Financial Statement Analysis Blog #5 – asset base composition analysis
“Any good business person applies financial discipline to everything they do.”
Now that we know what our example company Caterpillar (CAT) key performance indicators look like, it is time to look under the lid on how the company spends the cash that it brought in from both operating and financing activities. In other words, as an investor (or acquirer) of the company, we should investigate if the company has been spending its cash properly back into the company to drive growth.
A good way to go about this exercise is by performing Asset Base Composition Analysis. Starting from common-sizing the balance sheet in each time period by dividing each entry with total asset, followed by performing trend analyses on major components of current and long term assets. We conclude with a review of the numbers and trends given the lens of industry characteristics and general economy of the same historical period.
For CAT, a common-size balance sheet as a percentage of total assets is constructed as follow:
Trend analyses revealed the following perspectives:
Current assets, inventories, and PPE (property, plant, and equipment) are where CAT has made significant investments in the past. This is consistent with the industry characteristics of being a manufacturer.
Although there are increasing trends in the cash and short-term investments and Financial Products receivables, in general, trade receivables and inventories are decreasing - the net effect is a decline in total current assets. This observation is actually in conflict with the industry characteristics and general economy. With the general economy recovering from the 2007/08 economic crises, lower and lower jobs unemployment rate, and the growth of developing economies like China and India; there should be more demand for housing and new constructions. Therefore, a higher demand for construction machinery. Indeed, Hoovers' industry report confirms a positive outlook for the construction and construction machinery manufacturing industries until the year 2021. Further, the report points to the Asia Pacific as a growth opportunity for these industries. The fact that CAT’s receivables and inventories are declining can be an indicator of losing market share to competitors.
PPE is increasing, which is a good sign that CAT is still betting on a better future organic growth. The decreasing proportion of the asset mix in the intangibles (and its small existence as a part of total assets) along with the increase in cash and short-term investments signal that the company is not trying to grow via acquisitions.
This observation is confirmed by management's declaration to focus on core businesses in the 2015 10-K and by an analysis of their acquisitions activities:
Although the 2015 level of investment and acquisitions is up more than tenfold of the previous year, the period of 2012 through 2014 were a period of low inorganic growth for the company - certainly much less than the 2011 level.
The Excel file that calculates the above figures and drives the conclusion is embedded.