Is LU really that inefficient?
They sure are. In a previous post I pointed out that over the last 9 months LU was in a negative operating cash flow position, and only turned positive this quarter. That speaks to an inefficient operation, which, if turned around, will free up considerable capital. Mr. Fun, in properly criticizing my faulty analysis, pointed out that LU's operating cash flow was in the neighborhood of $170MM, which is considerably less than it's reported earnings. Ordinarily, this kind of disparity is a red flag.
However, I believe that LU is committed to improving its operations, and that will result in freeing up considerable capital that could be used for productive purposes. For the 9 month period LU had operating earnings of $4.54 BB (excluding one-time charges); in Sept 1998 it had non-current liabilities of 10.77 BB, debt maturing in one year of $2.23BB and equity of $7.71 BB.
If you define ROIC as the ratio of earnings to the sum of equity and non-current liabilities and debt maturing in one year you get 4.54/(10.77 + 7.71 + 2.23) = 21.9%, and annualizing that figure you get an ROIC of 30.25%. That's not too shabby a number, but suppose that through more efficient operations inventories and accounts receivable could be shaved by an aggregate of $2BB the ROIC could be increased to nearly 34%.
The aggregate amount of A/R, inventories and contracts in process totaled about 11.94 BB in September. The total was about $16 BB last quarter. The aggregate increase was 33.9% which is greater than the 19.4% increase in revenues yoy for the nine month period. This suggests that there is considerable room for improvement.
The argument that top line growth is most important is true, but only when taken in the context of the overall operation. If operations are sucking up cash due to inefficiencies it constrains top line growth because it limits the ability of the company to expand (without recourse to additional debt or equity).
I am certain the LU's management is well aware of these issues. They almost bring to mind the turn-around that IBM was able to engineer. If you recall, at the beginning the argument was made that IBM was achieving its improvements by cutting expenses and there was a limit to what could be done. But the fact was that by cutting unnecessary expenses and creating a more efficient operation IBM was able to reinvigorate top line growth.
TTFN,
CTC |
