Alstom is a French transport equipment company. It makes the TGV trains that you might have ridden during your gap year backpacking across Europe.
Last week, its shares took a massive tumble, erasing more than a third of its market value. The plunge occurred after Alstom reported negative half-year free cash flow of €1.15 billion, causing it to slash its free cash flow projections for the full year to between negative €500 million and negative €750 million.
It was a significant departure from its previous messaging to the market. As recently as 25 July, Alstom confirmed its short and mid-term targets and guided for “significantly positive free cash flow” for the 12 months ended March 2024. In other words, there must have been a severe turnaround in the company’s operating cash flow in August and September.
Whenever a company reports drastically worse than expected financial results there is also always a proximate cause. Most commonly, companies blame macro circumstances or changed circumstances at a customer such as a cancelled or delayed order.
Alstom blames the sudden deterioration in free cash flow on a ramp up in production, a tight supply chain, a delay in the completion of the deliveries in the UK and a significant increase in inventories. These are all valid reasons for a reduction in free cash flow.
Some might see the drop in free cash flow as primarily a timing issue. Indeed, UBS and JP Morgan quickly reiterated their “Buy” ratings after the announcement. So far, however, the market isn’t buying it.
Figure 1: Alstom’s stock takes the stairs up and the elevator back down
Source: tradingview.com
Morningstar placed its fair-value estimate for Alstom’s shares under review. Deutsche Bank said in a client note that the disclosures were a “major blow” to management’s credibility and flagged the increasing likelihood of a capital raise to bolster the company’s balance sheet.
Alstom management tried to get on the front foot. In an interview with Bloomberg News, CFO Bernard Delpit waved off speculation of a capital raise. “Commercial momentum, profitability, organic growth are in line” and the company is standing by its mid-term targets, he said.
The market remains unconvinced, with Alstom shares doing little to recover from last week’s plunge.
We think investors have taken a dim view of the news because Alstom has demonstrated signs of aggressive accounting in recent years. Since aggressive accounting typically leads deterioration in asset, income or cash quality, the price action in Alstom suggests investors fear there is more bad news to come.
What might investors be seeing as evidence of more aggressive accounting at Alstom? One of the things that many investors look for is a change in accounting method, especially if there are several changes in a short space of time which make the accounts more difficult to interpret.
Figure 2 shows a snapshot of some figures from Alstom’s recent accounts. These are taken from Bloomberg’s standard form accounts. In this snapshot, we highlight four changes in Alstom’s accounts in recent years.
First, is the growth of unbilled revenues (revenue accruals) and deferred revenue since 2018. This means Alstom now recognizes some revenue before accounts are billed (before payment) and does not recognize some revenue that has been paid in advance. This shift might reflect a change in Alstom’s business but it greatly muddies the relationship between cash flow and income.
In the case of accruals, there will be future cash flow when the money is actually paid but cash flow will be negative until payment is made. Deferred revenue is not reflected in the income statement but the payments are recorded in the cash statement. Deferred and accrued revenue were worth 68% of Alstom’s reported revenue in FY2023.
Since deferred revenue has exceeded accrued revenue by a wide margin, this treatment inflates current cash flow at the expense of cash flow in later years. It is a reason why investors might be worried about the free cash flow situation. The firm’s profitability is poor and the interest burden in Figure 2 has ballooned.
The deferred income situation will help reported profit in future years but not cash flow, which is what matters for debt service. We note that the company’s most recent Altman Z-score was 0.98. A reading below 1.8 is typically associated with looming bankruptcy. So, if operating cash flow is set to drop, investors have a right to be worried.
Figure 2: Snapshot of Alstom's recent accounts
Source: Bloomberg
Three other interesting features are: 1) the disappearance of capital leases in the balance sheet worth EUR709 million, 2) the appearance of negative “other inventory” readings in the balance sheet worth -EUR483 million in FY2023 and -EUR411 million in FY2023, and 3) the heavy swings in non-cash items in the cash statement, which have suddenly become positive instead of negative.
These are just some cursory observations any experienced investor would note when looking at Alstom’s accounts. The company may well have some very good reasons for these changes. There have been some big acquisitions which have indeed changed the company.
For many investors, however, increasingly complex accounts mean it is difficult to form a view on the company. Many have clearly put it in the too hard basket and elected to sell.
When the accounts of a company are in the too hard basket, thankfully these days one can use AI software.
Figure 2 provides an excerpt of Transparently.AI’s take on the Alstom financial results for the year ended March 2023. The overall risk score is 67% which suggests that Alstom has a high probability of account manipulation. The group’s accounting risk score is in the 90th percentile, which means it is in the bottom 10 percent of the class for account manipulation risk.
Notice that the accounting risk software rates the group as “Very High Risk” for asset quality, corporate governance, income quality and, surprise, surprise, cash quality.
Figure 2: An excerpt of Alstom’s accounting manipulation risk report for 2023
Source: Transparently.AI
The poor score for cash quality reflects factors such as dividend abnormalities, unusual interest expense and abnormal non-cash items.
If the interest expense figure is high relative to the interest paid figure, it could suggest that the company recognized a higher interest expense on its income statement than it actually paid in cash.
The system is highlighting potential risk factors beyond those we have recognized from a cursory inspection of the accounts.
The AI platform has warned about cash quality, income quality, asset quality and governance over recent years. For anyone using the platform, the recent warning on free cash flow would not have come as a surprise.
Disclaimer: Both the author and Transparently Pte Ltd do not have trading positions in the companies it expresses a view of. In no event should the author or Transparently Pte Ltd be liable for any direct or indirect trading losses caused by any information contained in these views. All expressions of opinion are subject to change without notice, and we do not undertake to update or supplement this report or any of the information contained herein.