Heartland reported its full 2012 results. They had the best year since the breach and the best year in the last ten years (length of history of data I have for them). They knocked the cover off the ball in every value metric - cash flow, margins, return on equity, and paid down debt.
Just to review our valuation metrics, we are going to take Heartland to the value investor's Mayo Clinic and examine the following data:
- Operating Margins, Free Cash Fow: how much the company earned after taxes
- Balance Sheet: Current Ratio & Long term debt/equity
- Return on Equity: as a proxy for how well the company is run - are they good stewards of capital?
Before we dive into that though, let's take a look at top line
Revenue (figures in millions).
Top ine revenue continued to grow each year.
Of course, businesses need profit, top line Revenue is of little importance if the profits don't flow. So let's look at this area and Operating Margins.
This is our first indicator of a robust return to health. Operating margins dipped in 2009-10, but they recovered to better than pre breach levels.
If you were running a candy store Free Cash Flow is the metric you would use to show much money came into your cash register and how much was left.
In 2011, I wrote that HPY had negative $46M FCF - "This is one area where see the breach effect lingering into 2010, likely the result of paying the fines out of cash flow, and its one to watch to see if the recovery is complete." What we saw last year was that 2011 put it in the rearview mirror
|Free Cash Flow||38M||52||20||-46||71||137|
For me this is the most significant indicator of recovery strength, the 2012 FCF held the gains in 2011 and more than doubles their bets pre Breach performance. Its a tailwind going into 2013.
The Current Ratio shows the liquidity in total current assets divided by the total current liabilities. The higher the number the better because this calculation divides Total Current Assets by Total Current Liabilities. As such its an important defensive calculation to check if the business is playing Balance Sheet games to achieve revenues. Revenue gains at the expense of balance sheet health is a poor tradeoff (looking at you Hewlett Packard).
Long term Debt to equity ratio looks at the company's solvency, here is another area where we saw an effect from the breach. The Long term debt jumped from $8M in 2009 to $85M in 2010. The effect is moderating in 2011, where Heartland paid down $15M debt to $70M
From a balance sheet perspective the debt number peaked in 2010 but did not reach danger zone, and it has been steadily paid down. Overall, the performance in growing revenues and margins has been achieved without permanently impairing the balance sheet.
Many investors consider Return on equity as the leading indicator of a well run business, it shows how well the company does at deploying capital.
This metric shows a Return on Equity that beats pre Breach measurements. Note that 30% Return on Equity places Heartland in the company of elite companies like Coca Cola which had a 28% ROE in 2012. Companies that deliver ROE around 20% generally do quite well over the long haul. Given what we can assume that Heartland has worked to do to secure the systems post breach it also appears that improving security is not at odds with a successful business.
One final note, HPY's dividend yield is small at 0.84% but it has been growing from $0.04/share in 2010 to $0.24/share in 2012.
In sum, we can see with four full years of data since the breach was reported, there was a hole in the balance sheet courtesy of fines, but those are in the rear view mirror. The overall stock and business metrics show a robust business that recovered and improved upon its pre Breach economics.
What do the numbers say?
I had a number of questions going in to this analysis. Heartland is a good example because its one line of business (not a conglomerate like say Sony), its public so there is data, its in an indsutry where security matters, and customers can switch if they want. So in looking at the questions, what would the numbers tell us? Each of the numbers tells its own story
Did customers leave en masse? No
Customers did not leave en masse, they were at $1.5B revenue in 2008 and over $2B today
Was there a short term impact? Yes
-$42M cap spending in 2008. Negative ROE in 2009.
Was there a long term impact? No
Free cash flow at record levels $137M today versus best year pre breach year of $52M.
Did presumably increased security blow up their cost structure so their profit margins went down? No.
Operating margins are 5.5% which is also better than pre-Breach levels (best pre Breach year 4.6)
Is the quality of the business impaired? No
They can still grow quite profitably, the Return on Equity today is 30% better than any year since 05 (33%)
Did they take on excessive debt to cover fines, lost customers, etc? No
Long term debt did increase to $85M in 2010, but its been paid down to 50M
An important point is that going into the breach, Heartland was a successful company with a good balance sheet. If they were run poorly and highly levered then this may be a different story since there was a short term impact, but the numbers show they were able to weather the storm.
The income statement, balance sheet and cash flows give clear answers to the questions I had going in. One question that I have after seeing how robust the recovery has turned out to be - is improved security a value add allowing Heartland to win business or retain customers? I do not expect to be able to answer that question but its interesting to ponder.
Disclosure: No position in HPY. I thought about buying some after the breach but thought the margins were too low (that was ~500% ago).
Three days of iOS and Android AppSec geekery with Gunnar Peterson and Ken van Wyk - Training dates for NYC April 29-May 1