Propeller Skies

I like to call enterprise value to free cash flow the thinking man’s price to earnings (PE) ratio*. Because the PE ratio relies on market capitalization, companies with higher debt loads can look cheaper or more attractive than competitors with less debt. Using enterprise value to free cash flow eliminates this potential distortion.

Investors are essentially purchasing future cash flows, also referred to as profits (or losses in the case of negative cash flows), so a higher enterprise value to free cash flow ratio means investors are paying more for future profits. Conversely, a lower value means investors are paying less and potentially getting a bargain. Enterprise value to free cash flow is best used to compare companies in the same industry or a company to its historical value.

Alert Propeller Skies readers will recall that enterprise value and free cash flow have been calculated already. So, without further ado, behold the 2006 enterprise value to free cash flow of six, count ‘em, six, North American Class I Railroads:

Strangely, CSX and Union Pacific (UNP) are trading at a premium to the industry average, despite generally poor operations. CSX also has the honor of being the only railroad with a negative enterprise value to free cash flow in 2005 and over the last five years, caused by negative free cash flow** in four out of five of those years. All the railroads except CSX and UNP currently have an enterprise value to free cash flow ratio above their five year average. Based on the enterprise value to free cash flow, railroads do not appear to be trading at a discount.

Also see the next post, Quick Ratio, the prior post Enterprise Value, or start at the beginning of the series with Railroad Performance Measures: Operating Ratio

notes:

* The price to earnings ratio is a company’s stock price divided by their earnings. While this gives a rough measure of value, accounting ninjas can produce bogus earnings quite easily.

** While operating cash flow was positive at CSX each year from 2001 to 2005, capital expenditures exceeded operating cash flows. Because railroads are a capital intensive business this is not the end of the world. However, I would like to see some improvement in operating performance measures after these massive capital outlays. Alert Prizzo Skeezy readers will recall that CSX’s operating ratio has been improving, but average train speed - which should benefit from capital improvements like more sidings and double tracking - is obviously not. Because of the lack of clear and broad based improvements in operating performance measures, CSX certainly does not , in my opinion, deserve a premium valuation.

Goddamn, Ben Bernanke is one sorry fuck. Taking it in the ass from a Freedom citizen is weak fucking sauce.

After global stock markets roached hard on Martin Luther King Day, Mr. Bernanke cut interest rates by an almost unprecedented 0.75 percentage points before the U.S. markets opened. For the record, the alleged job of the Federal Reserve is to fight inflation and maintain full employment, not bail out the stock market.

Later in the week, it came out that Freedom citizen Jerome Kerviel made tens of billions of dollars in bets in the futures market that stock markets would go up, with his employer’s money. I think it is 100 percent certain that Societe Generale’s unwinding (selling) of the positions caused and then exacerbated the global decline, leading to Mr. Bernanke’s bitch ass, and completely unnecessary, rate cut.

We here at the Prizzo Skeezy respectfully submit that Mr. Bernanke drag his sorry ass back to Princeton before doing any more damage to the United States.

notes:

In the interest of being all fair and balanced, please note that I disagree completely with the policies of the Bernanke Fed. In a nation of subprime addicted debt whores, punishing savers by lowering interest rates is completely counterproductive. Additionally, lower rates equal higher inflation - which stealthily reduces paychecks for everyone. Finally, lower rates make U.S. bonds less attractive to foreign investors, who then sell dollars driving the value down and the cost of imports up. Guess what we don’t import? Nothing is the correct answer! Basically, Mr. Bernanke has been fucking the working man up the ass with a cock large enough for a pachyderm while his Wall Street cronies pocket record bonuses. I realize that Wall Street bonuses were down this year, but after $100 billion and counting of bad debt related writedowns, a meager five percent reduction in million dollar bonuses is insulting to those of us who are required to be competent to hold down a job. Especially when the Wall Street cocksuckers run to the government like a bunch of whiny little bitches and ask for a bailout at taxpayer expense every single time they fuck something up and lose money. Fuck that.

Enterprise value is how much a company would cost to buy outright. Enterprise value is important for comparing companies against each other, because it accounts for debt and equity. While market capitalization is often referred to as how much a company is worth, this is a shortcut and ignores debt and cash on the books. Debt is a liability and cash is an asset. For example, if I sold my Acura on Craig’s List for $1,000 plus the remaining debt, the actual cost to the buyer would be $17,000 because he would have to pay off the remainder of the loan. In comparison, if I sold a file cabinet on Craig’s List for eighty dollars and the purchaser discovered a twenty dollar bill in the drawer, he would have effectively paid only sixty dollars.

The first step is to calculate the market capitalization, which is the share price times the number of shares out. Simple enough, right? Share price is highly variable, so I arbitrarily use the fourth quarter high for consistency when comparing companies within an industry and year over year. Generally, the high and low closing prices by quarter are in the 10-K somewhere, but some companies, such as Canadian National (CNI), are very unhelpful and refuse to publish this. Fucking Canadians. For number of shares out, I use diluted shares, found on the consolidated statements of income.

The second step is to add long term debt to the market capitalization. This is also known as debt due after one year and is found on the consolidated balance sheets. Alert Propeller Skies readers playing along at home can also add short term debt. I personally do not bother, but I do pay attention to trends in short term debt to suss out anomalies.

Finally, subtract the cash money. Cash and cash equivalents are found on the consolidated balance sheets.

Enterprise value by itself is not particularly useful. Stay tuned to find out how to combine enterprise value with other performance metrics to create informative measures. We might get nuts and leverage a few synergies up in this bitch, as well.

For further reading, see the next post in the series: Enterprise Value to Free Cash Flow, the previous post in the series: Free Cash Flow, or start at the beginning with Railroad Performance Measures: Operating Ratio.

Prior to requiring an irritating registration, the Motley Fool provided plenty of useful articles discussing tools for analyzing companies. One of these tools is free cash flow. While net income and earnings can be fudged easily, free cash flow is important because it is more difficult to manipulate. Free cash flow is actual cash money that a company can give back to investors (think dividends or share repurchases) or use to expand the business.

At its simplest, Free cash flow is cash from operating activities minus capital expenditures. The free cash flow calculation can be complicated endlessly by backing things out of operating expenditures that have nothing to do with operations, like the cost of stock option grants. I am lazy, but alert Prizzo Skeezy readers might Google “motley fool free cash flow” for more information. Cash from operating activities can be found on the consolidated statement of cash flows, as can capital expenditures. Sometimes cash from operating activities is labeled as net cash provided by operating activities, cash provided by operating activities, or something similar. Capital expenditures show up as total capital expenditures, property additions, capital investments, or similar.

Increasing free cash flow over time is desirable, while declining free cash flow is bad news. When comparing two companies in the same industry, the company with consistently higher free cash flow has an advantage. In the case of capital intensive industries, like railroads, a trend to watch for is declining capital expenditures. Because railroads require large capital investments in locomotives, freight cars, and rails to increase revenues, declining capital expenditures over a period of time is a red flag, even though free cash flow may be improving. While railroads are highlighted in this analysis and the following table free cash flow is a performance measure applicable to all companies.

All six railroads managed to increase free cash flow year over year and over their five year averages in 2006. As per usual, CSX (CSX) and Union Pacific (UNP) are getting smoked like it ain’t no thang by the other railroads. Canadian Pacific (CP) is also getting its ass handed to it. In contrast, Canadian National (CNI) is clearly kicking ass and taking names, while BNSF (BNI) and Norfolk Southern (NSC) are also doing quite well.

As free cash flow is dreadfully dull, it is time for more inspiration:

For more information on railroad specific performance measures, see previous posts in the series - Railroad Performance Measures: Average Train Speed and Railroad Performance Measures: Operating Ratio at the beginning.

As astute readers who peruse the Liquid Diet category have likely ascertained from its absence , I am not a fan of Vodka. Mostly because it lacks flavor. I am not fond of the Freedom either. Of course, there are exceptions - like smoldering news anchor Melissa Theuriau. The Petit Zinc is also an exception. Reverse engineered by Paul Harrington based on the limited recollection of a bar patron who had the drink on vacation in Freedom, The Petit Zinc is quite obscure.

This is another orange cocktail, like the Derby Cocktail or Satan’s Whiskers. The taste sensation is overwhelmingly orange with some nice herbal notes from the sweet vermouth. This cocktail is also rather sweet, especially compared to my usual libations.

The Petit Zinc is recommended, with reservations. While this is a mighty tasty concoction, I find the cocktail rather sweeter than I generally prefer.

Since it was snowing* in Crunklanta - Strip City, I decided to mix up a few cocktails. I picked up my copy of Vintage Spirits and Forgotten Cocktails and went looking for a recipe that included limes and sweet vermouth, since I have a surplus of both. Eventually, I came across The Derby Cocktail.

The Derby Cocktail is an orange color, reminiscent of Satan’s Whiskers. Initial taste is tart, with orange overtones from the Cointreau. Next, the smoky flavor of the bourbon kicks in. I found the aftertaste is pleasantly savory with lingering hints of bourbon.

The Derby Cocktail is smoove as hell and highly recommended.

notes:

* That means I’ll be working from home** tomorrow, since southerners can’t drive in the snow. I realize they can’t drive worth a damn anyway, but snow causes them to do even more retarded things and crash more often than usual.
** Normally, I would just call in sick, but The Man is keeping me down with a fuckton of work, so I will have to accomplish something.

Another railroad performance measure I follow is average train speed. This measure, speed, is a pain in my fucking ass. Because financial disclosure regulations do not require it, railroads report speed whenever the fuck they feel like it or, in the case of Canadian National (CNI), almost never. However, reporting has improved recently and railroad performance measures are updated weekly except for CNI.

Despite the lack of reporting, average train speed is a very useful performance measure to track. Basically, faster trains allow railroads to haul more shit with less cars and fewer locomotives. Since freight cars and locomotives cost a fuckton of money, and hauling stuff is how railroads generate revenue, less capital equipment plus more stuff delivered equals higher profits.

The first conclusion that can be drawn from the above table is only half the major North American railroads provide average velocity on a regular basis. From the limited data available, all three railroads managed a year over year improvement in average train speed. However, only Canadian Pacific (CP) had an average speed above the five year average. CSX and Union Pacific (UNP) both had slower average train velocities in 2006 compared to their 2001 - 2005 average. Alert readers will recall that CSX and UNP also had the highest operating ratios during 2006.

Speaking of alert readers, if anyone out there on the internet could hook a cracka up with sources of historical speed data for the missing railroads, I would be most appreciative. Average dwell time would be nice, too.

Average train velocity is merely one performance measure. See the next post in this series: Free Cash Flow or previous posts in the series - Railroad Performance Measures: Yield and Railroad Performance Measures: Operating Ratio at the beginning.

notes:

Useful links regarding performance measures:

• Canadian Pacific AAR Reports
• Union Pacific AAR and STB Reports
• Railroad Performance Measures - does not include CNI.

Normally, Housing Panic bashes Lawrence Yun quite well. Unfortunately, the chief cheerleader* recently made this dumbass statement, “although there could be some minor slippage in the first quarter, existing-home sales should hold in a narrow range before trending up,” which is so blatantly retarded that I have to weigh in and call bullshit. Sorry, Mr. Yun, but housing is going down like a University of Georgia sorority girl.

This morning, KB Home (KBH) reported a loss of almost $10 a share. For the fourth quarter. The stock promptly fell 9.2 percent. For perspective, KBH earned $5.82 per share in 2006. There is essentially no difference between new and existing homes, so when new home sales go in the shitter, existing home sales do too.

It gets better - fourth quarter revenue at KBH fell almost one billion dollars**. New home deliveries dropped 22 percent. Continuing the gravity theme, average selling price fell from $280,000 to $247,800, or 11.5 percent. By the way, just in case anyone thought real estate was local, KBH saw a nationwide decline in orders.

Stable, my ass. This is a horrible time to buy and Mr. Yun damn well knows it.

In other news, I wish I had not sold my KBH Jan 30 puts back in November for what seemed like an absurd profit of 240 percent. Had I kept them, I would be watching big titted lesbians have relations in high definition on a sweet new 50″ plasma right now instead of typing this for 3 readers.

notes

* Lawrence Yun’s official title is economist, but my toilet knows more about economics than he does, so I can’t in good conscience call him one.
** All figures are year over year.

Disappointed with the Seventh Heaven, I mixed up a La Floridita Daiquiri, which should not be confused with the La Floridita. Or the syrupy frozen sludge that masquerades as Daiquiris at suburban strip mall restaurants.

The La Floridita Daiquiri is a huge improvement over the Seventh Heaven. While this drink is similar to the standard Daiquiri and the Hemingway Daiquiri, the subtle flavor of the maraschino liqueur elevates it above the standard and the lack of grapefruit distinguishes it from the Hemingway. Overall, the La Floridita Daiquiri is pleasantly tart with a hint of the exotic. The La Floridita Daiquiri is recommended.