China Fishery – 1Q 2008 Financial Statements Analysis and Review

Since first quarter results typically do not tell much about the entire financial year, I have decided to give a condensed analysis to fit one posting instead of splitting it into two and making readers come back at a later time to read “Part 2”. Of course, typically quarterly results do not give a true reflection of the business conditions as they simply capture the performance for one quarter; while there may also be several timing issues for inventory, revenue recognition or receivables which may distort some of the numbers. For the intelligent enterprising investor, he should view all 4 quarters of a company’s financials against last year’s performance to see if there has been any improvement.

Profit and Loss Analysis

China Fishery’s (CFG) 1Q 2008 was a mixture of good and bad. First, the bad news is that revenues have dipped 2% from US$121.8 million in 1Q 2007 to US$119.3 million in 1Q 2008. This was attributed to weaker fishmeal prices as compared to the beginning of last year (currently, they are at about US$1,050 per ton), but Management sees prices stabilizing and they are confident it will trend slowly upwards as fishmeal is an important component to feedstock. Fortunately as well, the good news is that CFG’s trawling operations were much stronger in 1Q 2008, accounting for 81.7% of revenues compared to just 65.7% a year ago. This helped to offset some of the decrease in revenues from the lower ASP of fishmeal.

The good news (and this one is really very positive indeed) is that CFG has managed to control costs very effectively, to the extent that cost of sales dropped by 42.3% compared to the drop in revenue of just 2%. Vessel operating costs were also reduced by 23% and this improved gross margin greatly, from 34.8% in 1Q 2007 to 44.6% in 1Q 2008. CFG may be seeing the benefits of integrating their trawling and fishmeal operations to achieve greater economies of scale, and their margins are showing it.

By controlling costs over at the cost of goods level, CFG have managed to grow net profit from US$30.5 million in 1Q 2007 to US$40.4 million for 1Q 2008. Note that the first quarter is traditionally the stronger fishing season due to weather conditions, and may not be representative of the entire full year (in other words, do not just take 1Q results and multiply by 4 to annualize the net profit). However, with better cost management and greater economies of scale, plus the deployment of CFG’s three upgraded supertrawlers to new fishing grounds in the South Pacific, we should see much better revenue and earnings growth from 3Q 2008 onwards. Meanwhile, for 1Q 2008, net margins are an impressive 33.9% against just 25% last year.

Balance Sheet Review

There was not much noticeable change in the Balance Sheet and there are only a few things to highlight. Two things to note are the higher trade receivables amount of US$41.4 million compared to US$8.9 million as at December 31, 2007, as well as the higher deferred expenses of US$25.1 million. Higher receivables could be a result of a timing differences between receivable recognition and cash collection, but the explanation for the higher deferred expenses was due to the capital outlay associated with the purchase of an additional fishmeal plant in Peru in April 2008.

Bank loans were also drawn down for investments during the peak fishing season, thereby pushing up current portion of bank loans from US$44.8 million to US$70.4 million. As a result, most of the cash for 1Q 2008 came from financing activities, unlike in the previous quarter where most of the cash came from operating activities. Of course, one has to take into account the fact that indirect method of preparation of cash flow statement tends to use the differences in working capital changes to estimate cash flows movements; hence it may not take actual business conditions into consideration. A more accurate (but nevertheless burdensome) method of ascertaining the effects of cash would be to directly question Management.

Cash Flow Statement Analysis

Basically, there is nothing much to comment on the cash flows which I had not covered in my preceding paragraph. The large increases in working capital (i.e. trade receivables) and the large drop in trade payables contributed to the negative cash outflows from operating activities of US$16.2 million. This could either be a red flag or simply a timing difference in relation to cash yet to be received from trade debtors, or payments paid early to trade creditors. Without further information to enlighten us, we can only speculate; but CFG has a good track record of strong operating cash inflows, so I have a tendency to believe the latter rather than the former.

Proceeds were raised from short-term bank borrowings amounting to US$26.8 million, but gearing actually decreased from 108.3% to 100.3% due to the increase in retained earnings. Overall, I expect to see stronger operating cash inflows in the 2H 2008.

Future Plans and Strategies

As mentioned, CFG will deploy the upgraded super-trawlers in 2H 2008 into the South Pacific. This is expected to increase their revenues through increased catch. Subsequently, in FY 2009, they will deploy three more.

The acquisition of the additional fishmeal plan in Southern Peru should also help to improve efficiencies in processing fishmeal, and help to lower cost of goods. As can be seen, Management’s efforts to reduce costs are not merely empty words; in fact, they really did manage to reduce costs significantly which is very impressive and commendable. Moving forward, I would expect to see a good 2Q 2008 ahead.