April 19, 2017

Uniform Accounting highlights that NCR’s Adjusted EPS is stronger than as-reported metrics reflect, and growth is accelerating, which valuations don’t reflect


  • NCR’s traditional EPS is materially distorted by the accounting for operating leases and R&D
  • After making the appropriate UAFRS adjustments, EPS’ growth has been strong, is accelerating to 48% this year, and EPS’ is well above levels as-reported metrics would suggest
  • Additionally, NCR trades at an extremely inexpensive 0.25x UAFRS-adjusted PEG, trades at valuations below peers, and as-reported P/E overstates valuations

 

NCR Corporation (NCR) is expected to release Q1 2017 as-reported earnings of $0.44 per share on 4/20, representing 84% growth from $0.24 levels during the same period last year. Additionally, full-year EPS expectations are as aggressive, and are for 87% growth year-over-year, from $1.77 in 2016 to $3.31.  That said, the firm still trades below corporate average valuations, likely a result of investor aversion to investing in companies with volatile, recently negative earnings.

However, after making appropriate adjustments under Uniform Accounting Financial Reporting Standards (UAFRS), it is apparent that profitability has actually been much stronger than as-reported metrics suggest, and although growth is not expected to be as strong, it is accelerating and warrants a premium to where NCR is currently trading.

Specifically, under UAFRS, Adjusted EPS (EPS’) is expected to grow by 28% in Q1, to $1.06, and by 48% in the full year 2017, from $4.14 to $6.12.  Moreover, this is following a strong growth in 2016, when EPS’ grew 16%, and a strong profitability in 2015, with EPS’ at $3.57, which is directionally different than as-reported EPS of -$1.06 in 2015, indicating investors may not realize how strong and stable NCR’s profitability is.  After making the appropriate adjustments, it is apparent that NCR has earnings stability and EPS’ growth similar to firms trading at greater multiples, and this likely warrants upside from current levels.

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The quarterly results show a similar trend, with continued strength in EPS’ that is not expected to change soon.  As a result of greater-than-reported profitability, valuations are even cheaper than a 13.1x P/E indicates, and given that, would already represent a material discount to peers and further upside for NCR is likely justified.

ncr2-20170419

UAFRS, Uniform Adjusted Financial Reporting Standards, call for removal of distortions from issues like the treatment of leases and R&D. Once removed, it is apparent that while EPS’ growth will be slightly weaker than traditional EPS suggests, this is because EPS’ is already significantly greater.

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 NCR, the most material are related to R&D and operating leases.

GAAP and to a lesser extent IFRS (which allows for capitalization of a portion of R&D expense) treat R&D investments as expenses, when in actuality these are investments in a company’s future operations. They may be good investments or bad investments, but hard to think of R&D as cost of goods sold.

In the case of R&D expense, this is often a multi-year investment in a firm’s future offerings.  Expensing R&D violates the basic matching rule of accounting, that expenses should be recognized in the period the related revenue is recognized.  Expensing R&D can also dramatically increase earnings volatility, as the timing of R&D related to multi-year projects can create lumpy earnings volatility, distorting understanding of a company’s real profitability.

Meanwhile, NCR’s operating lease expense is material. The decision management makes between investing in capex and investing in a lease is not a decision between an expense and an investment, but rather a decision in how management wants to finance their investments. If they would rather spend cash up front for the asset, they will spend capex. However, if they want to spread the cost of the asset over several years, they will instead choose to lease the asset. That said, as-reported accounting statements treat one as an investment, and the other as an expense that does not impact the balance sheet. Because NCR materially spends on operating leases, as-reported metrics like EPS may not accurately reflect the firm’s earnings power.

UAFRS-reporting adjusts for these traditional accounting distortions by treating all operating leases and R&D as an investing cash flow. These simple reclassifications remove a tremendous amount of accounting noise related to investment activities and improves investors understanding of the operating earnings of a business.

Strong, stable EPS’ suggests that a discount related to volatile earnings is unwarranted

Not only are earnings greater, and growing nearly as fast as as-reported EPS suggests, but after making a host of other adjustments, it is apparent NCR is also cheaper than a 13.1x P/E implies.  In reality, NCR is trading at an 11.8x UAFRS-adjusted P/E, which is nearly half corporate averages, and compared to companies with similar expected EPS’ growth, are trading at a steep discount.

With an 11.8x adjusted P/E and projected 48% earnings growth in the next year, NCR is trading at an extremely inexpensive .25x UAFRS-adjusted PEG ratio, as the market is not pricing in any of the company’s likely growth, making it appear very inexpensive.

Also, at current levels, NCR is trading at a discount to NTAP (17.8x), Acer (15.5x), HPE (25.4x), and even XRX (18.8x).  Once making UAFRS adjustments, it is apparent that NCR has stable, growing earnings that would support a multiple nearly 2x where the firm trades now when compared to these peers, and investor aversion to negative earnings are likely unfounded.

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 NCR Corporation 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 Equities and Credit Research Committees, which are responsible for this article. Professor Litman is a recognized global expert in advanced financial statement analysis, corporate performance, and valuation.