On Friday, Russia's Sistema (OTC BB: JSFCY), the self-described "largest private sector consumer services company in Russia and the [Commonwealth of Independent States]" reported a 33% year-over-year increase in net profits for the first six months of 2005.
Because the company has been public for less than a year, IPOing on the Moscow Stock Exchange and issuing Global Depositary Receipts in February 2005, this was Sistema's first earnings report as a public company. It seems that buyers on the London Stock Exchange liked what they saw, bidding up Sistema's share price by 13% in response to the earnings news yesterday. This Fool, however, isn't so sure that the news justified that increase. True, a 33% profits increase in a "consumer services company" is remarkable. But it's also worth pointing out that the company increased its revenues by 38%. Thus, profits didn't outpace, and didn't even track, growth in revenues.
On the contrary, as Sistema diversified away from its core and primary telecoms business -- represented by flagship subsidiary Mobile TeleSystems (NYSE:MBT) -- it added larger amounts of fast-growing, but low-margin, tech business. Being less profitable, the new tech sales knocked Sistema's operating margin down from 32% to 28%. On the brighter side, its net margin slid just 20 basis points, from 7.0% last year to 6.8% this year. Of the company's 38% sales growth, Sistema attributed 28% to organic growth, with the balance coming from the lower-margin acquisitions.
Those acquisitions came at considerable cost -- and not just in the form of eroded margins. Although Sistema characterized the changes in its debt load as being made to "optimize its debt portfolio," there seems to have been a problem in the translation of the word "optimum" from its original Russian. Long-term debt increased by 74% over the past year, cresting the $3 billion mark. And while short-term debt declined by 29% over the same time period, the total ratio of debt to equity increased from 1.11 to 1.25. Is that an "optimum" level of debt? I'm not sure. The one thing I am sure of is that it's "more."
After reviewing the company's results, analysts at ING (NYSE:ING) pronounced the rise in Sistema's stock price "justified." But the bank then immediately cut its rating for Sistema from "buy" to "hold," suggesting that the good people at ING are also experiencing mixed feelings over Sistema's valuation.
For further Foolish coverage of Sistema, read:
Fool contributor Rich Smith does not own shares in any company mentioned above.
