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Receivables Growth

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Yesterday, John posted a mailbag on receivables growth. Here is my take on receivable growth. Analyzing receivable growth on the surface may produce a lot false positives.

Here is an example of CVS's receivable growth, which was growing at a rate faster than sales for awhile. Is it a bad sign? On the surface I'd say yes, however, that has not been the case. CVS has two categories of products: front end (which are bottled water, cigarettes, etc..) - basic consumables and back end - legal drugs. Payers for the majority of consumables are customers which either pay cash, check or credit/debt card. It takes 1-3 days to collect on the payment made at the front end. However, on the back end the story is different, as insurance companies are the (most of the time) payers for pharmaceuticals. It takes substantially longer for insurance companies to pay pharmacies - 30 plus days.

As pharmacy (back end) sales were growing at a faster pace, they became a larger portion of the company's sales, thus driving up the accounts receivable days (accounts receivables were growing at a faster rate than sales). So in the case of CVS accounts receivables growth is not an issue.

You are raising a very interesting point, and you are right in principal that when revenue growth outpaces sales growth that could be a sign of trouble. As I remember DELL doesn't issue credit to consumers (I'm pretty sure I am right about it, but please check), thus even if you receive credit to buy a computer on DELL's website a finance company like (GE, MBNA (KRB), CapitalOne (COF), etc...) are usually generating the loan and taking a credit risk.

Also, often above average growth in receivables in one quarter is followed by below average growth in the following quarter as calendar timing often distorts things in the short run. I'd definitely yellow flag DELL's accounts receivables and try to get to the bottom of the issue, but don't assume right away that there is a problem. In the case of DELL I'd check if customer mix has changed, as it usually takes longer for business customers to pay their bills then consumers.

I always feel uneasy when a company finances its customers, as incentives become misplaced and the company may end up making bad loans to please Wall Street. Lucent (LU) was a major offender of financing not financially viable dot-coms to make its numbers - we know how it ended.

On the surface Home Depot (HD) numbers looks very suspicious, especially as HD's account receivable days exceeds Lowe's (LOW) by a large margin. I'd definitely check into that one.

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