Heartland 2010

This is the fourth in a series of posts looking at Heartland's share price and business performance. 

In November I looked at the trouble their share price has had and how they have underperformed the market and their peers. There are some studies out there showing that share prices are not affected by breaches but it sure looks like the shares took a hit in this case. But whether its a long term hit or short term hit, we don't know. As Ben Graham said in the short run the market is a voting machine (what people intuit will happen), but in the long run its a weighing machine (the returns).

Last month I wrote two posts that analyzed what looked like a return to normalcy and growth at Heartland, the negative votes of the share price seemed to diverge from the weight of the overall positive returns. 

However, three quarters does not a year make and I was interested as you were to see what Q4 would look like, so let's dive in shall we?

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 & Net Profit 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). 

	2010	2009	2008	2007	2006
Revenue	$1,864	1,652	1,544	1,313	1,097

 

So in terms of weighting top line Revenue returns, we can see from 2006-2010 a 58% increase in Revenue. There are many, many businesses that would be happy with that performance over the financial crisis time period.

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.

	2010	2009	2008	2007	2006
Net profit	1.9%	-3.1	2.7	2.7	2.6

Net profit margins haven't completely recovered from the breach, but they are improving. 2009 margins showed the negative effect (and why the market "votes" were short term correct), but 2010 showed a return most of the way back to pre-breach profit margins. (Nota bene: if you were thinking of starting a business in this space, even in a good year these margins are razor thin)

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.

	2010	2009	2008	2007
Free Cash Flow	$-45.62	19.52	52.39	38.34

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.

The Current Ratio shows the liquidity in total current assets divided by the total current liabilities. This shows progress in Heartland's favor, assets higher than liabilities.

	2010	2009	2008	2007
Current Ratio	1.19	0.80	0.94	1.46

Long term Debt to equity ratio looks at the company's solvency, here is another area where we see an effect. The Long term debt jumped from $8M in 2009 to $85M in 2010.

	2010	2009	2008	2007
Long term debt/equity	48%	6.5	9.5	0

Many investors consider Return on equity as the leading indicator of a well run business.

	2010	2009	2008	2007
Return on Equity	19.5%	-40	23.4	21.7

This metric shows a return to pre Breach levels of ROE. Companies that deliver ROE around 20% generally do quite well over the long haul.

In sum, there is a hole in the balance sheet presumably courtesy of fines, but margins and ROE both show possible beginnings of a positive trend.

Comments

[ivan]

Gunnar, there are several observations to be made about this post:
1- correlation != causality. You attribute the degradation of performance to effect of the breach, it may very well be attributable to other things, for example the economic "downturn" in the 2008-2009 period.
2- you consider the breach to be a cause rather than a result. It would be equally valid to think of the breach as a result of missmanagement and to consider missmanagement as the cause of the other negative indicators as well as of the breach.
3- the analysis would be more fair if you compared the same metrics over the same periods against competitors and the market's benchmark. In your first post you refer to an investopedia article for comparison, I think that does not suffice to support your analysis.
4- perhaps a more simple analysis would be to compare the Beta variations of Heartland and competitors over the same period

[Gunnar]

@Ivan

1. if you notice it was only the Bottom line that suffered NOT the top line, its pretty easy to see if you read the financial statements

3. I did in the earlier post on share price, it showed HPY dramatically underperforming both its peers and the market
http://1raindrop.typepad.com/1_raindrop/2010/11/heartland-revisited.html

4. Beta is a worthless metric for investing or anything else and a leading cause of the financial crisis.

[Gunnar]

just to add to my point #1, if we are looking at the crisis as a reason for underperformance, we would expect both the top line revenue and the bottom line to be impacted.

Instead we got robust top line growth and negative profits and Free Cash Flow. I think its pretty clear in this case from simply reading the financial statements.

[VO]

"if we are looking at the crisis as a reason for underperformance, we would expect both the top line revenue and the bottom line to be impacted."

It is pretty easy to have huge revenues and negative profits, think of dotcom times. Simply give cashbacks or the like. Run a marketing campaign on the Superbowl. Nothing to do with security, all with the cost of sales, which does increase in the economic downturn.