Catching the falling knife – Eros International
Recently Eros media international has been in news although not for good reasons 🙂 Eros which is also listed in NYSE was downgraded by Wells Fargo ,a leading banking and financial services company.
See in this succinct note from the newspaper cut
Wells Fargo analyst Eric Katz had said the downgrade was driven by a continued increase in receivables in the United Arab Emirates business, concerns on whether Eros would turn free-cash-flow positive, and worries about Eros Now.
The management countered such claims
We would like to reassure our shareholders that there has been no material change to the previously announced strong fundamentals of the company.
The first quarter results have been strong and nothing has materially changed since then, the company said.
We will be announcing what we expect to be a strong second quarter in the first half of November,it added.
We reaffirm our commitment to enhance shareholder value.
We believe that the merit in our business and our fundamentals are there for everyone to see as we remain focused on achieving our business goals and objectives
also most of other brokerage houses that cover company continue to maintain their buy rating
My only exposure to Eros has been as a paying audience to some of their blockbusters latest being Salman Khan starter Bajrangi Bhaijaan , so the instant thought was is it a good company going through temporary crisis ?
Is Mr Market over reacting?
Before number crunching I had a brief look at company on edelweiss website, the numbers were decent
So the above convinced me to do some number crunching. My first focus typically is Earnings Quality Analysis followed by Capital allocation test and then RoE analysis and financial statement analysis. For few companies as I progress through first couple of items my interest increases for others it wanes down as I find red flags.
Earnings quality assessment is standardised so I always begin with it. Here is snapshot of Eros International’s financial information captured in Earnings quality template
From 2012 onwards they changed their reporting format in AR, so 2015-2013 are the numbers I am going to rely to deduce anything.
As I was compiling this information, few things started becoming very clear….
Enterprsing profit and Defensive profit were not matching up to reported profit numbers, In fact for last three years they had almost no enterprising and defensive profits, which means firm was not funding growth through internal generated funds also that growth was not adding any value to existing shareholders. All this while the reported EPS had impressive growth (60%).
Fixed asset Investment to Depreciation ratio was abnormally high, (Note – Even firms which are growing aggressively will have a ratio of 10 to 12)
Clearly, I was not happy with quality of earnings, in fact they can be termed poor
Next I turned my focus on sources of RoE by using our automated valuation tool
The RoE break down was satisfactory although I had to investigate why Asset turnover was going down ? typically in Movie business once you buy content you should be able to milk it multiple times with almost negligible marginal cost by distributing the content digitally.
In past sticking to firms which have had superior earnings quality has served me well. So I will give opportunity a pass (i.e. no further digging)
Disclosure – No position in Eros. This post is not recommendation to buy or sell.
Last minute note
While publishing this post I got to read today a stinging report by a short seller, obviously his objective is to create panic and make bountiful on his shorts but some of claims sound genuine.