Throughout the second quarter, gurus trimmed or eliminated their positions in packaged foods companies. Such companies, like Kellogg Co. (K, Financial) and Leucadia Corp. (LUK, Financial), have increasing days sales outstanding and contracting profit margins. This leads to decreased value opportunities in the packaged foods industry.
Which industries inefficiently operate receivables, payables and inventory?
The three “days ratios” – days inventory (DI), days sales outstanding (DSO) and days payable – can determine how efficiently a company manages its assets and liabilities. Companies that have increasing days inventory, increasing days sales outstanding or decreasing days payable are likely to have poor cash conversion, which can lead to weak cash-debt ratios.
Days inventory measures how long, on average, the company keeps its inventory on its shelf. Increasing days inventory suggests that the company has trouble selling its products, resulting in lower revenue. Even if the company generates sales, some sales are made on credit. Therefore, both DI and DSO should be considered to accurately measure how efficient a company manages its assets.
The average days inventory across industries ranges from 0 to 200 while the median is near 65. The distribution of DSO is moderately narrower; the average DSO across industries ranges from 10 to 90 with a median near 50.
Unlike the previous two days ratios, days payable is like a double-edged sword. From a cash perspective, increasing days payable yields more cash on hand, which allows companies to maintain healthy cash-to-debt levels. However, delaying payables can sever relationships between the company’s suppliers. Based on the distribution analysis, the average days payable across industries is about 45.
As discussed in the previous article, we can determine the industries to avoid by introducing the “sell potential score.” For this study, we compared the current days ratio to the historical median days ratio and assigned a score based on the following guidelines:
- If an industry’s current average DI is higher than its historical median average DI, assign a 2.
- For both the average DSO and the median DSO, assign a 2 if the current value is higher than the historical median value.
- For both the average days payable and the median days payable, assign a 1 if the current value is higher than the historical median.
Forty-seven of the industries have a sell-potential score of at least 6 out of 8, including the packaged foods industry.
High days sales outstanding can weaken a company’s business operation
With a poor financial strength rank of 4, Kellogg has a weak business operation. The cereal manufacturing company’s cash-debt ratio and equity-asset (E/A) ratio underperforms 85% and 93% of global packaged foods companies. As its E/A ratio steadily decreased following the second quarter of 2014, the company kept issuing long-term debt. As of June the company had about $6.28 billion in debt.
Although the company’s days sales outstanding generally reverted to its 10-year median, Kellogg’s days inventory has increased quarter over quarter since 2015. Both the company’s days inventory and DSO increased from June 2015 to June 2016 and are currently near a 10-year high.
Both Kellogg and Leucadia have five severe warning signs, including contracting profit margins and constant increase in long-term debt. One of Leucadia’s warning signs explicitly states “days sales outstanding: building up.” The beef processing company’s DSO currently underperforms 95% of global packaged foods companies.
Eight gurus, including Steven Cohen (Trades, Portfolio) and Richard Pzena (Trades, Portfolio), trimmed their positions in Kellogg. Cohen sold his 119,000-share holding in the company for an average price of $76.42 per share. After selling 12.64% of his Kellogg position, Pzena still owns the third-highest number of shares.
Ruane Cunniff (Trades, Portfolio) and Zeke Ashton (Trades, Portfolio) closed their positions in Leucadia, selling 16,471 and 29,000 shares for an average price of $17.06. With the transaction, Ashton pared 1% of his portfolio.
Based on the consensus sells screener data, Kellogg and 10 other consumer packaged goods companies have been sold by at least seven gurus and bought by at most four gurus in the past six months.
You can view the most active sells and the guru trades within a sector under the Gurus tab.
Disclosure: The author has no position in any stock mentioned in the article.
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