Pacific Andes - FY 2008 Financial Review and Analysis

This review and analysis was long overdue, I admit, but analysis takes time and I did not want to do an analysis that was too short and shoddy in case I missed out something important. As it is, there was recently an interview with Pacific Andes where CFO Dennis Chan gave updates on PAH's plans for CY 2008 and on how to tackle rising costs. More on that later.

Profit and Loss Analysis

For FY 2008, revenues were 32% up from HK$5.3 billion to HK$7 billion, while cost of sales only increased 26.3% from HK$4.3 billion to HK$5.5 billion. This reflects better efficiencies which PAH was able to employ in their operations, and gross margin improved from 17.8% in FY 2007 to 21.6% in FY 2008. However, selling and distribution expenses rose significantly (by 214%) as a result of higher expenses incurred in selling fishmeal and also PAH's expanded operations. Finance costs also ballooned to HK$402 million (up 76%) due to additional bank loans taken (HK$1.1 billion), coupled with the senior notes and convertible bonds.

As a result, net margin after tax for FY 2008 was 11.8%, when it could have been higher if not for the increased expenses. Still, it was better than FY 2007's net margin of 10.6% (after removing the exceptional item HK$385 million on gain on dilution of a subsidiary). Net profit after tax increased by 47.1% from HK$561 million to HK$826 million, reflecting the increase in business activity as PAH and CFG expanded their operations into Peru and into the fishmeal business in CY 2007. Profit attributable to equity holders increased by 25.2% to HK$481 million, and a dividend of 2.07 Singapore cents per share was declared. At my purchase price of 65.5 cents, this represents a yield of 3.16%.

Balance Sheet Review

For the balance sheet, the most obvious sign of PAH's increased operations is the increase in fixed assets to HK$1.6 billion, up from HK$864 million a year ago. This ws due to CFG acquiring 3 fishmeal plants and 11 additional purse seine vessels, plus the supply chain management division acquiring 2 reefer vessels to increase transportation efficiency.

Current ratio for March 31, 2008 stood at 1.52 versus 1.91 for March 31, 2007. The decrease was mainly due to higher short-term borrowings for PAH, increasing from HK$1.25 billion to HK$2.48 billion. Signs of increased borrowing are not always positive but as the (fishing) industry is capital intensive, I see it as a necessary evil for PAH to borrow so extensively. Whether or not this makes commercial sense, only time will tell and it also depends on Management's ability to utilize assets to generate more cash and earnings. A check on quick ration showed that it had dipped to 1.23 from 1.51 a year back. Cash position had improved slightly but this was mainly due to cash generated from financing activities, which means FY 2008 is a year of "borrowed money". Let's hope FY 2009 will see more cash flowing into the company from operations and investments, rather than financing.

Cash Flow Statement Review

Cash inflows from operating activities was weak at only HK$103 million, compared to HK$436 million a year back. This can be attributed mainly to the high finance costs paid for and much higher income taxes due to operations in Peruvian waters. As a result of this, there was substantially less operating cash inflows, and I hope this situation will improve when PAH releases their numbers for 1Q 2009.

Most of the cash outflow for investing activities went to acquire the additional stake in CFG, upping it from 28.8% to 64.1%. The company paid HK$2.37 billion for their increases stake in CFG. Seems expensive, until you realize that a lot of the value had crystallized from CFG into PAH as a result of the stake increase; and I think there will be long-term benefits coming from this increase in stake. Though of course the question remains whether PAH paid too much for their stake in CFG !

For financing activities, most of the cash came from 3 sources: proceeds from issue of convertible bonds, proceeds from 1:1 rights issue and additional bank loans taken up. This resulted in a net cash increase of just HK$53 million, and PAH are cutting it pretty close by raising just enough money for operations and investment. Since the acquisition of increased stake in CFG is a one-off event, I am not worried about future cash outflows to the tune of HK$2 billion ! Let's hope the company can manage to generate more free cash flows in time to come.

Prospects and Plans

PAH has highlighted several initiatives to grow revenues and to diversify its revenue stream moving into FY 2009. One of these is to deploy 2 additional reefer vessels to improve efficiency and increase performance, another is to send 3 upgraded supertrawlers to South Pacific Ocean for the fishing of new species, to be shipped to new markets. In the XFN interview with Mr. Dennis Chan on June 16, 2008, he mentioned that the aim of this deployment would be to ship 60,000 tons of Chilean Jack Mackeral to Nigeria (Africa). Africa would represent a new market for PAH but there are currently no plans to ship this species to China.

Rising fuel costs were cited as a major concern for PAH as their vessels and trawlers use fuel extensively to fish. I expect increased fuel costs to negatively impact margins in the next few quarters, with the result being a possible dip in earnings as the increase in revenues may not be able to fully compensate for the increase in cost of sales as a result of increased bunker costs. Assuming Management can control selling and admin expenses, net margins will probably dip and PAH may report lower earnings in the near-term. However, a long-term view of the business should see it sailing through the rough patches as it extends its footprint.

Mr. Chan also did not rule out potential future acquisitions within Peru as the fishing industry there is still very fragmented (he did mention this during the CFG AGM back in April 2008). PAH has managed to increase catch volume at Peru and Alaska, its 2 key fishing areas. Mr. Chan also alluded to the fact that PAH will have a "significant share" in the global catch of anchovies and Alaskan Pollock, though he did not provide further disclosure due to confidentiality reasons. I would conclude that it is prudent for one to be cautiously optimistic of PAH and CFG prospects, amid a high inflationary environment and high fuel costs.