Macro-economic events occurring since Titan Machinery (TITN) announced its last quarterly results increase the likelihood of its filing for bankruptcy this week.
The macro-economic events that have occurred since Titan Machinery last reported its quarterly earnings on September 9, 2014 increase the probability that the company will announce it has violated its credit agreement with Wells Fargo and other creditors. Its possible that this announcement could be made when Titan releases its 10/31/14 earnings report on December 10th. The company’s share price fell to new five-year low of $11.67 last week.
A violation of its credit agreement with Wells Fargo (WFC) and its other creditors would likely result in the company having to file for bankruptcy protection. According to the covenants that it entered into with its creditors, it must maintain a minimum Net Income and Tangible Book value to prevent the creditors from calling in the $850 million loan that the company is utilizing from its floor plan financing, etc.
The following macro-economic events have occurred since Titan reported earnings and updated its guidance on September 9, 2014:
- The price of corn and other crops in the US hit new five-year lows. The recent new price lows of agricultural commodities have resulted in the sentiment of the farmers (who are the potential buyers of farm equipment) turning increasingly negative. The prices of corn and all other crops in the US have declined by more than 10% and made new five-year lows.
- The price of oil hit five-year lows. The $30 decline since September in the price of a barrel of oil has resulted in the sentiment turning negative for the construction and construction equipment industries in North Dakota as well as its three border states. These four states account for more than 50% of Titan’s total number of construction equipment stores. The company’s construction equipment business had been the only bright spot in the presentation that its management made to investors in its last conference call.
- The US Dollar has strengthened significantly. The higher dollar will result in the prices of oil and crops remaining low for an extended period of time. Since Titan’s last earnings announcement and conference call, theEuro went to a new three-year low versus the US Dollar and the dollar hit a seven-year high versus the Yen. The higher dollar requires that the prices of global commodities such as crops, oil and precious metals to adjust downward. All global commodities are quoted in dollars.
The declining prices of corn and oil, etc., (which are negatively impacting Titan’s customers) along with the strengthening US Dollar (that will keep prices low) are detrimental to the company’s ability to maintain its tangible book value requirements. Titan Machinery has approximately $450 million of used equipment on its Balance Sheet and the company has a tangible book value of $366 million ($17.42 per share). Due to Titan’s deteriorating macro-economic environment and a Balance Sheet that consists of used equipment, its book value is vulnerable. The company is susceptible to generating cash losses from selling its used equipment as well as having its used equipment inventories and assets marked down by its auditors when they prepare the audit for its fiscal year ending January 31st.
According to Titan’s credit agreement, its total liabilities for its fourth fiscal quarter which ends on January 31, 2015, cannot be more than a multiple of 3.0 times its tangible book value on same date. What this means is that Titan will have to reduce its total liabilities from $1.22 billion to $1.10 billion by January 31st. However, this assumes that Titan’s tangible book value remains at $366 million. Should Titan report a loss for its third quarter ended October 31st, the amount that it would have to liquidate would be greater since any losses would directly reduce its book value by same amount.
Assuming that Titan’s used equipment assets of $450 million are sold at a discount or are marked down by 10%, the company’s tangible book value would decline by $45 million to $321 million. That would lower the maximum amount of total liabilities that it could have at January 31st to $963 million. The result would be that the amount of total assets it would need to liquidate in the last two months of its fiscal year would increase from $120 million to $257 million.
If Titan has to sell or mark down assets at a discount, this could force it into an asset liquidation death spiral. The more the assets its sells, the better the chance that the company would be forced to sell its remaining assets at an even deeper discount. Keep in mind that there is a limit to the total number of purchasers that the company has within the geographic area that its stores operate. This unfortunate fact serves to only worsen Titan’s problem.
Titan’s management made two strategic decisions that have backfired. The first was the strategy for the company to grow its inventories to record levels during the first two quarters of its current fiscal year and to then liquidate its equipment inventories during the second half of its current fiscal year. The prices of crops and oil were much higher and the US dollar was much weaker during the first half of its fiscal year. The second mistake was that management decided to not sell its used equipment inventories in order to meet its credit agreement requirements. The serious deterioration in the macro-economics that affect its construction and agriculture businesses increases the likelihood that its used equipment assets will be marked down by its auditors for Titan’s fiscal year ending January 31, 2015.
Titan’s quarterly interest expenses have grown to $8 million and are now at the point at which they have begun to eat away at Titan’s tangible book value. The company’s book value has declined over its last two consecutive fiscal quarters.
Titan Machinery’s Interest Expenses
for its last three fiscal years
I have been writing about Titan for more than a year and have been following its since its share price was above $30. My predictions have been that the company would eventually go out of business. My argument is that the company has a business model which is not, and has never been, viable. It has never generated any positive cash flow. Titan has generated positive earnings or net income while generating negative cash flow for every fiscal year since it became a public company. Titan has not generated positive cash flow from operations for any of its last five fiscal years. However, to investors, Titan appears to be a sound company because Titan has reported a cumulative $132 million in earnings or net income over its last 60 quarters. The problem is Titan’s reported earnings are totally cashless since over the same period it generated $462 million of negative cash flow.
What Titan Machinery’s management revealed during its September 9, 2014 investor conference call, provided me with the insight that I needed to understand how the company had been generating its cashless profits. What they revealed was that the profit margins from used equipment sales were lower than its profit margins on new equipment.
The lower profit margin that Titan makes on the sales of the used equipment in its inventories versus new equipment indicates that it operates similarly to a highly leveraged automobile dealer. Some automobile dealers routinely advertise that they will pay top dollar or an inflated trade-in value for a used automobile that is traded for a new car that the dealer sells at the list price. By utilizing this tactic, an automobile dealer can inflate its profits at the end of the month by utilizing used car trade-ins to sell its new cars at prices that it would otherwise not be able to get. The aggressive selling strategy enables the dealer to generate the profits and turnover to satisfy its floor plan financier at the end of the month. The traded used cars that would be difficult to make a profit on are moved into the next month’s financials or onto the dealers back lots. The scheme works as long as the dealer has access to ever higher credit lines. Most dealers (especially those that are not leveraged) normally make a greater profit on the sales of used automobiles than new ones.
Titan has been successful at playing its shell game, moving the traded used equipment into its inventories, only because it has been able to grow its debt and credit lines for every year since it went public. Having access to an ever increasing amount of credit is the reason why Titan Machinery has remained in business. Similarly, this is the underlying reason Titan is able to maintain a disproportionate amount of used equipment in its inventories. The fact that Titan Machinery will not be able to increase its credit lines for the first time and macro-economic events over the last 90 days have occurred which are having a significant impact on the buying habits of its customers makes it inevitable that Titan will soon have to file for bankruptcy.
For the first six months of its current fiscal year, Titan Machinery generated negative cash flow from operations of $79.4 million. This compared to $48.4 million of negative operating cash flow during the comparable six months of fiscal 2013.
Titan Machinery went on to my radar screen ever since it had been diagnosed multiple times by StockDiagnostics.com as having “The EPS Syndrome”. It’s a Financial Statement or Cash Flow Statement disorder that I discovered and named following my performing an autopsy on Enron after it filed for bankruptcy. I had also discovered that there were more than 100 companies prior to Enron including Sunbeam which had un-expectantly filed for bankruptcy after it had been afflicted with The EPS Syndrome. The video below titled “Titan Machinery, a Perfect Short” provides information on Titan and the companies before it including Lehman Brothers that had been diagnosed as having it before their demise.
To learn more about The EPS Syndrome and the well-known companies who went out of business after being diagnosed as having it including Lehman Brothers, there is a four minute video titled “Titan Machinery is a Perfect Short” that I recommend. Additional information on the EPS Syndrome and Perfect Short Research™ is available at www.onlinefinancialsector.com.