Sprint Nextel Corporation (NYSE:S) will release its financial results for the next quarter later this month. Telecommunications sector giant AT&T Inc. (NYSE:T) will be releasing its earnings on October 24th while Verizon Communications Inc.(NYSE:VZ) will do so on the 18th. Today CapitalCube evaluates Sprint’s Earnings Quality.
Our analysis suggests that while Sprint Nextel’s net margins look relatively weak, it has a reasonable level of accruals relative to peers. Our peers for Sprint Nextel Corporation (NYSE:S) are: AT&T Inc. (NYSE:T), Verizon Communications Inc.(NYSE:VZ), Deutsche Telekom AG (FRA:DTE) (ETR:DTE) (PINK:DTEGY), MetroPCS Communications Inc (NYSE:PCS), United States Cellular Corporation (NYSE:USM), and Clearwire Corporation (NASDAQ:CLWR). For similar Earnings Quality reports on other major players in the telecommunications sector including AT&T Inc.(NYSE:T) and Verizon Communications Inc.(NYSE:VZ) you can log in for a free trial.
Earlier this week we published our Fundamental Analysis for Sprint as well an assessment of potential corporate actions: Sprint Nextel (S): Target for a Merger or an Expensive Acquisition? Sprint did not pay any dividends. This Earnings Quality report wraps up our look at Sprint.
S-US’s relatively weak net income margins for the last twelve months combined with a level of accruals that is around peer median suggest that its reported net income is supported by a reasonable level of accruals.
Management of Reserves
The company’s accrual levels over the last twelve months are positive but around the peer median suggesting the company is recording a proper level of reserves relative to its peers.
Excluding the effects of change in revenue, the accounting categories causing the most impact on the movement of net income from the prior period to the current period are PP&E, Intangible Assets and SG&A.
Earnings: From Accounting or Cash Flow?
Net Income = Net Operating Cash Flow – “Accruals”
Accruals are estimates by company management of non-cash expenses, assets and liabilities that are recognized before they are paid. They are calculated as net operating cash flow less net income.
The analysis of accruals can help signal possible earnings management of reported net income and EPS results. For example, ‘Over-Accrued’ can signal under reported net income and/or the building of balance sheet reserve accounts, while ‘Under-Accrued’ can signal inflated Net Income results and/or release of balance sheet reserves to aid reported earnings.
Recent trend for S-US’s accruals
The annual trend suggests that S-US’s accruals to revenue ratio is its lowest over the last five years and compares to a high of 96.7% in 2007. Though its accruals to revenue ratio decreased to 19.5% from 25.4% (in 2010), its peer median remained relatively stable during this period at 19.5%. Relative to peers, accruals to revenue ratio fell 5.7 percentage points.
On a quarterly basis, S-US’s accruals to revenue ratio is its highest over the last five quarters and compares to a low of 10.9% in 2011-09-30. Though its accruals to revenue ratio increased to 28.8% from 21.1%, its peer median remained relatively stable during this period at 17.1. Relative to peers, accruals to revenue ratio rose 8.0 percentage points.
Net income is supported by a reasonable level of accruals.
S-US reported relatively weak net income margins for the last twelve months (-11.1% vs. peer median of 3.3%). However, the company booked a level of accruals that is around peer median (22.2% vs. peer median of 22.2%) for the same period, suggesting that its reported net income is supported by a reasonable level of accruals.
Management of Reserves
S-US’s accounting suggests a proper level of reserves.
S-US’s accruals over the last twelve months are positive suggesting a buildup of reserves. However, this level of accruals is also around the peer median and suggests the company is recording a proper level of reserves compared to its peers.
Key Items Impacting Cash Flow
PP&E, Accounts Payable and Intangible Assets have the most material impact on the movement of net income.
We assess the impact of various categories on the cash flow of the company by performing a variance analysis. For each category, this variance analysis measures the movement between the current and previous periods, normalized for the size of the company (e.g. days outstanding or percentage of revenues). This normalization eliminates any movement attributable to period-by-period growth and helps isolate the impact of any accounting policy changes the company might have made in recording the values in each category.
The chart on the right shows the impact of the top accounting categories on Sprint Nextel Corp.’s cash flow for the current quarter. We consider both positive and negative impacts on the cash flow since the categories could have either decreased or increased the reported net income.
The table below details the impact of the major accounting categories on Sprint Nextel Corp.’s net operating cash flow for the current quarter. While we have identified the major accrual categories, and conduct several tests on this standardized set, it should be noted that companies can sometimes have a non-standard accrual item that has a higher impact on the difference between net operating cash flow and net income.
|Item||Latest Quarter||Previous Quarter||Impact On Cash Flow (mn)||Impact On Cash Flow (%)|
|Accounts Receivable DSO||33.6||34.3||69.1||5.9|
|Accounts Payable DSO||32.1||27.8||412.7||35.1|
|Intangible Assets DSO||230.8||233.7||285.5||24.3|
|Tax Rate (%)||N/A||N/A||N/A||N/A|
|Restructuring Expense (% Revenue)||N/A||N/A||N/A||N/A|
|Other Income (% Revenue)||(8.8)||(8.9)||(3.5)||(0.3)|
Supporting Tests and Analytics
For further reference, we provide an extended analysis of the quality of accounting for each accrual category and the company’s results. We judge these results by comparing (i) against the company’s previous accounting policy — to ascertain if the policy has changed or (ii) against the peer group — to check if the company is being more aggressive or conservative than the peers or (iii) the appropriateness of the change and its implication. Log in
for detailed report.
Sprint Nextel (S): Target for a Merger or an Expensive Acquisition?
Sprint Nextel Corp. (S) stock suffered yesterday after an analyst downgrade that ended Sprint’s stock rally; the report also noted likely consolidation in the wireless sector. Earlier in February Sprint’s board voted against buying MetroPCS Communications (PCS).
Today CapitalCube assesses potential Corporate Actions for Sprint Nextel Corp. (S). Our M&A analysis is peer-based and looks at Sprint’s likelihood to merge or acquire within its peer group comprising: AT&T Inc. (NYSE:T), Verizon Communications Inc.(NYSE:VZ), Deutsche Telekom AG (FRA:DTE) (ETR:DTE) (PINK:DTEGY), MetroPCS Communications Inc (NYSE:PCS), United States Cellular Corporation (NYSE:USM), and Clearwire Corporation (NASDAQ:CLWR).
While S-US’s size alone will not prevent it from becoming a target in this peer group, its share price could make it a relatively expensive acquisition.
While S-US has the size (by book value) to acquire other firms within this peer group and may need to do so to meet the market’s growth expectations, it may not be able to add more goodwill to the balance sheet.
The company’s current share price is not sufficiently lower than its 52-week high (currently about 4% below) and does not justify a share buyback as the best use of cash at this time.
Dividend Not Present
S-US did not pay a dividend in the last twelve months prior to 2012-06-30. The combination of its relative operating results and cash flow is not strong enough (relative to peers) to justify a dividend initiation as the best use of cash in the near term.
Why merge or acquire?
Companies typically acquire to realize economies of scale, scope, gain customers, bundle complementary products, or gain vertical integration. From an investor’s perspective, these business reasons fall into natural screening categories that include: (a) buying companies to boost growth expectations; (b) buying to realize cost synergies; and (c) buying earnings through acquisitions that increase EPS.
Potential targets would typically be smaller than their peers though sometimes targets can be marginally larger than the acquirer. As a result, when identifying a company as a target, we check for a book value that is up to 80% more than the peer median. In addition, we also filter for a cheap valuation relative to peers (i.e. price to book is less than the peer median) and a share price that is trading sufficiently (i.e. at least 20%) below its 52-week high.
|M&A Target Conditions||S-US||Comparable||Pass/Fail|
|Book value||<=||1.8 x Peer median||9,227.0||16,608.6||Pass|
|% below 52-week high share price||>=||20%||4.2||20||Fail|
|Price to book (P/B)||<=||1.2 x Peer median*||1.8||2.2||Pass|
|* We use a 20% tolerance (0.8-1.2x) around the median.|
Typically, acquirers are larger than their peers though, as mentioned above, targets can sometimes be marginally larger than the acquirer. To identify a company as an acquirer, we look for a book value that is around or more than the peer median and for growth expectations (measured by its price to earnings or P/E) that are lower than peer median. In addition, we consider whether the company has the capacity to add intangible assets (like goodwill) and whether its valuation (measured by its price to book or P/B) is attractive relative to its peers.
|M&A Acquirer Conditions||S-US||Comparable||Pass/Fail|
|Book value||>=||0.8 x Peer median||9,227.0||7,381.6||Pass|
|Price to earnings (P/E)||<=||1.2 x Peer median*||N/A||38.3||N/A|
|Net tangible assets to equity||>=||25%||(143.0)||25||Fail|
|Price to book (P/B)||>=||0.8 x Peer median*||1.8||1.4||Pass|
|* We use a 20% tolerance (0.8-1.2x) around the median.|S-US’s share price could make it a relatively expensive acquisition in this peer group.
While S-US’s size (book value of USD9,227 million) alone will not prevent it from becoming a target in this peer group, its share price is not far from its 52-week high, which could make it a relatively expensive acquisition.
S-US appears not to have room for more goodwill on its balance sheet.
At the same time, S-US has the size (by book value) to acquire other firms in this peer group and may need to do so to meet the market’s growth expectations. However, the company has negative net tangible assets, which implies it would have difficulty justifying the added goodwill of further acquisitions and could be a signal of previous goodwill going bad.
Is the company likely to buy back shares?
In this section, we identify whether S-US is likely to buy back its shares. In order to screen for this event, we look for positive free cash flows and good liquidity in addition to a leverage, an earnings multiple and a current share price that are low enough to suggest that there is some pressure on management to buy back shares. If the company pays a dividend, we also confirm that its ending cash balance is more than the cash dividend in order to highlight the greater priority of paying a dividend versus buying back shares.
|Share Buyback Conditions||S-US||Comparable||Pass/Fail|
|% below 52-week high share price||>=||20%||4.2||20||Fail|
|Free cash flow (% revenue)||>||0%||1.2||0||Pass|
|Price to earnings (P/E)||<=||1.2 x Peer median*||N/A||38.3||N/A|
|Debt to market equity||<=||1.2 x Peer median*||217.5||149.1||Fail|
|Ending cash/dividend||>=||3 (Strong) or 1 (Moderate)||N/A||Strong or Moderate||N/A|
|* We use a 20% tolerance (0.8-1.2x) around the median.|S-US’s share price performance does not justify a share buyback as the best use of cash.
S-US’s current share price is not sufficiently below its 52-week high (currently 4.2% lower) and does not justify a share buyback as the best use of cash at this time. As a reference, the company’s cash balance is currently 40.8% of its market capitalization.
Dividend cut, increase or initiate?
In this section, we try to identify whether the company is likely to cut, increase or initiate a common stock dividend. In order to screen for these actions, we apply multiple tests to check whether the combination of operating performance, leverage, liquidity, growth expectations and share price performance is sufficient to permit such an action.
To check for a dividend initiation at S-US, we look for outperformance relative to its peers in terms of pre-tax margin and operating cash flow. In addition, we also filter for relatively low leverage and good liquidity, which indicates sufficient support for debt servicing. We also look for a price to book value (P/B) that is positive, relatively low growth expectations (based on P/E) and a share price that has underperformed its peers. Overall, these conditions suggest that there is pressure on management to return money to the shareholders in the form of a dividend in order to increase their total returns. Finally, we overlay the dividend quality (medium or high) and ending cash dividend coverage (moderate or strong) to indicate whether the company is likely to increase its dividend.
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Sprint Nextel Corp. provides a comprehensive range of wireless and wireline communications services that are designed to meet the needs of individual consumers, businesses, government subscribers and resellers. It provides 4G wireless broadband services. The company builds and operates next generation mobile broadband networks, which provide high-speed mobile Internet and residential access services, as well as residential voice services, in communities throughout the country. It operates through two reportable segments: Wireless and Wireline. The Wireless segment offers wireless services on a postpaid and prepaid payment basis to retail subscribers and also on a wholesale and affiliate basis, which includes the sale of wireless services which utilize the Sprint network but are sold under the wholesaler’s brand. The Wireline segment provides a broad suite of wireline voice and data communications services to other communications companies and targeted business and consumer subscribers. It also provides voice, data and IP communication services to Wireless segment and IP and other services to cable Multiple System Operators that resell local and long distance services and use back office systems and network assets in support of their telephone service provided over cable facilities primarily to residential end-user subscribers. Sprint Nextel was founded by Cleyson Brown in 1899 and is headquartered in Overland Park, KS.
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