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kcchongnz comment on London Biscuits
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.
Posted by kcchongnz at Nov 8, 2013 08:24 AM
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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
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
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
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
Thank you for sharing. You are a very intelligent and meticulous analyst/investor.
2013-11-09 09:25
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
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
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
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, 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
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
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
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Hup Seng biscuits is performing fine but not London biscuits...Perhaps, should renamed Holland biscuits. Ha 3!
2013-11-08 16:38