February 18, 2016

GAAP Accounting Distorts Delphi Automotive’s Economic Reality


Summary

  • Delphi Automotive’s Adjusted Cash Flows From Operations is at $3.8bn, a far cry from as-reported operating cash flows of $2.1bn.
  • One culprit behind this major distortion is the GAAP accounting for goodwill ($656mn), which leads to a significant distortion of the firm’s economic reality.
  • DLPH’s price-to-book ratio is also only at 2.5x once correctly adjusted, versus the traditional 7.9x P/B.
  • Additionally, the firm’s Adjusted Return on Assets is 15%, higher than the 12% ROA level reported by most financial databases.

DLPH PVP

Performance and Valuation Prime™ Chart

Under Generally Accepted Accounting Principles (GAAP), DLPH’s as-reported financial statements and financial ratios do not reflect economic reality. The traditional ROA computation understates the company’s profitability by incorrectly including certain items. The inclusion of goodwill ($656mn) and non-operating long-term assets ($228mn) inflates DLPH’s total assets, resulting in a distortion of performance measures. Additionally, the firm’s Adjusted Cash Flows from Operations is at $3.8bn, a far cry from as-reported operating cash flows of $2.1bn. The adjustments to operating cash flows are crucial because expensing items like R&D expenses and operating leases, rather than capitalizing them as part of a company’s investments, makes comparing the company to its peers, and even to its own historical performance, impossible. In the case of DLPH, their large R&D expenditures of $1.3bn and operating leases of $112mn lead to a material understatement of the firm’s operating cash flows.

After adjusting for these primary issues and a host of other GAAP-based miscategorizations, Valens calculates DLPH’s Adjusted ROA as 15% in 2015. In contrast, most financial databases show a traditional ROA of only 12%. Additionally, analysis shows that the firm’s Adjusted Forward P/E is at 2.5x, compared to a traditional P/B of 13.2x. Clearly, the profitability of DLPH’s operations and its stock valuation are not what traditional metrics indicate.


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