Wednesday, January 14, 2009

Bewildering Optimism

When considering a company for investment purposes, investors must be wary of managements that over promise and under deliver. One symptom of such a situation is over-optimism from managements in their quarterly reports and conference calls. Consider Rite-Aid (RAD), a US drugstore chain. Deep down in the company's press release, management noted reduced profit expectations going forward from an already negative $500 million to a more negative $700 million. But the company's press release headlines read as follows:

  • 8.5% EBITDA increase over prior year (as if debt, taxes, and depreciation are meaningless, all of which are higher than they were the previous year. Here are Buffett's thoughts on the practice of focusing on EBITDA.)
  • "Sales Trends In Acquired Stores Improved" which means sales still dropped, but not by as much as before.
Furthermore, the following bullish statements appear on RAD's press release, while little colour on the reasons for profit deterioration were provided:
  • I am pleased to report a significant improvement in our operating results this quarter
  • Our team has been totally focused on delivering profitable sales and taking unnecessary costs out of the business, and it showed
The conference call is even more riddled with tremendous exuberance. Reading management's comments on the press release and listening to the conference call alone would lead an investor to believe this company was profitable, or at the very least generated profits higher than those of last year...but this is not the case with Rite-Aid!

Meanwhile, as we discussed here, the company has to undergo a 10:1 reverse stock split just to maintain a stock price above $1 so that it can stay on the NYSE. The company is also trying to sell its stores and lease them back in order to pick up some short-term cash, despite the current dire real estate market!

Be wary of managements that can find a glass half-full in an empty glass.

No comments: