ERG rewrites the books
Recommendation
Management wanted to include the value of a licence sold to an associated German smartcard company as revenue, even though it received shares instead of cash. The auditors, quite rightly in our opinion, refused to allow that, claiming the value was insufficiently certain.
The effect was huge – reported profit came in at $6.1m on sales of $299.9m versus management's preferred profit of $37.5m.
Outrage
That's an outrageous difference. One thing is now clear – revenues, profits and cashflows from its automated fare collection and smartcard businesses are hardly steady and predictable.
In a market looking for earnings certainty, it is hardly surprising the shares have fallen another 23% since issue 86 (Hold While Unstable/Stop Losses - $8.60).
Management has been in damage control mode ever since. They are now talking up the positives and we admit there are a few.
During 2001 the company spent lots of cash winning business and implementing contracts in Rome, San Francisco and Singapore. The company continues to win contracts and its 'preferred tenderer' status in Sydney has reassured the market.
So 2002 will be better in a cashflow sense but it's still difficult to make reliable forecasts. The timing of contracts and revenue recognition is inherently uncertain.
We will tread warily. We like the strategy and think ERG has a world-class business but valuation is impossible while earnings are a moveable feast. The shares will remain volatile and we suspect the market's lost confidence will not be easily regained. SELL.