|
Fixed assets are necessary in order to be a world class company
Fixed assets are the property, plant and equipment of
an organization. They are capitalized and, except for “land,” depreciated.
Depreciation, moreover, is the process of allocating, to the “P&L,” the cost
of fixed assets over their useful life in a rational and systematic manner.
Normally, intangible assets are excluded.
Investors need
to know if a company’s fixed assets are strategically positioned to manage
its current business, as well as its future growth. There has been a big
push by companies to become the lowest cost producers in their markets.
Multinational companies have contracted out their manufacturing, customer
service, and informational technology functions to outsourcing companies in
places like China, Poland, India, and South America, where the labor costs
are inexpensive. My concern is that once these functions are outsourced, the
knowledge is lost forever! An organization cannot be a world-class company,
if it can’t produce the products that it sells.
For example, if one owns stock in a company that
designs and markets its products, but has no facilities for manufacturing
and distribution, it’s just a matter of time before the outsourcing
companies wise up and start grabbing more profits for themselves. When a
company no longer owns its facilities, its options are limited. Copying and
improving upon an existing plant is easy, but building from scratch is
difficult. Investors could find themselves buying stock in a company with
high profit margins, only to find the margins and value of their shares
reduced in the future.
Investors
also need to understand the amount of equity that is invested in fixed
assets, in terms of property, plant and equipment (“PP&E”). Most companies
do a nice job in describing the location, size, use, and ownership terms, of
PP&E in annual SEC 10K filings.
Investors need to focus their attention on the
quality of the facilities. Are the plants well maintained, cost efficient
and using state of the art equipment, or are they outdated, and cost
inefficient? Are the plants ISO certified? Are the facilities updated and
conducive to a competitive cost structure?
Another area of fixed assets that investors should
concern themselves with is fair value. The financial statements normally
value PP&E at historical cost less accumulated depreciation. Land is usually
valued at cost. Market value is always different. Another way of looking at
the fair value of PP&E is: what is the maximum collateral value that the
banks are willing to lend against.
Assets acquired as part of an acquisition can be
written-up to appraised/market value, as long as market value does not
exceed cost. Acquisition type companies are always having assets appraised
for their acquiring companies. While appraisals are expensive, they do give
credence to the reported PP&E values. Investors also need to review
undervalued assets on the balance sheet, such as:
·
Land that was acquired years ago and has now greatly
appreciated.
·
Low-cost long-term leases in desirable locations.
·
Fully paid for and depreciated equipment that is well
maintained and that has held its value long after its expected useful life.
·
Assets previously written off, that are now in demand.
These situations are more prevalent then one would
think. Investors have benefited in the past through increased stock prices
or dividends, when the values of these hidden assets were turned into cash
flow.
People make
the business, but the facilities also contribute to increased shareholder
value.
|
