Hello, I'm Professor Brian Welcome back. This is our second video in Financial Statement Analysis of Vulcan Materials Company in 2010. In this video, we're going to look at the company's growth or lack thereof in recent years. And we'll start to look at the performance of the company in 2010 starting with the earnings based numbers. Let's get started. Okay, let's move on to the next stop on our road map, which is, is the company growing? So why does growth matter for Vulcan? Well, they're trying to maintain and increase their market share in a very competitive market. And so, growth, we're going to look at revenue growth, which will give us an indication of their market share. Scale economies are a big deal, so Vulcan has these high fixed costs, and they need growth to cover these costs, growth in volume. And of course investors' growth expectations have a big influence on stock prices. >> Doesn't Vulcan also have to grow so that it can fight it can fight the Klingons again? But seriously, aren't these reasons that every company would need to grow? >> [LAUGH] Fight the Klingons, note that he made the Star Trek joke, not me, I'm still keeping my promise. Anyway, yes these are general motivations that any company would want to grow. The key one I think for Vulcan is the second one, which is, they need growth to cover all of these fixed costs. And as we get into the numbers later, you'll see that their decline in revenue is just killing them in terms of their cost structure and not being able to cover their costs with enough revenue When we talk about a company's overall growth, we're usually talking about revenue growth. But we're also going to measure growth in a bunch of other line items. And the formula for each is going to be the growth rate as the current year amount minus the prior year amount divided by the prior year. And it's important to try to identify the sources of the company's growth. So we're going to look at some segment analysis, so which segments are growing more than others. We're going to look at unit growth versus sales price growth. So is it volume increasing, sales price increasing? Both? Neither? And then ideally you'd look at organic growth versus growth by acquisitions, but it's going to be hard to tease that out because Vulcan does not provide that separate disclosure. So here are the growth rates in selective items from 1999 all the way through 2010. >> How did you get the numbers from 1999? The version of the Vulcan report that I studied last night only goes back to the year 2000. >> Good question, let me bring up the report. So this is from supplemental page four near the back of the Vulcan 10K. And as you can see, it only goes back to 2000. But if you grab last year's Vulcan 10K, then it'll go back to 1999. And it you grab an earlier one, you can get these dates going back even further. I think I have it in my spreadsheet going all the way back to star date 1992, but I didn't put those up here because I thought it would be overkill. So, I've taken all of the numbers from the Vulcan exhibit and then I have computed growth rates, here are your growth rates for each of the line items. So net sales, gross profit, net income, total assets, total liabilities, total share homes equity. And the, the results are really influenced by a couple big trends. Vulcan made large acquisitions in 1999 and 2007. So we can see that here by a 56.3% growth in sales, 99 versus 98, which I, I calculated but didn't show here. So big increase in assets and liabilities over the prior year. And then for 2007, you can not see the sales impact, but here you can definitely see the total assets and total liabilities go up dramatically with the acquisition. So, so why don't we see the same sales boost for the acquisition? Well, the subprime crisis started in 2006, and what that did in the US is it brought to a halt residential housing starts, it hurt the non-residential housing construction and eventually highways and we went into a big recession. So if you look at their growth patterns and revenues over time. What you see is starting in 04 but then 05, 06, there were big increases in revenue. And a lot of that was driven by the boom fueled by the subprime market. So there were all these easily available loans, housing starts were way up, and then what happened is that crashed right here. So, in 2007 when Florida Rock gets added, we have the core business going down, which is sort of overcoming the increase in sales from Florida Rock. Now you can see in 2008, we really get the, the sales boost from Florida Rock, which probably means the acquisition happened later in the year. But then [LAUGH] the sales growth was down substantially as we hit the recession after the financial crisis. And look in 2009 even after making this huge acquisition, their revenues are less than they were four years earlier. So that's the historical trend in their revenue growth, and you can see right now they're in a bad place. Same thing with the gross profit number. They were making a lot of money, a lot of profits. During the housing boom, and then that's been down substantially in recent years. Well, I guess there was a 467% increase in earnings here, but that was from 3 million to 18 million, which is far below the numbers they were getting during the housing boom. So, cautionary here, don't just look at growth rates but, but actually also look at the [LAUGH] numbers and see if it's just a small denominator issue. So right now we see a company in 2010. Which has experienced two to three years of pretty big negative growth. Next, we're going to look at growth by segment, and also look at unit versus price growth. So here, we have the aggregate segment. So that's the, the gravel, stone, sand mixture. Revenue has been down each of the last three years. And as you can see, big drops in units although I guess the trend is better so the drop in units was less negative in 2010 price was maintaining up until 2010 where now price is down as well. So it looks pretty dismal where both volume has gone down and they've had to lower their prices. For concrete, we see the drops in revenue driven by drops in units and price. Asphalt, drops in revenue driven by both units and price. Cement, we actually had an increase in revenue in 2010. Fueled by a big increase in units. >> It is not all bad news. Unit growth in cement is up by 33%. >> Yeah, but the problem is. Given its size, the growth in the aggregate segment is the one that really matters. So again, don't look at the growth rates. But now look at the dollars revenue. You've got about 1.8 billion from aggregates. Cement brings in a lousy 80 million of revenue. So sort of like who cares if cement is up 33% [LAUGH] it's you know, giving us an extra five million of revenue. The big ticket item here is aggregate so again the lesson is don't just look at the growth rates but also you know, look back at the dollars to make sure that you're looking at growth rates that really matter. So we've got negative price and unit growth and that's going to be a big challenge for Vulcan to try to turn around. And by the way, I won't pull this up, but if you look at page 30 and, 30 to 32 of the report or supplemental page three, that's where I got the data for this chart. Okay, that wraps up our look at growth, now we're going to look at what was the company's performance during the year. And there's a number of measures that we're going to look at to assess current performance. So there's a lot of earnings based measures like operating income, net income, and then EBITDA. We can look at line items like revenue and margins of expenses as percents of revenue. And we're going to look for one time items versus persistent changes. The persistent changes and earnings are the ones that are going to affect performance in the future. We can look at cash flow, so we'll look at operating cash flow and free cash flow. And we'll do a quick DuPont ratio analysis to try to identify any source of advantages or problems. >> Horse feathers! That is too many things to look at. Just tell me the one measure to look at. I am an old man, I don't have time for all of these measures. >> Well, first of all you don't look that old to me. But it also makes sense to learn all these measures because who knows what could happen? You could get stuck in a transporter beam loop for 75 years and have nothing to do but think about different kinds of financial performance measures. So, as we've talked about throughout the course, there's no one measure that gives you the best picture of how a company is doing, we want to look at all of these different measures because they're telling us different things. The earnings numbers are telling us, is the company pricing its product high enough to cover all of its cost of doing business. Whereas the cashflow numbers are telling us is there enough cash coming in to meet our current obligations and then meet our future debt obligations. And then the ratios tell us how efficiently the company is running the business, how their profitability is training over time, and what's going on with their leverage. Okay, let's first take a look at some of these measures of earnings. So I've pulled in some results from pages 27 and 28 of the report. I'm not going to bring that up. You can go and look at that if you want to see exactly where these come from. But I've got the dollar amount and the percent change for each item. So operating earnings, remember these are the revenues minus expenses from your core business. It's a pretty sad sight. [LAUGH] We have a steady decrease in operating earnings. Triple figure drop in 2010, and so it's actually got to the point where is an operating loss. Which means that the revenue we're getting from our product line is not covering the cost of the stones and the SG&A. So, we're not able to get enough revenue just to cover the basic costs of running the business. Next item is earnings from continuing operations. This would be the operating earnings minus net interest expense, plus any gains or losses from non-core items. Same sad story. Huge loss in net earnings, and as we'll see, a big difference, the big difference between operating earnings and net earnings is all the interest expense that they're incurring because of this Florida rock acquisition in 2007. Then we have net earnings of course, which also includes discontinued operations. We'll look at the effect of discontinued operations later, but obviously it makes sense to pull those out looking forward because the continuing operations are the only things that are going to be there going forward. Then there's Diluted EPS which was net earnings, the adjusted preferred dividends divided by waited average shared outstanding, and then adjusted for all the potential dilution. We talked about that last week. 2009, you got a quarter as a shareholder. And now, the company's losing 75 cents for every share that you own in the company. And then finally, there's a non-GAAP number, which is EBITDA, which actually is, even though it's declining, it's still positive. >> EBITDA is still positive. That is good news, right? Right? Right? >> Okay. Let me bring up Vulcan's EBITDA disclosure which is on page 27 of their 10K. And so here we can see the definition is, its interest. And then they add back taxes, interest, discontinued operations. So it's like a continuing operations measure of EBITDA, and depreciation, depletion, accretion and amortization to get EBITDA. And then the year where they had the Goodwill write off they off, off, also added that back to get an adjusted EBITDA, or I guess it was EBITDAG at that. Anyway, so yeah, EBITDA is positive, looks good except, what's the biggest item that's added back here? Depreciation, depletion. What's the biggest expense? What's the biggest cost of digging stones out of the ground to sell to customers? All the heavy equipment that you use to dig the stones out of the ground. In addition, we have this thing called depletion, where Vulcan is actually depreciating the land, now normally land is not depreciated. But if you're digging stones out of the ground and ruining the land as a process in the process, then you actually can depreciate it, we call it depletion. So to summarize the big cost of the business in my mind is all the equipment and the land to get the stones, and the problem with the EBIDTA measure is you're taking out their biggest expense. And sure enough, once you take out the biggest cost of doing business, they're profitable. Woo hoo. Okay, now we're going to take a look at what's called a margin analysis to get a sense for individual line items on the income statement. And to do this, we have to do common-size income statements, which are going to divide everything by revenue. To help remove the growth in all the line items and allow us to do time cu, series comparisons to see if a certain line item is going to grow more or less than another. This is going to help reveal our cost structure so we can look at COGS SG&A other costs, and see whether they're growing more or less than the company as a whole. And this would also be the basis that would use, you would use if you're going to forecast financial statements into future periods. Basically you forecast the margins, you forecast the revenue growth and everything falls out from there. So here is a concise income statement, I've taken all of the income statements from 1999 to 2010. Divided everything by net sales, so that you can see at the top line, net sales is always 100%. First thing I want to look at is gross profit, gross margin, this is net sales minus cost of goods sold, divided by net sales. So it gives you a markup over cost. And you can see back in the heydays of the housing boom, almost a 30% gross mar, gross profit, so markup over cost, that has plummeted precipitously in recent years. And the same time, the SG&A percent to sales increased substantially. So we've got bad news in terms of a drop and gross profit, and bad news in increase of SG&A expenses. >> Wait, gross margin going down is bad, and SG&A expense percentage going up is also bad. Is every movement up or down considered bad at this point? >> Well, keep in mind that gross profit is a profit number and we want that to go up. The SG&A expense ratio is an expense ratio, which means if it goes up it's more expenses as a part of percent of sales. So when we look at the expense ratios going down would be better than going up. Yeah, so these are bad trends in gross profit SG&A, and there's a bad trend in interest expense which went from less than 1% of revenue to now 7.5% of revenue in 2010. [NOISE] Basically this is the high interest expense due to debt taken on for the acquisition. The revenue growth has slowed and gone negative, but the interest costs stay the same, and so it's gone up as a percent of revenue. So we also have a large effective gain on sale of PPE. Which is interesting because usually this is below operating income, but Vulcan actually considers it above and it's helping them quite a bit. I think what's happening is, they're selling some of their PP&E as the revenue is shrinking. They're getting accounting gains on it, which is helping their operating earnings. There's also a big good will impairment that you'd want to adjust for if you're comparing 2008 to the other years, because that was a one time effect. And then there were big charges for legal expenses that were like a one time effect in 2010 that you don't see in other years. But basically what this tells us is, it's bad news seemingly all the way around. The markup over cost has gone down. Vulcan has not been able to shrink its SG&A expenses as its revenue has dropped. They still have to maintain some fixed costs, and one big fixed cost that's not going anywhere is this interest expense. So now I want to talk about earnings persistence. Because ideally where you would go from here is use these margins to try to predict what's going to happen in 2011, 2012, 2013 and beyond. And so what you have to do is go line by line and try to think which margins or items are going to persist into the future. And which ones are going to be transitory, there is a one time effect, but they'll go away. So, a good place to get a lot of this information is the MD&A. So, I'm going to go back out to the report to show you the parts of the MB&, MD&A. I'm not going to read it to you in detail, but I just want to show you what's there. So in the MD&A on page 28 there's a section called results of operations where they're going to talk about what happened during the past couple years with all their operations. So one of the cool things they do is they provide details on the changes in nett come from operations. How much of it is attributable to volume changes, selling price changes, SG&A expense, property plant and equipment gains, and so forth. Then they go and talk about all the different segments, and give you details on shipments, selling price, some of which we saw already. They talk about more details like it's driven by Florida and California. You get the same thing with concrete, asphalt, cement increase in unit sales volumes for cement. Remember that 33% was due to an increase in inter-segment sales. uh-oh, so that good news 33% was just one segment selling cement to the other segment. Hm. Then you get discussions on SG&A. Or, as they call, SAG expenses. [LAUGH] Everyone's gotta be different. And so they give you some explanation, like they're trying to reduce overhead. And you should see lower SG&A going forth going forward from 2011, 2011 they talked about some of it is like replacement of legacy IT systems. There's detail on the goodwill impairment they took a couple years ago, which if not surprisingly is the Florida rock acquisition. Their gain on property, plant and equipment that we saw was due to sale of non-strategic assets in rural Virginia. It's a good thing they didn't sell the strategic assets in rural Virginia. Interest expense details. Income Taxes. Here's the information on their Discontinued Operations, which is mainly from this chemical business that they sold a while ago, but they still have some effects of it in their earnings even though they've gotten rid of it. And so this section gives you. The management discussion and analysis hence the name of everything that they think has driven their change in performance over the last couple years. So having done all that work reading through the MD&A now you have to provide your own judgment. So for COGS and SG&A, you want to think, were there anything, was there anything you read about that was an unusual item that is going to go away, and so the margin should change in the future. For example, with SG&A expenses, if they spent a lot of money replacing old IT systems in this year, which should then have benefits going forward. Then when we project out for 2011, 2012, we might expect that this comes down to something like 10%, or, you know, some kind of historical level before this recent extra cost. Same thing with gross profit. If a lot of this drop is weakness in Florida and California, but we expect the market in Florida and California for products to improve, then you might increase this back up to some kind of historical level going forward like, you know, say 17%. For gain on PPE, other expense, impairment. These are often considered transitory items that don't persist. So, you can't necessarily count on another two and half percent gain from PPE next year, probably your best estimate is maybe 0, although it does look like they have some repeated gains over time. This chart for legal expense, that seemed like a one time thing, so forecasting in the future, that's probably going to be zero. Same thing for goodwill impairment they had a big write off there, you're probably not going to see that again going forward. Interest expense, the question is, are there going to be any changes in the amount of borrowing or interest rates that might affect this going forward? So at this point it's a matter of applying your judgment and knowledge to take the margins that you see here. And try to project them forward, counting on any things that you think are going to change or persist over time. >> Great, so now how do we predict what will happen next year and in the future? >> Yeah, you're right, that's the hard part predicting the future. The easy part as it were is finding this information so that you have some notion of what items may have been unusual this year versus what items are going to possibly persist in the future. But then the hard part is to actually predict the future. So often times what people will do is they'll have a spreadsheet with formulas set up, they'll project things out say with the gross margin going back up to 17%. Then they will see what things would look like if it only went to 15% or 12%, or then 20%, or 25%. And basically see how comfortable they are or what would have to happen for them to be comfortable investing in the stock. But before you can do all that playing around with forecasts, as a first step and it's an important first step is to really have a good handle for what's happened this year and for which of the things that happen this year will persist in the future. Versus which of the things that happen this year will be one and done, you won't see them happen again into the future. 'Kay, we're still in the middle of talking about the company's performance, but I'm going to cut the video off here, and we'll pick it up again next time looking at cash flow and ratio measures for Vulcan. I'll see you then. >> See you next video.
