Getting to the bottom of the bottom line

Analysts reveal how to decipher a carrier

By -- Logistics Management, 8/1/2000

OK, it's crunch time. You need to negotiate a contract with a new carrier and your job is on the line. Pick a good, financially sound company and you're a hero. Pick an underfinanced, fiscally shaky carrier and you're a zero.

Choosing an unreliable carrier is every logistics manager's nightmare. Make a mistake like that, and your company's goods won't get delivered on time or to the right location—if they get delivered at all. With all that's riding on your decision, how can you be sure you're making the right choice?

One way is by reading—and understanding—a carrier's financial statements. By using these statements as a starting point, you can decipher a lot about a company's fiscal health. We asked financial analysts from Merrill Lynch, Salomon Smith Barney, and SG Securities to tell us how.

A Question of Balance

A company's financial statements include a balance sheet, income statement, and statement of cash flow. The balance sheet is a snapshot of a company's financial position at one point in time. The income statement shows whether a company is profitable over a particular period of time. The cash-flow statement shows all the factors that affect a company's cash account during an accounting period.

What can you learn from a balance sheet? Well, you can determine how much working capital a carrier has by deducting its current liabilities from its current assets. (See Figure 1.) You want to work with a company that has a reasonable amount of working capital, says Jeffrey Kauffman, first vice president at Merrill Lynch. If your business is going to grow, you need a carrier with enough capital to grow along with you and provide the level of service you require, he points out.

To determine what's a reasonable amount of working capital, sharpen your pencil and calculate the current ratio. To find the current ratio, which shows a company's ability to meet current obligations from current assets, divide assets by liabilities. (See Figure 2.) Like most transportation companies, Heavenly Skies has no inventory to speak of and its receivables can quickly be transformed into cash. As a result, it could get by with its relatively low current ratio of 1.2.

You'll also want to know the carrier's debt-to-equity ratio, to make sure its debt load is manageable, according to Kauffman. To find the debt-to-equity ratio, divide long-term debt by shareholders' equity, which is the total equity interest that all shareholders have in a company. (See Figure 3.) The example shows Heavenly Skies has a 0.45 debt-to-equity ratio, meaning it has $0.45 in long-term debt for every $1 of shareholder equity. The lower the ratio, the lower the company's financial risk.

Income Statement Insights

Income statements are "the bread and butter" of financial analysts, says Ian Wild, a London-based transport analyst for SG Securities. Among other things, income statements list the amount of operating revenues, revenue from a company's operations. (The sum of operating revenues is usually found at the top of the statement.) The cost of sales or operating expenses refers to exactly that—what it costs a company to provide goods or services.

Subtracting operating costs from operating revenues provides the income from operations. Dividing operating costs by operating revenues reveals the operating ratio—an important guide to how efficiently a carrier is running. (See Figures 4 and 5.)

Scott Flowers, managing director of equity resources for Salomon Smith Barney and an analyst of the trucking, railroad, and airfreight industries, advises looking at several years' worth of income statements for an overview of where a carrier has been financially and where it's going.

Another way to judge a carrier's financial performance is to look at the net profit ratio, which is a company's final profit as a percentage of operating revenues. To find that figure, compare net income with revenues. (See Figure 6.) Again, compare several years' worth of figures so you can track a company's performance over time, advises Flowers.

Follow the Cash

Another step in assessing a carrier's financial health is to look at its statement of cash flow. A cash-flow statement allows you to determine whether a carrier is collecting and disbursing funds (in "real time" vs. "accounting time") efficiently enough to not only maintain operations but also to reinvest in new technology and equipment, allowing it to keep pace with competitors and serve shippers' own expansion plans.

Compare cash flow from operations (from the cash-flow statement) to current liabilities (found on the balance sheet) to determine if a company has enough cash to meet its immediate commitments. That's a liquidity ratio. (See Figure 7.) Heavenly Skies' ratio of 5.1 percent is somewhat lower than the ratios analysts like to see. It will need to improve cash flow, either by cutting back operations or by increasing its efficiency in collecting on receivables.

Also take a look at the percentage of growth in a company's earnings per share. If the growth over time seems to be out of line, the carrier may be paying too much to shareholders, Kauffman says. This could indicate that the carrier will seek a rate hike in order to keep shareholders happy, heexplains.

Caveats

Getting the financial information you need can be tricky, notes Wild of SG Securities. The timeline for gathering and publishing annual reports usually means the data are 12 to 18 months old by the time you get them. Privately held companies aren't required to reveal any financial data.

Even publicly held companies can give you data that simply don't translate into useful information. Wild gives as an example the financial statements of airlines that provide overall data from their passenger and cargo businesses, but don't break out the revenues that come specifically from the cargo part of the business.

Credit ratings on companies are usually available, although they may not reflect an accurate picture of a carrier's financial health. A company that recently underwent an expansion may have some lingering debt issues that can give it a black eye, Wild explains. Conversely, a carrier that is suddenly on shaky financial ground may still have a glowing credit report.

The key to judging a carrier's financial health is to understand the context that surrounds the companies you're considering, all the analysts agree. It helps to understand the carriers' environment as a whole, how individual carriers compare with their competitors, and how efficiently they run their own operations. As Flowers puts it, "Align your expectations with the industry being analyzed."

Editor's note: Heavenly Skies is a fictional company. Figures used in the examples are derived from those reported by actual companies but do not reflect any one company's performance.

Figure 1

Heavenly Skies Air Cargo

Current assets $1,127,900

Current liabilities- $927,400

Working capital $200,500

Figure 2

Current assets $1,127,900 = 1.2 or 1.2 to 1

Current liabilities $927,400 1

Figure 3

Debt-to-equity ratio

Long-term debt $462,600 = 0.45 or 0.45 to 1

Shareholder equity $1,039,200 1

Figure 4

1999 operating income

$1,841,600 operating revenues

-$1,610,100 operating costs

$231,500 in operating income

Figure 5

1999 operating ratio

$1,610,100 operating costs = 87.4% or 87.4 cents

$1,841,600 operating revenueto produce $1 in revenue

Figure 6

1999 net profit ratio

$120,800 net income = 6.56% or 6.56 cents net profit

$1,841,600 operating revenuesper $1 of revenues

Figure 7

Liquidity ratio

$47,400 cash flow from operations = 0.051 liquidity ratio

$927,400 current liabilities

Talking the Talk

Assets (current, fixed)

Current assets can be converted into cash within a year, e.g. accounts receivable or inventory. Fixed assets take more than a year to convert into cash, e.g., land, plant and equipment, accumulated depreciation, and investments.

Balance sheet

A report on a company's financial position, as of a given date.

Cash-flow statement

Shows cash receipts and payments from all company financial activities.

Current liability

A liability that must be paid during the normal operating cycle, usually one year.

Debt-to-total-capitalization ratio

The percentage of total capitalization that is debt. Total capital combines long-term and short-term debt, current maturities of long-term debt, and stockholders' equity.

Diluted earnings per share

Reduction in common earnings per share if convertible securities are converted, stock options and warrants are exercised, or other shares are issued.

ESP

Earnings per share. These come in two forms, diluted and basic. Diluted earnings per share reflect the reduction in common-stock earnings resulting from the cashing of stock options and warrants, issuance of more shares, or conversion of convertible securities. Basic earnings are derived by dividing a company's net income by the average number of shares outstanding for the period.