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CAT's Balance, Part 2
Landing on its feet
by Chris Rugaber (TMF RFK@aol.com)
Alexandria, VA (April 29, 1999) -- Our Foolish Four companies continue to zip along. On Wednesday, a Legg Mason analyst even predicted that Caterpillar's (NYSE: CAT) stock might reach $80 within 12 months! Of course, you shouldn't put much faith in that, but at least it ought to persuade you to stay the course. No need to sell your Foolish Four stocks to "lock in" any gains as has been debated on our message board recently.
I hope to write about that soon, but for now, let's pick up where we left off last week and continue looking at Caterpillar's accounts receivable (A/R), inventories, and accounts payable.
We've already calculated Days Sales Outstanding (DSO), which is a quick way to see how long it takes a company to collect payment on sales it has made. We can use the same methods to calculate Days in Inventory (DI) and Days Payables Outstanding (DPO). By combining them with DSO, we can calculate what is usually referred to as the "Cash Conversion Cycle," an overall measure of a company's efficiency. These numbers are interesting enough on their own but can be especially useful when compared to a company's competitors or its own previous performance.
First let's look at Caterpillar's and its competitors' fiscal 1998 numbers. As noted last week, Caterpillar's main competitors include Deere & Co. (NYSE: DE), the leading North American manufacturer of agricultural equipment, and Case Corporation (NYSE: CSE), #2 in the agricultural market and the leading producer of light and medium-size construction equipment.
(in millions) Caterpillar Deere & Co. Case Sales 19,972 13,821 5,738 Cost of Goods Sold (CoGS) 15,031 9,233 4,700 Operating Expenses 17,884 10,808 5,523 A/R 2,604 4,059 1,594 Inventory 2,842 1,287 1,430 Accts Payable 3,558 2,098 625
These figures exclude the financing divisions of each company and are from their fiscal 1998 10-K filings.
To quickly review, Days Sales Outstanding is computed by taking accounts receivable from the balance sheet and dividing it into sales, which produces the A/R turnover ratio, which is then divided into 365 in order to determine the number of days per year it takes for the company to collect on its outstanding invoices (see last week's article for a more complete explanation).
Days in Inventory is calculated in a similar fashion, with Cost of Goods Sold (CoGS) divided by inventory and the result divided into 365. For Caterpillar, we divide its $15.031 billion of CoGs by $2.842 billion in inventory and get an inventory turnover rate of 5.29. This indicates that as of the end of 1998, Caterpillar was selling all its inventory 5.29 times a year.
Next, we divide the annual inventory turnover figure of 5.29 into 365, giving us 69.01. In other words, it takes Caterpillar slightly more than 69 days to sell all its inventory. The lower the DI the better, but until we compare this number with Caterpillar's competitors and its previous years' performances, we won't be able to draw firm conclusions.
In 1997, Caterpillar's DI was 71.04, so there was a slight improvement in 1998. Compared to its competitors, Caterpillar is doing alright. Deere sells all its inventory, on average, in 50.1 days, much better than Caterpillar, but Case takes over 111 days, far worse than Caterpillar.
Let's make the same calculations with Days Payables Outstanding (DPO). The connection this time is between operating expenses on the income statement and accounts payable on the balance sheet. Operating expenses are usually set out as a separate line item and include CoGS as well as utilities, labor, rent or other payments for buildings, and so forth. Bills for all these items that have not yet been paid are included in accounts payable.
As explained in the Rule Maker portfolio, among other places, the longer a company can delay the payment of its bills, the better, since this gives it more cash to work with. Rather than making the company look like a deadbeat, which is how you or I would if we put off paying our bills, this is considered a sign of financial strength -- as long as the company actually has the cash, of course. (If the company couldn't pay their bills, as opposed to simply choosing to delay payment, this would be a very different story.) Therefore a higher DPO is generally a good thing, despite the fact that accounts payable is technically a liability and found on the liability side of the balance sheet.
Returning to Caterpillar, we divide operating expenses of $17.884 billion by accounts payable of $3.558 billion, which gives you accounts payable turnover of 5.03. Dividing that into 365, we see that Caterpillar on average doesn't pay its bills until 72.62 days after receiving them. Again, since we want this number to be higher, that's good, but let's do our comparisons: in 1997, the figure was 77.41, so Caterpillar has slipped a bit on this. Nevertheless, they're ahead of both Deere, at 70.85 DPO, and Case, at only 41.3.
Finally, let's use these figures to calculate the cash conversion cycle, which gives an investor a quick look at the efficiency with which a company turns its capital into cash profit. The cash conversion cycle is calculated by adding the DI and the DSO and then subtracting the DPO. (Eenough acronyms for you?)
For Caterpillar, then, we add the DSO of 47.59 and the DI of 69.01 and subtract the DPO of 72.62, which gives us a cash conversion cycle of 43.99, a significant improvement over the 1997 number of 61.07. In addition, Deere's cycle at the end of 1998 was 104.25, while Case's was 171.14. Clearly, Caterpillar is ahead of its competitors.
That's certainly a good thing, but it's by no means the last word. Next week, barring any major news flash, we'll look at the bigger picture. For example, how do these numbers look in different business models? In addition, as we look at future quarterly earnings, we can use these metrics to see how our companies are doing.
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Stock Change Last -------------------- CAT + 15/16 65.50 JPM +2 3/16 138.00 MMM +1 1/8 85.63 IP -1 1/8 56.25
Day Month Year History FOOL-4 +0.63% 27.14% 30.76% 32.70% DJIA +0.30% 11.16% 18.87% 18.40% S&P 500 -0.60% 4.39% 9.56% 9.82% NASDAQ -0.86% 2.71% 15.31% 16.89% Rec'd # Security In At Now Change 12/24/98 24 Caterpillar 43.08 65.50 52.04% 12/24/98 9 JP Morgan 105.51 138.00 30.79% 12/24/98 22 Int'l Paper 43.55 56.25 29.16% 12/24/98 14 3M 73.57 85.63 16.39% Rec'd # Security In At Value Change 12/24/98 24 Caterpillar 1034.00 1572.00 $538.00 12/24/98 9 JP Morgan 949.62 1242.00 $292.38 12/24/98 22 Int'l Paper 958.12 1237.50 $279.38 12/24/98 14 3M 1030.00 1198.75 $168.75 Dividends Received $29.45 Cash $28.26 TOTAL $5307.96
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