06 April 2007

TDW: Our Look Ahead

Before we look ahead to TDW's next earning's report, we suggest readers check out a good profile of TDW in Investor's Business Daily.

The scores calculated for each of our gauges were very high when we performed a financial analysis of TDW after the quarter that ended last December. The Overall score was an exceptional 75 points.

We are now anxiously awaiting the results for the quarter that ended on 31 March 2007, which was the fourth quarter of the company's fiscal year 2007. TDW announced that the new results will be reported on 26 April 2007, and the data will be reviewed in a conference call held the same day.

Given the run-up that occurred in TDW's stock price (21.1 percent) during in the first three months of 2007, it will be hard for the company to retain its stellar 20-point mark on the Value gauge. To put it simply, earnings and revenue will have to have grown during this quarter at paces that match or exceed the price increase just to stay even. Since we weight the Value gauge more heavily than the others, the Overall gauge will also be under significant pressure.

Let's put the value concern aside for a moment and speculate about company operations. What might we see in TDW's Income Statement for the most recent quarter when it is released in a few weeks? What would signify a continuation of the company's strong performance, and what would indicate a slowdown?

Revenue. In the early years of this decade, TDW's revenues were essentially stagnant. The first traces of top-line growth were seen in late 2004, revenues accelerate though much of 2005 and 2006. For example, revenue in the June 2006 quarter was 40 percent greater than the June 2005 quarter, which itself was 22 percent greater than the June 2004 quarter. Year-over-year revenue growth hit its maximum in September 2006 at 34 percent. This trailing 12-month growth rate (our preferred metric for growth rates) was still 33 percent at the end of December.

This pace is probably unsustainable -- there aren't (fortunately) major hurricanes every year that lead to extensive off-shore reconstruction and, less dramatically, there is a practical limit on how quickly new ships can be built and deployed -- but there hasn't been any information in the news to suggest that the drop off will be dramatic. Therefore, we think it is reasonable to assume the company's year-over-year revenue growth rate will be at least 28 percent through March 2007. This annual rate would translate into quarterly sales of $291 million and 12-month sales of $1123 million. The average revenue estimate of professional analysts for the quarter is $287 million, so we're a shade more optimistic. [To be honest, we shaved 1 percent off our assumed revenue growth rate when we saw the analyst estimates. There's nothing to be gained by riding too far in front of the herd.]

Gross margin. In the last couple of years, TDW's trailing-year gross margin has increased steadily, from around 36 percent to 53 percent. If, to be conservative, we assume the gross margin in the last quarter will back down a bit to 50 percent, the cost of revenues will be $146 and $530 million, respectively, for the quarter and year ending March 2007. [Note: even with a small assumed gross margin decline in the last quarter, the annual gross margin would still be closer to 53 percent.]

Depreciation. The strong growth in sales has allowed depreciation expenses to edge down to 11 percent of revenue from levels of around 15 percent a couple of years ago. If we assume depreciation will be 12 percent of revenues in the March quarter, the expense will be $35 and $121 million, respectively, for the quarter and year ending March 2007.

Sales, G&A. Similarly, strong sales has cut SG&A expenses from 11 to 9 percent of revenue. If we assume SG&A expenses will be 10 percent of revenue in the last quarter, the figures will be $29 and $102 million, respectively, for the quarter and year ending March 2007.

Operating income. The operating income is found by subtracting the operating expenses (cost of revenues, depreciation, and SG&A, in this case) from revenues. With the assumptions described above, operating income will be $82 and $370 million, respectively, for the quarter and year ending March 2007. This would be exceptional performance because the operating income for the 4 quarters ending in March 2006 was $225 million.

Net Income. To get the bottom-line results, we need to add in other "non-operating" income and subtract provisions for income taxes. We have assumed $10 million for other income in the last quarter -- notionally $5 million for asset sales and $5 million for net interest income. Estimating the tax rate is a more surprising challenge because it has varied widely for TDW. We're going to assume 25 percent for the last quarter, but the annual rate works out to be 22 percent based on tax provisions booked in the three previous quarters.

Rolling up all of the above, we see Net Income at $69 million, or $1.21 per share, for the quarter, up from $1.11 in the year-earlier quarter. We see Net Income at $338 million, or $5.93 per share, for the year, up from $4.04 the previous year. The professional estimates for the recent periods are $1.47 and $5.87. (We haven't yet resolved the incongruity of one value being significantly higher than our estimate and the other being somewhat lower.)

With these estimates, and with the 31 March stock price of $58.58, the P/E ratio would be 9.9, the PEG ratio would be a dirt-cheap 0.22, and Price/Sales would be 3.0. The industry averages, if we mix data from Reuters and Yahoo, are 18.55, 0.6, and 3.6, respectively. These figures suggest that TDW will remain inexpensive relative to its peers.

To estimate the gauge scores, we need to make assumptions about the balance sheet on 31 March 2007 and the cash flow statement for the quarter that ended on that date. For the former, we simply assume that the balance sheet didn't change between December and March. This might be simplistic, but most balance sheet ratios don't vary that much from quarter to quarter unless there was a big acquisition or problems with inventory (which isn't relevant to TDW).

We need to predict two cash flow numbers: the cash flow from operations and capital expenditures. An imperfect assumption for CFO (the correlation coefficient is a bit less than 70 percent) is Net Income plus Depreciation, which we conservatively estimated above at $69 million + $35 million for a total of $104 million. Capital spending has averaged around $48 million per quarter for the last 10 quarters, so we will assume $50 million for this expense in the March 2007 quarter.

With all of these assumptions, we estimate the following scores for TDW for the period ending 31 March 2007:
  • Cash Management: 14
  • Growth: 22
  • Profitability: 14
  • Value: 17
  • Overall: 66

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