Iowa-based Casey’s General Stores operates about 1,700 convenience stores in 11 Midwestern states. It’s facing declining margins, higher input costs and an increasingly competitive environment for cigarette sales, one of its primary products. In addition, higher capital expenditures and negative free cash flow mean that Casey’s General Stores is ringing up signs of poor earnings quality.
The consumer discretionary sector of the S&P 500 has seen earnings grow by more than 10% over the last few quarters, but Casey’s General Stores (CASY.O) has not benefited from the trend. It has seen year over year earnings fall for three consecutive quarters. As we’ll demonstrate, the StarMine Earnings Quality (EQ) model score of 10 indicates that Casey’s earnings may not be coming from sustainable sources.
Danger signs
The red sections of the bars below represent the amount by which free cash flow (FCF) trails net income. Note that this has happened for the last six quarters. In the last two quarters, even though the company reported positive net income, the FCF was negative in each of the quarters, with the largest negative free cash flow of $-63 million reported in the quarter ending Jan. 31, 2013. Earnings backed by strong free cash flows tend to be more sustainable than those that are not.
One reason for the poor free cash flows is increasing capital expenditures. In the last two quarters, Casey’s has spent $88 million and $81 million on capital expenditures, and as seen in the chart below, the levels have risen steadily. That’s not a problem if those expenditures are being funded from operations. However, in the last two quarters, cash flow from operations is far less than capital expenditures, and that’s not sustainable in the long run.
Source: Datastream Professional / StarMine
Less efficient
Increasing capital expenditures may make sense when that capital is efficiently used to generate profits. That does not seem to be the case for Casey’s. The chart below shows that trailing four-quarter operating profit margins have been falling gradually for the last three years, now a shade below 3%, two percentage points lower than just three years ago. It is also below the industry median of 4%. Return on net operating assets, which measures how efficiently the company is using its assets, has been falling, reaching a five-year low of 18%. Finally, for a convenience store operator like Casey’s, inventory management is important. Unfortunately for Casey’s, inventory days have increased to 12 days for the quarter ended in January. That’s two days more than it was just two years ago. An increase in inventory days could be an indication of poorer inventory management, another sign of poor earnings quality.
Source: Datastream Professional / StarMine
Rising costs
Casey’s has been in the process of redesigning and modernizing its stores, hoping to increase foot traffic. But in Illinois, an additional tax on cigarettes adversely affected traffic. CFO William J. Walljasper admitted that input costs have been going up: on the earnings call in March he said that input prices were rising for “pizza flour, but you also have some chicken, some packaging, some supplies.” While management has not been able to pass on those rising prices to customers yet, they hope to be able to do so in the “not-too-distant future,” he added. While that could help increase margins, the company risks losing foot traffic with higher prices. In either case, based on the current financial statements, the StarMine Earnings Quality model indicates that Casey’s earnings may not be generated from sustainable sources.
Receive stories like this to your inbox as they are published. Subscribe here and follow us @Alpha_Now on Twitter. If you are looking to access our data or analytics, register for a free trial.
