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Jones Soda, Breaking Down the Growth.

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April 28, 2007 – Comments (7)

When I look at a stock I always look at the fully diluted market cap and the P/E first. As of March 6, 2007 Jones Soda, JSDA, gives 25,667,491 shares, Stock Option 1,424,025 (2006 annual report), for a total 27,091,516. Additionally, it appears they have another 1,930,975 options they can issue. Current price as of Apr 28, 2007 is $23.02. That gives a fully diluted market cap of $623.6 million and if you include the options that can be issued, you get $628 million. I get two different P/E's, depending on which site I look at, 124 on Yahoo, and 99 on The Motley Fool Caps, neither of which looks good.

What do I calculate as a fully diluted P/E based on the 2006 income of $4.574 million and the fully diluted market cap? $623.6/$4.574 = 136.

If I use the 19c eps with the $23.02 price, I get a P/E of 121. If divide the 19c into the $4.574 million of earnings I get 24 million shares, so clearly the P/E of 121 is a understatement. I get a P/E more than 12% greater.

It is absurd to truncate eps calculations when they are mere pennies as from 18c to 19c is 5.6% difference in earnings. At 5c to 6c, you get 20% difference in earning. They ought to have 3 significant figures.

There is no question there is an awesome growth story here in terms of the business, but at the same time, from December 2000 with a share price of 41c to $23.02 today is 5,500% growth in share price, and because of increased shares, the growth in the market cap would be 7600%, yet revenue in 2000 was $19 million and in 2006 it was $39 million, only double.

What is striking about Jones Soda is that eps went from 6c/share to 19c/share, a stellar 217% improvement considering revenue only increased by 16.5%.

Where did the growth come from?

Breaking down Jones Soda's growth numbers show that actual sales revenue went up 16.5%, yet their cost of goods only went up 8.3%. This change enabled them to increase their gross margin by 30%, from $12.3 million to $16 million.

Thirty percent growth in gross margin is great, but, keep in mind that $16 million is only 2.5% of the market cap. They still have to pay promotion, selling, general and administrative expenses from this.

The promotion and selling expenses increased by 10.6%, and as an expense that accounts for more than half the gross margin, keeping this expense down relative to the gross margin is very good. The one place where they did not do so well is the general and administrative expenses which increased by 42%. Combined these expenses actually went up 20%, which exceeds the increase in sales revenue, but, because the margin was up 30%, it further leverage earnings.

The licensing part of gross margin declined by 6%. Overall the licensing revenue accounted for 2.67c/share of the income.

Earning before interest and taxes increased by a whopping 111%. This kind of number sounds great, but it means that earnings increased from $1.3 million to $2.7 million, or from 2/10ths of one percent of the market cap to 4/10th of one percent of the market cap. This is so far behind the rate of inflation, it is effectively a negative earning rate. It makes up for about 11 of the 19c eps, or 60% of the eps, before taxes.

What made up the other 40% of the EPS?


Taking a closer look at the earning for the year you find that the revenue was way more consistent than the earnings:


 2006  Q1  Q2  Q3  Q4
Revenue  8,760,380  10,025,978  10,200,843  10,047,925
Earnings  2,542 2,313,795   194,774 2,063,328
 EPS  $0.00  $0.10  $0.01  $0.08
 Using 3 s.f.
$0.000123  $0.0964  $0.0741 $0.0787 
Interest
12,710
100,637
438,958
912,557



What has happened in Q2 is a deferred income tax credit of $1,482,934, or $0.0618 per share, fully 34% of the earnings. This had come from a new equity issue, which leads to another significant portion of the earnings, interest!

The company issued new equity, and much of that was invested and has given interest income. Fully, 20% of the earnings is from interest, or $0.0371 per share.

Together the interest and the deferred taxes make up 52.4% of the earnings.

The are separate adjustment where taxes are paid and the deferred taxes are reduced, leaving $1,144,491 still outstanding, or $0.0465/share.

What would the growth look like without the equity offering?

Without the equity offering there would not be this enormous increase in interest. Based on Q1, there might have $50k of interest income for the year. There would also not be the enormous deferred tax item, and the eps would be less than the 11c eps without taxes calculated above.

I have no idea what taxes would be without the interest income and and with the increased earnings. Taxes paid were $50k in 2005. There is $150k payable liability on the 2006 balance sheet. It would be fair to expect earning to be $100k less due to taxes if the equity offering had not happened, or eps of about $0.10, or a 69% increase, still stellar, but about 1/3rd of the 217% growth.

The earnings per share from actual operations is about 4/10ths of one percent of the market cap. They rest is from a tax thing that can not be repeated, and interest.

The interest component is especially interesting to think about. They have gotten $28,113,000 from an equity offering which has enabled them to earn about $900,000 in interest, or perhaps 5-6%. Investors in the stock then essentially buy these earnings in the form of at a P/E of 136, or 0.7% eps or they are paying a 1200% premium for these earnings.

I repeat, Jones Soda made about $900k of interest, and investors have created $900*136 = $122 million of market cap for it!

Alternatively, say the allocation of market cap to the interest is at 6%, or $15 million of market cap. The deferred tax thing is not worth any market cap, so that leaves about $610 million of market cap for the $2.6 million of business earnings. It gives a P/E of 235. They need to increase the real earnings of the business at least 10-fold to catch up with the market cap.

What is the company doing with the equity?

It appears that they are preparing to expand directly into business rather than using their licensing option. There agreement with Target ended December 31, 2006, and with it goes some of that licensing revenue. They need to build replacement business for that revenue, and they have raised enough equity to expect to do that.

It took them about 6 years to double their revenue, excluding licensing. This stock is going to crash.

Attention getters for me:

As of December 31, 2006 we had 67 full-time employees.
Ok, so a lot of the business is through distribution, etc., but $623 million of market cap for 67 employees?

 To me it simply points to the degree to which the business is over valued. That's about $9 million of market cap per employee. It just gets my attention.

Net income for 2005 was $1,285,000 compared to net income of #1,330,000 for 2004. The decrease ... was primarily due to an increase in income tax expense (tax espense increased by 37k) and a smaller contribution from other income (interest income declined by 25k).


These same items are going to murder earnings in the future and if you've understood this post, you'll understand why.

7 Comments – Post Your Own

#1) On April 29, 2007 at 1:33 AM, GunLock123 (< 20) wrote:

Great analysis, Jones is way overpriced. As they switch to using cane sugar their costs will further rise and squeeze margins. The stock will underperform because of the incredible and unwarranted euphoria surrounding it but the underlying company might still be a good long term story.

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#2) On April 29, 2007 at 1:20 PM, dwot (41.80) wrote:

Thanks StockMeister.

 I didn't even consider that their costs would be going up from switching to  sugar.

 I looked at Coke and their costs of goods is way less than Jones, like around 1/3rd, or maybe 40%, so I figured that Jones might have some room to improve margins as their cost of goods is still more than half their costs.

 I figure it would take them at least 3-4 years to double again, and if they can keep their margin due to increased efficiencies, well, they'd be making about 20c/share from operations after paying taxes.

 I just don't give much weight to earnings from "other income" because it really isn't the business income and not separating it out in your considerations lead to dismal investment decisions.

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#3) On April 30, 2007 at 10:14 PM, ikkyu2 (99.29) wrote:

This is the best blog entry I've read on here.  Thanks for posting it.

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#4) On May 01, 2007 at 9:52 PM, btown819 (94.97) wrote:

I like the financial analysis, well done.  It's the work that users like you put into CAPS that make it all worthwhile. 

I agree, Jones is a bit over priced but I don't think it is as severely overpriced as many people think.  That said, there is no bargain here. 

 While informative to backout the interest from the equity placement, I believe it foolish to consider it as an indicator of earnings going forward.  The fact of the matter remains that they got a lot of cash a few months ago and presumably they are going to put it to good use, other than for interest income.

Looking beyond the numbers, the business itself is fantastic.  It seems the more visible short-term growth is something the Street [and small retail investors] have likely overpaid for.

 A couple of things that I think many people overlook is the significance of the deal Jones has with National Beverage.  All of these people keep crying "Wal-mart squeezes margins, wah wah wah!" and that Jones will take a hit.  While Wal-mart does squeeze margins, you have to realize that Jones Soda already offers some of the highest profit margins to retailers of any carbonated soda product.  The likelihood that Wal-mart or any retailer would demand even more of the pie from Jones doesn't look too likely in my opinion.  Second, Jones should benefit greatly from saved expenses related to capital expenditures they otherwise would have had to incur if it were not for the FIZ deal.  The cost savings Jones will realize from this should easily be enough to mitigate any margins driven earnings decline Jones would otherwise have to give up to Wal-mart to retain their profitability.

To summarize, while past business performance makes this stock look like it's going back to single digits, a closer look at major changes with the business likely suggest this is a $15 - $20 stock that is not as severely overpriced as most people would assume, but not necessarily worth adding to your portfolio at current prices either. 

 Keep in mind that lost licensing revenue from Target should now be replaced with sales of soda at Target via the concentrate. 4th quarter 2006 was the first quarter to include concentrate sales.  Although slotting fees and marketing expense has probably been omitted, we should still get a better idea of the gross margin effect on Thursday's quarterly conference call.  If this stock really does go back to single digits, I would jump all over it.  Not after it has doubled in price, "like Cramericans" tend to do.  

Based on my observations and recent news, I do not think Jones is going to have "mind blowing" earnings like many people have come to expect based on the stock price.  Jones will however, remain competitive and I think they are more likely to keep their prices more competitive with Coke and Pepsi to increase the value of their brand rather than to increase their margins short-term to please the impatient short-sighted citizens of Wall Street.

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#5) On May 02, 2007 at 12:23 AM, dwot (41.80) wrote:

 I think a look at their earning growth speaks as to how long it takes and how much has built into this stock.  I think about 10 years of growth... 

Year Revenue
1998 4,727,291
1999 11,086,450
2000 19,016,496
2001 23,615,911
2002 18,566,564
2003 20,100,864
2004 27,449,674
2005 33,511,053
2006 39,035,125
 

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#6) On May 04, 2007 at 9:07 PM, Greshm (97.17) wrote:

And today reveals...

Yet ANOTHER great call from dwot!

 

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#7) On May 20, 2007 at 11:39 AM, btown819 (94.97) wrote:

Dwot, I like your analysis but for various reasons I think this business may be an exception to what otherwise seems to be an absurdly overvalued stock [@ 21/share +/-]. 

I will check back for FYE 2007 and FYE 2008.  Unlike Greshm, I think it's a little too early to make conclusive judgment for or against JSDA after one or two quarters considering potential major changes to their business.  This includes a switch to the concentrate model, outsourcing the production of a new potential major product line, and possible use of PIPE capital to quickly accelerate rollout of other major product lines.

The use of the PIPE money is what I am interested in... if it is to be used to invest in projects, it is likely going to take much longer than two quarters to start realizing returns from those projects.  Likewise, it will likely take equally as long or more for the price of the stock to decline when the market realizes management may be sitting idle on piles of cash and decreasing value for shareholders due to the lost opportunity cost.

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