2023-08-02 13:45:39 ET
Summary
- L.B. Foster's financial performance has been poor, and the trend is expected to continue with a forecasted EPS of $0.08 for the first half of the year.
- The company's costs have risen faster than revenue, and there's no indication that this trend will reverse.
- The stock price is relatively volatile and does not accurately reflect the company's performance. The market is assuming a 20% growth rate, which is overly optimistic in my view.
It's been about four months since I announced to an eagerly awaiting world that I'm continuing to avoid L.B. Foster Company ( FSTR ), and in that time, the shares have returned about 19.5% against a gain of about 15% for the S&P 500. The company has announced earnings since, so I thought I'd review those to see if it makes sense to continue to avoid. Additionally, the company is going to release on Wednesday, so I thought I'd reveal my forecast of what I think will happen, and, based on that, determine whether or not it makes sense to continue to avoid, or buy some shares. I'll make that determination by looking at the latest financials, my prediction for the upcoming quarter, and comparing those to the current valuation.
Welcome to the "thesis statement" portion of the article, where I give you the gist of my thinking, so you will have the option to avoid reading through the entirety of my screed, and thus be insulated from the bad jokes, and proper spelling of words like "favour" and "rumour," for example. You're welcome. I'm going to continue to avoid these shares for a few reasons. First, the company's financial performance has not been great, and I'm predicting that trend will continue, and I'm forecasting EPS of $.08 for the first half of this year. In spite of this softness, the shares are priced fairly richly in my view. A rich share price in the teeth of sclerotic financial performance is never a good combination, and so I'd rather sit this one out. That written, given the optimism on display here, it's quite possible that the share price will spike, and I'll miss out on another run. In my view, though, it's better to preserve capital than to try to ride waves of probability. We must remember that we're seeking "risk-adjusted returns" and not simply "returns." So, the shares may spike higher after tomorrow's earnings, but what the market giveth, the market can taketh awayeth.
Financial Snapshot
The most recent financial results have not been great in my estimation. In spite of a 16.9% uptick in revenue relative to the same period a year ago, net income is down by fully 37%. There's no one-off item to blame for this, I'm afraid. The majority of costs rose at a faster rate than revenue. For instance, costs of goods sold, and cost of services increased by 11.8% and 13% respectively. Additionally, selling and administrative expenses grew 24%. In my view, there's no reason to think that these costs will be brought back down to previous levels. Equally troubling in my view is the fact that 2022 was hardly a record year for the company. Revenue that year was actually about 3.15% lower than it was in 2021, so we don't have the "tough comparison year" excuse.
L.B. Foster Financials (L.B. Foster investor relations)
Forecast
I'm going to assume that the trends on the top line and costs will continue from last year to this. So, revenue for the first quarter of this year is up 16.9%, so I'm going to assume that revenue for the first six months of the year will be up by 16.9%, etc. I'll apply the same approach to various costs, except for interest expense, which is up massively from last year to this. I'm simply going to double the interest expense of $1.388 million in Q1 to $2.7666 million for the first half of the year. Additionally, I'm keeping "other expense" constant, as there's no way to forecast it from period to period. Finally, I'm assuming the share count remains fixed from the most recent quarter to the quarter we're about to see. Given all of that, I'm forecasting an EPS figure of about $.08 for the first half of the year. If true, that would work out to a trailing twelve month EPS figure of $-4.21.
L.B. Foster Earnings Forecast (Author estimates)
The Stock
It's great to talk about the financial performance of a company, but we don't access the cash flows of businesses directly. We access those cash flows by buying these things called "stocks," and they're sometimes a poor proxy for what's going on at the firm itself. Stock price movements are much more volatile than you'd expect them to be, given the much more slow-moving changes happening at a given firm. For instance, an investor who bought these shares on June 16 is up about 7% on their investment so far. Someone who bought a mere 14 days later is basically flat on their investment. This variance in returns can't be accounted for by anything that happened at the firm at that time, and it was a function of the unpredictable, short-term price movements of the stock. The person who bought on the 16th bought at a cheaper price, and did better as a result, which is why I like to always buy stock as cheaply as possible.
I measure the cheapness of a stock in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of price to some measure of economic value, like earnings, free cash flow, and the like. Ideally, I want to see a stock trading at a discount to both the overall market and its own history. I decided to continue to eschew these shares some months ago because the shares were trading at a PE ratio of about 44 times. There is no "E" in "PE" at the moment, so there's no way to judge that figure against history. Similarly, there's no free cash flow, so it's impossible to calculate that ratio. When I last reviewed the stock, the shares were trading at a PS ratio of about .25, which I'll admit was on the low side for this business. Although still relatively low compared to its history, the shares are about 20% more expensive than they were based on this measure.
If you're one of my regulars for some reason, you know that I think ratios can be helpful, but I also want to try to work out what the market is "thinking" about a given investment. The way I do this is by employing methods described in books like Professor Stephen Penman's "Accounting for Value" and Mauboussin and Rappaport's "Expectations Investing." Each of these uses the stock price itself as a rich source of information. Penman, in particular, shows investors how they can employ a bit of high school algebra to isolate the "g" (growth) formula in a standard finance formula to work out what the market expects from a given company. Applying this way of thinking to L.B. Foster at the moment suggests the market is assuming that this company will grow earnings at a rate of about 20% from current levels. In fact, it seems that the forecast is for the company to post positive EPS of $.53 this year, and a very near doubling the following year. I consider that to be a massively optimistic forecast, and for that reason alone I will continue to avoid these shares.
For further details see:
A Forecast Of L.B. Foster's Upcoming Earnings: It's Not Pretty