When looking at earnings quality, we at The Motley Fool have two databases -- EQ Scan and EQ Score -- that help us to uncover cash flow and revenue-recognition issues. Smart financial officers can use several techniques to manipulate financial results, and manipulation of any of the three financial statements usually affects the other two. But a critical eye on these statements can often uncover trends that can help protect investors against losing their hard-earned money.
The EQ Score database assigns an index rank to the company from 1, for the lowest quality, to 5, for the highest. As the company's financial status changes over time, the database adjusts its rank and illuminates trends that will affect earnings quality going forward.
Let's look today at priceline.com (Nasdaq: PCLN). The online travel company known for longtime spokesman William Shatner beams in with a lowly EQ Score of 1 and a downward earnings trend since the start of the year. The stock has been traveling at warp speed lately, with a 50.74% gain last quarter alone, and currently hovers around $745. Does this stock deserve its lofty trailing and forward P/Es of 36.16, and 19.43 respectively, or is this ship headed into a black hole?
Priceline has grown earnings at a 65% average over the past five years, and earnings expectations for the current fiscal year are $31.22 per share and $38.31 next year. Analysts claim that Priceline's European market potential deserves a premium multiple versus other Internet companies. However, analysts also anticipate that Priceline's growth rate for the next five years will average only 23%. Astute fools should recognize that when the earnings growth rate slows, the stock price may also abate. And with recent warnings that Europe's and Asia's economies are slowing, remember that leisure activities are a discretionary purchase.
The company employs around 4,000 agents who work with approximately 185,000 hotels and 4,000 rental-car locations in 160 countries -- and that means no inventory, which in turn means that Priceline's business model produces high margins.
Revenue and gross margin have been on an upward flight path.
PCLN Revenues data by YCharts
Revenue has nearly doubled in the past two years to $990.77 million, and those annual third-quarter spikes are due to increased sales during the summer months.
Now let's look at the year-over-year rates of change -- whether growth or decline -- since 2007 for several metrics. We're looking for trends that may help us determine how the stock could perform going forward.
|
Metric |
2007-2008 % Change |
2008-2009 % Change |
2009-2010 % Change |
2010-2011 % Change |
Average % Change |
|---|---|---|---|---|---|
| Revenue | 31.99% | 24.06% | 31.93% | 41.19% | 32.29% |
| Cost of Goods Sold | 17.78% | 15.99% | 9.14% | 8.49% | 12.85% |
| Gross Profit | 49.52% | 31.88% | 51.14% | 61.34% | 48.47% |
| SG&A | 52.45% | 19.77% | 43.86% | 51.40% | 41.87% |
| Net Income | 29.77% | 168.66% | 7.76% | 100.27% | 76.62% |
| EPS | 25.80% | 148.93% | (4.70%) | 93.39% | 65.86% |
Priceline ended 2011 with FCF of $200 million and year-end cash on hand of $273.9 million. Days sales outstanding has grown from 20 to 24 days over the past two years, and days payable outstanding, a measure of how long it takes to pay bills, more than doubled from 24 days in 2009 to 50 days in 2011. This is an artificial boost to cash flow and a warning of lower cash flows ahead.
Total current liabilities equaled $1.1 billion -- including $497 million in long-term debt -- at year end, a significant jump from last year. Another factor affecting cash flow as well as reported revenue is accounts receivable, which jumped from $183 million a year earlier to $288.3 million in 2011.
Among its competitors, Expedia (Nasdaq: EXPE) has higher gross margins but much lower operating margins, because it has almost twice as many employees as Priceline does. Orbitz Worldwide (NYSE: OWW) has an even higher GM than Expedia or Priceline, at 81.8%, but it operates even more inefficiently than the other two companies. Orbitz reported negative quarterly year-over-year revenue growth, as well as negative net income and EPS despite the high gross margin.
Priceline shows strong income-statement metrics and trends, and the ability to profit by selling "still available" leisure and travel deals at bargain-basement rates. FCF and year-end cash on hand are adequate, but they may be weaker in the future because of extended payables. Thus, the stock price has outstripped future potential cash flows and already bakes in stellar revenues, leaving no margin of safety. In short, this stock price has ventured too far into outer space in too short a time. Before you ask to be beamed aboard the U.S.S. Priceline, set your phaser to "stun."
