AIOCF thoughts

Investment Analysis Clubs Saul’s Investing Discussions
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Last night, I finally got around to reading the earnings call transcript. Prior to reading the transcript I had one concern about this company: profitability as a percentage of sales was down. Was it down temporarily or will it increase going forward. Some of the analyst’s questions focused directly or indirectly on this question. I think EDITDA was 8.7% of revenue last quarter. Adj EPS were 12c vs 10c (up 20%) in the same quarter last year yet revenue was up 66%. Here’s what Fernandes had to say in response to a question about the prospects for improved profitability in the future:

Robin Manson-Hing – CIBC World Markets

Hi, in terms of growing the bottom line I know obviously top line is statistical, but as you look towards your 500 million run rate goal, are you still hoping to get 20% to 25% EBITDA margin by that time?

Alexander Fernandes

Yes, so Robin that’s certainly margin that the business can support even today. So the reason its not there today is because we are spending on growth and if you look at from a historical perspective the trajectory that we are on leads us to getting to 500 million in advance of the stated timeframe and so and really saying its investments today for greater opportunity tomorrow is what where doing.

So if AIOCF was spending to grow then EDITDA would be more like 20-25% instead of 8.7%. I think this would translate into adj EPS closer to 30c instead of the 12c they achieved last quarter. Now, Fernandes is laser focused on getting to $500M revenue by 2016. It’s his main priority and he’s willing to have lower profits to achieve that. So what happens after 2016? Will additional investment always be required to support future growth? Or will the percentage of this investment decline as the company grows? I think we can expect profits to be depressed (due to investment in future growth) for the next 2 quarters. They went from 455 employees at the end of 2013 to 586 at the end of Q2. I think they want to be at 900 by then end of 2014. That’s another 445 employees added between 6/30 and 12/31 and the hiring will accelerate. Wow that’s close to doubling the size of the workforce in 6 months which has to affect profitability and lower efficiency until all these new employees can get up to speed and begin generating sales. It makes me wonder what the profitability will look like in next 2 quarters. I suspect the y/y earnings won’t look that good. I also makes me wonder if Fernandes is trying to force faster revenue growth than is fiscally prudent. The company lacks a good CFO and it really needs someone who can influence Fernandes to grow this business in a financially prudent manner.

So I’m wondering if the stock price will stay depressed (relative to other companies that I could invest in) until results for Q1 or Q2 of 2015 come out (that’s May or August of next year). Maybe the best time to buy this stock will be next April.

Chris

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Great info Chris.

The other thing I am thinking about is currency loss. We could have just as long a discussion about the relative value of the US dollar vs the Canadian dollar. I think Saul previously pointed out that sales will be significant outside of Canada, but do they hedge on currencies? That is an important question, I am not sure there is a right or wrong answer to it, but it has implications for investors. Do the go unhedged an accept currency swings, do the have someone in the company actively hedging.

My last job in the USAF was in engineering management, I remember in one of the large program offices they had a young officer in accounting who was dealing with different currencies, he started to move money around to try to capture currency movements. It did not take long for him to turn into a currency TRADER, those first gains made him feel invincible. I think when he was stopped he was still up a considerable amount. Wiser heads realized that we were buying large weapons systems, our mission was not currency trading. While he was successful, the billions of dollars were not going to be replaced when he made the inevitable losing trade. Who wanted to go to a congressional hearing on that one?

Maybe I generalize that lesson too much, but I think about human nature and how it impacts actions. Small companies learn lesson the hard way. Larger companies have learned those lesson and have systems in place, limits… They fail sometimes to be sure, but small companies often don’t have the limits in the first place. This company may, I don’t know. But I have a small stake…