When Titan Machinery ($TITN) released its fiscal 2014 year end results on April 10, 2014, it forecasted or provided guidance for its operating cash flow. Titan stated that it was going to generate $60 million to $80 million in positive non GAAP operating cash flow for its current fiscal year ending January 31, 2015. It further stated that the method that it would utilize for the Company to generate positive operating cash flow in a fiscal year for the first time in at least six years was its liquidation or its reduction of its equipment inventories by $250 million. Under Titan’s inventories reduction guidance total inventories would decline from $1.08 billion as of January 31, 2014 to $758 million by January 31, 2015.
We are highly confident that the decision by Titan’s management to reduce its inventories to $758 million will result in a decline in the Company’s revenue and profits for fiscal 2016 as compared to fiscal 2015. Fiscal 2016, would be the second consecutive year that Titan’s revenues decline. Titan, based on its own guidance that it has already given, will depart fiscal 2015 by reporting its first annual revenue decline since it’s been a public company.
Those who are invested in Titan’s shares are having a great time at the grand party that started as soon as its management concluded their conference call. During the call, which included a 23 page presentation, Titan’s management provided details and highlights for its fiscal 2014 earnings report. It also provided guidance for fiscal 2015.
Every great party always ends with a hangover. As Titan moves through fiscal 2015, the analysts making of and publishing their projections for its next fiscal year (2016) beginning on February 1, 2015, will become increasingly paramount. As the analysts and Titan’s institutional investors begin to do their homework we have no doubt that they will come to the same conclusion that we have come to. Doubts as to whether or not Titan can continue to be a growth company or even meet its EPS projections for 2015 will begin to surface. During 2013, Titan’s management lowered it EPS guidance for its 2014 fiscal year three consecutive times.
Titan Machinery’s EPS Guidance
for Fiscal Year (FY) January 31, 2014
There was one highlight at the bottom of page 19 of the presentation which Titan’s management provided to analysts and investors on April 10, 2014 that raised our eyebrows. It was that the company had “$410.7 Million Available on $1.2 Billion Floorplan lines of Credit”. On November 14, 2013, Titan’s Credit Agreement with Wells Fargo had been amended. Under the amended terms and conditions Titan’s Net Leverage Ratio (Total Liabilities/Tangible Equity) was permitted to be a maximum of 3.5 for any fiscal period on or after January 31, 2014.
According to the Balance Sheet data which Titan published in its April 10th press release its Total Liabilities were $1.15 billion on January 31, 2014. Titan’s permitted Total Liabilities under the Credit Agreement that was amended on November 14, 2013 was $1.31 billion. The maximum net amount that Titan could have increased its Total Liabilities by as of January 31st was $160 million and not the $410.7 million that the company claimed was available via its unused portion of its Floorplan lines of Credit. The difference between the two amounts is $250.7 million.
On April 3, 2014, which was one week before Titan announced its earnings, the company’s Credit Agreement with Wells Fargo was again amended. Under the new terms the Company’s Consolidated Net Leverage Ratio was decreased from 3.5 to 3.25 by October 31, 2014 and to 3.0 by January 31, 2015. The Total Liabilities permitted under the amended terms was $1.22 billion for fiscal quarters ending July and October 31st and $1.12 billion on January 31st. This assumes no change in Titan’s tangible book value. In its guidance Titan indicated that the company would take a $4.2 million pre-tax charge associated with the company’s realignment that it expects to be realized in the first quarter of fiscal 2015. This charge could lower Titan’s tangible book value and reduce it permitted Total Liabilities.
Based on the recently amended Wells Fargo Credit Agreement, Titan’s Total Liabilities for its fiscal quarters ending on July 31, 2014 and October 31, 2014, can only increase by $70 million as compared to what its Total Liabilities were on January 31, 2014. By January 31, 2015, Titan’s Total Liabilities will have to decline by $30 million as compared to January 31, 2014 for the company to remain under its ratio of 3.0. The unused portion ($410.7 million) of its Floorplan line of credit will be un-utilizable.
Obviously, the decision that management made to reduce its inventories for the purpose of Titan to begin to generate positive operating cash flow was based on necessity. However, Titan’s management overreacted in their including a $250 million reduction of inventories by January 31, 2015, in their guidance for Fiscal 2015. Titan’s management did not do their homework. They have not seriously considered the ramifications or repercussions from their reducing inventories by 25%.
There are two issues that Titan’s management should have considered before they calculated the amount of that they were reducing their inventories by for their fiscal 2015 guidance. If these issues had been considered we believe that they would have made the decision to reduce Titan Machinery’s Inventories by an amount that was much less than $250 million.
The first issue that they did not address is that there is a strong historical correlation between Titan’s revenue and its Inventories growth rates. The table below illustrates and compares the growth rates of Titan’s inventories and revenue for its fiscal years 2010 through 2014. The decline in the growth rate of its inventories for 2014 to 8.5% from 24.2% resulted in a sharp decline in its revenue growth rate to 1.3% from 32.5%.
Growth Rates for Titan Machinery’s Inventory
and Revenue for Fiscal Years 2010 through 2014
The second issue that Titan’s management failed to consider is the company’s historical Revenue/Inventories ratio. The table below further illustrates the relationship or ratio between Titan’s revenue and its inventories. The ratio or multiple of Revenue that Titan has generated has ranged between 2.06 and 2.53 times its inventories since 2010.
Titan Machinery’s Revenue/Inventories
Ratios, Fiscal Years 2010 through 2014
Titan has forecasted that it will reduce its inventories from $1.08 billion to $758 million by January 31, 2015. It’s the one and only forecast in Titan’s guidance that will be easy for them to achieve.
Since Titan’s $250 million reduction in its Inventories is all but guaranteed it’s much easier for even a novice to project future revenue for the company. Projecting the minimum and maximum ranges of future annual revenue for Titan is as simple as multiplying the projected amount of inventories by the company’s lowest and highest revenue/inventories ratios over its prior five years. With the reduction in Titan’s inventories we are projecting its revenue range for fiscal 2016 to be $1.56 billion at the low end and $1.91 billion at the high end. Our top end number for 2016 is below Titan’s low end revenue number of $1.95 billion for fiscal 2015.
Titan’s management in providing guidance on its operating cash flows and reduction in inventories has painted itself into a corner. Its due to them not considering the downside regarding the reduction of inventories by 25% in fiscal 2015 as compared to fiscal 2014. Its extremely difficult for any company to make the argument that they can continue to increase revenue while significantly decreasing inventories. We have no doubt that savvy investors and analysts will confront Titan’s management with the same mathematical argument that we are making. Titan’s severe inventory reductions will result in its generating significantly lower revenue and EPS for both its 2015 and 2016 fiscal years.
As soon as the stock market starts to price in or discount the increasing probability that Titan Machinery will have lower revenue in fiscal 2016 as compared to fiscal 2015, its share price will begin to head lower and go to a single digit price to earnings (PE) multiple or ratio. Either actual or projected consecutive annual revenue declines will relegate Titan Machinery to being a cyclical tractor dealership play. Based on Titan’s minimum non GAAP earning per share projection of $.70 and maximum of $1.00, and its history of guiding forecasts down during prior fiscal years we are projecting that its share price will be trading below $10 by the end of 2014.
Based on the announced guidance by Titan Machinery that it intends on reducing its inventories by 25% it has become rather obvious that Titan is no longer a growth company or growth stock play. Given this significant new development there are several issues that its management and its current shareholders need to be aware of:
1. Titan may generate losses from the reduction of its inventories by $250 million. The liquidation of $250 million of inventory over 10 months will not be easy. Its especially since Titan’s management never had to deal with this previously.
2. Most of Titan’s existing institutional shareholders will liquidate their shares. The funds who hold 90% of Titan’s outstanding shares have mandates that require that they invest ONLY in growth companies. Titan shares are going to be under selling pressure when it reports its second consecutive quarter of declining revenue in June of 2014 and thereafter when its annualized revenue comparisons will start to show declines.
3. Value investors invest at a discount to book value. For institutional and professional “value investors” to invest in Titan its shares will have to trade at a price that is at significant discount to its tangible book value of $18.00 per share.
Titan’s share price initially rallied on its earnings announcement for its Fiscal Year and 4th quarter ended January 31, 2014. Its probably due to short covering by short sellers. Titan’s short interest is approximately 6 million or 34% of its outstanding shares. We also believe that after those institutional investors who hold its shares and the securities analysts who follow it do their homework there will be tremendous selling pressure on Titan’s shares.
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