May 18, 2017

Teekay’s Uniform Adjusted EPS’ is shrinking, not growing, implying it is not as cheap as it initially appears


  • TGP’s profitability is materially distorted by accounting for depreciation under GAAP
  • As such, their UAFRS EPS’ is expected to fall to $1.10 this year, a 26% decline, not rise to $1.77
  • After making the appropriate UAFRS adjustments, TGP is trading at a 21.4x Uniform P/E, which is far higher than as-reported P/E of 10.2x, and considering material expected profitability declines, further downside may be warranted

 

Teekay LNG Partners LP (TGP) is expected to release Q1 2017 EPS of $0.43 this morning, which would represent a material improvement over negative earnings in the same period last year. Full-year 2017 expectations are similarly optimistic, and are for 2% growth in EPS, from $1.73 last year to $1.77. As the market has grown more optimistic following a poor 2015, shares have rebounded, rising from $10 levels in early 2016 back to current $16 levels.

However, after making appropriate adjustments under Uniform Adjusted Financial Reporting Standards (UAFRS), it is apparent that profitability is actually shrinking, not improving, and at current valuations, that would warrant further downside going forward.

Specifically, under UAFRS, while Uniform EPS (EPS’) is expected to inflect positively from year-ago EPS, it is only expected to reach $0.27 in Q1. Moreover, full-year EPS’ is expected to fall to $1.10, from $1.49, a shrinkage of 26%. Considering EPS’ is expected to shrink faster than as-reported EPS, and reach levels that are well below as-reported EPS, valuations are far greater than as-reported P/E suggests, implying TGP remains overvalued, and downside is likely warranted.

The quarterly results show a similar trend, with EPS’ falling below traditional EPS in each of the last three quarters, with expectations for this to continue going forward.

UAFRS, Uniform Adjusted Financial Reporting Standards, call for removal of distortions from issues like the treatment of relatively long-lived assets. Once removed, it is apparent that EPS’ is actually declining, not growing, suggesting the firm is more expensive than investors may realize, and downside may be justified.

UAFRS vs. As-Reported EPS

Investors make major decisions about which companies to own based on quarterly company earnings, the most common metric mentioned in traditional corporate investment analysis.

However, more often than not, the earnings that companies report in any given quarter can swing wildly and lead investors to completely wrong conclusions, because GAAP and IFRS rules force management to report results in ways that are not representative of the real operating performance of the business.

While there is a case to be made that some management teams can use “creative accounting” to adjust numbers, the research would show that more often than not, the real problem is with the accounting rules themselves, not management’s use of them.

Impact of Adjustments from GAAP to UAFRS

There are several adjustments required to make earnings representative of a firm’s true cash flows. For TGP, the most material is related to adjusting for the true depreciation of the firm’s assets.

Given the long-lived nature of Teekay’s assets, the true maintenance capex costs related to their assets is much higher than depreciation, which is reflective of the cost of those assets when the company bought them, which happened 7-10 years ago for many of these assets.  As such, nominal asset values should be restated into constant-currency values to improve the reliability of business performance metrics, and the related depreciation (maintenance capex) expense should then be calculated off of the value of the Adjusted Asset base.

UAFRS-reporting adjusts for these traditional accounting distortions by estimating the age of assets and using a GDP deflator to adjust the asset value and associated depreciation expense into the values reflective of what replacement cost would be in the current year being measured. This simple adjustment removes a tremendous amount of accounting noise related to investment activities and improves investors understanding of the operating earnings of a business.

Greater-than-reported declines in EPS’ suggest TGP is not as cheap as it appears

At current prices, TGP is trading at a 10.2x as-reported forward P/E, suggesting the firm remains cheap even after the recent rebound. However, after making the requisite adjustments, it is apparent that TGP is actually trading at a higher level, which may be unwarranted considering expected profitability declines.

Specifically, the firm is actually trading at a 21.4x UAFRS-based P/E (P/E’), which is actually around U.S. corporate averages. Given expected long-term EPS’ declines, this is likely unwarranted, and should the firm fail to reverse recent profit declines, downside may persist going forward.

By using Uniform Adjusted Financial Reporting Standards (UAFRS), investors see a cleaner picture that distorted GAAP and IFRS metrics cannot show. By standardizing financial reporting consistently across time and across companies, corporate performance and valuation metrics improve dramatically. Comparability of a company’s earnings over time, trends in corporate profitability and comparability in earnings power and earnings growth across close competitors and different sectors becomes far more relevant and reliable.

To find out more about Teekay LNG Partners LP and how their performance and market expectations compare to peers, click here to access the open beta of the Valens Research database.

Our Chief Investment Strategist, Joel Litman, chairs the Valens Research Committee, which is responsible for this article. Professor Litman is regarded globally for his expertise in financial statement analysis, fundamental research, and particularly Uniform Accounting, UAFRS.