Is a Revenue Miss Coming for Tesco?

There's no foolproof way to know the future for Tesco (Nasdaq: TESO  ) or any other company. However, certain clues may help you see potential stumbles before they happen -- and before your stock craters as a result.

A cloudy crystal ball
In this series, we use accounts receivable and days sales outstanding to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- the number of days' worth of sales owed to the company -- don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.

Sometimes, problems with AR or DSO simply indicate a change in the business (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can also suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Alternately, it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)

Why might an upstanding firm like Tesco do this? For the same reason any other company might: to make the numbers. Investors don't like revenue shortfalls, and employees don't like reporting them to their superiors.

Is Tesco sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:

Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. FQ = fiscal quarter.

The standard way to calculate DSO uses average accounts receivable. I prefer to look at end-of-quarter receivables, but I've plotted both above.

Watching the trends
When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars indicates a trend worth worrying about. Tesco's latest average DSO stands at 82.7 days, and the end-of-quarter figure is 77.0 days. Differences in business models can generate variations in DSO, and business needs can require occasional fluctuations, but all things being equal, I like to see this figure stay steady. So, let's get back to our original question: Based on DSO and sales, does Tesco look like it might miss its numbers in the next quarter or two?

The numbers don't paint a clear picture. For the last fully reported fiscal quarter, Tesco's year-over-year revenue grew 16.5%, and its AR grew 21.6%. That looks OK. End-of-quarter DSO increased 4.4% over the prior-year quarter. It was down 3.0% versus the prior quarter. Still, I'm no fortuneteller, and these are just numbers. Investors putting their money on the line always need to dig into the filings for the root causes and draw their own conclusions.

What now?
I use this kind of analysis to figure out which investments I need to watch more closely as I hunt the market's best returns. However, some investors actively seek out companies on the wrong side of AR trends in order to sell them short, profiting when they eventually fall. Which way would you play this one? Let us know in the comments below, or keep up with the stocks mentioned in this article by tracking them in our free watchlist service, My Watchlist.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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  • Report this Comment On September 27, 2012, at 2:32 PM, Grunchy wrote:

    I actually work at Tesco at the manufacturing facility, we just had a town hall meeting and this phenomenon was noted by the management. I can confirm that at the end of every quarter - for several quarters in a row now - the manufacturing facility goes into overdrive to "make the numbers". The problem isn't with sales however, it has to do with execution at the plant. If the plant were able to make more units, it would immediately turn into revenue, because the place is production-constrained. However we are also in the midst of a major shift towards Lean production techniques, which so far have gone a long way to cleaning up the facility (both physically organize it, and sort out the business processes) and identify bottlenecks in production - and deal with them by process improvements. We got ISO-9000 a few years ago, but that was not much more than documenting business processes we intended to follow - but those got out of date since then. Lean is mostly about doing the follow-up and applying continuous improvement to the processes. Right now that's a major PITA because it takes your attention away from executing, but as the months go past and we achieve process improvements, standard work is becoming easier and we have more time to dedicate to process improvement. I don't have any private financial information to share, but I can share that the current problem at Tesco is shortfall in production and every month that goes by that problem is evaporating. In fact this quarter was pretty much the first quarter end where we didn't have departments verbally battling each other. So I see good things coming in the year and years ahead.

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