Why Eastman Kodak is probably manipulating its earnings

Eastman Kodak (KODK) offers analog and digital innovations. It operates through the following segments: Printing Systems; business inkjet systems; Flexographic packaging; Software and Solutions; Consumer and Movie; Advanced materials and 3D printing technology; Eastman Business Park and All Others.

We are neutral on the stock due to its terrible fundamentals.

Eastman Kodak has no competitive advantage

There are several ways to quantify a company’s competitive advantage using only its income statement. The first method is to calculate the Earning Power Value (EPV) of a company.

The value of earning power is measured as after-tax adjusted EBIT divided by the weighted average cost of capital, and the value of reproduction (the cost of reproducing the business) can be measured using the total value of the asset. If the earning power value is greater than the reproductive value, then a firm is considered to have a competitive advantage.

For KODK, the calculation is as follows:

EPV = Adjusted Earnings EPV / WACC
$480 million = $48 million / 0.1

Given that Eastman Kodak has a total asset value of $2.19 billion, it can be said that it has no competitive advantage. In other words, assuming no growth for Eastman Kodak, it would take $2.19 billion in assets to generate $480 million in value over time.

The second method to determine if a company has a competitive advantage is to look at its gross margin. Indeed, the gross margin represents the premium that consumers are willing to pay in relation to the cost of a product or service. An expanding margin indicates that a sustainable competitive advantage is present.

If a company does not have an edge, new entrants will gradually take market share, leading to lower gross margins as price wars ensue to stay competitive.

In the case of Eastman Kodak, its gross margin has contracted over the past decade. It peaked in fiscal year 2016 at 24.6%, dropping to 15.7% a year later. Its gross margin now stands at 13.4%. Therefore, this trend indicates that there is no competitive advantage in this regard either.

Risk analysis

To measure risk, we will start by analyzing the quality of the company’s earnings. We want to determine if the earnings figures are reliable or if they are manipulated by the accountants. To do this, we will use a method known as Beneish M-Score, which can help us determine if a company is a profit manipulator.

The interpretation is quite simple. If the M-Score is above -1.78, the company is likely an earnings manipulator. On the other hand, if the M-Score is below -2, the company is probably not an earnings manipulator. Finally, a score between -1.78 and -2 is a possible manipulator.

If the interpretation is simple, the calculation is not and requires many steps. The formula for this method is:

M-score =

(+) 0.528 × GMI
(+) 0.404 × AQI
(+) 0.892 × GIS
(+) 0.115 × DEPI
(+)-0.172 × SGAI
(+) 4.679 × TATA
(+)-0.327 × IGVG


DSRI = Sales Days in Receivables Index
DSRI = (Net Receivable / Sales) / (Net Receivable t-1 / Sales t-1)

GMI = gross margin index
GMR = [(Sales t-1 – COGS t-1) / Sales t-1] / [(Sales t – COGS t) / Sales t]

AQI = Asset Quality Index
AQI = [(Total Assets – Current Assets t – PP&E t) / Total Assets t] / [(Total Assets – Current Assets t-1 – PP&E t-1) / Total Assets t-1]

SGI = Sales Growth Index
SGI = Sales t / Sales t-1

DEPI = depreciation index
DEPI = (Amortization t-1/ (PP&E t-1 + Amortization t-1)) / (Amortization t / (PP&E t + Amortization t))

SGAI = Sales General and Administrative Expense Index
SGAI = (SG&A expenses t / Sales t) / (SG&A expenses t-1 / Sales t-1)

LVGI = leverage index
IGVG = [(Current Liabilities t + Total Long Term Debt t) / Total Assets t] / [(Current Liabilities t-1 + Total Long Term Debt t-1) / Total Assets t-1]

TATA = Total accrued charges to total assets
TATA = (Revenue from continuing operations t – Operating cash flow t) / Total assets t

Now that we have defined the formula, we need to gather the data to enter into the equations, which you will find in the image below:

Image created by the author

Using the data above, we can perform the calculations, which we have summarized in the image below:

Therefore, Eastman Kodak is likely to be an earnings manipulator as it has an M-Score of -1.76.

A quick comparison between the company’s EBITDA and free cash flow adds further evidence to the company’s sketchy accounting. Since 2013, KODK has shown positive EBITDA figures every year. However, free cash flow was very negative.

The differences between these two measures tend to run into the hundreds of millions of dollars. A similar discrepancy can be seen by looking at EBIT and net profit for certain years.

Although its net profit is volatile, with some positive and negative years, the positive years are simply paper profits that do not generate real cash. As a result, the company’s cash has steadily declined over the past 10 years, from $1.1 billion in 2012 to $300 million in the past 12 months.

Additionally, there are other risks associated with the business. According to Tipranks’ risk analysis, Eastman Kodak disclosed 41 risks in its latest earnings report. The highest level of risk came from the Finance & Corporate category.

The total number of risks has remained relatively stable over time, as shown in the image below.

Smart Score Evaluation

Currently, no analyst is following Eastman Kodak. Therefore, we will be looking at TipRanks’ Smart Score Rating, which gives the company a 1 out of 10 rating. This corresponds to its poor fundamentals and dwindling cash flow due to lack of cash earnings.

Based on its smart score, KODK will likely underperform going forward.

Final Thoughts

Eastman Kodak has terrible fundamentals and shrinking cash. This is likely an earnings manipulator, meaning the EPV figure we used earlier is likely inflated if it exists.

Accordingly, we are neutral on the stock as its volatile price makes shorting the company very risky. So, it’s probably best for investors to avoid it altogether.

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