May 26, 2017

AMWD’s Uniform Adjusted EPS’ is greater than reported, implying valuations are not as expensive as they initially appear


  • AMWD’s profitability is materially distorted by accounting for operating leases and stock option expenses under GAAP
  • As such, their UAFRS EPS’ is expected to grow to $5.29 this year, 15% higher than as-reported EPS of $4.60
  • After making the appropriate UAFRS adjustments, AMWD is trading at a 16.0x Uniform P/E, which is a material discount to many other firms in the Building Products industry

 

American Woodmark Corporation (AMWD) is expected to release Q4 2017 GAAP EPS of $1.00 on 5/30, which would represent material, 23% growth over EPS of $0.81 in the same period last year. Expectations for the next four quarters are similarly optimistic and are for EPS to grow by 12%, from $4.10 in the four quarters ended Q3 3017 to $4.60.  As markets have become more optimistic, shares have rallied, up 15% YTD, though now approaching a level suggesting fair value, with valuations reaching corporate averages.

However, after making appropriate adjustments under Uniform Adjusted Financial Reporting Standards (UAFRS), it is apparent that profitability is actually greater than as-reported, and valuations are thus still at a discount to corporate averages, and as a result, further upside is likely warranted.

Specifically, under UAFRS, Uniform EPS (EPS’) is expected to grow to $1.17 in Q4 2017, 17% greater than as-reported EPS, and is forecast to grow at double-digit rates over EPS’ in the same period last year.  Additionally, EPS’ over the next four quarters is expected to reach $5.29, 15% greater than expectations for as-reported EPS, and over 10% greater than EPS’ in the last four quarters.  Given greater-than-reported EPS’, valuations are not at corporate averages, but instead are still at a discount, and given expected growth rates, this suggests further upside is likely warranted for the name.

The quarterly results show a similar trend, with EPS’ consistently stronger than traditional EPS in each of the last four 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 operating leases and stock options. Once removed, it is apparent that EPS’ is actually far greater than as-reported, and growing at rates that would support further upside going forward.

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

Two key UAFRS adjustments have the largest impact to AMWD’s income statement, to get from earnings to UAFRS-adjusted earnings. These are related to stock option expenses and operating leases.

AMWD’s operating lease expense is somewhat 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.

Meanwhile, stock option expenses are treated as an expense to the company in accounting statements, when it is actually a way for the company to give employees an ownership stake in the company. As such, this non-cash expense should be treated as a dilution to equity holders and another claim against the Enterprise Value of the firm, as opposed to it being treated as an annual expense. This is especially true as, unless the company uses cash to buy shares (to suppress dilution for equity holders from the option grants being exercised), there is no cash impact on the company.

UAFRS-reporting adjusts for these traditional accounting distortions by treating all operating leases as investing cash flows and rebucketing stock option expenses into the enterprise value of the firm. These simple reclassifications remove a tremendous amount of accounting noise related to investment activities and improve investors understanding of the operating earnings of a business.

Strong EPS’ suggests further upside might be warranted at current valuations

After the recent run in share prices, AMWD is trading at an 18.6x traditional forward P/E, suggesting it is likely approaching fair value.  However, after making the requisite adjustments, it is apparent that the firm is actually trading at a 16.0x UAFRS-based P/E (Fwd V/E’), still a discount to peers.

Specifically, at this valuation, AMWD is trading at a discount to numerous other building products firms such as JCI (21.3x V/E’), MAS (17.7x V/E’), AOS (21.5x V/E’), and ALLE (22.1x V/E’). As such, should the firm just sustain expected growth rates, AMWD is still trading at a discount, and further upside remains warranted.

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 American Woodmark 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 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.