Creditors Forcing Titan To Switch Gears
report by Michael Markowski, www.OnlinefinancialSector.com
When Titan Machinery released its fiscal 2014 year end
results on April 10, 2014, it forecasted or provided guidance for its operating
cash flow. Titan stated that it was
going to generate $60 million to $80 million in positive non GAAP operating
cash flow for its current fiscal year ending January 31, 2015. It further stated that the method that it
would utilize for the Company to generate positive operating cash flow in a fiscal
year for the first time in at least six years was its liquidation or its
reduction of its equipment inventories by $250 million. Under Titan’s inventories reduction guidance total
inventories would decline from $1.08 billion as of January 31, 2014 to $758
million by January 31, 2015.
We are highly confident that the decision by Titan’s
management to reduce its inventories to $758 million will result in a decline
in the Company’s revenue and profits for fiscal 2016 as compared to fiscal
2015. Fiscal 2016, would be the second
consecutive year that Titan’s revenues decline.
Titan, based on its own guidance that it has already given, will depart
fiscal 2015 by reporting its first annual revenue decline since it’s been a
public company.
Those who are invested in Titan’s shares are having a great time
at the grand party that started as soon as its management concluded their
conference call. During the call, which
included a 23 page presentation, Titan’s management provided details and
highlights for its fiscal 2014 earnings report.
It also provided guidance for fiscal 2015.
Every great party always ends with a hangover. As Titan moves through fiscal 2015, the
analysts making of and publishing their projections for its next fiscal year
(2016) beginning on February 1, 2015, will become increasingly paramount. As the analysts and Titan’s institutional
investors begin to do their homework we have no doubt that they will come to
the same conclusion that we have come to.
Doubts as to whether or not Titan can continue to be a growth company or
even meet its EPS projections for 2015 will begin to surface. During 2013, Titan’s management lowered it
EPS guidance for its 2014 fiscal year three consecutive times. .
Titan Machinery’s
EPS Guidance
for Fiscal Year (FY)
January 31, 2014
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There was one highlight at the bottom of page 19 of the
presentation which Titan’s management provided to analysts and investors on
April 10, 2014 that raised our eyebrows.
It was that the company had “$410.7 Million Available on $1.2 Billion Floorplan lines of Credit”. On November 14, 2013, Titan’s Credit
Agreement with Wells Fargo had been amended.
Under the amended terms and conditions Titan’s Net Leverage Ratio (Total
Liabilities/Tangible Equity) was permitted to be a maximum of 3.5 for any
fiscal period on or after January 31, 2014.
According to the Balance Sheet data which Titan published in
its April 10th press release its Total Liabilities were $1.15
billion on January 31, 2014. Titan’s
permitted Total Liabilities under the Credit Agreement that was amended on
November 14, 2013 was $1.31 billion. The
maximum net amount that Titan could have increased its Total Liabilities by as
of January 31st was $160 million and not the $410.7 million that the
company claimed was available via its unused portion of its Floorplan lines of
Credit. The difference between the two
amounts is $250.7 million.
On April 3, 2014, which was one week before Titan announced
its earnings, the company’s Credit
Agreement with Wells Fargo was again amended. Under the new terms the Company’s
Consolidated Net Leverage Ratio was decreased from 3.5 to 3.25 by October 31,
2014 and to 3.0 by January 31, 2015. The
Total Liabilities permitted under the amended terms was $1.22 billion for fiscal
quarters ending July and October 31st and $1.12 billion on January
31st. This assumes no change
in Titan’s tangible book value. In its guidance Titan indicated that the
company would take a $4.2 million
pre-tax charge associated with the company’s realignment that it expects to be
realized in the first quarter of fiscal 2015.
This charge could lower Titan’s tangible book value and reduce it
permitted Total Liabilities.
Based on the recently amended Wells Fargo Credit Agreement,
Titan’s Total Liabilities for its fiscal quarters ending on July 31, 2014 and
October 31, 2014, can only increase by $70 million as compared to what its
Total Liabilities were on January 31, 2014.
By January 31, 2015, Titan’s Total Liabilities will have to decline by
$30 million as compared to January 31, 2014 for the company to remain under its
ratio of 3.0. The unused portion ($410.7
million) of its Floorplan line of credit will be un-utilizable.
Obviously, the decision that management made to reduce its
inventories for the purpose of Titan to begin to generate positive operating
cash flow was based on necessity.
However, Titan’s management overreacted in their including a $250
million reduction of inventories by January 31, 2015, in their guidance for
Fiscal 2015. Titan’s management did not
do their homework. They have not
seriously considered the ramifications or repercussions from their reducing
inventories by 25%.
There are two issues that Titan’s management should have
considered before they calculated the amount of that they were reducing their
inventories by for their fiscal 2015 guidance.
If these issues had been considered we believe that they would have made
the decision to reduce Titan Machinery’s Inventories by an amount that was much
less than $250 million.
The first issue that they did not address is that there is a
strong historical correlation between Titan’s revenue and its Inventories
growth rates. The table below illustrates and compares the growth rates of
Titan’s inventories and revenue for its fiscal years 2010 through 2014. The decline in the growth rate of its
inventories for 2014 to 8.5% from 24.2% resulted in a sharp decline in its
revenue growth rate to 1.3% from 32.5%.
Growth
Rates for Titan Machinery’s Inventory
and
Revenue for Fiscal Years 2010 through 2014
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The second issue that Titan’s management failed to consider
is the company’s historical Revenue/Inventories ratio. The
table below further illustrates the relationship or ratio between Titan’s revenue
and its inventories. The ratio or
multiple of Revenue that Titan has generated has ranged between 2.06 and 2.53
times its inventories since 2010.
Titan
Machinery’s Revenue/Inventories
Ratios,
Fiscal Years 2010 through 2014
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Titan has forecasted
that it will reduce its inventories from $1.08 billion to $758 million by
January 31, 2015. It’s the one and only
forecast in Titan’s guidance that will be easy for them to achieve.
Since Titan’s $250
million reduction in its Inventories is all but guaranteed it’s much easier for
even a novice to project future revenue for the company. Projecting the minimum and maximum ranges of future
annual revenue for Titan is as simple as multiplying the projected amount of
inventories by the company’s lowest and highest revenue/inventories ratios over
its prior five years. With the
reduction in Titan’s inventories we are projecting its revenue range for fiscal
2016 to be $1.56 billion at the low end and $1.91 billion at the high end. Our top end number for 2016 is below Titan’s
low end revenue number of $1.95 billion for fiscal 2015.
Titan’s management in providing guidance on its operating
cash flows and reduction in inventories has painted itself into a corner. Its due to them not considering the downside
regarding the reduction of inventories by 25% in fiscal 2015 as compared to
fiscal 2014. Its extremely difficult for
any company to make the argument that they can continue to increase revenue
while significantly decreasing inventories.
We have no doubt that savvy investors and analysts will confront Titan’s
management with the same mathematical argument that we are making. Titan’s severe inventory reductions will
result in its generating significantly lower revenue and EPS for both its 2015
and 2016 fiscal years.
As soon as the stock market starts to price in or discount
the increasing probability that Titan Machinery will have lower revenue in fiscal
2016 as compared to fiscal 2015, its share price will begin to head lower and
go to a single digit price to earnings (PE) multiple or ratio. Either actual or projected consecutive annual
revenue declines will relegate Titan Machinery to being a cyclical tractor
dealership play. Based on Titan’s minimum
non GAAP earning per share projection of $.70 and maximum of $1.00, and its
history of guiding forecasts down during prior fiscal years we are projecting
that its share price will be trading below $10 by the end of 2014.
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