We closed this position on February 26, 2016. A copy of the associated Position Update report is here.
- Misleading earnings = accounting profits are positive and rising while true, economic profits are negative and falling
- High Valuation = very high expectations embedded in the current valuation.
- Misleading Earnings: VMC reported a $34mm increase in GAAP earnings while our model shows economic earnings declined by $218mm. The main drivers of the difference between Economic versus Accounting earnings are VMC’s’s (a) $261mm in asset write-offs — 4% of Net Assets and (b) $887mm of deferrred tax liabilities — 12% of Net Assets.
- Very Dangerous Valuation: Stock price of $36.89 implies VMC must grow its NOPAT at 12% compounded annually for 40 years. A 40-year Growth Appreciation Period with a 12% compounding growth rate is quite a high standard to beat, as per my post on How To Make Money Picking Stocks.
- Underfunded Pensions of $334mm (7% of market value)
- Stock option liabilities of $22mm (0.5% of market value)
Overall, the Risk/Reward of investing in VMC’s stock looks Very Dangerous to me. There is lots of downside risk given the Misleading Earnings and there is little upside reward given the already-rich expectations embedded in the stock price.
See Appendix 4 to learn how VMC NOPAT plummeted even though Net Income rose in its last fiscal year based on a big decrease in non-operating expenses versus the prior year. See Appendix 5 for details on VMC’s Invested Capital. Appendix 7 (in the Return on Invested Capital section) shows how the falling NOPAT Margin and Invested Capital Turns result in a decrease in ROIC (to 0.9% from 3.4%) and Economic Profit, which fell by $218mm while Net Income rose by $34.4mm.