Monday, November 2, 2009

Earnings Pops

For companies with high fixed costs, earnings are particularly sensitive to drops in revenue. As a result, we have seen many such companies show negative earnings over the last few quarters. But while reported revenue figures have continued to decline, some backlog numbers have started to tick up, suggesting that for some, higher revenue is on the way. This higher revenue can translate into much higher earnings for companies with fixed costs. For such companies that currently trade at low earnings multiples, strong price appreciation potential exists.

For example, consider Canam (CAM), a company that specializes in designing and building heavy-construction components. Year-over-year quarterly revenue is down over 30%, resulting in a reduction to operating income of over 60%. Despite the revenue shocks, the company has managed to eek out small profits every quarter, and now trades at a P/E multiple under 10 using earnings over the last four quarters.

But these are trough earnings for a company with high fixed costs. Consider the company's backlog over the last several quarters, shown below:

It would appear that revenues will soon be on the mend. Furthermore, subsequent to the end of the Q3 2009 quarter, the company was awarded a $100+ million contract to help build the new roof for BC Place Stadium in Vancouver, which is not included in the above chart.

In addition to the fact that Canam trades at a cheap multiple to trough earnings, Canam has no net debt, and management has recently signaled that it will be buying back and canceling shares. For value investors looking to buy good businesses at attractive prices, Canam may offer such an opportunity.

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Disclosure: Author has a long position in shares of CAM


Davis said...

Hi Saj - I appreciate your blog and enjoy reading it. In this post, you mention that CAM is trading at PE a discount based on "trough" earnings, but cite those earnings at TTM rather than a run-rate based on the recent quarter. How do you think about the difference? I think ideally the company would trade at low multiples using the run-rate financials rather than TTM as those TTM numbers include some great quarters. I worry that using multiples calculated on TTM are artificially low, and would be higher if the forward few quarters are like the last two.


Saj Karsan said...

Hi Davis,

It would be nice indeed if the P/E multiple was cheap (it is 17) using this quarter's run-rate, but that might be asking too much. The last three quarters haven't been great, but the fourth quarter "ago" was fairly strong, so I understand what you're saying. However, analyzing a company's earnings based on just one quarter, and its worst one at that, rather than trying to estimate the company's normalized long-term earnings going forward, may leave a lot of opportunities on the table.