Friday, August 17, 2007

Pacific Andes – 1Q 2008 Results Analysis

Pacific Andes reported their 1Q 2008 results on August 14, 2007. The results were in line with my expectations as the Group (including CFG) has been aggressively expanding their fleet of purse seine vessels as well as supertrawlers. The surprise came from the growth in their fishmeal operations and also the increased margins for PAH, as cost of goods sold increased by only 33.7% while revenue zoomed ahead by 42.5%, resulting in an increase in gross profit of HK$197.9 million (101.5% increase). I will analyze the results according to the following sections:-

Income Statement

Top line growth was strong with 42.5% growth in revenues to HK$2.138 billion. The frozen fish SCM business made up HK$1.275 billion (59.7%) of the revenue pie, while the fishing division made up the remaining HK$0.863 billion (40.3%). This increase for the fishing division was more than 100% as compared to 1Q 2007. This was mainly due to PAH’s fishing division under CFG which saw strong growth in 2007 with the acquisition of more vessels and associated economies of scale. The frozen fish SCM business did not register much profit growth (only 15.4%) but the fishing division saw an 81.8% growth in profits. Thus, PAH’s strategy of acquiring a larger stake in CFG through the convertible bonds and rights issue was a wise move, as much value was crystallized from this division. Moving forward, more growth is expected from the fishing division as the recent acquisitions of the additional supertrawlers and purse seine vessels have yet to be fully incorporated into the operating results.

As for margins, taking the net profit attributable to shareholders breakdown from each division divided by the revenue contributions, we get a margin of 3.64% for the frozen fish SCM business and 5.85% for the fishing division. This is just an indication of the relative profitability of each division as it should be noted that as at the date of this report, PAH still owns only 28.8% of CFG and this is why net margins seem to low. Still, it can be readily seen that the fishing division has a higher margin than the SCM business; and since this is the main growth driver moving forward, we should expect strong earnings accretion from PAH for the rest of FY 2008. Note: PAH will recognized the 63.9% earnings from CFG from 2Q 2008 onwards.

Gross margins were 18.4% for 1Q 2008 versus 13% for 1Q 2006, boosted mainly from the economies of scale in operating a larger fleet of vessels, as well as efficient use of their supertrawlers. Net margin improved from 8.62% to 10.4% which is also an encouraging sign that Management can control expenses effectively even though finance costs have risen 172%. Overall, net profit (before allocation to shareholders and MI) grew an impressive 71.3%.

A quick note on the breakdown of revenues by geographical regions: China still made up the bulk of revenues, taking up 78% or HK$1.667 billion for 1Q 2008. Recently, China has been rocked by various scandals involving tainted toys (recall by Mattel), cardboard in buns and contaminated toothpaste. As a result, consumers all over the world have been wary of China food products and China’s reputation has also been tarnished as a result of this. Even the Chinese themselves are more wary of their own country’s food and fortunately, PAH sources for ocean catch which means that they should not be affected too badly by this current negative sentiment.

Balance Sheet

PAH has a sound balance sheet in which current liabilities are more than adequately backed up by liquid current assets. Current ratio stands at a healthy 2.25 for 1Q 2008 as compared to 1.91 for 1Q 2007, while quick ratio improved from 1.51 in 1Q 2007 to the current 1.93 in 1Q 2008. Of course, part of this improvement came as a result of lower inventories as the fishing season is very cyclical (more fish tends to get caught around 1Q of the financial year i.e. April to June); but the increase in cash and bank balances is also a welcome surprise as PAH have had to bear much higher interest payments as a result of the issuance of their US$93 million convertible bonds due 2012.

Speaking of convertible bonds, PAH reported that US$9.1 million of convertible bonds were exercised in 1Q 2008 giving rise to the issuance of about 12.8 million shares, causing slight dilution to shareholders. The remaining convertible bond amount is US$83.9 million and the conversion price has been reset to S$0.8553 as a result of the rights issue. This is actually a blessing in disguise (even though shareholders may not welcome the dilution) as this means PAH can save on a portion of interest expenses moving forward.

Cash Flow Statement

Net cash received from operations actually decreased from HK$636 million in 1Q 2007 to HK$254 million in 1Q 2008. This was due to higher interest expenses from the convertible bonds (about 5.5 times higher) and also much higher income taxes due to the tax regulations imposed by the Peruvian authorities. These two major cash flow drains are likely to persist for quite some time, but PAH has still managed to chalk up a net operating cash flow in spite of these ramped up expenses as their operations have also expanded proportionately. Moving forward, I would expect the higher contributions from the fishing division to bring in healthy cash inflows to offset the increases in income taxes and interest costs.

For investing cash flows, the main culprit for the reduction in cash was the acquisition of an increased stake in CFG (from 28.8% to 63.9%, as many shareholders would by now be aware of). Funds were raised from the issuance of convertible bonds (under financing cash flows) in order to pay for the increase in stake. A total of HK$555 million was paid out as a deposit for the acquisition of shares, and to date the acquisition has already been completed. The cash flow statement is not indicative or representative of the normal operations of the company as they are in a state of transition from owning 28.8% to 63.9% of CFG; thus shareholders should not be unduly worried about the large cash inflows and outflows resulting from the two sections as mentioned in this paragraph.

Outlook and Prospects

PAH should be able to enhance their earnings from the fishing division strongly as this is the faster growing division for PAH and CFG. Powered by recent acquisitions and economies of scale, shareholders should see margins improving and revenues plus earnings growing strongly as more value is unlocked. CFG is also continuously on the lookout for more potentially earnings-accretive acquisitions in Peru in order to position itself as one of the dominant players in the fishmeal market. The rise of fishmeal prices and growing worldwide affluence also bodes well for the industry and should contribute to strong growth for CFG and consequently, PAH as well.

New fishing grounds will also be tapped for the fishing of Chilean Jack Mackerel, which is a “relatively under-utilized” fish species. All PAH would say is that they had conducted “trial operations” for this species and results turned out to be “satisfactory”. The new upgraded supertrawlers will be deployed for this task so we have to assume that fish hold capacity is integral to achieving high enough yields of this species (as well as other profitable species) to justify the capex for the upgrade(s). However, much is left intentionally vague as I believe Management have no clue as to whether this new species would prove to be successful in generating good margins (similar to fishmeal and Peruvian anchovy). Still, it’s a step in the right direction since it shows that Management is pro-actively seeking new revenue sources while at the same time, growing their existing operations for SCM and fishmeal.

Finally, yet another positive for the Group is the ability to enjoy better efficiencies once it deploys the new upgraded supertrawlers by the end of CY 2007. This will not only enhance fish hold capacity (which is integral in increasing their catch) but also allows the Group to reduce reliance on third-party suppliers of fishmeal, thus improving margins. Moving forward, catalysts to look out for will be further acquisitions of Peruvian assets to drive growth, as well as positive developments within the fishmeal industry.

Update: I have purchased 4 more lots of PAH at S$0.615 today, lowering my average cost in PAH to S$0.655 from S$0.665. The situation in Peru is still uncertain, but as shareholders we have to hope for the best !

10 comments:

Anonymous said...

MW,
Good analysis.

Can you please explain what Senior Note is?

Thanks,

musicwhiz said...

Hello there,

Senior Notes are a form of debt obligation (long-term borrowings) which the company uses to raise cash. It is basically similar to a debenture in that the company issues notes to noteholders (lenders) in return for cash. There is a fixed interest rate of 9.25% on the notes till FY 2012, which is considered a very high interest rate.

PAH and CFG will use this leverage in order to build and expand their business, and to build up their fleet in order to generate cash flows to cover this interest payment and also to augment their business further. Some may argue that equity fund raising is better as it does not incur high interest costs, but the resulting dilution can also be detrimental to shareholders.

Anonymous said...

Hi, based on the accountings, are you able to tell if the mgt is focusing on big costs items and hence reducing them to improve their profit margins? Thanks.

musicwhiz said...

Hi Anonymous,

I don't quite get what you mean by "based on the accounting", but I guess you mean by looking at the numbers.

Let me say that it is NOT possible to gauge what happens within the organization in detail unless you are actually working in it and making the decisions on how to run it ! The numbers from the financials only give a brief glimpse into what Management has achieved to grow the company and for myself, the analysis is the best that I can do with the available information. As such, the "things" I have noticed are an improvement in margns, yes, but I cannot say for sure how it came about and if it specifically pointed to Management focusing on "big cost items".

Cheers....musicwhiz

ym said...

Some points for Peru fishmeal
page 9 of 22
http://www.copeinca.com/images/upload/noticia/archivo/Copeinca%20ASA%20Seafood%20Conference%20Oslo%2026%20March%202007.pdf

musicwhiz said...

Hi ym,

Thanks a lot for the link ! :)

Regards, musicwhiz

Anonymous said...

was trying to catch at 62c on Friday but failed... only to see it run up today.

I wanted to buy more because I have faith (hopefully not blind faith) that the company is a value co. and could not comprehend why this counter is beaten down so badly after the rts issue. (b4 the earthquake in Peru and stock mkt in general). Sad thing is that my avg cost is 90c.

musicwhiz said...

Hi Anonymous,

I would think this company is a value play as well, as its earnings are set to grow steadily (not suddenly). It's 5-year history already shows that it can build its competencies and earnings well, as well as generate good FCF to drive operations.

Don't worry too much about your average cost though, I think at this price (66c) it is still good to average down unless you are somehow worried about some aspects of the business.

Good luck !

ym said...

CF also can increase margins by further shift towards food products later, like another fishmeal company, page 15/40
http://www.auss.no/auss_no/documents/AUSSPRE21092006.pdf

musicwhiz said...

Thanks yw, your sources of information are truly helpful ! These are companies involved in the fishing cum fishmeal industry that are going IPO or doing placement, thus yes they are indicative of potential conditions for PAH and CFG. The question now is whether the Management of CFG (Mr. Mg Joo Siang) can grab such opportunities as they come. Let's wait and see. :)