With just 8 days left until year end, I will give the new board chair and management team the benefit of the doubt, and assume that no news is good news and they are all working diligently on closing out 2013, getting ready for good things in 2014.
In the meantime, here is my thought for the day.
Investors will evaluate what they are willing to pay for a share in a company based on what current and future earnings that company will generate. Using a P/E ratio of 5 times, one cent of annual earnings justifies a 5 cent stock price, suggesting a 20% return requirement. At a P/E of 10, the same one cent of earnings justifies a 10 cent stock price, suggesting a 10% annual return requirement. Investors who believe future earnings will grow beyond the current level are usually prepared to pay more for the stock, trading off a lower return requirement today for expected higher returns in the future. Lets assume the Discovery Air situation is somewhere in that 5 to 10 P/E range. The current share price at $2.60 would therefore be justified at annual earnings of 26 cents per share (at a P/E of 10) or 52 cents per share (at a P/E of 5). On a trailing actual earnings basis using the 39 cents EPS figure from fiscal 2012, the current $2.60 share price generates a trailing P/E ratio of 6.7, which is well within our assumed 5 to 10 range.
With 14.5 million common shares outstanding, a one cent per share change in the annual earnings of the company is $145,000. If the new team can find a way to permanently reduce costs by $145,000 a year, they will add $0.01 to the reported EPS. Given the Company has a positive bottom line, it currently faces a corporate tax liability of approximately 30%. This means it would actually take a permanent annual cost reduction of $207,142 before tax to generate a $145,000 after tax impact on the bottom line. Given the current 6.6 P/E ratio, every one cent increase in EPS will move the stock price by 6.6 cents, so every $207,142 decrease in costs (without impacting top line revenues) should increase the Company's share price by 6.6 cents.
What cost categories might most readily generate permanent savings without impacting the top line revenues? I would suggest two are immediate candidates: financing costs and corporate overhead.
In 2012, the Company spent $17.415 million on financing (mostly interest expense on debt, but also various fees and stand-by charges). This respresented 84 cents of annual after tax EPS, or $5.55 of share price value at the 6.6 times P/E level. Yes, the Company needed the $100 to $130 million in capital these financing charges provided, but might it have been accomplished at a cost lower than the $17.4 million paid out? $207,142 represents than 16 basis points on $130 million in borrowing. A full 1% reduction in our borrowing costs would generate a $1.3 million in savings or 6.3 cents in annual after tax EPS, with a share price impact of 41 cents per share. Reducting the overall debt outstanding, and lowering the overall cost of borrowing, including standby charges and rollover financing fees, must be a key plank in the 2014 and beyond strategy, IMHO.
On the corporate overhead front, the first cost I would like to see eliminated is the current annual advisory fee being charged by Clairvest at $250,000 per year. This is a a 1.2 cent per year drag on after tax EPS and takes 8 cents off the current share price. Senior management salaries are also an issue, when they are layered on top of the senior management at the operating companies.
What do folks think?