Continuing from the previous look at Somero’s balance sheet, I will now review the income statement. Much of the analysis is extremely simple and easy to follow – I am simply looking, like most, for companies with good revenue and profits, low cost structures and apparent consistency in earnings. Further, I like to consider what proportion of operating expenses are likely to remain level, allowing some insight into the forward relationship between the top and bottom lines. The sustainability of forward earnings should also be considered but this information is not gleaned from the income statement which is, by nature, a backward looking statement.
Revenue and Consistency of Revenue
Over the past few years, since 2011, revenue has risen steadily and convincingly. The growth rate in revenue since then has been not far off 30% – while this is certainly impressive, I think that it is prudent not to assume that this will continue. That said, as mentioned in an earlier post, management intend to double 2013 revenue by 2018, so at least they are optimistic about forward earnings growth.
Looking back a bit further, the longer term trend in revenue is very revealing of the key flaw in this business model. Like all construction business’s, it depends on construction demand for it’s revenue; if people aren’t building more warehouses or car parks, then Somero’s services are essentially useless. We saw revenue fall before, and more recently have seen it rise on the back of an economic recovery, forcing me to classify it as cyclical in nature. This analysis of revenue trends has reinforced my earlier thoughts and I believe the business to be very sensitive to a down turn in the US or Chinese economies in particular.
Cost Structure
First up is cost of sales, at $27m this year vs $59m in revenue, the business’s gross margin currently sits at 54%. This is a stunning number in my view and just goes to show the extent of the value added by Somero’s manufacturing process – any process that takes raw inputs and doubles their value is worth taking note of. In 2013, gross margin was 52%, in 2012 it was 49% and in 2011 47%, demonstrating that, over the past few years, Somero have been able to consistently improve production efficiency. Whether this trend will continue is not clear but it would appear that a gross margin of around 50% can be…
