May 22, 2017

GCO’s Uniform Adjusted EPS’ is growing, not shrinking, and GCO is trading at a discount to peers


  • GCO’s profitability is materially distorted by accounting for operating leases under GAAP
  • As such, their UAFRS EPS’ is expected to grow to $8.38 this year, a 9% improvement, not fall to $4.48
  • After making the appropriate UAFRS adjustments, GCO is trading at a 21.2x Uniform P/E, which is a discount to other peers in Apparel Retail, including ITX, ANF, BURL, and GES, suggesting the firm is likely fairly valued at worst

 

Genesco (GCO) is expected to release Q1 2018 EPS of $0.40 on 5/25, which would represent a material, 20% decline over EPS in the same period last year. Full-year 2018 expectations are similarly pessimistic, and are for 3% shrinkage in EPS, from $4.90 last year to $4.48. As the market has grown more pessimistic, shares have declined, falling 25% YTD.

However, after making appropriate adjustments under Uniform Adjusted Financial Reporting Standards (UAFRS), it is apparent that profitability is actually expected to grow, and although valuations are slightly more aggressive than as-reported P/E suggests, this is warranted, and a rebound in GCO shares may be warranted.

Specifically, under UAFRS, Uniform EPS (EPS’) is expected to grow in 2018, not shrink, and reach $8.38 levels that are over 80% greater than as-reported EPS. Although EPS’ is expected to decline in Q1 compared to Q1 last year, subsequent quarters are expected to be much stronger, driving expected full-year growth of 9%, from $7.72 levels last year.  As the charts below highlight, consistently strong EPS’ suggests that markets may be overly pessimistic on the name, and upside may be warranted should GCO drive growth above current expectations.

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. Once removed, it is apparent that EPS’ is actually growing, not declining, suggesting recent pessimism may be unwarranted, and the firm is likely fairly valued at worst.

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 GCO, the most important are related to operating leases.

GCO’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 GCO materially spends on operating leases, as-reported metrics like EPS can materially understate the firm’s earnings power.

UAFRS-reporting adjusts for this traditional accounting distortion by treating all operating lease expenses as investing cash flows. This simple reclassification removes a tremendous amount of accounting noise related to investment activities and improves investors’ understanding of the operating earnings of a business.

Growing EPS’ suggests recent declines in GCO share prices may have been unwarranted

After making the requisite adjustments, it is apparent that while GCO is trading at a greater multiple than as-reported metrics suggest, it is still trading near corporate averages, and at a discount to peers with similar or worse outlooks in terms of growth.

Specifically, at a 21.9x UAFRS-based P/E (Fwd V/E’), GCO is trading at a discount to peers such as ANF (46.2x UAFRS P/E), GES (29.7x), BURL (27.2x) and ITX (32.2x).  As such, the firm is likely fairly valued at worst considering expected growth rates, and should they drive greater than expected growth, upside would be 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 Genesco Inc. 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.