Loblaw: Losses never looked so good. Understanding Adjusted Earnings and Free Cash Flow.

Loblaw (TSE: L) announced earnings recently (Loblaw Press Release), opening with the statement by Galen Weston that "the second quarter of 2014 marked the opening of the next chapter for Loblaw, combining the number one food retailer in Canada with the number one pharmacy and beauty retailer."

The acquisition of Shoppers Drug Mart by Canada's largest grocery chain marks a clear avenue for future expansion by the retailer, and millions of dollars in synergies as it combines the operations of the two companies into a more efficient Canadian corporate behemoth.

Including the results from Shoppers, Loblaw announced revenue of $10,307 million, an increase of 37.1% over the second quarter of 2013. Adjusted basic net earnings per common share were also up 17.2% to $0.75 compared to $0.64 in the second quarter of 2013.

The headline numbers, however, highlight that the company lost $1.13 per share in the second quarter of 2014, due primarily to costs associated with the purchase of Shoppers. This distinction provides us with an important lesson in "adjusted earnings," which can be used regularly by a number of publicly traded companies.

Adjusted earnings figures are used when a company believes that earnings for a particular financial period are distorted either positively or negatively by "one-off" or unusual events. In this case, the distortion is the artificially high loss caused by costs incurred due to buying Shoppers Drug Mart. Since Loblaw will not be incurring those costs regularly in the future, it does not believe that those costs reflect the company's true performance in the last quarter. To help shareholders better understand the company's true operational performance, it reports what the company would have made if you exclude the irregular costs. In this case, the difference is quite large, from an actual loss of $1.13 per share, to a profit of $0.75 per share.

Intelligent Investors should beware of adjusted numbers, and investigate why the adjustments were made, and if they seem reasonable. In this case, it is clearly understood that the costs are associated with the purchase and integration of another major Canadian retailer. This will not be a standard or common occurrence for Loblaw in most quarters, so the adjustment is most likely reasonable.

Many investors, such as Olstein, are calling for an end to adjusted earnings, as they think it misleads investors. However, the Intelligent Investor simply needs to investigate why the earnings are being adjusted, and how often the company utilizes adjustments. If the company regularly adjusts earnings by a large margin, be careful, but otherwise, the practice can be perfectly reasonable.

To help better understand how the company is performing, it is always helpful to look at Free Cash Flow during the quarter. Free Cash Flow represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. This can be calculated by taking operating cash flow, and subtracting capital expenditures. In the case of Loblaw, the company had Free Cash Flow of $801 million for the quarter, a very healthy number.

Loblaw now has its fingers in a number of very profitable business pies. It is engaged in the financial business through its thriving credit card division (PC Financial now has over $2.5 billion in credit card receivables), the clothing business through Joe Fresh, the real estate business through Choice Properties, the drug business through Shoppers Drug Mart, and of course, the good old fashioned grocery business through entities such as Loblaws, No Frills, and Real Canadian Superstore.

For those Intelligent Investors looking for portfolio diversity, a decent dividend, and strong Free Cash Flow, take some time to look at Loblaw.

Happy Investing!

What Does the Investor Need to Know About Financial Statements? The Cash Flow Statement

They say that "cash is king," and indeed, cash forms the lifeblood of any business. For the Intelligent Investor, it is cash that is used to pay dividends, buy back stock, and fund daily operations. When companies experience a cash squeeze, they find themselves at the mercy of lenders and often find it difficult to concentrate on their long-term corporate goals. This can lead to hurried and poor decision making. Healthy levels of cash lead to the flexibility corporation's need for continued success.

So how can the investor examine the cash flows of a potential business opportunity? They should start by referencing the "Statement of Cash Flows" found within a companies financial statements. The Statement of Cash Flows should be publicly issued every three months with the quarterly reports, and can be found in the Investor Relations section of most publicly traded companies' websites. 

The 3rd Quarter 2013 Statement of Cash Flows for Tim Horton's (TSE: THI) is found by clicking on this link and scrolling to page four. 

Whereas balance sheets present a snapshot in time for a companies overall financial health, the cash flow statement shows activities over a period of time. Because the ever important earnings per share numbers are not found within the cash flow statement, this statement is often overlooked by investors. However, it is crucial for properly understanding the health of any business. 

What does the Cash Flow Statement commonly look like and what does the investor need to know? At its most basic level, the cash flow statement is segmented into three parts:

Section # 1) Operating Cash Flows

+

Section #2) Investing Cash Flows

+

Section #3) Financing Cash Flows

=

Net Cash Flows

Each section can have a positive or negative balance, and the sum total of these three sections will result in a number titled "Net Cash Flows." Generally, a negative number is displayed in brackets. Net cash flow helps the investor to identify whether or not the business had a net inflow or outflow of cash during the period of time being measured. It is very important for the Intelligent Investor to remember that a positive or negative net cash flow is not necessarily good or bad, it all depends on HOW the inflow or outflow of cash was realized. This can be understood by examining the three sections highlighted above. 

The investor must act like a detective to discover the story behind the net cash flow number. You can begin doing this by asking some basic key questions:

1) Is the Operating Cash Flow positive or negative? Why? 2) Is the Financing Cash Flow positive or negative? Why? 3) Is the Investing Cash Flow positive or negative? Why?

By examining the information listed below for a hypothetical corporation, we can see the following: 

1) Operating cash flow is positive, primarily due to large income levels experienced during the period, there is not excess depreciation being added into this equation. This is a good sign. 

2) Financing cash flow is positive, and this is primarily from a share issuance. As an existing investor, you generally do not want there to see more shares issued, as this decreases your stake in the company. This could be a warning sign... especially if these funds are needed to pay off debt or to pay dividends. 

3) Investing cash flow is negative, and we can see that this is due to the purchase of new fixed assets. If these assets contribute to increased profits in the future, this may be a worthy cash outflow, and not a negative sign. If, however, there are large inflows of cash from asset sales... you should investigate why. Sometimes it is a sign that a company may be experiencing trouble and selling existing assets to raise money to cover other obligations. 

Hypothetical Statement of Cash Flows for Acme Corporation

Operating Cash Flows

Income for the period +$64,795

Depreciation +$2,000

Equity Income -$5,000

Minority Interest +$2,000 

__________________

Net Operating Cash Flows = + $63,795

Financing Cash Flows

Proceeds from a Share Issue +$10,000

Repayment of Debt -$2,000

Dividends Paid -$1,000

__________________

Net Financing Cash Flows = +$7,000

Investing Cash Flows

Acquisition of Fixed Assets -$15,000

__________________

Net Investing Cash Flows = -$15,000

__________________

__________________

Total Increase or Decrease in Cash (Net Cash Flow) = +$55,795

The Intelligent Investor must always look for warning signs within the cash flow statement, such as: 

1) a business continuing its operations through the use of debt and equity financing (borrowing money or issuing shares), and using that money to fund losses highlighted at the start of their Operating Cash Flows. 

2) a business that is essentially "borrowing from Peter to pay Paul," which may appear as outflows of cash in the form of dividend payments, but inflows of cash in the form of share issuances or the issuance of new debt. This might be evident by seeing new shares being issued and/or new borrowing happening, while at the same time relatively large dividends are being paid.  

3) a business that is experiencing higher levels of depreciation than it is investing in new assets. This might result in positive cash flow numbers for a period of time because decaying assets are not being replaced with new ones, but eventually this might cause trouble as technology becomes obsolete or assets need to be replaced to maintain day to day operations or keep attracting customers. 

An interesting cash flow statement to examine is the one issued for Exxon Mobil (NYSE: XOM), which generally experiences positive levels of Operating Cash Flows, and negative levels of Investing and Financing Cash Flows. This means that the company is taking large positive influxes of cash from sales to its customers (Operating Cash Flow), and utilizing that cash to heavily invest in new assets (Investing Cash Flow), and return profits to shareholders via share buybacks and dividend payments (Financing Cash Flow).

Below you can see a graphic illustrating this activity from 2008-2012.   

As with the Balance Sheet, you can dig deeper into the Cash Flow Statement, and I encourage you to do so. Please ask if you have any questions, and Happy Investing!

Cheers, 

Matthew.

What Should the Investor Look for in the Financial Statements? The Balance Sheet.

The first section to tackle when examining the financial statements of any investment enterprise is the Balance Sheet.  The balance sheet shows the company's financial situation on a certain date, and is like a snapshot of a company's financial health.

There are three primary sections of the balance sheet:

1) Assets: what the company owns and has owing to it from others. 

2) Liabilities: what the company owes to others. 

3) Shareholders Equity: the net worth of the company, or the shareholders' interest in the company. It will always equal the Assets minus the Liabilities.  

The reason it is called a "balance" sheet is because both sides of the balance sheet equation must always be the same. 

Assets = Liabilities + Shareholders Equity

Often, the Shareholders Equity will be referred to as the Book Value of the company, and can be thought of theoretically as what the value of the company would be if it sold all of its assets and paid off all of its debts. 

In reality, for a variety of reasons, the business could be worth more or less than its Shareholders Equity or Book Value. This is primarily because the company will either have a certain degree of earning power to generate more assets in the future, or lack earning power, and its assets may decrease in value over time with future losses and depreciation. 

Also, sometimes the real value of a company's assets may be difficult or hard to determine, and an example of this might be the value of a patent on a new technology that a company owns. 

Assets, Liabilities, and Shareholders Equity can be categorized into a wide number of different items, such as: 

Assets: Cash, Temporary Investments, Accounts Receivable, Prepaid Expenses, Inventories. 

Liabilities: Current Liabilities, Future Income Taxes, Non-Controlling Interest in Subsidiary Companies, Long-Term Debt

Shareholder Equity: Share Capital, Contributed Surplus, Retained Earnings

There are additional categories to be explored later, but the crucial thing for the Intelligent Investor to understand is the importance of a "healthy" balance sheet. 

A healthy balance sheet is one showing ample assets to cover any future liabilities, and no warning signs that would indicate limited amounts of cash or "liquid" assets to fund ongoing operations.

A number of seemingly great businesses, upon further inspection, are buried in liabilities that seriously limit shareholder gains over time, and can pose a serious risk to shareholders during a tough economy or business environment. 

To highlight an example of a poor balance sheet, below is some information on Wynn Resorts Limited, (NASDAQ:WYNN):

The current balance sheet of Wynn highlights $7.3 Billion in Assets and $5.8 Billion in Debt... if all Liabilities are included, the number rises to $7.5 Billion. Therefore, the following is true for Wynn:

Assets ($7.3 Billion) = Liabilities ($7.5 Billion) + Shareholders Equity ($-0.2 Billion). 

As a shareholder, this would not be a positive situation, and for the Intelligent Investor, in general should be avoided. 

In future, we will examine more characteristics of the Balance Sheet, and in particular the Earnings Statement and the Cash Flow Statement.

Cheers, and Happy Investing.  

Matthew. 

Investing in the Future of Natural Gas: Making Money Reducing the Carbon Footprint.

America's current plan for tackling climate change is less than stellar... or even all that existent in reality. But of particular note has been some recent comments by President Obama in a speech at Georgetown University. 

President Obama declared that America would reduce its annual carbon pollution by 50% over the next 20 years. To achieve this, he plans to empower the Environmental Protection Agency to create carbon emission standards for new and existing power plants. 

Why should this news be relevant for the Intelligent Investor?

If electricity producers have to limit the amount of carbon pollution that they emit, a strong and natural incentive will develop to shift from coal to natural gas. Natural gas has been an alternative for years, but in the last few years the price has dropped to such a level to make it increasingly more attractive when compared to coal, especially if emissions become a concern.

Natural gas reached its lowest level in a decade last spring, but there is a very long lead-time from when a power plant is planned, and when it actually begins buying fuel for production. This means that the low price point reached last spring, could be the start of a very long up-ward trend in natural gas prices as large scale buyers of natural gas, such as power plants, finally start utilizing the fuel in their completed operations. 

Other key demand drivers for natural gas are: transportation fuel, LNG exporters, and residential and commercial heating.

People have long been declaring the growth of natural gas utilization for transportation, but there is now increasingly more evidence that predictions are finally coming to fruition. Major companies such as Waste Management and UPS have already made the commitment by buying fleets of natural gas trucks, while other key transportation players in the rail-road industry, such as Norfolk Southern and Union Pacific, are seriously considering converting many engines to natural gas. 

Right now, supply for natural gas in North America is very high (especially from recent shale gas production), and for an investor, that means prices will remain low right now and profit margins may not currently be as high as investments in oil, but once demand for natural gas increases, and price comes up to an equilibrium, a lot of the investment money will already be made by those in on the ground floor. 

Where can the Intelligent Investor find an investment in natural gas?

Encana is Canada's largest natural gas producer, and easily one of the markets purest ways to invest in natural gas production. Second quarter operating profit at the company increased 25 percent recently as volumes at the company soared.

Capital spending at Encana for the year is expected to be in the $3 billion range, which will be above current cash flow levels. This means that the company will have to sell some assets or borrow money in the short-term, but as natural gas prices rise, or capital expenditures decline, free cash flow at Encana will leave shareholders with plenty of money leftover for dividends and share buybacks.

Cheers and Happy Investing.

Matthew Clarke. 

(Full Disclosure: Matthew Clarke's clients and family may own or hold shares in Encana)

Fee-Only Financial Planning: How do Most Canadians Pay Their Financial Advisors?

Today’s Globe and Mail sheds light on the industry of fee-only financial planning. Most Canadians are completely unfamiliar with the concept of hourly-rate financial planners, but as the Globe and Mail notes, a small shift is beginning developing within the financial consumer’s mindset.

How do Most Canadians Currently Pay for Financial Advice?

Most Canadians pay for financial advice in one of two ways: 

1. A commission on the dollar amount of investments being managed. Most often this is reflected as a percentage of a particular financial transaction. For instance, if John and Jane Smith invest $100,000, they would pay a commission of anywhere from about $1500 to $2500 for the service. Some investment companies may charge as high as 5%, or $5000, but that is getting increasingly rare. 
2. A percentage fee charged annually on the amount of money invested. Most often, this charge is hidden within a wide range of investment and/or mutual funds fees and charges that is simply deducted from the investment returns of the customer. For instance, if John and Jane Smith invest that $100,000 in a balanced mutual fund at the bank, they would most often pay about $2,000 to $2,500 per year in mutual fund fees. Now, if the bank actually showed those charges to the customer, there would be an outrage… so they simply hide them in the prospectus and reports. How do they do this? Let us imagine that John and Jane earn 5% on their investments valued at $100,000, or $5000. In order to pay their fees of 2% per year, the bank or financial institution would simply show them a net return of $3,000 or 3% (Their $5,000 actual investment return, minus 2%, or $2,000 in fees).

There is, however, a third, and much more transparent way that Canadians can pay for financial advice: 

3.  Hiring a fee-only financial consultant or planner. This method generally involves the individual financial consultant billing the customer an hourly rate for the advice that they give. For instance, if the advisor charges $75 per hour, and the customer seeks an hour of advice, the bill would be $75. Plain and simple, with no hidden charges or secret fees buried inside the prospectus or report. Obviously, this method would not earn as much for the planner or financial institution, so it is less common and little advertised.

Why don’t more Canadians use fee-only financial planners / consultants? It is easy for the population to be manipulated by the financial industry into thinking that they are not “paying” their advisors or planners when they do not get an obvious bill for services rendered. Of course, the truth is that they are often paying more than necessary. Perhaps it is time for a change!

Cheers, and Happy Planning and Investing!

Matthew. 

Leon's Takeover of The Brick Almost Complete: Competition Hurdle is Cleared.

The takeover of The Brick Ltd (TSE: BRK) is almost complete as the Leon's Furniture corporation (TSE: LNF) received a "no-action" letter from the Competition Commissioner in Canada. This means that the retail operations of both companies will be able to consolidate, and profit from any associated synergies, without have to sell any stores or significantly alter their businesses. 

The Brick's shareholders are going to receive $5.40 per common share from Leon's, and the deal is expected to be completed by the 28th of March, 2013. 

Currently, Leon's has 73 stores, and The Brick has 230. Combined, they should be able to share warehousing and distribution, and head office and administrative employees, which should reduce costs, as well as increase their overall buying power with their suppliers. Increased buying power can result in lower per unit costs for retailers, and either lower prices for customers or higher profit margins for the stores.

Are other Canadian retailers ripe for more activity down the road?

Sears Canada has long been struggling to survive under the rule of its American parent (Sears Holdings (Nasdaq: SHLD), but their days seem to be numbered as profits and sales continue to fall. Also, the newly re-listed Hudson's Bay Company (TSE: HBC), despite recent re-branding efforts and an apparent reversal of fortune, will continue to be pressured to release even more of its valuable real estate holdings into the marketplace. 

Continue to keep an eye on both going forward.

Cheers, and Happy Investing!

Matthew. 

Here We Go Again! Student Loans Being Packaged as Investment Vehicles.

The Wall Street Journal has reported that billions  of dollars in student loans are now being packaged together as investments for investment banking clients around the world. 

Reminiscent of the recent mortgage loan crisis that occurred only 5 years ago, and that we are still feeling the pain from today, thousands of student loans are being bundled together so that they can be sold as "safe and secure" interest bearing securities. 

SLM Corporation (NYSE: SLM), the largest student loan company in the United States, sold $1.1 billion of the loans recently, and demand was high enough to make it glaringly obvious that few lessons were learned from the mortgage crisis, and investors are willing to "reach for yield," or take a lot more risk if it means earning some extra percentage points in return. 

Interest rates in the current investment environment are at historically low levels, and SLM Corporation is taking advantage of the climate by offering investors the chance to make a little extra money, while at the same time ridding their balance sheet of billions of dollars in loans to students with limited job prospects in a dismal market for young graduates.

Interestingly, student loan levels are rising, delinquencies and defaults are rising, and yet many banks are now choosing this time to package the loans and sell them to investors... if only these banks had some sort of responsibility to actually care for their clients or customers.

Cheers, and responsible investing : )

Matthew. 

Death of ING Direct Almost Complete. Scotiabank and Capital One Implementing Takeover. It was a Good Idea While it Lasted.

The slow death of ING Direct in North America is almost complete. After Capital One's $9 Billion purchase of the American unit of ING, and ScotiaBanks's $3.1 Billion purchase of the Canadian unit, both banks have been shuttering a number of ING's once thriving business units.

In Canada, Scotia announced that they will be closing ING Direct's Mortgage Broker unit, which offered discount mortgage loans to Canadians via mortgage brokerage offices. Clearly, this is an attempt to consolidate and direct business to the traditional ScotiaBank unit, and hopefully raise costs and rates for Canadians through reduced competition. This is happening after ScotiaBank just recently promised everything would stay as-is at the ING unit, and that they would not attempt to reduce competition through their acquisition. Did Scotia lie?... I am sure everyone is very surprised : )

In the United States, Capital One is renaming ING Direct "Capital One 360," and eliminating the firm's iconic orange branding. The new colour for ING? Dark blue and maroon. Capital One, however, promises ING clients no change in services, which sounds familiar to what Scotia said in Canada. 

Undoubtedly, both Capital One and Scotiabank will start enacting "cost saving measures" to increase "efficiency" at their new banking units, and this will mean job losses for many of ING's North American employees. This will be good news for Scotiabank and Capital One shareholders, but undoubtedly bad news for those employees, their families, and probably ING Direct's North American customers as well.

Less competition is good for corporate profits, but bad for banking customers. Continued consolidation in the banking sector leads to reduced options and higher prices. This means higher interest rates on loans, lower interest rates on savings, and higher banking fees. For investors in Scotia and Capital One, it means higher profits.

Cheers, and Happy Investing! 

Canadian House Prices. Sales Down, but Prices Hold Firm. Toronto and Vancouver Real Estate Weigh Heavily.

The average resale housing price has risen to $352,800, up 1.6 percent over last December. That is the good news. Overall, sales of existing homes in Canada declined by 17 percent from the level last year.

In addition, the supply of new homes onto the market has been steadily declining for three months. This reduced level of supply has helped to ensure that prices have remained relatively steady, as has a reluctance from home-owners to accept prices lower than they have become accustomed to in hot markets.

According to the CREA's chief economist, Gregory Klump, sellers are simply taking their homes off the market and holding firm if the prices they desire are not materializing. This has made for a slower market, but at the same time, there is a strong semblance of stability. 

The national average is being particularly weighed down by Toronto and Vancouver, which if removed from the sales data, results in a 3.3 percent price increase. 

Bad news for home owners and real estate investors? Not necessarily. Stability and consolidation in the marketplace is a good thing. A long slow period of price consolidation can help to familiarize buyers and sellers with more realistic and current price levels, and help mitigate a price collapse in the future. Also, as indicated above, Toronto and Vancouver are seriously weighing down data, so for those buying in many smaller urban centres across the country, the current situation is actually better. 

Cheers, and Happy Investing. 

A Business Plan for Entrepreneurs, Investors, and Business Owners. Stay on Target.

A recently published CX Blog article highlighted some strategic questions that have to be asked when preparing your sales plan. Though written primarily for the eyes of entrepreneurs, the information and message is very useful for independent business owners and shareholders alike. 

If you had to reflect on the sales plan for any of your investments, do they make sense? Are they clear? Or are they convoluted and lacking focus and attention? 

Below I have highlighted 7 strategic business questions for you to consider as owners, entrepreneurs, and investors: 

1. Why should people want what you're selling?

What does the product or service help people do? What need does it satisfy? 

2. Who are you selling to?

Are there target markets for the product or service that you want to sell? Do they have specific demographic characteristics? Are you focusing on a specific region really well? Or are your efforts scatter-shot all across the map?

3. Who is your competition?

Who are the top competitors in this industry? How are you different? What do you do better? What can you learn from your competitors, and what are they not doing well? Is there a hole in the market that they are not satisfying?

4. What is your price point?

You need to consider what the current price range is for the product or service that is being offered? Where do you fit into the mix? Is there something you are offering, or that you can offer that can put you into a higher price point? Or do you want to be at the bottom? If you want to be at the bottom, make sure your costs are less than those of your competitor. 

5. How many customers do you need to reach your profit goals?

Or, how much volume do you need to do? Have you established your break-even point, above which you start to make a profit, and below which you are operating at a loss. Not knowing key information such as this leads to a lot of business failure early on. 

6. How will you reach your market?

How will you gain new customers? Will you utilize referrals, advertising, sales promotions, et cetera? Try to track what works and what does not. For instance, have you had any success with old media like newspaper ads, or do you need to shift your focus on-line? 

7. Is there a clear sales pitch?

Often referred to as the 30 second elevator speech, a business needs to have a directive clear and transparent enough to be explained in 30 seconds or less. You need to be able to state what need you are satisfying in the market, and either differentiate yourself from the crowd or place yourself in a target niche. Will anyone remember or be able to explain to someone else what exactly it is you or the business does?  

Try to read the above noted points a few times, and think about them in relation to your own business interests, or even perhaps your own personal brand. 

Cheers, and Happy Investing. 

Matthew.