[London Biscuits writes off receivables of RM363 million

Dear KC,

You saw this happening years ago during our class. i m one of many that benefitted from your FA approach. Thank you again!]

The share price of London Biscuits was practically staying at about 60 sen for the last few years from 2015 and dipped below 40 sen in April 2018. It mystically rose back to 60 sen on February 8, 2019, and then plunged to 5 sen upon announcement of its default of a mere RM9m bank loan. Owing to this, London Biscuit had gone into the PN17 status, and a liquidator has also been appointed. London Biscuit’s share price rose up again to close at 9 sen at the end of November 2019. Figure 1 below shows the share price movement of London Biscuit in the last 5 years.

Figure 1: Share price movement of London Biscuit

London Biscuit announced its final quarter result for FY2019 on 30^th November 2019. Owing to an impairment loss in Receivables of a whopping RM363m, it made a loss of RM443m, or RM1.52 per share. This wiped up its equity completely, resulting with a deficit of 25 sen per share. London Biscuit has gone to Holland with a one-way ticket.

Could this be foreseen years ago? Could investors avoid huge losses?

Many years back since the year 2013, London Biscuit has been used as a real-life stock for case study in my fundamental investment course on how to identify a lemon in stock. An exercise was given in the course with its 10-year financial statements. I searched the old record and here is a detail analysis from one of the course participants. This is an interesting to learn so that one will not repeat it.

Cash Flow Analysis for London Biscuit

The Statement of Cash Flows is arguably the most important of the three major financial statements. It tells us how much cash a company is able to generate from its operating, investing and financing activities.

Cash flow from operating activities

The cash flows from operating activities is the more important of the three cash flows statement as it shows how much cash inflow and outflow from operating its core business. Please note that we should look at the “net cash flows from operating activities”, or CFFO, the last line in the statement, as this as you can see from the statement, it belongs to the equity shareholders, which we use to compare with the net income, which is also the final amount due to the equity shareholders, to be consistent. As share investors, this CFFO is what we are interested in.

Table 4 in the Appendix shows the three cash flows statements of London Biscuit from 2006 to 2016.

The cash flow statements of London Biscuit shows that after adding back depreciation and amortization and other non-cash and non-operating items, and adjust the change in working capital etc., London Biscuit generally has positive Net Cash Flows from Operations (CFFO) close to or above Net Income attributed to common shareholders, except for the year 2011 and 2015 as shown in Table 3 in the Appendix and Figure 1 above. The company experienced a major dip in CFFO when its CFFO plunged into negative RM19.5million in 2011 due to the huge increase in Receivables of 30.3m, increase in inventories of 4.8m, and decrease in Payables of 15.9m.

The company managed to reverse the situation in the following year by successfully collecting the outstanding Receivables and reduction in Inventories and achieved a record high CFFO of RM50.2million in 2012. CFFO returns to a normal level of RM18.4million in 2013 and 12.1m in 2014, about the Net Income.

However, CFFO for the financial year 2015 plunge into huge deficit again of RM29.4m. This is due to the huge and abnormal 72.6%, or RM79.3m increase in trade and other receivables as shown in the balance sheet, when the revenue increases by only 12% from 2015 to 2016. It has not enough cash from the operation even to fund its operating costs. Note we haven’t even talked about where to find money for its persistent huge annual capital expenses yet. Fortunately, CFFO in 2016 improves to positive RM21.6m due to a little improvement in less increase in Receivables.

Let’s have a look at the Cash Flow from Investing Activities (CFFI) and see how the company spends money in its investment activities.

Cash flow from investing activities

Table 1: Expenses on property, plant and equipment

Table 1 above shows that Company seems to be playing a game in buying and selling of property, plant and equipment (PPE} throughout the years. For example, in 2010, the company spent a whopping 47.7m in purchasing of PPE, and then followed by selling of 16.4m of PPE in 2011. It appeared that it has been doing it all the time. It purchased a whopping 91.7m in PPE in 2012 when it had the highest level of CFFO, again sucking huge amount of cash resulting huge negative FCF of RM41.5m. And what kind of net income resulted in the following years? A meager net income of average of 16m in the following years, with 91.7m in capital expenses?

In the year 2015, the situation worsens with even CFFO plunging to an incredible huge negative CFFO of RM29.4m, due to the sharp increase in receivables as you may recall from the previous exercise on its balance sheet, and yet the company spent another RM21m in purchase of PPE, resulting the highest negative FCF, or cash flowing out, for the last 10 years of a whopping RM49.3m!

In the year 2015, the company earned RM18.2m, but huge cash amount of RM49.3m came out from the company. This is not the only year of exception as it has a number of years similar like this. Can you see the elephant in the room?

Most of the time, its net capital expenses are way higher than its net income. As shown in Table 1 above, in the last 11 years, it has acquired a total PPE of RM388m, during which it only made a total net income of just RM171m, or a total CFFO of just RM166m, both less than half the amount it spent on capital expenses alone. It also sold almost RM100m in PPE.

Is biscuit making its core business or buying and selling of PPE its core business? How come Co A in my previous analysis that Apollo Food only required a faction of London Biscuit’s PPE to do similar business and have much better income and cash flows?

In the last 11 years, the company was bleeding cash like there is no tomorrow. A total of RM125m cash flowed out from the London Biscuits shown in Table 1 above, despite it making “profit” every year. Still can’t see the elephant in the room?

Free cash flow (FCF) is the lifeblood of the company. It provides the fund for the company  to pay dividends, buy back shares and reduce debts. Without positive free cash flow, the company will have to resort to asking money from shareholders in the form of right issues, and increasing debts, even for the normal operations of the company. That is exactly the dilemma of London Biscuit,  and what the management has been doing; issued more shares and diluting earnings per share, and borrowing more and more as you have seen in the previous exercise of its balance sheet.

Not only that, the management of the company is also fond of investing in other businesses they were not familiar with and resulted in heavy losses. For the last 11 years, it has spent 50m acquiring subsidiary and associate companies, and subsequently dispose of at 27m, causing a loss of 23m as shown in the cash flow in investing activities.

Cash flow from financing activities

The persistent negative free cash flow is why the company has to get more money from shareholders and banks every year as summarized in Table 2 of cash flow from financing activities below.

Table 2: Cash flow from financing activities

With negative FCF, London Biscuit must continuously borrow money from the banks. Net borrowing has increased by 180% from RM91m in 2006 to RM255m in 2015, down a little to RM204m in 2016. This is despite that share capital has also increased by a large amount of a total of RM116m to RM187m now as shown in its balance sheet. It is unable to pay dividend from internally generated fund. Dividend has decreased hugely from 15 sen per share 11 years ago to nothing now. With poor FCF, London Biscuit has to resort to continuously asking more money from shareholders from rights issues or private placements and as a result increased in the number of shares, and diluting earnings, and borrowing more from banks to carry on its business with increasing amounts as shown in Figure 2 below.

This obviously is a not a good business to get involved in. But how come Appollo Food with the same business can do so well as shown in the previous post in our blog? Hence, it is not the poor business they are in, rather it is the capability and credibility of the management.

Net Cash Flow

Table 3 below shows the summary of cash flows.

Table 3: Net Cash Flow for 2016

Table 3 above shows there is a net cash surplus of 32.2m for 2016, mainly due to additional borrowings.  As investors, we want to see cash surplus and increase in cash in balance sheet from cash generated from the ordinary operations, and not from additional money fork out by themselves, or additional borrowings.

With cash at the beginning of the year of 13.756m, at the end of the year, cash is increased to RM45.963m. This includes RM22.047m from bank overraft. The cash and cash equivalent in the balance sheet is RM23.916m.

Conclusions

Earnings is important. But earnings, or earnings growth is useless if it is not converted to hard cash. Even good CFFO is deceiving as shown in LonBis’s case, as it constantly requires high capital expenses which “eats up” its cash.

Without free cash flows, a company just doesn’t have internally generated fund to do its business, and have no choice but to resort issuing more shares and hence diluting earnings per share, or continue to borrow money and resulting the company under higher bankruptcy risk.

When in doubt with the capability and credibility of the management in managing its cash flow, just walk away. This is the kind of lemon an investor must avoid at all costs in order not to jeopardise his overall investment return. This stock of this company is one I won’t touch with a ten-foot pole.  

Appendix: Table 4: Cash flows statements of London Biscuit