Tuesday, August 26, 2008

Inventing Inventory

A.M. Castle (NYSE: CAS) is a metals and plastics distribution company out of Illinois. As of its latest quarterly report, it had inventory of $248 million. The inventory is also stated to have a replacement cost of $423 million. So how can it be that the company has two seemingly different levels of inventory, $174 million apart? The actual goods in inventory are considered the same in both cases, but what's different is the way the value of that inventory is calculated.

Is this even important? In most cases, the way inventory is calculated has minimal effect on the overall assessment of the company. In this case, however, CAS has total shareholder's equity of just $407 million, meaning the way inventory is calculated changes the book value by 43%! (174/407)

As we've discussed here, book value is not a perfect measure of a company's true worth (in fact, sometimes it's not even close). However, in this case, the inventory difference of $174 million is so large that it makes a rather large difference in whether this company is undervalued or not, as Castle has a market value of just $470 million.

Companies are allowed to calculate their inventories in more than one way. FIFO and LIFO are two such methods. When prices are rising, inventories calculated using FIFO will be larger than those using LIFO. For a refresher on these methods, see the article here. So what value of inventory do you think we should use for this company? More discussion to follow...

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