, the total payments made by ESI under PEAKS guarantee and of behalf of borrowers were $13.6 and $42.5 million for the three months ended March 31, 2015, and March 31, 2014, respectively.

Explanation:

In accordance with the terms of the PEAKS Letter Agreement, the company paid $40,000 on March 20, 2014, which is considered to be a payment under the PEAKS Guarantee and was applied primarily to make a mandatory prepayment of the PEAKS Senior Debt.

The company has agreed that after the date of the PEAKS Letter of Agreement, ESI will not make any more payments on behalf of any borrowers in respect of a private education loan made under the PEAKS Program. Further, any such payments in lieu of making payments to maintain the applicable required Asset/Liability Ratio would constitute a breach of the terms of the PEAKS Guarantee and an event of default under the indenture and credit agreement for the PEAKS Program

Interpretation:

ESI make payments on behalf of the borrowers to maintain the Asset/Liability Ratio of 1.40/1.0 under the PEAKS Program.

2.1.4 Revenue and Expenses of CUSO Program

ESI CUSO revenue and expense

Facts:

  • The revenue in the three months ended March 31, 2015, under the CUSO Program, was $1 million.
  • The total expenses of CUSO were $4.48 million in the three months ended March 31, 2015.
  • Student services and administrative expenses were $396 thousand in the three months ended March 31, 2015.
  • Further, the provision for private education loan losses was $441 thousand in the three months ended March 31, 2015.
  • Moreover, interest expense paid was $3.6 million in the three months ended March 31, 2015.
  • In addition, the loss before provision for income taxes was $3.4 million in the three months ended March 31, 2015.

Explanation:

  • The revenue of the CUSO is consists of the interest income on the CUSO student loans and an administrative fee paid by the CUSO participants to the CUSO on a monthly basis.
  • On the other hand, the expenses under the CUSO program were, student services and administrative expenses, provision for private education loan losses and interest expense.
  • Total expenses under the CUSO program represents 421 percent of the revenue, in other words, expenses are greater by 321 percent of its revenue.
  • The student services and administrative expenses represents 9 percent of the total expenses of CUSO in the three months ended March 31, 2015.
  • Moreover, the provision for private education losses represents the allowance for loan losses during the period. The allowance for loan losses represents the carrying value and the present value of the expected collection of the principal and interest in a loan pool.
  • In addition, the provision for private education losses represents 10 percent of the total expenses of CUSO in the three months ended March 31, 2015.
  • Interest expense represents the interest expense in the CUSO secured borrowing obligations.
  • In addition, the interest expense represents 81 percent of the total expenses of CUSO in the three months ended March 31, 2015.

Interpretation:

The Company did not recognize any revenue and expense in its consolidated income statement for the three months ended March 31, 2014, because the CUSO consolidated was effective September 30, 2014.

2.1.5 The CUSO-RSA / Payments made to CUSO related to ESI’s guarantee obligations under the CUSO RSA

ESI Payments made to CUSO

Facts:

  • The regular payments made by ESI under the guarantee obligations for the three months ended March 31, 2015, and 2014 were $2.3 and $1.2 million, respectively.
  • On the other hand, the discharge payments made for the three months ended March 31, 2015, and 2014 were $2.7 million and $0, respectively.
  • In addition, the total payments made to CUSO related to Guarantee obligations under the CUSO RSA for the three months ended March 31, 2015, and 2014, were $$5 and $1.2 million, respectively. 

Explanation:

  • The regular payments made to CUSO of $2.3 million in the three months ended March 31, 2015, is the net of $290 million of recoveries. This came from charged-off loans owned by the company that they have offset against the amount they owed under the CUSO RSA.
  • ESI made advances to the CUSO under the Revolving Note prior to 2012, so that, CUSO could use the funds to provide to provide additional funding to the CUSO to purchase private educational loans made under the CUSO program.
  • Moreover, ESI offsets $8.47 million owned by ESI under the CUSO RSA against amounts owed to them by the CUSO under the Revolving Note, instead of making additional payments in that amount. The amounts owed to ESI under the Revolving Note, excluding offsets, was approximate $8.2 million, according to ESI.

Interpretation:

Under the CUSO RSA, the company is entitled to all amounts with regard to recoveries from CUSO loans that have been charged-off. This will goes on until all payments that ESI have made to the CUSO loans have been fully paid to the company. The company claimed they have the right to offset payments in which the SEC did not agree.

2.2 Shares Repurchase Activity of ESI

ESI repurchase

Facts:

  • The beginning authorized common stock repurchase were 7.8, 5.8 and 4.8 million in December 31, 2013, 2012 and 2011, respectively.
  • And the additional repurchase authorization was 0, 5.0, 5.0 million on December 31, 2013, 2012 and 2011, respectively.
  • Further, the number of shares repurchased was 0, 3.0, 4.0 on December 31, 2013, 2012 and 2011 respectively.
  • The repurchase authorization at year ended December 31, 2013, 2012 and 2011 were 7.8, 7.8 and 5.8 million, respectively.
  • Furthermore, the total cost of shares repurchased were $0.00, $207.90 and $282.70 on December 31, 2013, 2012 and 2011, respectively.
  • In addition, the average cost per share were $0.00, $68.72 and $69.98 in December 31, 2013, 2012 and 2011, respectively.

Explanation:

  • The proceeds from the stock options in the year ended December 31, 2013, 2012 and 2011 were $0.00, $8.4 and $5.6 million, respectively.
  • Excess tax benefits from the exercise of stock options were $0.00, $1.4 and $1.2 million in December 31, 2013, 2012 and 2011, respectively.

Interpretation:

ESI has no stocks repurchase in 2013, although they have repurchase authorization of 7.8 million. In 2012, the total number of repurchased represents 28 percent of the total authorized to repurchase. In addition, in 2011, the total number of repurchased represents 31 percent of the total authorized to repurchase.

3. Analyzing Liquidity and Solvency Ratios

Liquidity is the ability of the management to pay its current financial obligations using its current assets when the due date comes. Solvency is the ability of the management to meet its long-term financial obligations in due time, such as obligations to banks, creditors, and investors.

ESI liquidity   Facts:

  • The current ratio of ITT was averaging 1.12 and its trailing twelve months ratio was 0.92.
  • Quick ratio was averaging 0.93, in 2013 and the trailing twelve months ratio was 0.64.
  • The financial leverage ratio was averaging 5.09 and it is trailing twelve months as 4.79.
  • And the debt to equity ratio was averaging 1.09 and its trailing twelve months ratio was 1.39.
  • In addition, debt to asset ratio was averaging 0.28 and its trailing twelve months was 0.37.

Explanation:

  • Short-term liquidity means, the company’s ability to meet its current obligations. ESI’s current ratio beginning 2013 up to the trailing twelve months was less than 1.0. It tells us that the company might have a hard time meeting all its current financial obligations when the due date comes using its current assets.
  • While the quick ratio beginning 2013 up to the trailing twelve months was less than 1.0 ratio. It indicates, that the company is not capable of paying all its short-term financial obligations using its quick assets.
  • Also financial leverage indicates that ESI is high leverage, in other words, the company uses more debt in its capital structure.
  • In addition, debt to equity ratio tells us that, total debt, which is the short and long-term debt are higher than its equity,  in other words, total debt is 152 percent of its equity.
  • Moreover, the debt to asset ratio is a solvency ratio that measures the company’s total liabilities against its total assets. The table shows that the company’s total liabilities is averaging 80 percent compared to its total assets.

Interpretation:

The ratios indicate that the company is high leverage.

4. Shares Outstanding

ESI shares outstanding

Facts:

  • The share outstanding in 2014 and the trailing twelve months was 24 million shares.
  • And the shares outstanding in 2009 and in the trailing twelve months were 38 and 24 million, respectively.
  • The share outstanding had decreased by 14 million or 37 percent in the last five years.

Explanation:

Shares outstanding are the company’s stock currently held by all its shareholders.  The historical shares outstanding is deteriorating year over year in the last five years at an average rate of 7 percent. The 5 years growth of shares outstanding was negative 37 percent.

Interpretation:

ESI 2014 annual report indicated that the Board of Directors has authorized the company to repurchase 7,771,025 common stock shares in the open market. Or through privately negotiated transactions in accordance with Rule 10b-18 of the Exchange Act (the “Repurchased Program”). Further, the shares that remained available for repurchase under the Repurchase Program were 7,771,025 shares as of December 31, 2014.

B. ESI INCOME STATEMENT

Ratio

1. Analyzing Efficiency Ratio

1.1  CCC and Turnovers

ESI CCC Facts:

  • Day’s sales outstanding was averaging 21.01 and its trailing twelve months ratio was 23.65.
  • The payable period was averaging 48.30 and its trailing twelve months ratio was 57.81.
  • Receivables turnover was averaging 18.64 and its trailing twelve months ratio 15.44.
  • Fixed assets turnover was averaging 6.77 and its trailing twelve months ratio was 6.03.
  • Asset turnover was averaging 1.79 and its trailing twelve months ratio was 1.26.

Explanation:

  • Days sales outstanding or average collection period or days sales in receivables measures the average number of days a business takes to collect its credit sales. It measures the liquidity and efficiency of sales collection activities.
  • Payable Period measures the number of days the company takes to pay its suppliers.
  • Receivables turnover measures how many times a firm collects its average accounts receivables balance during a certain period. In other words, it measures the efficiency of the business to collect credit sales. A higher result is favorable and a lower result is unfavorable.
  • The fixed assets turnover ratio or the sales to fixed assets ratio. This ratio measures how efficient is the company in utilizing its fixed assets to generate revenue.
  • Asset turnover measures management efficiency in utilizing its assets in generating sales or revenue.

Interpretation:

  • The day’s sales outstanding in the trailing twelve months 23.65 or 24 days. In other words, it will take 24 days for the sales to be converted into cash.
  • The payable period indicates that the average period for the company to pay its suppliers is 58 days from the date of purchase.
  • Receivables turnover ratio shows that ESI collects its receivables 15 times in one year.
  • Fixed assets turnover tells us that the company generates $6 for every $1 investment in fixed assets.
  • And the asset turnover ratio, tells us that, the company is generating $1.26 of revenue for every $1 invested in assets. This ratio looks at revenue and not profit.

 1.2. Profitability Ratio

ESI Margins  Facts:

  • Gross margin was averaging 59 percent in the last five years. The margin decreases year over year at an average of 4 percent.
  • While the operating margin was averaging 21 percent in the last five years. The margin decreases year over year at an average of 22 percent.
  • In addition, the net margin was averaging 12 percent in the last five years. The margin decreases year over year at an average rate of 80 percent.
  • Moreover, return on equity was averaging 109 percent in the last five years. The ratio decreases year over year at an average rate of 70 percent.

Explanation:

  • Gross profit margin is the percentage of profit after deducting the cost of revenue from the total revenue. In the trailing twelve months, the gross profit was 59 percent.
  • While, operating margin is the percentage of profit after deducting the general, sales and administrative expenses from the gross profit. In the trailing twelve months, the company’s student services and administrative expenses that were deducted from the gross profit was 38 percent of the revenue.
  • Also, net margins are the percentage of earnings after deducting provision for income taxes, interest and adding or deducting other income or expenses. In other words, it measures the overall operating efficiency of the firm. It shows that, after deducting income taxes, interest, and other expenses from the operating income, there were a 3.8 percent net earnings left.
  • Moreover, return on equity measures the overall efficiency of the company in managing its total investments in assets and in generating a return to its stockholders. It indicates that the company was able to generate a 26.43 return on the stock investments in the trailing twelve months.

Interpretation:

The profitability ratios indicate that the company’s revenue and profit are deteriorating in the last five years. It may indicate, that the management is getting more and more inefficient in managing the business.

2. Company’s Profitability

2.1. Amount/Growth rates

ESI growth

Facts:

  • Total revenue growth in the last 5 years was negative 28 percent.
  • Total expenses have negative growth of 10 percent.
  • The net income has an average growth of 88 percent in the last five years.
  • The year over year growth of net earnings was erratic in movement.

Explanation:

  • The revenue of ESI is deteriorating year over year at an average rate of 4.5 percent.
  • Total expenses are decreasing year over year in the last five years in an erratic movement.
  • Net income falls very steep in 2013 at a rate of 119 percent and managed to increase by 208 percent in 2014.

Interpretation:

Overview, the profitability test of ITT Educational Services indicates that the business is not generating enough revenue for the business operation.

2.2 Profitability Graph

ESI Profitability

Explanation

As seen in the graph above, the highest revenue was in the year 2010, then in 2011 onwards, it shows that revenue is gradually decreasing. The net income was approximately 20 percent in 2009 and in 2010 going forward the earnings is decreasing year over year.  While in 2013 and 2014, the net earnings were 3 percent of the revenue. Total expenses were high. In addition, in 2013 and 2014, it almost leveled the revenue, this is due to the consolidation of the financial statement.

C. ESI STATEMENT OF CASH FLOWS 

A Statement of Cash Flows is one of the main financial statements. It reports the incoming or where the money comes from and the outgoing of cash or where the company spends its money in a given period of time. In other words, it reports the sources and uses of cash in operating activities.

ESI CF

Facts:

  • Cash from operating activities was averaging $245 million.
  • While capital expenditure was averaging negative $18 million.
  • Also the Free Cash Flows was averaging $224 million.

Explanation:

Cash from operating activities and free cash flows were decreasing year over year in the last four years. However, in 2014, it shows an upward trend in both accounts.

Interpretation:

The decreased in the operating activities and free cash flows were due to the decreasing revenue and net earnings year over year.

ESI Valuation

1. The Investment in Enterprise Value

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value (EV) is the present value of the entire company. EV is a more accurate measure of a company’s true market value than market capitalization. EV measures the value of the productive assets that produced its product or services. Both equity capital (market capitalization) and debt capital. Market capitalization is the total value of the company’s equity shares. In essence, EV is a company’s theoretical takeover price. Because the buyer would have to buy all of the stock and pay off existing debt while taking any remaining cash. This gives the buyer solid grounds for making its offer.

ITT Educational ESI

Facts:

The market capitalization of ESI was deteriorating year over year in the last five years. The growth of market capitalization was negative 95 percent. While the total debt was 124 percent and its cash and cash equivalent was 66 percent of the enterprise value for the trailing twelve months. On the other hand, the enterprise value was $220 million while the market capitalization of $94.5 million. Buying the ESI, an investor would be paying 42 percent equity and 58 percent of the debt.

The takeover price of the entire business is $234 million at $9.75 per share, while the current share price of $4.46, as of July 21, 2015.

2. The Discounted Cash Flow Approach

Discounted Cash Flow is a method of valuing the intrinsic value of a company (or asset). In simple terms, discounted cash flow tries to work out the value today. Based on future projections of all of the cash that the company could make available to investors in the future. In other words, the amount of cash that the company will receive in the future is worth less than the cash today.

DCF Formula

Where:

  • Vo is the value of the equity of a business today.
  • CF1 to CFn represent the expected cash flows (or benefits) to be derived for periods 1 to n period.  The discounted cash flow model is based on time periods of time of equal length. We use the terms “periods” and “years” almost interchangeably for purposes of this theoretical discussion.
  • r is the discount rate that converts future dollars of CF into present dollars of value.

ESI DCF Historical CF

Facts:

The historical EBITDA was used as cash inflows because it represents the cash earnings excluding tax, depreciation, and amortization. It shows that EBITDA has an erratic movement. Moreover, in 2010 shows the highest record and 2013 shows the lowest record. Because of the losses incurred in the two private student loan programs. However, in 2014, the figures increased by 583 percent and followed by an increase of 14 percent in the trailing twelve months. Further, the growth of EBITDA in the last five years was negative 27 percent.

ESI DCF Projected CF

Facts:

The growth using the United States Gross Domestic Product (GDP) annual growth rate average of 3.24 percent. 

  • The projected cash inflows at:
    • year 1 (n1) are $108 million.
    • at year 2 (n2) are $111 million.
    • at year 3 (n3) are $115 million.
    • year 4 (n4) are $119 million.
    • in year 5 (n5) are $122 million.
    • The terminal value was at $987 million. 

ESI Terminal value

Where:

ESI TV (2)

  • Terminal Value = $122,451,874 * (1+3.24%) / (16.0498% – 3.24%)  = $986,895,306
  • While Enterprise Value was $841,455,404, it is the sum of future cash inflows in year 1 to year 5.
  • In addition, the Fair Value of the company was $703,811,404, the table below will show us the calculation.

ESI FV

Explanation

Net debt is the sum of short and long-term debt minus cash and cash equivalent.

  • The Intrinsic Value is the Fair Value of the company.

ESI IV

Explanation

The Intrinsic Value was $29.33 per share. On the other hand, the Margin of Safety was at $24.87. Compared with the current price of $4.46 per share, as of July 21, 2015. The stock price was undervalued.

  • The Required Rate of Return (RRR) or the Discount Rate.

ESI RRR

Explanation:

  1. The required rate of return (RRR) or the discount rate was 16.0498%.
  2. The US 10 year Generic Bond rate was usually used as the Risk-Free Rate. It is to estimate the discount rate in the valuation. The current US 10 year Generic Bond that was used was 2.3648%.
  3. The Market Risk Premium in the USA was 5.75%.
  4. The Beta for ESI was 2.38. Beta measures the stock volatility in which the stock price fluctuates in the overall market.
  5. Long-term Cash Flow Growth or the average long-term GDP used was 3.24 percent.

2.1 The Present Value of the Projected Cash in Flows and Terminal Value

This method of valuation tries to work out the value today of the projected cash inflows in the future. Going forward below is the formula for the present value.

PV

Or

PV = FV (1+r) n

Where:

ESI PV FV

Present Value of Projected Cash inflows in year 5

PV = $122,451,874 / (1 + 16.0498%) ^5

= $122,451,874 (1.160498%) ^5

$58,175,946

Present Value of Terminal Value

PV = $986,895,306 / (1 + 16.0498%) ^5

= $986,895,306 / 1.100498%) ^5

$468,866,390

  • Terminal value is the present value of all future cash flows at a future point in time.
  • While the present value of the future projected cash inflows at year 5 is $58,175,946 million.
  • In addition, the present value of the terminal value was $468,866,390 million.

Conclusion

ESI is put in a very controversial situation after the announcement made by the US Securities and Exchange Commission.  Although 2014 Financials meets investors’ expectations, the stock price of the company. Became unstable and suffered ups and downs.  The company has to answer in court all alleges made by the US Securities and Exchange Commission.

ESI has its financial statements and filings of the consolidated financial statements. It has disclosed the controversies regarding the two private student loan programs. Which are the PEAKS and the CUSO?  The quarterly report ended March 31, 2013, June 30, 2013, and September 30, 2013, were unreliable and needs to be restated.

Regardingcorrected quarterly reports

On October 9, 2014, ESI delivered to the indenture trustee the corrected quarterly reports. And on the same date, the company had made payments under the accurate quarterly reports. Moreover, it is stated in the Financials that they have already accurately corrected the quarterly financial reports. Under risk and uncertainties, the following statement:

“Many of the amounts of assets, liabilities, revenue, and expenses reported in our consolidated financial statements are based on estimates and assumptions that affect the amounts reported. While we are subject to risks and uncertainties that could affect amounts reported in our consolidated financial statements in future periods. Moreover, our future performance, results of operations, financial condition, cash flows, liquidity, capital resources, ability to meet our obligations and ability to comply with covenants, metrics, and regulatory requirements are subject to significant risks and uncertainties that could cause actual results to be materially different from our estimated results.”

Payments made under the PEAKS trust

Further, in order to maintain the asset/liability ratio of 1.40 / 1.0 in the PEAKS trust, ESI made payments of $13.6 million in the three months ended March 31, 2015. In addition, another payment of $156.6 in the year ended December 31, 2014. In addition, these payments were made under the PEAKS trust guarantee applied by the PEAKS trust to reduce the amount of the PEAKS senior debt.

Effects after filing the quarterly report

The stock price of ESI started to rise up after the filing of the quarter ending March 31, 2015, financial statements. However, the stock still remains unstable. The company was able to increase its cash and cash equivalent by $10 million as of March 31, 2015.  However, it states in the 10Q 2015 ESI has a negative working capital on March 31, 2015, December 31, 2014, and March 31, 2014. This is for the reason that the consolidation of financial statements.

The investigation from the SEC and the Department of Education may be over for a period. Further, the Department of Education may not want to shut down ITT Educational Services at around 50,000 students.

Overall

The stock price of ESI may still be swinging until all alleges in the government sector are resolved. Therefore, I recommend a SELL in the stock of ITT Educational Services (ESI).

For latest update please click here.

CITATION

https://www.sec.gov/Archives/edgar/data/922475/000119312515156866/d856991d10q.htm

http://www.sec.gov/Archives/edgar/data/922475/000092247514000048/exhibit10_1.htm

http://www.consumeraffairs.com/education/itt.html

http://www.help.senate.gov/imo/media/for_profit_report/PartII/ITT.pdf

http://www.sec.gov/Archives/edgar/data/922475/000092247510000032/filename1.htm

https://www.youtube.com/watch?v=Pa1DxUWMsEU

https://www.youtube.com/watch?v=8JV0tBFV9Bw

http://www.sec.gov/Archives/edgar/data/922475/000119312515205473/d915248d10k.htm#tx915248_31

http://www.streetinsider.com/Corporate+News/ITT+Educational+Services+%28ESI%29+Plans+Consolidation+of+PEAKS+Trust%3B+May+Not+be+in+Compliance+With+Some+Credit+Agreements/9610383.html

http://www.sec.gov/Archives/edgar/data/922475/000119312515221226/d935543d10q.htm

http://www.streetinsider.com/Corporate+News/ITT+Educational+Services+%28ESI%29+Plans+Consolidation+of+PEAKS+Trust%3B+May+Not+be+in+Compliance+With+Some+Credit+Agreements/9610383.html

http://www.help.senate.gov/imo/media/for_profit_report/PartII/ITT.pdf

http://www.sec.gov/Archives/edgar/data/922475/000092247510000032/filename1.htm

Researched and Written by Criselda

Twitter: criseldarome

 

Interested to learn more about the company? Here’s investment guide for a quick view, company research to know more of its background and history; and value investing guide for the financial status.

Tesla Motors Inc

Tesla Motors Inc (TSLA) Investment Valuation

April 13th, 2014 Posted by Deep Analysis No Comment yet

TESLA MOTORS INC (TSLA) was founded in 2003 by a group of Silicon Valley engineers who prove that electric vehicles are awesome.

Tesla logored

About

Tesla Motors Inc (TSLA) design, develop, manufacture and sell high-performance fully electric vehicles and electric vehicle powertrain components. They have operationally structured their business in a manner that they believe will enable them to rapidly develop and launch advanced electric vehicles and technologies. In addition, TSLA believes their electric vehicles are engineered by expertise, and their operational structure differentiates them from incumbent automobile manufacturers.

Moreover, Tesla Motors uses proprietary technology, world-class design, and state-of-the-art manufacturing processes to create a new electric vehicle capable of highways. They used an innovative distribution model that is Company-owned sales and service centers. This approach allows them to maintain the highest levels of customer experience and they make sure that their customer needs are fulfilled. They believe their operational infrastructure provides them with a competitive advantage compared to ordinary automobile manufacturers.

Incorporation

Tesla Motors Inc (TSLA.O), Tesla Motors, Inc. (Tesla), incorporated on July 1, 2003.  The Company is also producing commercially an electric vehicle, the Tesla Roadster, aside from developing it’s Model S and vehicle manufacturing capabilities at the Tesla Factory. Tesla is designing, developing and manufacturing lithium-ion battery packs, electric motors, gearboxes, and components both for its vehicles and for its original equipment manufacturer customers.

Manufacturing Activities

The manufacturing activities are manufactured at the companies electric powertrain manufacturing facility in Palo Alto, California and at the Tesla Factory. Moreover, the Company also provides services for the development of electric powertrain components and sells electric powertrain components to other automotive manufacturers.

Tesla has provided development services and powertrain components to Daimler AG (Daimler) for its Smart for two and A-Class electric vehicles. The Company has received an initial purchase order for the development of a powertrain system for an additional Mercedes Benz vehicle from Daimler.

How does the company make money?

Tesla Motors Inc makes the best electric cars and electric powertrains in the world. Tesla technology has the most efficient path to future supportable energy. Hybrids no. Hydrogen no. Hype no. The Tesla electric drivetrain offers a radically different experience. The driver, the car, and the environment connect in ways they’ve never connected before.

On the other hand, the goal of Tesla is to increase the world’s transition to electric mobility with a full range of increasingly affordable electric cars. further, the Company is bringing on the change in the industry. According to Tesla vehicles and EVs powered by Tesla are fun to drive and environmentally responsible.

TESLA PRODUCTS 

ModelS 2015-tesla-model-x

MODEL S AND MODEL X

The Model S and Model X are the next steps in Tesla’s “Secret Plan” to increase the world’s transition to electric mobility. Model S is now in production!

Tesla Motors Inc recognized its revenue from the sales of Model S and the Tesla Roadster, including vehicle options, sales in accessories and services.

THE TESLA ROADSTER

The Tesla Roadster was seen used in early 2008 as a car with no equal.

TSLA Roadster

The company has sold approximately 2,500 Tesla Roadsters to customers in over 30 countries, generally in North America and Europe. The production of Tesla Roadster flows at Lotus Cars Limited in January 2012.

Gen III

Tesla has announced their intent to develop a third generation electric vehicle, to which they refer as “Gen III”, to be produced at the Tesla Factory. In addition, they also intend to offer this vehicle at a lower price point and expect to produce it at higher volumes than their Model S. They expect that this vehicle will be produced in approximately three years.

Powertrain Development and Sales

Moreover to their own vehicles, they also design, develop, manufacture and sell electric vehicle powertrain components to other automotive manufacturers. Tesla has provided development services and complete powertrain systems and components to Daimler for its Smart for two, A-Class, and B-Class electric vehicles.

Stationary Energy Storage Applications

In 2013, Tesla developed stationary energy storage products for use in homes, commercial sites and utilities. They plan to ramp sales of these products in 2014.

Tesla’s Batteries and Powertrains will help lessen global dependence on petroleum-based transportation and drive down the cost of electric vehicles. By cooperating with other car manufacturers, they hope to increase more electric cars on the road.

TSLA product8  TSLA product12   TSLA product7

PLUG IN Anywhere. Seriously. Where there’s an outlet, you can charge. The type of outlet or charging station will determine how fast you can charge. Every TESLA AND EV using their technology is a step towards making increasingly affordable electric cars available to the consumer. It’s more than electric, it’s Tesla.

ACCESSORIES

Tesla has a variety of accessories, here are some of their product accessories.

TSLA product4TSLA product9tesla-energy

RISK FACTORS TO CONSIDER

There are certain risks that must be carefully considered, they may be unable to sustain their current level of production and deliveries of Model S or increase production and deliveries in line with their plans, both of which could harm their business and prospects. This statement was written in the financial report of Tesla on its annual 2013 SEC filings.

Who is running the Business?

The two most important people behind Tesla Motors Inc was the Chief Executive Officer and the Chief Financial Officer.  Let us find out what makes them great.

Elon MuskCo-Founder, CEO, and Product Architect

ElonMusk1

Elon Musk is the CEO and Product Architect of Tesla Motors and the CEO/CTO of Space Exploration Technologies (SpaceX).

Elon has overseen product development and design from the beginning, including the all-electric Tesla Roadster, Model S and Model X. Transitioning to a maintainable energy economy, in which electric vehicles play a crucial role, has been one of his central interests for almost two decades, beginning from his time as a physics student working on ultracapacitors in Silicon Valley.

  • Elon is the chief designer, overseeing the development of rockets and spacecraft for missions to Earth orbit and ultimately to other planets at SpaceX.
  • Moreover, in 2008, SpaceX’s Falcon 9 rocket and Dragon spacecraft won the NASA contract to provide a commercial replacement for the cargo transport function of the Space Shuttle, which retired in 2011.

More about SpaceX

  • The SpaceX Falcon 1 was the first privately developed liquid fuel rocket to reach orbit.
  • In 2010, SpaceX became the first commercial company to successfully recover a spacecraft from Earth orbit with its Dragon spacecraft.
  • SpaceX became the first commercial company to dock with the International Space Station and return cargo to Earth with the Dragon in 2012.
  • In addition, Elon is the non-executive chairman and principal shareholder of SolarCity, which he helped create. SolarCity is now the leading provider of solar power systems in the United States.
  • Prior to SpaceX, Elon co-founded PayPal, the world’s leading Internet payment system, and served as the company’s Chairman and CEO.
  • Before PayPal, Mr. Musk co-founded Zip2, a provider of Internet software to the media industry.
  • Moreover, Elon has a physics degree from the University of Pennsylvania and a business degree from Wharton.

Deepak AhujaChief Financial Officer 

Deepak CFO

Deepak brings more than 15 years of global automotive finance experience to the Tesla team. As Chief Financial Officer, Deepak brings invaluable insight into a well-versed industry

  • Prior to joining Tesla Motors, Deepak was the Controller of Small Cars Product Development at Ford with the goal of bringing several exciting fuel-efficient automobiles to the North American market.
  • Previously, Deepak was CFO for Ford of Southern Africa, a $3 Billion subsidiary where he oversaw the finance, legal and IT functions.
  • Prior to that, Deepak served as CFO for Auto Alliance International, a joint venture between Ford and Mazda with over $4 billion in revenue.

Moreover,

  • His career at Ford included assignments in all aspects of the business, including Manufacturing, Marketing, and Sales, Treasury, Acquisition, and Divestitures.
  • Before joining Ford, Deepak worked as an engineer for Kennametal, Inc. near Pittsburgh, PA for almost 6 years and developed two new ceramic composites cutting tools for machining of aluminum alloys in aerospace and automotive industries.
  • Deepak holds a bachelor’s and master’s degrees in materials engineering from Banaras Hindu University and Northwestern University, respectively and an MBA from Carnegie Mellon University.
  • In 2010, following Tesla’s successful IPO, Deepak was named Silicon Valley Business Journal’s CFO of the Year.

Value Investing Guide on Tesla Motors Inc 

Liquidity and Solvency

A solvent company is one that owns more than it owes; in other words, it delivers a positive net worth and a manageable debt burden.

Liquidity

Let us review the liquidity of Tesla Motors Inc. The key ratios are the current and quick ratios. It shows that the average current ratio of Tesla was 1.61, although the rule of thumb is 2.0, it tells us that the company appears to have sufficient current assets to meet its short-term debt obligations when it falls due.

Quick Ratio

In addition, the quick ratio was averaging 0.99, the rule of thumb is 1.0, meaning, Tesla has the capability of paying its short-term financial obligations using their liquid assets.  Current assets by definition are convertible into cash in less than one year. You will notice that in 2012, the current ratio decreased by 50.26 percent from 2011, this is due to higher expenses associated the expansion of their network and service infrastructure as well as the growth of their business in general. It tells us further that the company is not struggling financially.

Solvency

Now, let us walk a little further and find out the solvency ratio of Tesla.  Solvency ratio was averaging negative 0.90 because the company suffered losses for the past three years of its operations. From 2010 to 2012, Tesla is having a hard time meeting its long-term debt. Although the ratio was negative, the yearly trend shows a favorable improvement. In 2013, the ratio was positive at 0.05, meaning its net income plus depreciation and amortization were greater by 5 percent against its total debt or in other words, the ratio in 2013 has increased by 1,492 percent from 2012. Therefore, it means that Tesla has now the ability to meet its long-term debt.

Leverage

In addition, the leverage ratio was averaging 1.44 or 144 percent for the past 4 years. It means that Tesla has 144 percent total debt against its shareholders’ equity. In other words, the company is using more debt or 44 percent above its shareholders’ equity as part of its capitalization structure. Since borrowing money is very common in a capital-intensive company such as automobile manufacturers, Tesla is using debt almost half above its equity for its capital investments. Moreover, the financial leverage ratio was averaging 3.41, it tells us that total assets were 341 percent against shareholders’ equity.

Tesla Motors Inc Income Statement

Revenue

Explanation

The table above shows that the revenue trend from 2009 to 2013 was 1,697 percent increased. On the other hand, although, net income was negative for the past 5 years, 2013 shows a favorable result with an increase of 435 percent from 2012. During 2012, Tesla Motors Inc has suffered a large loss of $396 million, a little more than half of that in 2011, because of the expansion in retail network and the launching of Supercharger network in California which brought additional expenses.

Interpretation

However, despite the negative earnings, the growth in 2013 was satisfactory. Tesla shows the possibility of profitability in the future as they intend to commence deliveries to China in the spring of 2014. In addition, they plan to significantly expand production capacity for Model S and Model X, and various plans they intend to do in the succeeding years. This indicates that Tesla Motors Inc has the capacity to generate more revenue in the future.

Profitability Ratios

Let me guide you another step in the profitability ratios of Tesla Motors Inc. The gross margin of Tesla Motors Inc was averaging 19 percent. To explain further, the cost of goods sold was averaging 81 percent, these are the expenses required to manufacture the products. The operating margins were negative, however, the ratio was improving year over year. The operating margins, not only include the cost of goods sold but also the selling and administrative expenses as well as depreciation. It is the income associated with the ongoing operations of the company’s core business.

Net Margins

Tesla’s net margins were also negative for the past 5 years, however, the ratio was favorably improving. Since Tesla Motors Inc is young and in the process of developing its products, their cost of revenue was high. It is anticipated that in 2014 its net income would be positive and will show a favorable result due to its annual trending.

Tesla Motors Inc Cash Flow Statement

The cash flow margin of Tesla was negative from 2009 until 2012 due to its negative net earnings. However, in 2013, it shows a positive sign of 12.82 percent. The free cash flow and operating cash flow was also negative from the past 5 years, except in 2013, where the operating cash flow shows a positive sign of $258 million. Moreover, during 2012, the company has the highest loss from its 5 years of operation due to the expansions and launching of Supercharges network expenses, aside from these expenses they also incurred significant amount in advertising expenses.

Explanation

Although Tesla Motors Inc suffered losses from 2009 to 2012, 2013 shows a favorable sign of improvement. For a young growth company, it is anticipated that the first few years of its operation will be a loss or breakeven.  It indicates that the company is capable of generating revenue from its production and it will be sufficient in the next succeeding years.

The Investment Valuation of Tesla 

This investment valuation was prepared in a very simple and easy way to evaluate a company for business valuation.  My basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement.

The Discounted Cash Flow (DCF) Approach

Discounted Cash Flow (DCF) is a method of valuing the intrinsic value of Tesla Motors Inc. DCF calculates the value today based on cash projections that Tesla could make available to investors in the future. It is called “discounted” because of the concept that the value of the dollar to be received in the future is less than the value of a dollar on hand today.

DCF formula

Where:

  • Vo is the value of the equity of a business today.
  • CF1 to CFn represent the expected cash flows (or benefits) to be derived from periods 1 to n.  The discounted cash flow model is based on time periods of time of equal length.  Because forecasts are often made on an annual basis in practice, we use the terms “periods” and “years” almost interchangeably for purposes of this theoretical discussion.
  • r is the discount rate that converts future dollars of CF into present dollars of value.

The equation above is the basic discounted cash flow (DCF) model.

Summary

TSLA DCF

The discounted cash flow indicates a present value of $247.9 million, at a rate of 15 percent. The calculated future value was $498.62 at the end of 5 time periods or 5 years. In other words, the future value of $498.62 is equal to the present value of $247.90.

The future value of money is how much it will be worth at some time in the future. In other words, it shows how much an investment will be worth after compounding for so many years.

The Relative Valuation Method of Tesla

There are two basic methods of valuing stocks. The most frequently used method is a relative valuation, which compares a stock’s valuation with those of other stocks or with the company’s own historical valuations.

The book value growth rate of Tesla Motors Inc. was 20 percent from 2010 to 2013. The calculated book value in 5 years’ time was $13.48 per share at $1.6 billion. Moreover, the earnings per share and the return on equity were negative for the past 5 years due to negative net earnings, however, it is trending positively in a high percentage significantly in 2013.

Conclusion

Overview, it indicates that Tesla Motors Inc is capable of producing more revenue, and has sufficient current assets to meet financial obligations. The company shows significant improvements year over year when it comes to its earnings and productions. Since, Tesla is a young, high-growth company, therefore, I recommend a Buy on the stock of Tesla Motors Inc.

Part II

After the above information was published, I perceived that the company needed to be revisited and some further insights needed to be explained.  It was decided that it is better to continue with the analysis for a deeper aspect.

This company updates are an additional analysis of Tesla Motors Inc with regards to its historical data. This analysis is significant to include with your investment decision on Tesla.

Tesla’s Run Rate

Tesla Motors Inc has made significant progress in increasing its production level aided by its manufacturing, design and quality improvements and the strong efforts from their suppliers. The company expects production to increase from 600 vehicles per week presently to about 1,000 vehicles per week by the end of 2014 or from 31,200 vehicles to 52,000 vehicles annually, as they expand their factory capacity and address supplier bottlenecks. This was taken in the 2013 Tesla SEC filings. In consideration of Tesla’s working capital of 2013, it has a tremendous increased from 2012 to 4321 percent.

Problems regarding supplier

According to Elon Musk in one of his interview, that, they planned to increase their cash and cash equivalent for the purposes of unanticipated issues or problems regarding the suppliers’ delay in the delivery of the materials needed in their production. The management will make it possible to maintain its full production capacity without delays and sacrificing the quality of their products.

Risk Factors

There are risk factors that could materially affect Tesla’s financial condition and future results. Here are some of the risk factors that Tesla Motors Inc is facing.

Model S

Model S contains numerous purchased parts which they source globally from over 300 direct suppliers, the majority of whom are currently single source suppliers for these components. If these single suppliers fail to deliver Tesla’s requirements on a timely basis at a competitive price, could suffer delays, possibility of losses, might incur higher cost of revenue, in which case, Tesla may not be able to sustain their current level of production and deliveries of Model S or increase their production as planned, which may affect the operating results of the company as they continue to focus on supplier capabilities and constraints. Tesla has not qualified alternative sources for most of the single sourced components used in their vehicles and they do not maintain long-term agreements with a number of its suppliers.

Maintaining desired quality levels

Tesla’s ability to use their manufacturing processes as planned for volume production while maintaining their desired quality levels and efficiently making design changes to ensure consistently high quality since the production process is still maturing, due to the new product, new equipment, and new employees.

Moreover, they have limited experience in the high volume delivery of their Model S vehicles. They have just started their deliveries in Europe and may face difficulties meeting their delivery and growth plans in Asia and other right-hand drive markets later this year, which may impact their ability to achieve their worldwide delivery goals.

Tesla has introduced a number of new manufacturing technologies and techniques. Model S has a number of new and unique design features, such as a 17-inch display screen, newly designed retractable exterior door handles and a panoramic roof, each of which poses unique manufacturing challenges.

Production and deliveries

Model S production and deliveries will continue to require significant resources and they may experience unexpected delays or difficulties. It may harm their ability to maintain full manufacturing capacity for Model S, or cause them to miss planned production targets, any of which could have a material adverse effect on their financial condition and operating results.

Moreover, in October 2013, they entered into an amendment to their existing supply agreement with Panasonic Corporation in order to address their anticipated short- to medium-term lithium-ion battery cell needs. While Tesla expects that this supply agreement, as amended, will provide them with sufficient cells for the next few years. They may not be able to meet their long-term needs, including for their third generation electric vehicle, which they refer to as “Gen III.” And other programs they may introduce, without securing additional suppliers or other sources for cells. If Tesla Motors Inc cannot secure such additional suppliers or sources, they might experience production delays, which could have a material adverse effect on their financial condition and operating results.

Production Costs for Model S

Tesla’s production costs for Model S were high initially due to start-up costs at the Factory, manufacturing inefficiencies including low absorption of fixed manufacturing costs, higher logistics costs due to the immaturity of their supply chain, and higher initial prices for component parts during the initial period after the launch and ramp of Model S. As they have gradually ramped production of Model S, manufacturing costs per vehicle have fallen.

The Executive Compensation

I would like to cite the compensation of Tesla’s executives’ as I find it significant to include in this article. The information below shows the total compensation of Tesla’s executives in 2012, the 2013 report on compensation will be included in their 2014 financial statement.

TSLA executive compensation

Facts:

The total cash compensation is comprised of yearly Base Pay and Bonuses. Further, the total aggregates grant date fair value of stock and option awards and long term incentives granted during the fiscal year. On the other hand, the Other Compensation-like awards that are not applicable to the other categories.

The board of directors of Tesla has a fortune worth $6.8 billion, deserves a generous incentive package because the company wants to “appropriately reward the CEO’s previous and current contributions and to create incentives for the CEO to continue to contribute significantly”, gathered from Tesla’s SEC filings.

News about Tesla

Furthermore, the latest news from AutoGuide.com, in an article entitled Tesla CEO Took 99.9 Percent Pay Cut in 2013, I quote, “In 2013, Tesla CEO Elon Musk received total compensation of $69,989 with the value of stock and options totaling just $36,709. That’s a sharp contrast compared to his total compensation from 2012 when the CEO received $78.2 million in total compensation. His value of stock and options from 2012 was $78.1 million.”

Liquidity Ratio in 2014 Q1

The current ratio and the quick ratio of Tesla Motors Inc in the trailing twelve months 2014 were 1.04 and 0.72, respectively.

Discounted Cash Flow (DCF) Method 

Estimating the absolute value of a company’s stock is not an easy way to do because you have to consider a lot of factors. However, the discounted cash flow is one of the methods that some analysts commonly used to determine stock prices in a different and sound way. Further, I review the trend in the company’s historical five-year financial data and its ability to produce or manufacture its products. And, I came up with the following figures presented in the table below. Slowly, I will walk you through step by step process on the explanation and interpretation of the data.

Projected Quarterly 2014

TSLA Projected Q

The above table shows the calculated projected quarterly 2014 revenue of Tesla Motors Inc. According to Elon Musk, the CEO of Tesla Motors Inc, in its 2013 financial report presentation, that they are capable of producing 40,000 units or more of Model S by the end of 2014. Above shows, the projected total number of units was 42,250. The total projected revenue is $3.8 billion ends of 2014. Now, let us walk further, and compute the present value of $3.8 billion.

The formula for the present value is:

Present Value

                                       Or = PV = FV / (1 + r) n

Where:

PV – Present Value

FV – Future Value

r – Rate of Return

n – Number of Periods

Therefore, based on the table above, where the future value at the end of 2014 was $3,832,920,000. Now, we are going to calculate the Present Value discounted at 15 percent.

PV = FV/ (1+0.15) ^1

= $3,832,920,000 / (1+0.15) ^1

$3,832,920,000 / 1.15^1

        $3,332,973,913.04

The calculated present value of the projected 2014 cash flow is $3,332,973,913.04 discounted at 15 percent. In other words, the future value of $3,832,920,000 is worth $3,332,973,913 today.

Projected Cash Inflows

Moving forward, I have prepared a yearly projected cash inflow for five years.

TSLA Projected A

Explanation

The projected total revenue including service income by the end of 2014 was $3.8 billion. On the other hand, the projected number of units at the end of five years (2019), was 259,521 and the total revenue inclusive of service income was $23.54 billion. Since this method of valuation tries to work out the value today of the projected cash flows in the future, let us calculate the present value of $23.54 billion by the following formula:

PV = FV / (1 + r) n

PV = $23,543,711,100 / (1 + 0.15) ^5

= $23,543,711,100 / 1.15 ^5

$23,543,711,100 / 2.011357188

          $11,705,385,421.50

Explanation

Therefore, the calculated present value of the projected cash inflows in the year 2019 of $23,543,711,100 discounted at 15 percent is worth $11,705,385,421.50 today. This is also called the discounted value or the current worth of future value. Total projected growth from 2014 to 2019 was 514 percent. Moreover, the present market price to date, May 5, 2014, was $210.91 per share. If we divide the discounted cash flow value with its present number of outstanding shares, the fundamental or intrinsic value is $98.36 per share. The stocks of Tesla are overvalued by 114 percent. In valuing a young high growth company, in most cases, the results will give us an overvalued price.

Free Cash Flow to the Equity (FCFE)

FCFE is often used to determine the value of a company.  It is a measure of how much cash is available to the equity shareholders’ after all expenses, reinvestment, and debt is paid, and a measure of equity capital usage, according to Investopedia.

Calculation:

FCEE = Net Income – (Capital Expenditures – Depreciation) – Changes in Non-cash Working Capital – (Principal  Repayments – New Debt Issues)

or alternatively,

FCEE = Cash from Operations – (Capital Expenditures – Depreciation) + Net Borrowing.

The table below is the results of my calculations, in which I have used the alternative. Let us find out the results.

TSLA FCEE

Explanation

The free cash flow to the equity of Tesla Motors Inc was improving year over year. It shows that the company is managing its resources effectively. In addition, it tells us how well Tesla is managing its debt load. Tesla’s first two years, 2009 and 2010 shows negative results, which imply that Tesla is in the early stage of a growth outbreak. Hence, the succeeding years, 2012 and 2013 increased dramatically by 160 and 46 percent, respectively.

Sources of Cash

The company’s sources of cash include cash from the deliveries of Model S, customer deposits, the sale of regulatory credits. And cash from the provision of development services and sales of powertrain components and systems. Due to problems incurred recently regarding some suppliers’ inability to supply on time. The reason why Tesla planned to have adequate sources of liquidity to continue on with their current plans. Moreover, to fund their ongoing operations, continue research and development projects, and for expansions.

Tesla’s Industry Peers in China – BYD

BYD was established in January 2003 and headquartered in Shenzhen, China. The Company specializes in IT, automobile, and new energy. Further, BYD is the largest supplier of rechargeable batteries in the globe. Moreover, it has the largest market share for Nickel-cadmium batteries, handset Li-ion batteries, cell-phone chargers, and keypads worldwide. Furthermore, HK. BYD IPO price is HK$10.95 per share. It was the highest IPO price among all of the H-share companies at that moment.

Here is some basic information on BYD Company Ltd.

TSLA BYD

Explanation

The current price of BYD was $5.38, it is lower by 88 percent against its total value of $43.52. The stock price of BYD was undervalued. However, its liquidity ratios were very low. Consequently, it indicates that BYD is having a hard time paying its short term and long term financial obligations. In addition, its debt to equity ratio was 0.20 or 20 percent. Moreover, the calculated book value in year 5 was $6.90.

The bottom line 

Tesla Motors Inc is growing very fast. The market is anticipating a $3.65 billion revenue at the end of 2014 with low profits. For long-term shareholders’ it will not be easy to forecast whether they will be able to make a decent return. For the reason that the market somehow can bake the stock regardless, they will make a good profit or not. However, for short-term investors, Tesla may be an appropriate investment.

CITATION

  1. http://www.reuters.com/finance/stocks/companyProfile?symbol=TSLA.O
  2. http://ir.teslamotors.com/
  3. http://www.teslamotors.com/about
  4. http://www.teslamotors.com/executives
  5. Elon Musk interviews, articles, and blog posts
  6. http://quote.morningstar.com/stock-filing/Annual-Report/2013/12/31/t.aspx?t=XNAS:TSLA&ft=10-K&d=00cab30124b955d581c89f0ff007ad13
  7. https://www.youtube.com/watch?v=SE6GF1Y5WHE
  8. http://www1.salary.com/TESLA-MOTORS-INC-Executive-Salaries.html

Researched and Written by Criselda

Twitter: criseldarome

cf-industries-holdings-inc-cf

CF Industries (CF) The World Leader In Fertilizer

February 26th, 2014 Posted by Deep Analysis No Comment yet

CF logo

CF Industries Holdings Inc (CF) is a manufacturing and distributor of fertilizer around the globe and the second largest producer of nitrogen fertilizer globally and the number three largest producer of phosphate fertilizer of all public companies. Further, the company is operating and owns a world-scale nitrogen and phosphate plants.

How does the company make money?

CF Industries produces nitrogen fertilizer which is vital for healthy plant growth and for yielding high crop, especially for corn, cotton, and wheat. Phosphate fertilizer helps plants generate necessary sugars, germinate seeds, and build strong root structures. Nitrogen is also produced for industrial and environmental applications.

Primary nitrogen products produced by CF Industries are:

Urea Ammonium Nitrate (UAN) Solution

  • Anhydrous Ammonia
  • Granular Urea
  • Ammonium Nitrate
  • Other Urea Diesel Exhaust Fluid (DEF)

Primary phosphate fertilizers produced by CF Industries are:

  • Diammonium Phosphate (DAP)
  • Monoammonium Phosphate (MAP)
  • MAPplus Sulfur Enhanced Monoammonium Phosphate

Custom fertilizer products include Aqua Ammonia, UAN with   Sulfur, DAP – Turf grade, and others.

CF product2

Man-made fertilizers have had a great influence on farm productivity and food availability.

Who is running the Business?

The CF Industries organization is headed by a team of executives who have a great experience building and growing successful companies. These executives are supported by more than 2,400 CF Industries employees at the company’s headquarters, manufacturing, distribution, and other locations.

W. Anthony Will, President, and Chief Executive Officer, CF Industries Holdings, Inc.

CF Tony Will

Anthony Will has served as the president and chief executive officer and as a member of the board of directors of CF Industries Holdings, Inc. since January 2014.

 

 

 

Special events:

  • Mr. Will joined CF Industries in 2007 as the company’s first vice president, corporate development.
  • He was promoted to vice president, manufacturing and distribution in 2009 and senior vice president, manufacturing, and distribution in 2012.
  • He has also served as the chairman, president, and chief executive officer of Terra Nitrogen GP, Inc. (TNGP), a wholly-owned subsidiary of CF Industries Holdings, Inc. and the sole general partner of Terra Nitrogen Company, L.P., a publicly-traded producer of nitrogen fertilizer products, since January 2014.
  • He has been a member of the TNGP board since 2010.
  • Prior to joining CF Industries, Mr. Will was a partner at Accenture Ltd., a global management consulting, technology services, and outsourcing company.
  • Earlier in his career, he held positions as vice president, business development at Sears, Roebuck and Company and vice president, strategy and corporate development at the Fort James Corporation.
  • Prior to that, Mr. Will was a manager with the Boston Consulting Group, a worldwide management consulting firm.
  • Moreover, Mr. Will holds a B.S. degree in electrical engineering from Iowa State University
  • And also an M.M. degree (M.B.A.) from the Kellogg Graduate School of Management at Northwestern University.
  • He serves on the board of directors and the executive committee of The Fertilizer Institute and is a member of the Business Roundtable.

Dennis Kelleher, Senior Vice President, and Chief Financial Officer

CF Dennis Kelleher

 

 

 

Special events:

  • Kelleher joined CF Industries in August 2011.
  • Prior to that, he had been vice president, portfolio, and strategy for BP’s upstream business.
  • Earlier, he served as a chief financial officer for Pan American Energy, LLC, and in other financial positions in the operations of BP PLC and Amoco Corporation.
  • In addition, he is a certified public accountant
  • And has a Bachelor’s degree in accounting from the University of Illinois and an MBA from Northwestern University.

CF Industries Value Investing Guide

The analysis below was created as your value investing guide.

Liquidity and Solvency

CF liquidity

The table above shows that the current ratio was averaging 2.31 and the quick ratio was averaging 1.84. The rule of thumb is 2.0 and 1.0, respectively. It indicates that the company has the capability of meeting its short-term financial obligations when the due date comes. On the other hand, it tells us that CF Industries Holdings Inc has strong liquidity. The current ratio and quick ratio in 2010, went down by 47 percent, due to the acquisition of properties.

Moreover, the solvency ratio was averaging 48.93. It shows that CF Industries Holdings Inc is able to sustain $0.49 for every $1 total debt. The highest ratio was in 2008, and the lowest was in 2010. The leverage ratio was averaging 14 percent, total debt was 14 percent of the shareholders’ equity. CF Industries has the ability to pay its long-term financial debt. On the other hand, financial leverage was averaging 1.87 or 187 percent. This is the percentage of assets against the shareholders’ equity. Overall position, CF Industries Holdings Inc has a solid financial position.

Profitability Ratios

CF profitability

CF Industries has an acceptable gross margin, operating margin, and net margins were averaging 39.58, 36.0 and 20.74 percent, respectively. Although the ratios are somewhat erratic in movement, overall, the ratios increased by 47, 49 and 64 percent, respectively. The company has not suffered any losses from the last 5 years of its operation. Overall view, CF Industries is financially stable and sound.

The Cash Flow Statement

CF CF

  • The cash flow margin was stable, averaging 0.88 percent.
  • The ratios were erratic in movement.
  • Free cash flow has an average of $12 million.
  • On the other hand, the operating cash flow was lower in 2010, due to the purchased of properties, as mentioned earlier.
  • CF Industries Holdings, Inc has not suffered any negative ratios and negative cash flows. It tells us that the company was profitable.

CF Industries Investment Valuation

The Investment in Enterprise Value

Enterprise Value (EV) is the first step in this valuation. The concept of enterprise value is to calculate what it would cost to purchase an entire business. In other words, the Enterprise Value (EV) is the present value of the entire company.  EV takes into account the balance sheet, so, it is a much more accurate measure of a company’s true market value than market capitalization.  Significantly, it assesses the value of the productive assets that brought about its product or services, both equity capital (market capitalization) and debt capital.

CF EV

The enterprise value of CF was averaging $807 per share and the market capitalization was averaging $817 per share. The total debt was 16.22 percent and the cash and cash equivalent was 14.59 percent of the enterprise value, therefore, buying the entire business of CF, the investor would be paying 98.37 percent of equity and 1.63 percent of its total debt. In addition, the takeover price to date, February 25, 2014, was $14.73 billion at $241.43 per share. The market price to date was $242.79 per share.

Margin of Safety

In the calculation, the enterprise value was used because it takes into account the balance sheet, so it is considered a much more appropriate measure of the company’s true market value rather than the market capitalization.  Let us walk through the margin of the safety table.

CF MOS

The margin of safety was averaging 74 percent and the intrinsic value was averaging $1,376 per share from 2009 to 2013, respectively. It indicates that it has a greater margin of safety against future uncertainty and a greater stock’s resilience to market downturns.

Intrinsic Value

Here is the calculation for the intrinsic value.

Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)

EPS, the company’s last 12-month earnings per share; G: the company’s long- term (five years) sustainable growth estimate; 9: the constant represents the appropriate P-E ratio for a no-growth company as proposed by Graham (Graham proposed an 8.5, but I changed it to 9); 2: the average yield on high-grade corporate bonds.

CF IV

Intrinsic value was averaging $1376.26 per share and the earnings per share were averaging $18.14 from 2009 to 2013. The annual growth rate was 67.10 percent. The term earnings per share (EPS) represent the portion of a company’s earnings, fewer taxes, and preferred stock dividends that are allocated to each share of common stock. The computation of EPS is:

CF EPS

On the other hand, the sustainable growth rate (SGR) is a measure of how much a firm can grow without borrowing more money. Here is the table for the sustainable growth rate.

CF SGR

The sustainable growth rate was averaging 29.05 percent and the return on equity was averaging 27.52 percent from 2009 to 2013. Further, the payout ratio was averaging $5.84 from 2009 to 2013. Furthermore, the ROE was lower in 2010 where the company suffered its lowest positive net earnings in the last five years and this is the year they had invested in property and equipment. And also,, the CF payout ratio was high in 2010.

Return on Equity formula:

CF ROE

The Return on equity (ROE) is an indicator of a company’s profitability by measuring how much profit the company generates with the money invested by common stock owners. The historical summary of the Benjamin Graham method above can be viewed in the table below.

CF Graham

The margin of safety was lower in 2010, so as to the intrinsic value, however, during the succeeding periods, 2011 and 2012 it went up by 886 and 30 percent, respectively and in 2013 it decreased by 19 percent. Moreover, the sustainable growth rate was also low in 2010 but managed to increase the succeeding periods. It shows that CF was profitable.

CF Industries Relative Valuation

The relative valuation methods for valuing a stock is to compare the market values of the stock with the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.

Price to Earnings/Earning Per Share (P/E*EPS)    

This valuation will determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share, we can determine the status of the stock price.   Below is the calculation for the P/E*EPS valuation.

CF PE EPS

Overall, the P/E*EPS indicates that the stock of CF was trading at an undervalued price because the P/E*EPS ratio was higher by 1 percent of the enterprise value. This valuation shows the relationship between the stock price and the company’s earnings. The price to earnings is the price that the market is willing to pay for the company’s earnings. The price to earnings of the company can change daily as the market price changes.

Enterprise Value (EV) / Earnings before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA)  

This EV/EBITDA metric is used in the valuation of the business. This metric used to compare the value of the company with its debt and other liabilities to its actual cash earnings, not including non-cash disbursements. In addition, it is applicable in analyzing and comparing profitability between companies and industries.  As a result, this gives us an idea of how long it would take the earnings of the company to pay off the price of buying the entire business, including debt.

CF EV EBITDA

The EV/EBITDA valuation indicates that it will take 5 times the cash earnings of CF to recover the costs of buying the entire business. In other words, it will take 5 years to recover the purchase price of buying the entire business.

Summary of Historical Ratios

The table below is the summary of the five years of historical data on CF Industries Holdings Inc.

CF Relative

The above financial ratios will give us a view of the 5-year historical trend in the company’s operation. As seen above, the book value increases from  2008 to 2012; however, in 2013, there was a 5 percent decreased in value. Further, the price to earnings was erratic in movement. Furthermore, the earnings per share and the return on equity shows a decreased in 2009 and 2010, and an increased of 196 percent in 2011.

The Book Value Growth and the Return on Equity Approach

This approach is the historical book value growth analysis plus the return on equity analysis. The 5 years historical Price to Earnings, the current dividend yield, and the current market price was factored. In addition, the percentage of risk was 15 percent. It determines whether the stock is over or undervalued.

Summary

CF Growth

Facts:

  • The book value growth of CF Industries was 26 percent with its historical data of 5 years.
  • The calculated future book value at year 5 was $284.50 per share.
  • The ROE was averaging 32.85 percent,
  • And also, the return on book value at year 5 was $93.46.
  • In addition, the future price in year 5 was $1,121.51 per share.
  • The calculated present value of the stock was $484.86 per share.
  • Further, the value of the margin of safety was $290.92
  • Furthermore, the calculated total value was $309.53, compared to the current market price of $242.79,
  • Finally, the stock of CF Industries Holdings, Inc was undervalued at 27.49 percent as of February 25, 2014.

Conclusion

The company has a solid financial position, a reasonable level of debt and a notable return on equity. The company’s market price increased by 1,437 percent from the time it started its IPO in 2005 up to the trailing twelve months of 2014, at $16.20 to $249.05 per share.  Finally, the stock price was trading at an undervalued price.  Therefore, a BUY is best recommended for the stock of CF Industries Holdings Inc (CF).

CITATION

http://phx.corporate-ir.net/phoenix.zhtml?c=190537&p=irol-homeProfile&t=&id=

http://www.cfindustries.com/profile_history.html

http://www.cfindustries.com/profile_leadership.html

http://www.cfindustries.com/products_overview.html

Researched and written by Cris

Twitter: criseldarome

Note:

Research Reports can be found under the company tab.