One week ago, when the after hours algos sent INTC stock soaring on headline-scanning euphoria by nearly 10% to over $32/share, we did a snap analysis [5] showing that the only reason why Intel beat was because it literally used the oldest trick in the book: instead of its historical tax rate of 28.7%, the company "decided" that a 9.3% tax rate was more appropriate...
[6]
... as a result converting a 25% plunge in operating income into flat EPS. Subsequently the algos finally read what we posted, and as of this writing INTC stock was over $4 lower than those after hours peaks from last Wednesday.
Fast forward to today, when moments ago key Dow Jones component Coca Cola (KO) reported that non-GAAP EPS of $0.63 [7], beating expectations of $0.60 and, sure enough, sending its stock higher.
So we decided to take a look at these better than expected earnings and much to our dismay, we found that KO used precisely the same gimmick and yes, the algos fell for it all over again.
Here is how KO reported its Q2 income statement:
[8]
Here are the notable outliers:
- 3% drop in revenues
- 4% drop in Profit
- 20% drop in Operating Income
And yet... a 29% increase in pretax Net Income and a 21% increase in EPS.
How is that possible? The answer is highlighted in yellow: "Other [below the line] income" of $1.6 billion.
Here is how KO explains this unexpected boon to the bottom line:
Reported EPS was $0.71 and comparable EPS was $0.63. Items impacting comparability increased reported EPS by a net $0.08 and were primarily related to a net gain recognized in connection with the closing of the transaction with Monster Beverage Corporation, partially offset by costs associated with our previously announced productivity program. For additional details on items impacting comparability, refer to the Reconciliation of GAAP and Non-GAAP Financial Measures schedule
Ok, fine: so Coke did a perfectly acceptable below the line adjustment involving a non-cash benefit from its Monster deal.
We decided to track it down and for that we had to go to Coke's separately filed, 17 page long GAAP to non-GAAP reconciliation [9], one which puts even Tesla to shame.
This is how KO broke down the Monster adjustment:
[10]
And while the income statement bridge is once again perfectly legitimate if subject to management's non-GAAPy interpretation of reality, the one item that does stand out is Coke's revelation that its tax rate, or rather non-GAAP tax rate, is some 6% lower than where it should be: instead of 28.7%, which incidentally is what INTC's tax rate also should have been, KO used a 22.5% "effective" tax rate.
What does this mean? Well, if KO had applied the proper tax rate of 28.7% to its non-GAAP pre tax income of $3.6 billion, the EPS number it would get is not $0.63, but $0.58.
Why is this material? Because Wall Street's consensus estimate for KO EPS was $0.60, or right in the middle.
And that, ladies and gentlemen, is how both Intel and now Coca Cola used the oldest trick in the accounting book to "beat" EPS: by simply using an unrealistically low tax rate and hoping nobody would notice.
Still, even with this clarification out of the way, we are confident the algos will keep buying for one simple reason - the following line in the company's press release:
- We are now targeting full-year 2015 net share repurchases of $2.0 to $2.5 billion.
Because when the company itself is perfectly eager to continue squeezing shorts, there is no point in even attempting "price discovery."
