Inventory is made up of raw materials, works in progress, purchased components, and finished goods.
If you take a look at the area I highlighted, the latest quarter is showing a disturbing difference compared to the same period over dating back 10 years.
The last time there was such a drop in works in progress was back in 2004. Seagate Technology PLC (NASDAQ:STX) was making more products even during the recession. Is this what Chanos was talking about?
Now that finished goods for the latest quarter is up 94% compared to one year ago, the next few quarters will be a telling sign depending on whether the inventory sells.
Here is another look by reviewing the quarters sequentially.
The way the inventory line items integrate with each other is like this.
Company buys raw materials when prices are cheap or when there is an expected increase in orders and sales
As orders come in, “works in progress”.
Finished goods decrease as it is sold off and then replaced with new inventory once the works in progress products are complete
Additional interpretations to know:
Raw materials up, works in progress up, finished goods same or down = Good sign. More orders are coming in. Company is selling quicker than they can make.
Raw material up, works in progress up, finished goods up = Need to watch. If the following quarters continue to show finished goods going up, then that’s bad as the company can’t sell its inventory or is making too much. On the flipside, if finished goods go down, then it has become a good sign.
Raw materials down, works in progress down, finished goods down = Bad sign. Business is slowing down. Could be cyclical, but expect lower turnover or sales.
Raw materials down, works in progress down, finished goods up = Horrible sign. There is a glut of inventory that needs to be cleared. New orders are not coming in and current inventory will likely be sold off at a discount.
Applying this interpretation to Seagate Technology PLC (NASDAQ:STX), the line that draws my eye is works in progress. Compare it to the previous periods and there are big differences.
When it comes to inventory for Seagate, Chanos may be onto something, but there is nothing concrete at the moment.
Accounting Manipulation Checks
Running a quick earnings manipulation check via the Beneish M score, the score comes out to be a solid -3.03.
While the Beneish score or models can never replace a thorough and manual investigation, a cursory look reveals that Seagate doesn’t have any earnings manipulation factors to worry about.
If you are adventurous, here is a list of 52 techniques you can perform for detect financial manipulation.
Is Chanos Right or Wrong?
It is too early to tell.
Because it seems like he is shorting based on a top down approach, we’ll see whether his thesis plays out. I’m just not in the game of predicting industry trends.
If Seagate Technology PLC (NASDAQ:STX) was showing fundamental flaws and a breakdown in fundamentals, then it could be come a compelling case, but Seagate does not fit into a value trap mold or one to short at this time unless you have deep pockets and can ride out margin calls.
This article was originally written by Jae Jun, and posted on OldSchoolValue.
