Whenever you research a company, ask yourself, "How is value created, and where does it go?" We'll revisit that question after we see what happened with Timken
Timken reported its fourth-quarter and 2004 results yesterday. Sales grew 16% and 19% respectively. On a GAAP basis, diluted earnings per share grew 184% and 239% respectively. And management showed some confidence by increasing the dividend 15% to $0.15 per share for the quarter. With those kinds of results, it's no wonder the stock gained almost 5% to close at $27 a pop. I should warn you Fools that the story is going to go downhill from here.
A unique position can create value, though it's hard to believe Timken is in such a great position. Since 2001, Timken has received $190 million in payments from the Continued Dumping and Subsidy Offset Act (CDSOA). To me, this means that the industry is hypercompetitive and certain international companies are willing to compete with unrealistically low prices. Despite the fact that Timken makes great products (I know this because I have designed with them), relying on subsidies for value is inherently unstable.
To see where the value is going, track the cash flows. For FY2004, $153 million went to capital expenditures. Timken is a manufacturer, and factories and machines cost money. $114 million went to accounts receivable. $130 million went to inventory, and accounts payable shrank by $25 million. That's an additional $269 million of working capital required to keep the doors open. In other words, much of the cash generated has to go back into the business instead of to shareholders.
I was glad to see that Timken broke out its results by business segment in the press release. That way, we can see who is doing what. The Automotive Group had a fairly tough year, with operating income showing only a smidgeon of growth. But then again, I would not want to be a supplier to General Motors
The Steel Group posted a 37% yearly revenue gain and emphatically positive EBIT (last year had negative operating profit) -- fantastic results for a business line that's had its ups and downs. While I'm all for the group's positive results, I'd favor a wait-and-see approach for just a bit longer here.
Another bright spot was the Industrial Group. The group, a consistent performer for the company, can turn a profit because it makes specialty bearings and components for companies such as GE
Again, always try to figure out where the value is going before you invest. As a shareholder, you want to coming to you. And since so much cash has to go back into the business or out to customer, that leaves considerably less for shareholders.