Micheal Teo

Hup Seng biscuits is performing fine but not London biscuits...Perhaps, should renamed Holland biscuits. Ha 3!

2013-11-08 16:38

kcchongnz

I have written many articles in i3 on how I pick stocks based on the value investing strategies on good companies. This is one of the very few articles I have written on how not get yourself into a murder hole. To me this type of knowledge is at least equally important, if not more important than those I wrote about picking the good stocks for newbies who wish to have a reasonable return from investing in the stock market with less risks.

I first bought London Biscuits three and half years ago on 7th April 2010 at RM1.16. I read about it in a finance blog where people were bragging and chanting about their prowess in making money from day trading in the stock market. At that time, I already have high qualification in finance and investment (just to show a high qualification even in finance means nothing in the real world investing). However I lacked the real experience in the real world. I bought London Biscuits based on a single metric which most people used, if ever, that is the PE ratio.

At RM1.16, the PE ratio of London biscuits was about 7, P/B of 0.5 and the dividend was 4.5 sen, or a dividend yield of 3.9%. Was that a good investment? Four and a half years have passed and London biscuits share price closed at 71.5 sen now for a loss of 40 sen, or about 35%.
KLSE has risen from 1334 to 1804, also 35%, but the other way round. The net loss is a whopping 70% compared to KLSE!

Exactly on the same day on 7th April 2010, I bought Kumpulan Fima at RM1.08. With all the dividends through the years, Kumpulan Fima has easily more than double in return on investment.

What has gone wrong with London Biscuits?

For the performance of London Biscuits in 2010, its return of equity (ROE) and return on invested capital (ROIC) was at 7% and 6% respectively, way below the costs of its capitals; warning number 1.

The low ROE was achieved with high financial leverage of 2 with a high debt-to-equity ratio of 0.6 and solvency ratio way below the minimum of 1; warning number 2. The net borrowings have been increasing all the years then; warning number 3. It has negative free cash flow, just like the years before it (and also after that); warning number 4.

At RM1.16 then, the PE ratio of 7 appeared to be low. However, I failed to look at the more important number, its enterprise value as London Biscuits has huge borrowings. The enterprise value was 12 times its earnings before interest and tax, exactly the same as it is now, warning number 5.

At that time the management, instead of focussing on its business, has already been playing with the property, plant and equipment, and fiddling with all the numbers without me having a clue about it; warning number 6.

Furthermore as I have mentioned, so many people were bragging and chanting about London Biscuits then; warning number 7.
As I have mentioned, a simple check with Altman Z-Score of just 1.2 (<<minimum 3) would have shown the risk inherent in investing in this stock then; warning number 8.

Despite with the high qualification in Finance I have then, I still didn’t see all these warnings. So what does it tell you? What valuable lessons has one learned?

2013-11-08 18:20

sense maker

This company was called Chocolate Product in 1990s, I think.

2013-11-08 19:08

ipomember

thumbs up for you kcchong, indeed a good points mentioned by you

2013-11-08 19:10

yungshen1

how about knm pe ration. roe , debt ratio

2013-11-08 19:24

東风

Thanks KC

2013-11-09 00:57

kcchongnz

Posted by scjm3 > Nov 8, 2013 07:02 PM | Report Abuse

hi kcchong, you are very detailed in your analyses, as usual. here i could think that one very good indicator is to check on the company's cash flow. if it is negative, it showed that its management has failed miserably to manage its working capital properly with receivables being way too high than liabilites. and to aggravate the matter, borrowings had to be topped up continuously to cover the widening deficit as a result of the 'growing' business.
guess one has to be vigilant at all time and look for signs of weakness as numbers could be easily cooked up or covered up to present a purportedly nice scenario.

scjm3, happy to see your comments. Poor free cash flow for the initial stage of fast growing small companies is all right to me. They need capital to grow and expand their business. However, negative cash flow from operations due to heavy build up of inventories, receivables is not acceptable for me. Even for free cash flow, companies must eventual make positive FCF, otherwise it makes no sense investing in that company because either you have to put in more money, or keep on borrowing money from banks for the business. Persistent negative FCF due to heavy and continuous capital expenses is not a good business to invest in. It is risky. Most companies failed not because of poor earnings, but problems with cash flows.

The capital expenses you made for the business must yield return which is higher than the cost of capital. London Biscuits marginal ROIC of just 4% is really pathetic, and it is not even half the cost of capital. It is a very poor allocation of capital on the management's part.

Yes, I do notice a lot of cooking of numbers, not only cooking in the income statement and balance sheet. It happened also in cash flow statement, especially for companies with auditors of small accounting firm. It is a jungle out there.

2013-11-09 08:06

bsngpg

Hi KC Chong : Sorry to you and others for my interruption on your topic on L.Biscuit but this is the way to ensure you receive my message.
I saw some very high quality discussions on thread on “How to become super investor”. I always see you as one of the member of that league. In this case, you may not agree with Mr Koon on JT, but I opine that your participation surely can spark the discussion further. Please consider to drop in. There must be a great fun for you and readers as me.

2013-11-09 08:43

bsngpg

大佬: I removed the last sentence from the earlier post as it is inappropriate. This is a re-post.

2013-11-09 08:46

RonnieKimLondon

Thank you for sharing. You are a very intelligent and meticulous analyst/investor.

2013-11-09 09:25

bsngpg

KC Chong大佬: you see, beside me others also see you in that league too. Your name has appeared on that thread already. 来吧, 朋友, 不少人在等你.

2013-11-09 09:37

inwest88

bsngpg - agree if kcchong can come in with his views. The only concern, which I thinks he feels the same. would invite unnecessary remarks (cynical/sarcastic) from others as not all behave courteously or gentlemanly. Some gets personal.

2013-11-09 09:44

bsngpg

inwest88: Agreed and unfortunately that his critic is there since last night. Anyway, KC has used to him and know how to handle. In my thought, the biggest hindrance is that KC disgrees with JTiasa at all.

2013-11-09 09:59

bsngpg

Even you disgree with JTiasa, many would like to hear your voice too. The more voices from difference views, the healthier the discussion. 来吧, 朋友.

2013-11-09 10:02

yungshen1

knm PE ration is 5.7 .u use rm 5 to earning rm1 that is good.

2013-11-09 10:28

kcchongnz

yungshen1, I have commented about KNM numerous times in the KNM thread which some of them as requested by you and most of them you have read. My view on KNM has not changed a bit.

You must understand what is this E is the PE ratio. It is not what you earn in the real sense. E is an accounting number. It could mean all sorts of things, definitely not what you "earn".

Go check again on my comments what is this "E" for KNM in that thread.

2013-11-09 10:45

tsurukame

E for KNM means Earnings from Accounting Treatment ...not earnings derived from operating a fabrication business...If KNM truly produce great earnings from fabrication business operations then it is worth revisiting this stock...

2013-11-09 11:33

kcchongnz

Good news, London Biscuits (LonBis)is seeking mandate for buying back its own shares in the coming AGM.

http://www.bursamalaysia.com/market/listed-companies/company-announcements/1483769

Company uses its free cash flow from its ordinary operations to buy back its own shares to reduce the number of outstanding shares in the market when it is selling at a discount. This increases its earnings per share (EPS) and hence good for shareholders. So great job by the management, or is it? Let us see where does LonBis gets its money to buy back shares.

Last financial ended 30/6/13, LonBis made a net profit of 12.4m. Yeah there is money to buy back shares. Are you sure? The net inflow of money (collected from debtors and paid creditors), or cash flow from operations (CFFO) is 18.4m. LonBis had to pay a interest of 12.2m for its loan of 263m from this amount, leaving behind 6.2m. It then spent 22m to purchase property, plant and equipment (PPE). So it needs 15.8m from somewhere just for capital expenses. It has to get money just to do that. Where do they get money to buy back share? May be it has heaps of money in its balance sheet to do that. Let us see.

As mentioned, it has a total 263m debts, or a high of 63% of its equity. Its solvency risk is so high with current ratio of just 0.6. So want to borrow more to buy back its shares, or are they intending to call for a right issue to do that? By the way, is its share cheap?

At the close of 68.5 sen today (5/12/13), it is trading at a PE ratio of 8 times. Isn’t that cheap? Not until you realize that it has huge debt as discussed above. In term of enterprise value (EV), it is trading at an EV of 12 times it earnings before interest and tax. Is that cheap?

With the kind of poor quality earnings, precarious balance sheet, and consistently negative free cash flows for donkey years, I won’t even pay an EV/Ebit of 2 times!

What kind of management LonBis has? Instead of wasting your time preparing the document and talking nonsense about share buyback, why don't you spend time improving your business?

2013-12-05 18:03