Tuesday, July 16, 2013

Company: Pharmaniaga Bhd

This is a classic example of why we need to be more careful in reading financial statements.

The numbers and indicators above paint a positive picture of recent performance of the company:
  • Healthy growth in revenue, profits and earnings per share ("EPS")
  • Growing shareholders' equity and net assets per share
  • Growing dividend per share
  • Improving profit margin since 2010

Things seem perfect.

But if you analyze its Balance Sheets, it gives you a different picture.

Pay attention to the changes in balance sheet items.

The working capital in total, i.e. inventory ADD trade debtors LESS creditors (I+D-C), increased more than RM300million or by 576% since year ended 2010!
  • Inventory turnover deteriorate from 71 days in 2010 to 102 days in 2012. The company needed to fund the inventory, in year ended 2012, twice the size of that in year ended 2010. (2012: RM465million, 2010: RM230million)
  • Net profits for financial year 2011 and 2012 are RM52.8million and RM63.2million respectively. In total, RM116.0million. The working capital I+D-C increased by RM305.2million from 31 Dec 2010 to 31 Dec 2012. This means profits did not turn into real cash but merely used to accumulate inventory.
  • The revenue growth was in the range of 10% - 20%, but the working capital (I+D-C) growth was 366.9% in 2011 and 44.8% in 2012

In fact, the company turned from net cash position of RM69.9million in year end of 2010 to net debts of RM306.5million in year end of 2012. It was a deterioration of RM376.3million!

Large borrowings in year end of 2012.
EDR of 59:41 is beyond my comfort level of 70:30 to invest in the company's shares.

With deteriorating gearing ratio and bloating inventory, it is only natural for me to have doubts like
  • Is the profit real since the company generate little cash flow from operations? 
  • Any problem with inventory valuation? or any problem in manufacturing or planning that caused a high inventory book value?
  • With such gearing and cash flow, is current dividend payout sustainable?
  • Current trend of cash usage is definitely not sustainable, when will there be a reversal of trend?

In 2013 Quarter 1 results, the inventory level did improve a little. The net borrowings position improved marginally to RM304.3 million. The overall picture in Q1 2013 stayed the same.

As investor, we have limited bullets (limited cash available for investment). We need to be selective. There may be many good reasons or exciting growth stories of why the Company's balance sheet should be like this for just a while. But it is not important, because it means uncertainty. And that there are other listed companies that give a positive, crystal clear AND consistent picture of its financial affair, available in the stock markets.

I remind myself of my investment objectives:
  • There are other listed companies that shows growth, positive cash flow and with healthy gearing. So I don't need to jump into such uncertainty of outcome investing in this company
  • I am looking for Company with business that can sustain a growing dividend to its shareholders
As such, I am looking elsewhere and not dwelling into valuation of the shares.