CXDC Why China XD Plastics May Be About to Take Off
By Seth Jayson
January 9, 2012
Here at The Motley Fool, I've long cautioned investors to keep a close eye on inventory levels. It’s a part of my standard diligence when searching for the market's best stocks. I think a quarterly checkup can help you spot potential problems. For many companies, products that sit on the shelves too long can become big trouble. Stale inventory may be sold for lower prices, hurting profitability. In extreme cases, it may be written off completely and sent to the shredder.
In this series, I examine inventory using a simple rule of thumb: Inventory increases ought to roughly parallel revenue increases. If inventory bloats more quickly than sales grow, this might be a sign that expected sales haven't materialized. Is the current inventory situation at China XD Plastics (Nasdaq: CXDC ) out of line? To figure that out, start by comparing the company’s inventory growth to sales growth.
How is China XD Plastics doing by this quick checkup? At first glance, pretty well. Trailing-12-month revenue increased 55.6%, and inventory increased 10.5%. Over the sequential quarterly period, the trend looks worrisome. Revenue grew 17.7%, and inventory grew 59.7%.
I don’t stop my checkup there, because the type of inventory can matter even more than the overall quantity. There’s even one type of inventory bulge we sometimes like to see. You can check for it by examining the quarterly filings to evaluate the different kinds of inventory: raw materials, work-in-progress inventory, and finished goods. (Some companies report the first two types as a single category.)
A company ramping up for increased demand may increase raw materials and work-in-progress inventory at a faster rate when it expects robust future growth. As such, we might consider oversized growth in those categories to offer a clue to a brighter future, and a clue that most other investors will miss. We call it "positive inventory divergence.”
On the other hand, if we see a big increase in finished goods, that often means product isn’t moving as well as expected, and it’s time to hunker down with the filings and conference calls to find out why.
What’s going on with the inventory at China XD Plastics? I chart the details below for both quarterly and 12-month periods.
Source: S&P Capital IQ. Data is current as of latest fully-reported quarter. Dollar amounts in millions. FY = fiscal year. TTM = trailing 12 months.
Source: S&P Capital IQ. Data is current as of latest fully-reported quarter. Dollar amounts in millions. FQ = fiscal quarter.
Let's dig into the inventory specifics. On a trailing-12-month basis, raw materials inventory was the fastest-growing segment, up 70.2%. On a sequential-quarter basis, raw materials inventory was also the fastest-growing segment, up 80.4%. China XD Plastics may display positive inventory divergence, suggesting that management sees increased demand on the horizon.