From Barron's:
Enron could face some tough questions from investors when it reports third-quarter profits on Tuesday.
Enron, which became a favorite of Janus and other new-economy believers in 1999 and 2000, has fallen sharply this year, dropping 56% to 36 amid concerns about its huge energy trading operations, which contribute the lion's share of its profits and account for the bulk of its market value. Enron peaked at around 90 last year and traded as low as 24 last month.
While most Street analysts love Enron, many investors are worried about the company's earnings quality, complex financial structure, debt burden, negative operating cash flow and setbacks in the broadband area. Enron also has been hurt by the departure of several key managers, including Jeff Skilling, who abruptly quit at Enron's chief executive in August. There's also a suspicion that Enron was a beneficiary of the run-up in electricity and natural gas prices last year and that the company now is operating in a more difficult environment given lower prices and reduced volatility.
Enron has shown strong profit growth in recent years, driven largely by what it calls wholesale services, which involve trading and market-making in electricity, natural gas and other energy products. Enron expects to earn $1.80 a share this year, up from $1.47 in 2000 and it sees $2.15 in 2002 profits.
Enron reveals little about its energy trading activities. The company also has murky financial arrangements with various private partnerships with links to Enron. Some investors also are puzzled about the discrepancy between Enron's reported first-half profits of $788 million, or 94 cents a share, and negative operating cash flow of $1.3 billion.
Street analysts don't shed much light on Enron other than to reiterate their confidence in management. Goldman Sachs analyst David Fleischer, a fan of the stock, sought recently to take on Enron's critics by addressing the negative market speculation.
Regarding the negative cash flow in the first half, Fleischer said in a note to clients that it stemmed from the repayment of margin balances that were taken in last year when energy prices were high. One of the major charges against Enron is that it manufactures profits through fair-value accounting of complex energy contracts. The Goldman analyst downplayed these concerns, saying this accounting is used in only a small part of the energy trading operations and that most of Enron's profits are recurring in nature.
The bull case for Enron is that the company is the innovative market leader in the booming energy trading area and will continue to generate high annual profit growth.
The bears assert that Enron's profit growth is unsustainable and that some of its past profits are suspect. Their view is that energy trading is inherently volatile, like stock or bond trading, and that Enron's Byzantine financial dealings represent an attempt to smooth out volatile earnings and get a higher P/E multiple assigned to its earnings. They compare Enron to trading-oriented Wall Street firms, such as Bear Stearns and Lehman Brothers, that typically command 10-12 times profits and less than two times book value. Enron fetches 20 times projected 2001 profits and four times tangible book.
Don't expect Enron's third-quarter profits to resolve the debate. The company is expected to earn 43 cents a share, up from 34 cents a year ago. |
