Sometimes earnings are relevant, sometimes not. Consider Pulse Seismic Inc., a Canadian corporation engaged in the acquisition, marketing and licensing of two-dimensional (2D) and three-dimensional (3D) seismic data for the energy sector in Canada.
This company is losing money on paper last year and will probably break-even this year. In the previous years (before recession) the company had a small earning per share. They clocked around 0.05 EPS. Resulting on a P/E of 40! That is way too high for a low profit – slow growth company.
After getting into the details of the financial statements, you may see that non-cash item (in this case depreciation) accounts for over 24M understating the actual cash created by 0.45 per share! But does this company invest completely this cash to maintain its operations? By checking the cashflow statement of PSD, we see that investment activities were around 10M. This overall investing minus depreciating assets results in a net cash increase of 14M per year giving a supplemental free cash of around 0.27 per share. Adding the average profit of previous years (0.05), we get a P/FCF around 16. It is still a little high for a slow growth company, but what are the “outstanding” actions.
- In the recession, dividend of 0.15 to 0.20 per share was cut. Management has agreed to get it back as soon as debt from acquisition was covered resulting in a dividend yield around 8%.
- Assets of one competitor were acquired last year at a bargain price resulting in revenue increase of about 20M (based on last year sale by Divestco, acquired company). Increasing FCF per share by 0.38 next year!
- Some sales due to contractual end resulting from merger / acquisions were not recorded yet but could create a onetime profit of 10M (0.18 per share).
- Company target Alberta land acquisition and this market is currently booming which should result in supplemental sales for PSD.
Giving these “outstanding” actions, P/FCF is changing to 2.9 without even considering the dividend or the onetime profit!
Target multiple of 10 regarding P/FCF, would give a target price around 7$ for a profit of 350%!
There is a great analysis by David Brown of Hawk Ridge Management that can be found here.
Disclosure : Author has a position in PSD.TO