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London Biscuits: something seems wrong - M.A. Wind

Tan KW
Publish date: Fri, 08 Nov 2013, 01:09 AM
Tan KW
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Thursday, 7 November 2013

 
KiniBiz raised the red flag over London Biscuits latest audited accounts:

"Confectionary maker London Biscuits Bhd (LBB)’s latest annual audited accounts recorded yet another year of significant property, plant and equipment (PPE) acquisition cost, raising questions over its PPE expenditure which now averages RM63.64 million in the last five years.
 .....
 Additionally, the company has seen a net loss from PPE disposals for the past five years, recording a loss of RM1.76 million in 2013. Since it was listed in 2002, LBB has only seen a net gain from PPE disposals once in 2008, recording RM501,284."


I think that indeed the amount in PPE is worrisome. I have made a simple comparison between 2003 and 2013, all amounts in millions RM:

                   2003        2013
Revenue              53         290
PAT                   9          15
Depreciation          6          16
Dividend              2           1


PPE                  80         517
Shareholders Funds   71         299
Cash                 10          27
Debt                 36         263

Some observations:
  • Revenue is 5.5 times larger in 2013, but PAT has hardly grown
  • Dividend is even cut, to almost nothing
  • PPE has grown astonishing, 6.5 times larger
  • Shareholders Funds of RM 299 million looks impressive, but only RM 120 million is retained profit, money has been raised with the IPO, with Private Placements, Rights Issue, etc.
  • The growth in debt minus cash is highly worrisome
  • Although the company claims to be profitable, cash flow seems to be consistently negative
Two questions:
  • How is it possible that a company that claims to be profitable and hardly pays any dividend needs such a large debt?
  • How is it possible that the company needs RM 517 million PPE, to generate a revenue of only RM 290 million?
My guess is that this could all be caused by systematically understating of the depreciation on the PPE. My reasons for this:
  • In 2003 depreciation was 7.5% of PPE, but in 2013 only 3.1%.
  • In 2003 revenue was 66% of PPE, in 2013 only 56% (I would have expected the reverse pattern due to economy of scale, more efficient machines, etc.)
  • Almost all PPE disposals are done at a loss.
Too low depreciation would explain [1] overstated profits and [2] overstated value of the PPE

Ze Moolah has paid attention to London Biscuits, here pointing at the ever growing debt and here pointing at the ever growing PPE. The first warnings he wrote more than three years ago. Unfortunately (for investors in London Biscuits), it looks like he is right again.
 

 

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Discussions
1 person likes this. Showing 3 of 3 comments

kcchongnz

Ever wonder why the knowledge of financial statement interpretation is so important before one goes around punting stocks like London Biscuit, KNM,Amedai, etc?

2013-11-08 05:15

kcchongnz

One of my “favourite” companies , London Biscuits, announced its audited annual report for period ending June 30 2013 just a week ago. Revenue and earnings before tax improved by 14% and 32% to 290m and 18.8m respectively. What can I say except Wow!

With its closing price at 68 sen yesterday on 7th November 2013, and its earnings per share (EPS) of 9.15, PE ratio is just 7.4 and the price is just one third of its book value. Furthermore there is a dividend of one sen, not much, but there is still a dividend yield of 1.5%, better than nothing, right? Cash flow from operations is 18.5m, 122% of its net income, signifying a good quality earnings. Its net asset backing per share also increased from 2.05 to RM2.10 last year. So LonBiscuit must be a fantastic stock to invest in, isn’t it?

Wait a minute! If LonBiscuit is doing so well in its financial performance all this year (It has never made a loss for at least 9 years already), why is its net borrowing keeps on increasing every year constantly from 172m three years ago to 236m now? And this is despite that cash calls have been made and the number of shares outstanding have also increased steadily from 96m to 142m now. Didn’t I mention that the cash flow from operations is good? But where has the cash gone to?

Yes, some people must have guessed it correctly, all money from operations have gone to capital expenses, buying property, plant and equipment (PPE) as required for the operations. Buying PPE for the operations, are you sure?

Capital expenses is good for sustaining and growing the earnings power of a company and hence should be viewed as a good capital allocation. But LonBiscuit spent an average of 47m a year for the last 9 years to buy PPE, and yield an average net profit of just 14m. It is not hard to see why the total debts of the company has grown to such a magnitude at 63% of its equity now. Why would a business like that require such a relatively huge amount of capital expenses? What kind of shareholder value has this capital expenses created?

A company can raise cash from shareholders, borrow from banks etc and increases its earnings. However this money must provide a return higher than its cost, otherwise it destroys shareholder value. The return of equity last year was only at 4.2%. Are you willing to invest in a company like this with so much risks but just yield a return of capital of just 4.2%? By coincidence the return of invested capital of LonBiscuit was at the same magnitude last year. This brings out the question that why would investors want to put in money for such a low return but with so much risks.

However, a bad company can still be a good investment if its price is right. At a PE ratio of 7.4 and if you flip it over you get an earnings yield of 14% which appears to be good, but is it?

LonBiscuit has a lot of debts. A proper measure should be its enterprise value, which includes all debts and minority interest. At this price of 68 sen and its debt level, LonBiscuit is selling at an enterprise value of 12 times its earnings before interest and tax. This is way above my requirement of 5 for a company with those metrics mentioned like LonBiscuits.

Actually the worst part of LonBiscuits is its extreme poor free cash flow which is negative every year without fail. Ever wonder where the dividends to the shareholders come from now?

Worse still, it is believed that instead of concentrating in doing business well, the management could be speculating from buying and selling of PPE. It is also probable that there is element of financial shenanigans in the manipulation of its financial statements.

If one does a risk checking with an Altman Z-Score or Pitroski Screen test, I am very sure that he would run far away from investing in London Biscuits.

2013-11-08 08:24

htyeap125

KCchongnz, really your effort in providing such detail analysis to all of us, TQ

2013-11-08 08:38

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