At the end of each earnings season, the StarMine team uses the StarMine Earnings Quality model to identify three companies in each world region exhibiting this important financial indicator. Here we take a look at Asian companies. The Earnings Quality model employs a quantitative multi-factor approach to predict the persistence of earnings. It differentially weights the sources of earnings based on analysis of their relative sustainability.
Our picks for companies in Asia this season: Amcor Ltd. (AMC.AX), Venture Corp. Ltd. (VENM.SI) and China High Speed Transmission Equipment Group Co. (0658.HK).
Amcor Ltd. (AMC.AX)
Source: Eikon/StarMine
Strong operational performance
Amcor is in the packaging business, serving industries ranging from food and healthcare to home and tobacco. It has global operations but so far has had a weak presence in the fast- growing Latin American market. That is about to change as the company announced plans to acquire Alusa, a major player in that market, for $435 million. That acquisition is not likely to strain the balance sheet as the company has almost $500 million in cash.
Source: Eikon/StarMine
Good returns
The company is showing signs of having strong earnings quality. Trailing 4Q Return on net operating assets is at a five year high of 23%. It has steadily increased over the last five years and far exceeded the sector median. That trend has been driven by two things:
- Improving operating margins – which reached a 10-year high of 11.3% in the last quarter. This indicates that Amcor has had some pricing power and benefits from lower commodity costs.
- Improving net operating asset turnover – which reached a five-year high of 2. This indicates that Amcor has been efficient at generating revenues from its asset base.
Source: Eikon/StarMine
Check cash flow
Amcor also generates strong cash flow, another sign of strong earnings quality, and a sign that earnings are likely to be sustainable. Amcor has had eight consecutive quarters of positive free cash flow, and generated over $700 million in the last two semi-annual periods. That strong cash flow is one reason the company could acquire LatAm player Alusa.
Amcor has benefitted from having a diverse customer base and is also geographically diverse, with no region accounting for more than 35% of revenues. Therefore, regional slowdowns are cushioned by other regions. That makes the acquisition in Alusa even more compelling, as it looks to diversify its revenue stream further. Analysts seem to have taken note and have raised their earnings estimates for the rest of the year as well as next year. It’s no wonder that the company scores 96 on the StarMine Earnings Quality model which indicates that these earnings are likely to be sustainable going forward.
Venture Corp. Ltd. (VENM.SI)
Source: Eikon/StarMine
New product releases
With strong product releases, including water filtration related devices, Venture Corp. has seen higher revenues. These new products also command premium prices, which help margins.
The company is a Singapore-based global provider of technology services, products and solutions. Despite the global slowdown in demand for its products, the company has managed eight consecutive quarters of Y-O-Y growth in revenues, which have come even as margins have risen in the same period. That bodes well for future earnings. What’s even more encouraging is that these earnings are being backed by strong earnings quality. The company scores a strong 92 out of a possible 100 on the StarMine Earnings Quality Model which indicates that earnings are coming from sustainable sources. In fact, in the quarter ending December 31, the company reported free cash flow exceeding SG$ 100 million for the first time in more than five years.
Source: Eikon/StarMine
Efficient use of assets
Return on net operating assets (RNOA) is a measure of operating efficiency. By this measure, Venture has done well over the past three years. Trailing 4Q RNOA has increased from under 9% in 2013 to 11.2% in the most recent quarter. That improvement has been driven by both improving margins as well as improved operating asset turnover. Management has done a good job of cutting personnel costs, which also helps margins.
Another sign of strong earnings quality is improved cash flow. As you can see in the headline chart, free cash flow from operations has been strong over the past three quarters, with free cash flow exceeding net income. When earnings are backed by strong cash flow, they tend to be more sustainable in the long run.
Source: Eikon/StarMine
A model company
Venture also performs well on many other StarMine models. It seems to have strong analyst revisions momentum, and with negligible debt on the balance sheet, it looks financially strong. The fundamentals are aligned with what institutional investors currently value, based on the Smart Holdings model score of 94. Earnings look set to continue on the strong trajectory despite a weak economic backdrop.
China High Speed Transmission Equipment Group Co. (0658.HK)
Source: Eikon/StarMine
High-speed results
With the growth of high-speed rail globally, China High Speed has benefited. It manufactures transmission gears for everything from high speed rail to marine and even wind turbines, another fast growing business. The company scores in the top decile of all companies in the region with a 95 on the Earnings Quality model. That will likely serve as a tailwind for future earnings. The company has strong cash flow, improving margins and improving revenues, among other measures, which indicate that earnings are likely to be sustainable going forward. Let’s dig a little deeper.
Source: Eikon/StarMine
A turnaround story
As you can see in the chart above, after many years of large investments and negative free cash flow, China High Speed has turned it around in the last three semiannual periods, with record cash flow. Those investments seem to be paying off as the company reported over 4.5 billion yuan in free cash flow over the last two semiannual periods. When earnings are backed by strong cash flow, it’s a good sign for the future.
Source: Eikon/StarMine
Revenue, inventory indicators
China High Speed has seen revenues almost double in just three years. And that revenue growth comes with improved margins over the last three semiannual periods, another sign of strong earnings quality. In fact, over the past three years, trailing year margins have gone from 7% to 21%, a 300% increase. When companies grow quickly, sometimes inventory management becomes an issue. However, management has done a good job of keeping this in check. As you can see in the headline chart, inventory days have declined over the past two years. That means that the company is doing a great job selling its products and ensuring that inventory does not become obsolete. That is important in such a fast paced industry.
Source: Eikon/StarMine
Analysts on board
While the stock has had negative price momentum in the past year, analysts certainly have been bullish recently. The company has more buy and strong buy recommendations now that just 90 days ago. Analysts have raised earnings estimates for the current year by 5.7% and by 16% for next year as they see strong potential for the wind turbine business segment. Look for China High Speed earnings to remain strong with continued strong execution by management and helped by high quality earnings.
