The thing that really jumps out from the company's press release is that management predicts only 4%-6% revenue growth for 2004, but 11%-20% earnings growth. When a company is capable of growing earnings at several times the rate it grows revenues, yet trades at a discount to the S&P's trailing P/E ratio (21 vs. 28, to be exact), you begin to suspect that you might have found one of those "underrated companies at cheap valuations" that are the hallmark of Tom Gardner's Motley Fool Hidden Gems.
Another clue to a company's underrated status can be its generation of free cash flow in considerable excess of its reported earnings. American Standard meets this test as well, with free cash flow rushing in at 113% the rate of earnings in 2002.
But company executives should perhaps not be flushed with pride just yet.
When a firm generates that much free cash flow, but has a mid-single-digit rate of revenue growth, you generally look for it to be paying out a tidy dividend. Either the money is not being used effectively to grow the business or the business is so sufficiently mature that it simply cannot grow at double-digit rates. Therefore, management should be returning cash to the shareholders in the form of a dividend -- yet American Standard pays no dividend at all.
To find out why, look to the balance sheet. There, the reason for the lack of a dividend becomes clear -- the company supports a hefty debt load. With a debt-to-equity ratio of 3.6, and interest rates at historic lows that have nowhere to go but up, American Standard probably sees paying down its debt as a more important priority than paying out dividends. Also, the company is subject to covenants from its creditors that limit its ability to pay out dividends while there's still debt on the books.
That's how things stand for now, at least. But if the debt situation gets unclogged -- and the company is progressing towards that goal, too -- American Standard could well use its free cash flow to earn a place in Mathew Emmert's Motley Fool Income Investor.
Rich Smith owns no shares in American Standard.