Red Flag Report: Alternative Fuel Mixture Credit (AFMC) Windfall

The second report in our Red Flag series focuses on a little-known earnings Windfall in the Paper and Products Industry. This report is another example of the deep analysis New Constructs performs on all 3000+ companies under coverage.  Our expertise is in navigating poor and confusing disclosure in the Financial Footnotes to find the truth about corporate profitability and valuation. Our focus is not just on accounting loopholes that affect all companies but loopholes that affect ANY company. Indeed, this report covers only 16 companies but the adjustment we make for the Alternative Fuel Mixture Credit (AFMC) Windfall wipes out 161% of the reported pre-tax income of the companies involved. Below are highlights and some background info from our free report (request access via research@newconstructs.com) on the Alternative Fuel Mixture Credit (AFMC) Windfall.

• The Alternative Fuel Mixture Credit (AFMC) Windfall is non-recurring income in the Paper Products Industry that can mask poor economic earnings with record-breaking accounting earnings.
• 16 companies reported an AFMC Windfall in 2009, averaging 8% of revenues. Figure 1 shows the impact on five companies.
• Disclosure of the AFMC Windfall is highly inconsistent. Two companies received a failing grade. See Figure 4 for a sample of five AFMC Windfall Disclosure Grades. Buy our Premium Report for all 16 Disclosure Grades.
• Buy our Premium Report for an example of aggressive and misleading accounting for the AFMC Windfall.
• See all 16 companies’ detailed Overall Risk/Reward Ratings in the Premium Report.
• All our 3,000+ models include vital data like the AFMC Windfall that is scoured from the Financial Footnotes.

Background on the Alternative Fuel Mixture Credit (AFMC) Windfall

During 2009, paper companies that converted black liquor (a byproduct of paper mills) into alternative fuel became eligible for an Alternative Fuel Mixture (AFMC) tax credit. The tax credit was an unexpected boon for paper companies. Sixteen paper companies reported an AFMC Windfall in 2009, averaging 8% of revenues and 161% of pre-tax income. The tax credit lasted for less than a year-—it expired on December 31, 2009.

The AFMC Windfall is a one-time, non-recurring source of income that can mask poor economic earnings with record-breaking accounting earnings. Accounting earnings are full of distortions that mask true economic earnings—-the AFMC Windfall is just another example of why accounting earnings were not designed for equity analysis. See economic versus accounting earnings and our chapter in the Valuation Handbook (Wiley Finance, 2009) for more details.

The AFMC offers a unique opportunity to assess the consistency of companies’ accounting treatment and disclosure of this one-time item. We expected to see similar accounting treatment and disclosure, but the companies’ disclosure was highly inconsistent, and in several cases, highly misleading.

We provided the Senate Banking Committee a list of companies that commit Corporate Disclosure Transgressions (request access to this report via research@newconstructs.com).

Of the 16 companies receiving the AFMC Windfall, one company chose to capitalize part of the AFMC Windfall into inventory. This aggressive accounting essentially gives the company a cookie jar of earnings to use next year. Despite the fact that the AFMC expired on December 31st, 2009, this company’s aggressive accounting will allow it to book $0.31 in earnings per share in 2010 related to the Windfall. This company is the only company in 2010 to book earnings from 2009’s expired AFMC Windfall. It should be no surprise that this company also had the worst disclosure. As Warren Buffett says, “There is never just one cockroach in the kitchen.”

Download the Free Report for more details. The Premium Report contains detailed information and case studies on misleading earnings, poor disclosure, and aggressive accounting.

Poor disclosure and aggressive accounting make it extremely difficult for everyday investors to reverse accounting distortions to measure a company’s true economic earnings. Our expertise is in navigating poor and confusing disclosure in the Financial Footnotes to find the truth about corporate profitability and valuation. All our 3,000+ models include vital data like the AFMC Windfall that is scoured from the Financial Footnotes.