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Affiliated Computer Services and TECO Energy

Subtitle: Stock Study Twofer

by Diane Graese

Diane Graese reviews TECO Energy and Affiliated Computer Services, the July 2006 BetterInvesting Magazine Undervalued Stock and Stock to Study. Diane pays special attention to earnings, dividends, cash flow, and news items.

Editor's Note: Stock study articles are for educational purposes only. There are no recommendations intended for any of the stocks mentioned. We urge readers to conduct their own studies.

Stocks to Study -- OK

Stocks to Buy -- No Way!

When I heard the Better Investing Computer Group Advisory Board was reviving BITS, I volunteered to write something. Soon I was asked to tackle one of the two monthly stocks selected by the BetterInvesting Securities Review Committee.

BetterInvestng announces the two monthly stock selections via a press release on its media site, BetterInvesting Newsroom. If you wish to sign up to receive email announcements of press releases, choose the Newsfeed link. I opened my e-mail on May 4, 2006, and found the announcement below. Details of the announcement are on the website.

"MADISON HEIGHTS, Mich. -- May 3 -- The Editorial Advisory and Securities Review Committee of BetterInvesting Magazine today announced Affiliated Computer Services, Inc. (NYSE: ACS) as its July "Stock to Study" and TECO Energy, Inc. (NYSE: TE) as its July "Undervalued Stock" for investors' informational and educational use."

I already had some familiarity with both companies. I used Affiliated Computer Services as an example in my CompuFest 2004 class, Footnote Findings. The company had a very complex capital structure with significant earnings dilution from both stock options and convertible debt. I once contemplated buying TECO based on its high yield, but the company was on the verge of bankruptcy; I declined. Already, I was thinking these were not beginner-friendly stocks.

It reminded me of the days when I was one of several contributors to the former NAIC Online Investor's School. On a monthly basis, one of us would tackle the BetterInvesting Magazine Stock to Study. We often didn't like the stocks selected but we decided that if they are BetterInvesting Stocks to Study, then there must be some lessons. We could always find something to discuss.

(Note: The NAIC Online Investor's School continued the tradition of online workshops generated by volunteers under the auspices of the Computer Group Advisory Board. We spent several years publishing weekly educational sessions. A few of those workshops and some i-club-list workshops are available on the BetterInvesting website (http://www.betterinvesting.org/articles/web/4254) but many of the links are broken.)

I do not have the benefit of knowing what the BetterInvesting Securities Review Committee was thinking. I'll read the write-ups in the magazine just like you. But in the meantime, I was left scratching my head. Why did the committee like these companies?

(Editor's Note: Diane Graese wrote her study of Affiliated Computer Services and TECO before the July 2006 issue of BetterInvesting Magazine was published on June 1, 2006. See the Related Links section on the top of the page for links to the articles.)

I didn't want to study either one! Both are terribly damaged merchandise in my opinion, and very risky situations for any investor. The issues involved are complex and may be beyond the understanding of even an experienced investor. I'll do my best to explain my point of view. You can read the magazine for the other side of what must be a debate.

TECO Energy

"A completed SSG is required for all Stock to Study nominations, but not for Undervalued Feature nominations." -- January 2004, BetterInvesting Magazine, Letters to the Editor

So if the Securities Review Committee isn't using a Stock Selection Guide, the primary stock analysis tool used by the BetterInvesting Community, for BetterInvesting Undervalued Stocks, what is the methodology one should be using? (It is interesting to note they provide SSG data for selections before April 2003.) The website says, "The Committee looks for "Undervalued Stocks" that have the potential to increase 20 percent (including market appreciation and dividends) in the next 18-24 months."

I know how to measure dividend returns; I can take those checks right to the bank. But how do we, as BetterInvesting investors, contemplate market appreciation that isn't potentially based on an examination of a stock's sales and earnings?

Many trading systems seem to rely on interpreting charts. Could we use the SSG as just such a chart? I used May 3, 2006 data from the S&P Stock Data Service (formerly Online Premium Services/OPS) and Stock Analyst software to prepare the TECO SSG below.

Editor's Note: If you have trouble viewing the TECO Value Line sheet, download the same file from the Related Files section on the top of the page. Likewise, the front pages of the TECO and Afilliated Services SSGs are in the related files. Those SSG images appear later in the article.

Click to enlarge.

TECO SSG, Front

Price

Let's ignore those fundamental sales and earnings lines for a minute to focus on the stock price action. I drew a horizontal pink line through the vertical price lines from 1996 to 2002 at about $25 per share. TECO fluctuated around that point for seven years. As a shareholder, you wouldn't have made any money except for your dividend checks.

The price declined steeply in 2002. The price doubled over the last three years and rebounded from $9.47, the low price in 2003. The nice up trend line that I marked in blue follows higher new low prices each year since 2003. This is actually a price pattern you like to see for a stock.

The second set of pink horizontal price bands shows that the stock appears to be trading in a new range around $16 with a recent high price of $20. The price on May 3, 2006 was $15.92.

If we were to buy the stock in the $15 to $16 range and the stock returned to $20, the $4 to $5 increase in share price would provide a nominal return of 25 percent to 33 percent. Those figures don't include dividends that would to add to return. I suspect this is the potential return seen by the committee.

What moves stock prices up? Buyers. Unfortunately, as I write this article, the stock continues to appear on the daily new low lists in the paper. Value managers usually talk about catalysts that will bring buyers back to the market. Having solid fundamentals allows a good company to survive during a market malaise and patient investors can take some comfort in receiving dividends while they wait for the rest of the market to see the value they see. Is this the case with TECO?

Let's use the TECO Value Line report and part of the back of the TECO SSG to explore some of the stock's fundamentals.

Click to enlarge.

TECO Value Line

Earnings Per Share

Click to enlarge.

TECO Price-Earnings History

Let's start with earnings. The front page of the SSG plots "normalized" earnings according to the S&P Stock Data Service (SDS). They are also reported in the third section of the SSG, Price-Earnings History, column C.

I'm sure many of you are familiar with the fact that data differences sometimes exist between the SDS and Value Line (VL). Not everyone views "normal" the same way. The earnings figures are in the table below.

TECO SDS vs. VL EPS

Most of the time, differences between the data providers are insignificant. Here they are much larger than usual. Since the BetterInvesting Securities Review Committee did not provide us with an SSG, we don't know which set of numbers they were using. How should we decide which numbers are most "normal"?

Value Line includes a footnote (A) at the bottom left of the TECO report that explains they excluded losses of ($4.97) and ($0.77) in 2003 and 2004, respectively, from reported earnings. That totals $5.74 per share in shareholder's equity that disappeared! It may not be normal or recurring, but had you been a shareholder, you would have felt the pain.

Value Line Footnote A

Dividends

The BetterInvesting committee mentions the attractive dividend yield. Dividends are supposed to be one of the more predictable elements of total return when evaluating a stock. See my workshop on stocks that pay dividends at the Better Investing Community.

TECO Dividends 2001-2005

Column F shows us the trend of dividend reductions to the current level of $.76. Column G shows that the company paid dividends exceeding net income in two of the last three years. That's indicated by the dividend payout ratio that exceeded 100% based on normalized earnings that were higher than reported earnings in both 2003 and 2004.

Column H shows the highest yield was 14.1 percent. But the people who bought the stock in 2002 thinking they would see a 14.1 percent dividend yield were promptly slapped in the face with a reality check when the dividends were cut. Indeed, the dividend was cut twice from that point. So if we are buying to receive dividend checks, we must ask, "Is the dividend safe today?"

Debt to Equity

I mentioned that there were concerns about bankruptcy a few years back. The SSG shows us those signs in retrospect. One of features I have always liked in Stock Analyst is percent debt to equity data in the Evaluating Management section, 2C. Toolkit users can now get the same data with the Alt+D hot key.

Click to enlarge.

TECO Debt/Equity

TECO's ratio of debt to equity has been high. That's not uncommon for a utility, but it skyrocketed from 2001 to 2004. While it retreated in 2005, debt is still 233 percent of equity. So who owns this company? It isn't the shareholders; it's the debt holders!

Have the bankruptcy concerns of the past disappeared? If the debt holders don't feel safe, there is no value for shareholders. I went to Moodys.com to look at the debt ratings. After completing the free site registration, you can use the upper right hand search feature to locate a company by either Issuer Name or Ticker Symbol. While you are only allowed limited access for free, the titles of the articles can be telling enough.

The most recent action for TECO was a listing on August 17, 2005, "Moody's assigns speculative grade liquidity rating . . ." Speculative is a big warning flag. Liquidity is all about cash and the ability to meet debt payments. If you aren't paying debt holders, you surely won't be paying shareholders.

Value Line TECO Capital Structure

The Capital Structure box on the Value Line page indicates about 28 percent of the company's debt is due in five years ($1,065 mill long-term debt divided by total debt of $3,836 mill). (And I won't even get into a discussion on the implications of their underfunded pensions also shown in this box.)

In the Form 10-K (annual report filing with the Securities and Exchange Commission or SEC), management says they are trying to raise cash to retire debt due in 2006 and 2007. Where is the money going to come from to pay this debt?

Cash Flow

Let's take a quick look at part of my favorite financial statement, cash flow. The complete cash flow statement is available on the web.

TECO Cash Flow Summary

For the past three years, the company has been selling off operations to generate cash to meet net capital expenditure needs and to pay dividends. There has been limited excess cash to meet debt service. This suggests to me that they may need to cut dividends again to raise cash. The Value Line analyst also sounds a cautious warning: ". . . the company's earnings growth prospects beyond 2007 . . . are in question, and we project little or no dividend growth through the end of the decade."

No growth in earnings. No growth in dividends. Questions about the ability to repay debt and continue dividends. Where are the catalysts that will attract stock buyers? Where is the "Value" in any of that?

On to Affiliated Computer Services

So while the SSG can sometimes show you things, there are other times when it doesn't show you the things you really need to know. You may have heard comments like the SSG only shows you 80 percent of what you need to know. In the case of Affiliated Computer Services (ACS), I knew a lot about the other 20 percent. And to me it was very important.

Click to enlarge.

ACS SSG -- Front

A quick look at the front of the SSG shows a company that has had rising sales and earnings, a welcome pattern of trend lines. The most recent quarterly results identified by the red dot trend line and the box in the upper left corner shows sales continuing to rise while earnings flatten and then decline.

The stock price has been rather flat over the last five years trading around $50. See the pink horizontal price bar I drew on the SSG graph and notice that the $54 price on May 3, 2006 was back near that point.

If recent results are based on short-term issues and the company can continue the longer-term trends, the current price may be a good entry point to buy into this "growth" company.

ACS News

The company is familiar to many BetterInvesting members. It has been the topic of many conversations over the years at the BI Forum at CompuServe.

In late December 2005, there had been rumors of an offer to sell the company at around $62 a share. Forum members felt this was too low and discussed their dilemmas in the thread, ACS Price Spike.

The deal subsequently fell through. This probably should have been a warning that potential investors likely saw something distasteful during their due diligence or felt that $62 was too high a price to pay for what they were seeing. Instead, ACS initiated a Dutch Tender -- an offer to buy back shares. Discussions ensued: ACS Buy Back.

Although it was unknown how many shares would be tendered, the plan might require the company to take on massive amounts of debt. Credit agencies lowered the ACS debt rating. Moodys.com shows a notation on February 14, 2006, "Moody's downgrades Affiliated Computer Services Senior Notes rating to Ba2 . . ." To repeat something we should have learned from studying TECO: if the debt is risky, owning the stock is even riskier.

But the piece de resistance was the scandal du jour that implicated Affiliate Computer Services for backdating stock option grants. On the same day as the BI press release, ACS made an SEC filing announcing the filing of a shareholder lawsuit. Now you don't need to know a single thing about stock options or options accounting to understand that there is lots of confusion going on: lawsuits are filed, management says that charges will be recorded and the financial statements may need to be restated, and the SEC starts investigating.

If we can't rely on historical numbers and management's actions (integrity?) are being questioned, can we possibly want to try to study this company?

We are often told that Stocks to Study are just that; they are not buy recommendations. Please heed that message. In my opinion, you should not consider buying either TECO Energy or Affiliated Computer Services at the current time.

But the time I spent looking at them wasn't exactly wasted. I do hope, through this article, you might have learned about a few new warning signs.

Diane Graese was formerly an officer of the Computer Group Advisory Board and a director for the BetterInvesting Las Vegas Chapter. She is an active member of i-club-list and the BetterIinvesting Community at Compuserve. Diane is well known for her seminars on cash flow and interpreting financial statements. Contact Diane at dmg1031@aol.com.