Friday, October 17, 2008

Un-Balanced Sheets

During this week Wall Street pundits and news reporters have been talking up hedge fund redemptions as the latest wave of repercussions from the so-called credit crisis. I have been looking even further ahead to how the squeeze in credit will affect business activity.

The credit crisis has been as much a lack of confidence as a real bottleneck in liquidity. Banks have been unwilling to lend to even the most prestigious among their own peers. It is not a surprise then that businesses are getting the door slammed in their faces when they come knocking for growth capital, or worse yet working capital.

Investors everywhere should be looking carefully not only at the question of adequate capitalization in the companies they own, they should also look at the risks in the rest of the balance sheet - namely accounts receivable. For example, nearly all the companies in the Crystal Equity Research coverage universe are well capitalized, have little or now debt, good cash balances and positive cash flows from operations.

What about the credit extended to customers? Customers in trouble lead to cancelled orders, slowing collections and even defaults.

Few companies reveal all their customers, but a look at the balance sheets of the leaders in each market vertical should provide some clues as to the risk that might be building in A/R. If customers are carry debt and have low cash balances there is reason to get worried. Another good place to look is Days Sales Outstanding (DSOs) - a measure of how much of the company’s recognized revenue has yet to be collected from customers. I expect to see increase in DSOs when earnings are reported for the third quarter, followed by another steeper jump in the December quarter.

Cemex (CX: NYSE) is among the few companies that have reported earnings so far this month. The Mexico-based cement producer reported a 5% decrease in sales this week compared to a year ago. Accounts receivable are down 17% from a year-ago. DSOs were 30 days at the end of the September quarter, compared to 40 days a year ago. Cemex has customers in 50 countries none of which account for more than 10% of total sales.

When Intel Corp. (INTC: Nasdaq) reported third quarter results this week, sales were better than expected but the chief financial officer warned of slowed spending on IT in the coming months. Intel’s DSOs were 23 days based on the most recent quarter, down slightly from 26 days last year. Dell Computers (DELL: Nasdaq) accounts for at least 18% of Intel’s sales and Hewlett Packard (HPQ: NYSE) another 17%. Neither presents a significant credit risk, but watch for the earnings releases of both companies in the third week in November to look for clues of whether orders could slow.


Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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