In Search Of Efficiency Experts



With the economy contracting and credit tight, liquidity takes on greater importance. Cash-flow trends are useful for assessing liquidity, but investors should also consider measures of company efficiency.

Days receivable, days inventory, and operating cycles measure flexibility, helping investors identify nimble players — and avoid lumbering firms that could get tripped up by the downturn.

Days receivable, calculated by dividing the ratio of 12-month revenue to average receivables by 365, can provide a glimpse at the solvency of a company’s customers. A rise in days receivable suggests collection is becoming more difficult and could portend an increase in write-offs of doubtful accounts.

Inventory trends also provide valuable insight. Companies are loath to tie up cash in unproductive assets, so they seek to keep inventory as lean as possible without crimping sales. To assess how well a company manages its inventory, look at days inventory, the ratio of 12-month cost of goods sold to average inventory, divided by 365.

The operating cycle combines days inventory and days receivables to measure the length of the entire transaction from the time a product hits inventory to receipt of payment for a sale. The quicker a company turns inventory into cash, the more flexibility it has to deal with changes in the business environment.

These metrics vary widely between sectors and are most useful relative to industry peers. Trends in these metrics are also useful, as improving efficiency reflects well on management. Listed on the right and profiled below are companies with improving efficiency.

Chevron ($69; CVX) has shortened its operating cycle through more efficient receivables processing, though ramped-up production could boost inventories in the year ahead. Production should rise at least modestly in 2009 after several years of disappointing results. Although some new projects won’t become profitable until oil reaches $60 a barrel, others can generate profits with oil at current prices. Chevron is a Buy and a Long-Term Buy.

Laboratory Corp. of America ($58; LH) cut days receivable in the December quarter even as hospitals struggled with financing. In 2008, LabCorp’s bad debt rose to 5.3% from 4.8%, increasing at a rate comparable to revenue growth. Management plans to limit further bad debt by offering incentives to improve collections and by swiping patients’ credit cards at the time of procedures so it can charge for costs not covered by insurance. In February, LabCorp reaffirmed 2009 per-share-profit guidance of $4.75 to $4.95, up from $4.60 in 2008. LabCorp is a Buy and a Long-Term Buy.

In the December quarter, St. Jude Medical’s ($38; STJ) operating cycle improved sharply, mostly because of faster inventory turnover. While days inventory fell 9% from the same period last year, sales rose 11%. That increase in efficiency — and the resultant liquidity boost — could help support St. Jude’s plans to acquire troubled rivals. The consensus projects per-share profits will climb 9% for the year. St. Jude Medical is a Focus List Buy and a Long-Term Buy.

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