Whirlpool's Earnings Are All Wet

Give Whirlpool's (WHR Quote - Cramer on WHR - Stock Picks) earnings a good wash and they could shrink like a mohair sweater that's been through the hot cycle.

The home appliance maker posted $162 million, or $2.40 a share, in so-called core earnings in the first half of this year. These profits have convinced many that Whirlpool is righting itself after hitting a number of bumps in its ambitious, decadelong global expansion. But core profits could be 25% lower if income is excluded from two arguably nonoperating sources: Brazilian tax breaks and the company's pension plan.

The Up Cycle Whirlpool's 12-month climb

And there's more earnings noise. Currency movements are helping Whirlpool make strong profits from its Latin American operations. Next, the regularity with which the company takes restructuring charges is leading some to wonder whether operating expenses are being buried in these charges. Finally, question marks hang over Whirlpool's unusually high level of short-term borrowings.

Whirlpool finance chief Mark Brown defends the quality of the company's earnings and its borrowings, and dismisses the allegation that core expenses have been tucked into restructuring charges.

At first glance, the stock, trading at 11.5 times expected 2001 earnings of $5.41, appears cheap. However, if the noise is a sign that recent earnings performance isn't sustainable, and a profit warning ensues, Whirlpool's 12-month rally could easily reverse itself.

And some on Wall Street are uneasy. "Our basic issue with Whirlpool is that it's being more than a little creative in representing ongoing sustainable earnings," says Nicholas Heymann, appliances analyst with Prudential Securities. (He rates Whirlpool sell and his firm doesn't do underwriting.)

Creativity

Let's crunch some numbers. First, the Brazilian tax credits. These added about 28 cents to per share core earnings in the first half. Higher-than-expected returns from the company's pension plan yielded an additional 30 cents to core earnings. Brown says the tax credits are used to reduce the overall tax burden in Brazil. To the extent that these taxes can be considered operating expenses, a reduction in them should be considered as part of any calculation of operating earnings, he says.

As for the pension benefit, Brown says: "It's great to have," adding that Whirlpool's decision to include it in core earnings is standard practice at many other companies.

Through the Roof Cash flows from short-term debt*

Source: Whirlpool financials. *Cash flows from short-term borrowings and repayments done each quarter -- not short-term debt outstanding.

Whirlpool also reduced its provision for trade receivables that may not get paid, by $40 million in the second quarter, from the year-ago period. That reduction could be translated into a hefty 32-cent benefit to second-quarter earnings. But Brown says Whirlpool is justified in bringing down its provision, both in dollar terms and as a percentage of receivables. "We are very comfortable with our balance sheet reserves," he says.

Question of Timing

Whirlpool has taken at least four restructuring charges since 1994. The most recent is being applied this year and could end up equivalent to as much as $2.90 a share, well in excess of first-half earnings.

Charges of that size always raise eyebrows because companies have been known to wrap some core expenses into them and thus boost earnings. Says Brown, "We never have and never will do that." But it's not just the size and regularity of the charges, but also the way they're taken, says Prudential's Heymann. He notes that Whirlpool doesn't say how much of a quarterly charge it's going to take and what it's for -- until the charge has been taken.

Often, companies will give investors details in advance of how a big charge is to be broken up over a number of quarters, and will frequently outline reasons behind each installment. Whirlpool's method has generated suspicions that the company is tweaking quarterly charges to meet earnings expectations. But Brown explains that the company has taken this approach recently because it wants Brazilian workers affected by downsizing measures to know about them before they are flagged in press releases to financial investors.

Blowout second-quarter numbers in Whirlpool's Latin American operation also are generating skepticism. Operating profits from the region jumped a massive 35% from the first quarter. The operating profit margin of 9.1% was the best since the fourth quarter of 1999, according to Heymann. Brown attributes the strong performance partly to operating improvements, like expense cuts, good sales and the ability to price products at reasonable levels.

However, he also says the weakness of the Brazilian real also helped. Why? Because the weaker currency allows Whirlpool's manufacturers to export more goods. Exported sales are denominated in hard currencies like the dollar, while the costs of making the goods are denominated in real. Hence, the top line goes up while costs are lower in dollar terms. Brown declined to break out the respective contributions to Latin American profits of currency movements and operating factors.

Lend-Lease

Finally, what to make of the enormous short-term borrowings and repayments Whirlpool carries out each quarter? The company borrowed $10.2 billion in the second quarter and paid back $10.4 billion; both sums are up more than $2 billion on first-quarter figures. The basics of the business don't seem to warrant this level of borrowing, considering that Whirlpool has quarterly sales of about $2.6 billion and inventory of $1.1 billion. Moreover, compare it with Maytag (MYG Quote - Cramer on MYG - Stock Picks), which had short-term debt repayments in the second quarter of only $190 million, and no borrowings. Its second-quarter inventory was $419 million on sales of $1.1 billion.

Could Whirlpool be borrowing and repaying these large sums to finance nonoperating speculation, as its Brazilian operations used to do in the mid-'90s? Brown denies this charge and says the debt is commercial paper of maturities of between one week and 30 days. The advantage of rolling over large amounts is to be able to borrow at the very low interest rate that exists on CP, he says. This CP strategy suits Whirlpool's capital structure and the ratings agencies are fully aware of it, Brown adds.

The next few quarters will be tough for appliance makers as the global economy slows. Interesting to see what comes out in the wash.