I guess there’s a time for everything, and the time had finally come for me to close the curtain on my investment in China Fishery. On the morning of January 21, 2010, I decided to divest my entire stake in China Fishery at a price of about S$1.92, netting a gain of about 87% on my initial investment (excluding dividends). This decision did not come lightly, and follows on the heels of a somewhat love-hate relationship I have with this company, and also the turmoil and conflicts within my brain which came along in the process of owning it. Taking into account my total holding period of about 2 years 2 months, the annual return is approximately 40% (non-compounded).
On the morning of January 21, 2010, China Fishery (“CFG”) announced their intention to dual-list (secondary offering of shares) on the Stock Exchange of Oslo Bors, located in Norway. The aim of the dual listing was to increase recognition of China Fishery as many fishing and fish processing companies were listed on Oslo Bors (there are currently three – Aker Seafoods, Leroy Seafood Group and Austevoll Seafood). The listing would also raise the profile of CFG in Norway and Europe, where many of CFG’s customers and business partners were located. A third reason was also provided of attracting institutional investors in Europe who would be able to trade CFG’s shares in two different time zones, thus improving the trading liquidity of the counter. Apparently, Management believed that going the dual-listing way would improve valuations and allow the counter to trade at a significantly higher valuation (and hence market price).
The arguments and rationale provided above is indeed compelling, but then again once you scratch under the surface and reveal the underside of things, it started to get questionable. I will present the facts and logic of my reason for divestment, and though I do not classify this strictly as an investment mistake per se, let’s say that I did learn a lot of lessons from this episode and will, in future, be a lot more cautious and exercise more due diligence and prudence in conducting my investment affairs.
1) Weak Balance Sheet, High Capex
CFG’s Balance Sheet has always carried high debt, and this was a very uncomfortable aspect of the Company which precluded my original rationale for purchasing it (which was high barriers to entry, just to state the fact). In the most recent FY 2009 results (ended September 28, 2009) released by CFG, it stated that net debt to equity had decreased from 92.2% to 84.3%, which was still uncomfortably high. Finance costs for 9M 2009 stood at US$20.7 million alone, and for 12M 2008 interest expenses went to as high as US$31.1 million, which was about 6.7% of revenues. Debt continues to be a prominent feature of CFG as it took on additional bank loans in 2009 to finance its South Pacific expansion, and also previously issued Senior Notes due 2013 to finance its capex for additional reefer vessels/supertrawlers and to acquire fishmeal processing plans. The Group’s plans to expand further will probably result in more re-financing of their loans in future, and more additional debt taken on in addition to the Notes issued and existing banking lines. All these activities make this Company a high risk investment, as its gearing is a little too high for comfort.
2) Frequent Fund-Raising and presence of Scrip Dividend
It should become immediately apparent to the casual observer (and actually, to the astute investor, of which I am not), that the whole Pacific Andes Group has undergone frequent fund-raising. Pacific Andes Resources Development (PARD, formerly known as Pacific Andes Holdings Limited or PAH) recently concluded a 1-for-1 rights issue (announced May 22, 2009) of about 1.5 billion shares at S$0.15 per share, as well as 305 million detachable warrants at an exercise price of S$0.23 per share to raise a total of about S$300 million for working capital purposes. Previously, PARD had also issued 4% Convertible Bonds due 2012. Both CFG and PARD also have scrip dividend policies in place for FY 2009 dividend, in order to conserve cash; and it is estimated that the majority shareholders will choose scrip instead of cash, thereby diluting existing retail shareholders even further (for those who choose cash over scrip). Even in the previous year (i.e. FY 2008), CFG had a 1-for-10 bonus issue instead of a cash dividend, all in the name of further conserving cash. Thus, though the Cash Flow Statement of CFG shows an operating cash inflow of US$80 million for FY 2009, capex was US$119 million and new bank loans made up another US$178 million. This shows that the Group had consistently negative FREE CASH FLOWS, even though operating cash flows were mostly positive over the years.
3) Complex Group Structure
I’ve always wondered about this point, and it was one of the points brought up by concerned investors as well as readers of my blog. The relationship between PAIH (listed in Hong Kong), PARD and CFG is very complex, and involves a lot of cross-holdings using companies such as Golden Target for example. The Complex Group structure makes it hard to really compute the valuation and profits to be accrued from CFG to parent PARD, for instance, and also complicates matters when it comes to understanding the impact of Group decisions made and also how policies made at the parent level will cascade down to the subsidiaries. In short, complexity is NOT good for the investor as it makes matters more opaque and offers less clarity into the affairs of a Company. This inherently increases risk as well, as one’s understanding is compromised.
4) Not fully in tune with the Group’s business
I’ve realized over time that CFG’s business was not as simple to understand as I had previously thought. In the first place, there are the (Vessel Operating Agreements) VOA signed which are carried in the books as deferred expenses and deferred charter hire, and even the structure of the 4th VOA is not easily explained. Considering I am accounting trained and I don’t really understand the accounting treatment for these items says volumes about how ordinary retail investors must be able to understand these issues! There are also aspects such as pledging of inventory for loans, tracking of fishmeal prices, El Nino effects on the availability of fish and other aspects which are pretty hard to track and follow unless you have a good grasp of the industry and intimate knowledge of the operational aspects of the Group. Suffice to say I probably did not have the appropriate level of interest or inclination to dig out the facts to track the Company, and did not do enough detailed reading on the species of fish they caught (CJM and Peruvian Anchovy). Thus, I felt that this lack of understanding compromised my investment position and I was better off divesting my position since I did not truly understand the forces which affected the business.
5) Potential Dilution from Secondary Listing
In case most investors out there have not realized, the proposed secondary listing for CFG actually involves the issuance of NEW shares to institutions and retail investors in Norway; and will cause dilution equivalent to a private placement of shares (assuming it had been done in Singapore). As at the time of the announcement, it was still not known of the issue size and pricing for the secondary listing, or whether or not Oslo Bors would approve the listing (there is a high chance they will, though). But what is immediately apparent is that CFG has to raise funds once again, and they are doing it through equity issuance this time instead of turning to debt (e.g. loans and senior notes). The FC of Pacific Andes Group acknowledged that this move would “dilute earnings” but will ultimately benefit the Company because of the working capital raised. This does imply that the Group has insufficient recurring cash to work on and always needs to turn to capital markets to raise funds. This share issuance will dilute not just earnings, but also future dividends as well as there will be an enlarged share capital base!
6) Peer Valuations on Oslo Bors
According to a Lim and Tan Daily Review report, the other 3 seafood and fishing companies on Oslo Bors trade at around 8x-10x FY 2010 PER, and have a P/B of about 1.3x on average. CFG, on the other hand, is priced expensively at about 16x FY 2009 PER and 12x FY 2010 PER, and has a P/B of 3.4x. This seems to suggest that CFG is trading at elevated prices with respect to the other listed fishing companies in Norway, so I am not sure what kind of “improved valuations” the CEO was talking about. In fact, the P/B alone would probably signal that CFG may be trading at a premium price currently, with a lot of positives already factored in. For me, that’s my feel of the situation – a lot of the positives have been included in the share price, such as expansion into South Pacific, completion of their new mega-vessel The Lafayette, as well as implementation of the ITQ system.
7) Environmental Issues and Concerns about Over-fishing
This was kindly highlighted to me by a fellow blogger called Donmihaihai, who also pointed out certain aspects of Ezra to me in his blog; and he has been a very astute and helpful investor who deeply analyzes the numbers and facts. He did mention on the sustainability of fishing resources, and highlighted the fact that such supertrawlers actually destroy many natural habitats and are not environmentally friendly. The environmentalists are fervently lobbying against stricter regulations against over-fishing, but the vessel Lafayette would probably put a spanner in their works as it is able to fish all year round, without having to re-fuel. Separately, I myself also had personal misgivings about being vested in a Company which “rapes” the oceans; even though of course the Directors proclaim that they are adhering to international standards on over-fishing; but one has to take note that the South Pacific is a relatively new fishing ground and there are still inadequate legal controls over the fishing environment there. Therefore, one can argue that CFG would be left alone to do what it has to in order to “maximize shareholder value”. This was a nagging thought which stayed with me for quite some time, and I was unable to shake it off; and was a minor contributing factor to my decision to divest.
The case of CFG may be classified as an investment thesis which was partially flawed, since I first purchased my shares in late 2007 when I had just switched to the value investing methodology. During that time, I did not do much in-depth research into my purchases as I do now, and it was also a bit of luck that I averaged down on my purchase subsequently during the 2008-2009 bear market; and the Company had managed to stay afloat during this trying period. I recall being very nervous and being unable to sleep well because of the high debt which the Group was holding; and also seeing many companies like Ferrochina, Celestial and Fibrechem encountering problems and being suspended from trading. I had told myself, after learning the harsh lessons of the previous bear market, that I would never again over-expose myself in this way through the ownership of a Company with such high gearing.
Fortunately for me, the dual listing news came at an opportune time, as it raised a minor euphoria as had been expected from the recent announcements of dual listings from companies such as Z-Obee, Oceanus, Epure and Novo Group. I made use of the heightened expectations to sell and even though in the interim, the share price may scale new heights, there are no regrets as I had to move on to companies with better structures and with a less risky value proposition. Suffice to say that I now have the unenviable task of deciding how to allocate the monies freed up from this divestment; and I shall have to actively seek out investment opportunities in a climate of rising valuations.
Overall, this has been a positive learning experience, and the profits and resulting cash inflow will bolster my cash reserves and allow me to scout around for more investment opportunities. The realized profits from the divestment of CFG will be reflected in my January 2010 portfolio review. The total dividends I had received from CFG over my entire holding period amounted to S$220, so the bulk of the gains came from capital gains. Moving forward, I hope to achieve a more balanced mix of dividends and capital gains from future investments. More time and effort will be spent researching such opportunities to avoid the mistakes made for CFG.
Showing posts with label China Fishery. Show all posts
Showing posts with label China Fishery. Show all posts
Tuesday, January 26, 2010
Friday, August 21, 2009
China Fishery – 1H 2009 Financial Review and Analysis
China Fishery reported a rather surprising set of 2Q 2009 results, with revenue falling 21.7% as the Company decided to shift their vessel allocation for the South Pacific ocean in anticipation of higher fishmeal and fish prices in 4Q 2009. However, for 1H 2009, revenue increased marginally by 6.8%. I will be reviewing China Fishery in the same fashion as per all my other companies; and this review and analysis will be the only one done as I only do two per financial year – one for half-year results and another for full-year results. There is only the requirement to re-look at the Company in the event of any significant corporate events taking place, of which I do not expect.
Profit and Loss Review and Analysis
It is interesting to note that the ITQ system kicked in during April 2009, and was in force throughout the entire 2Q 2009. The financial effects were pretty dramatic in that cost of sales for 2Q 20009 fell by 60.1% against a 21.7% drop in revenues. Charter hire expenses dropped as a result of lower utilization of vessels as some were deferred to 4Q 2009 where they will be deployed to the South Pacific to increase the quota there. However, for 1H 2009 cost of sales increased by 13.6% compared to a 6.8% rise in revenues; but overall cost of sales for FY 2009 is expected to drop further as the ITQ system continues to exert a positive effect on gross margins and to enhance cost effectiveness. Vessel operating costs fell by 29.1% for 2Q 2009 to US$44.6 million due to the drop in oil prices to around US$70 per barrel, compared to nearly US$147 per barrel during last June 2008. Unfortunately, for 1H 2009, there was still a slight increase in vessel operating costs of 7.6% (about US$8 million).
As a result of the reduction in costs, gross profit for 2Q 2009 only fell a marginal 0.6% and gross profit margin improved from 30.3% to 38.5%. For 1H 2009, gross profit also improved marginally from 36.9% to 37.3%. It is expected that with the ongoing ITQ system in place, this will allow for better control and rationalization of costs for CFG and gross margins should improve further moving forward.
Net margin for 2Q 2009 was 23.3% against 17.1% for 2Q 2008, with income tax expense increasing a significant 49.2%. Finance costs only dipped 3.3% and a still very significant worry of mine is the high interest expense they are paying both of their bank loans as well as their senior notes due 2013.
Balance Sheet Review
One immediately noticeable good sign in their Balance Sheet is the increase in cash and bank balances from US$7.6 million half a year ago, to the current US$20.4 million. This factor, coupled with an increase in trade and other receivables and a slight drop in current liabilities, helped to improve current ratio from 1.33 as at Dec 31, 2008 to 1.79 as at June 30, 2009. Inventories had also dropped from US$33.3 million to US$22.4 million, a sign that the large stockpile of fishmeal as at year-end was being cleared off.
Unfortunately, a glance at their debt shows that long-term liabilities increased from US$279 million to US$309.3 million, mainly due to an increase in long-term bank loans offset by a marginal drop in finance leases and deferred tax liabilities. Even though the press release maintains that net debt to equity fell from 92.2% to 81.7%, one should note in this case that the denominator had increased from US$335.8 million to US$403.8 million; but net debt in fact increased because long-term bank loans increased by US$33.7 million while cash only increased by about US$12.7 million. The press release conveniently glosses over this fact and a closer look at the numbers reveal that debt is not exactly being lowered in spite of the Group completing their upgrades for their supertrawlers. In fact, the Group may continue to maintain its high gearing to take advantage of the relatively untapped waters off the South Pacific to increase their catch of Chilean Jack Mackerel.
While it is noticeably certain that the Group is able to manage their gearing well as well as their high capex, it is obviously worrying to note that gearing is not being actively reduced, as the tenure of the senior notes has 4 more years to go, which means the clock is ticking for them to be able to generate enough sustainable operating cash flows to pay off this huge liability. The senior notes were issued in 2007 to be allow CFG to expand aggressively in Peru by purchasing supertrawlers, upgrading them, buying fishmeal plants and purse seine vessels. I would expect their expansion plans to at least taper off and die down by FY 2010 and that is when I would expect cash flow generation to improve greatly, thus reducing gearing drastically. I will have to observe their net gearing and cash generation capabilities in the next few quarters to reaffirm my understanding of their strategy; or else it would seem that this debt would not be paid off easily. The fact that they managed to secure an additional US$60 million 3-year term loan also attests to the fact that banks are very comfortable with CFG’s financial position and market power even in the midst of a severe downturn.
Cash Flow Statement Review
Net cash flow from operating activities was healthy at US$35.1 million (for 2Q 2009) compared to US$31.5 million a year ago (2Q 2008). At first glance, this looks roughly comparable with not much difference. However, looking at 1H 2009 there was a net operating cash inflow of US$53.3 million against a much lower net operating cash inflow of US$15.3 million for 1H 2008. The much improved numbers at least helps to instil confidence in me that CFG’s operations are generating very healthy cash inflows, and as soon as their capex plans (upgrading of supertrawlers, purchase of additional purse seine vessels) are done with, their cash balance would dramatically improve.
For investing activities, CFG spent US$73.1 million in 1H 2009, presumably on their capex plans for upgrading (elongation) of supertrawlers to increase fish hold capacity. The amount spent was much higher than 1H 2008’s amount of just US$5.3 million, as CFG had, in 2008, scaled down on their capex due to the (then) sharp economic downturn and drying up of financing. Only about US$8.6 million was spent last year acquiring a subsidiary (Peru fishmeal plant). It remains to be seen if the Group will spend even more on capex in 2H 2009, though I hope that most of the elongation and deployment will be done by 4Q 2009. For FY 2010, I would expect them to scale down capex unless absolutely necessary, in order to be able to slowly reap the cash flow benefits from their aggressive spending.
As mentioned in Balance Sheet review, the cash flow statement shows up that additional bank loans of about US$34 million were taken up in 1H 2009 (net off additions of bank loans against repayments), compared to an addition of just US$13 million for 1H 2008. I suspect these additional loans were taken up as short-term financing for their capex and for working capital requirements.
Prospects and Plans
The Group plans to shift more of their vessels to the South Pacific to be able to capture a higher quota there, and they are deploying their vessels there during 2Q 2009 to be positioned and ready. Since they are also considering leasing additional vessels, they must feel that there is vast potential in the South Pacific which has yet to be properly tapped and exploited.
With the Peruvian Government implementing the ITQ, this will result in more sustainable fish resources and a slower depletion of natural fish habitats, thus enabling CFG to continue to milk ocean catch and to make it more desirable than say, fish from aquaculture (which is also gaining in popularity). All fishing companies will enjoy better utilization of their vessels which in turn will reduce costs significantly (one example is Copeinca which reported a 20% rise in EBITDA as a result of ITQ); in time to come China Fishery should be able to reap the full benefits of the new system as compared to the “racing” Olympic system.
Management also hopes that with the gradual recovery in the economy, fish and fishmeal prices will slowly trend up and they can improve their selling prices. This may prove to be a further impetus for higher gross margins. However, with improved economic conditions also come higher oil prices, and this will offset the higher margins a little. I look forward to 2H 2009 when Management reports on their South Pacific strategy, and hopefully are able to provide clear direction and articulation of their strategic intentions for FY 2010 and beyond, with a focus on reduction of debt and paying off their senior notes by 2013.
Profit and Loss Review and Analysis
It is interesting to note that the ITQ system kicked in during April 2009, and was in force throughout the entire 2Q 2009. The financial effects were pretty dramatic in that cost of sales for 2Q 20009 fell by 60.1% against a 21.7% drop in revenues. Charter hire expenses dropped as a result of lower utilization of vessels as some were deferred to 4Q 2009 where they will be deployed to the South Pacific to increase the quota there. However, for 1H 2009 cost of sales increased by 13.6% compared to a 6.8% rise in revenues; but overall cost of sales for FY 2009 is expected to drop further as the ITQ system continues to exert a positive effect on gross margins and to enhance cost effectiveness. Vessel operating costs fell by 29.1% for 2Q 2009 to US$44.6 million due to the drop in oil prices to around US$70 per barrel, compared to nearly US$147 per barrel during last June 2008. Unfortunately, for 1H 2009, there was still a slight increase in vessel operating costs of 7.6% (about US$8 million).
As a result of the reduction in costs, gross profit for 2Q 2009 only fell a marginal 0.6% and gross profit margin improved from 30.3% to 38.5%. For 1H 2009, gross profit also improved marginally from 36.9% to 37.3%. It is expected that with the ongoing ITQ system in place, this will allow for better control and rationalization of costs for CFG and gross margins should improve further moving forward.
Net margin for 2Q 2009 was 23.3% against 17.1% for 2Q 2008, with income tax expense increasing a significant 49.2%. Finance costs only dipped 3.3% and a still very significant worry of mine is the high interest expense they are paying both of their bank loans as well as their senior notes due 2013.
Balance Sheet Review
One immediately noticeable good sign in their Balance Sheet is the increase in cash and bank balances from US$7.6 million half a year ago, to the current US$20.4 million. This factor, coupled with an increase in trade and other receivables and a slight drop in current liabilities, helped to improve current ratio from 1.33 as at Dec 31, 2008 to 1.79 as at June 30, 2009. Inventories had also dropped from US$33.3 million to US$22.4 million, a sign that the large stockpile of fishmeal as at year-end was being cleared off.
Unfortunately, a glance at their debt shows that long-term liabilities increased from US$279 million to US$309.3 million, mainly due to an increase in long-term bank loans offset by a marginal drop in finance leases and deferred tax liabilities. Even though the press release maintains that net debt to equity fell from 92.2% to 81.7%, one should note in this case that the denominator had increased from US$335.8 million to US$403.8 million; but net debt in fact increased because long-term bank loans increased by US$33.7 million while cash only increased by about US$12.7 million. The press release conveniently glosses over this fact and a closer look at the numbers reveal that debt is not exactly being lowered in spite of the Group completing their upgrades for their supertrawlers. In fact, the Group may continue to maintain its high gearing to take advantage of the relatively untapped waters off the South Pacific to increase their catch of Chilean Jack Mackerel.
While it is noticeably certain that the Group is able to manage their gearing well as well as their high capex, it is obviously worrying to note that gearing is not being actively reduced, as the tenure of the senior notes has 4 more years to go, which means the clock is ticking for them to be able to generate enough sustainable operating cash flows to pay off this huge liability. The senior notes were issued in 2007 to be allow CFG to expand aggressively in Peru by purchasing supertrawlers, upgrading them, buying fishmeal plants and purse seine vessels. I would expect their expansion plans to at least taper off and die down by FY 2010 and that is when I would expect cash flow generation to improve greatly, thus reducing gearing drastically. I will have to observe their net gearing and cash generation capabilities in the next few quarters to reaffirm my understanding of their strategy; or else it would seem that this debt would not be paid off easily. The fact that they managed to secure an additional US$60 million 3-year term loan also attests to the fact that banks are very comfortable with CFG’s financial position and market power even in the midst of a severe downturn.
Cash Flow Statement Review
Net cash flow from operating activities was healthy at US$35.1 million (for 2Q 2009) compared to US$31.5 million a year ago (2Q 2008). At first glance, this looks roughly comparable with not much difference. However, looking at 1H 2009 there was a net operating cash inflow of US$53.3 million against a much lower net operating cash inflow of US$15.3 million for 1H 2008. The much improved numbers at least helps to instil confidence in me that CFG’s operations are generating very healthy cash inflows, and as soon as their capex plans (upgrading of supertrawlers, purchase of additional purse seine vessels) are done with, their cash balance would dramatically improve.
For investing activities, CFG spent US$73.1 million in 1H 2009, presumably on their capex plans for upgrading (elongation) of supertrawlers to increase fish hold capacity. The amount spent was much higher than 1H 2008’s amount of just US$5.3 million, as CFG had, in 2008, scaled down on their capex due to the (then) sharp economic downturn and drying up of financing. Only about US$8.6 million was spent last year acquiring a subsidiary (Peru fishmeal plant). It remains to be seen if the Group will spend even more on capex in 2H 2009, though I hope that most of the elongation and deployment will be done by 4Q 2009. For FY 2010, I would expect them to scale down capex unless absolutely necessary, in order to be able to slowly reap the cash flow benefits from their aggressive spending.
As mentioned in Balance Sheet review, the cash flow statement shows up that additional bank loans of about US$34 million were taken up in 1H 2009 (net off additions of bank loans against repayments), compared to an addition of just US$13 million for 1H 2008. I suspect these additional loans were taken up as short-term financing for their capex and for working capital requirements.
Prospects and Plans
The Group plans to shift more of their vessels to the South Pacific to be able to capture a higher quota there, and they are deploying their vessels there during 2Q 2009 to be positioned and ready. Since they are also considering leasing additional vessels, they must feel that there is vast potential in the South Pacific which has yet to be properly tapped and exploited.
With the Peruvian Government implementing the ITQ, this will result in more sustainable fish resources and a slower depletion of natural fish habitats, thus enabling CFG to continue to milk ocean catch and to make it more desirable than say, fish from aquaculture (which is also gaining in popularity). All fishing companies will enjoy better utilization of their vessels which in turn will reduce costs significantly (one example is Copeinca which reported a 20% rise in EBITDA as a result of ITQ); in time to come China Fishery should be able to reap the full benefits of the new system as compared to the “racing” Olympic system.
Management also hopes that with the gradual recovery in the economy, fish and fishmeal prices will slowly trend up and they can improve their selling prices. This may prove to be a further impetus for higher gross margins. However, with improved economic conditions also come higher oil prices, and this will offset the higher margins a little. I look forward to 2H 2009 when Management reports on their South Pacific strategy, and hopefully are able to provide clear direction and articulation of their strategic intentions for FY 2010 and beyond, with a focus on reduction of debt and paying off their senior notes by 2013.
Monday, May 25, 2009
Pacific Andes - Rationale for Divestment
I sold off my entire stake in Pacific Andes today, capping a three-year long investment which saw one round of capital injection; and which resulted in a significant 38% loss. Even though the Company had announced a decent set of full-year (FY) 2009 results, with net profit attributable to shareholders up 38% to HK$664 million, the nail in the coffin came with the announcement of a fresh rights issue, coming hot on the heels of a previous one in March 2007. The offer this time was a 1-for-1 rights issue at 15 cents per share (a 50% discount to the last closing price of 30.5 cents) with additional warrants attached (1 warrant for every 5 rights shares subscribed for, exercise price 23 cents). The rights were supposed to raise about S$228.6 million while the warrants could potential add another S$70.1 million to the Company's coffers.
So one might ask - why is this the "nail in the coffin" ? Presumably, if I had wanted to increase my stake in PAH, I could have done so at 18 cents back during March 2009, but hesitated from doing so. In fact, a cursory glance at PAH's business model and financials would not leave one surprised as to the timing or magnitude of the rights issue. While I had previously added more PAH back in 2008 at a price of 44 cents, I had failed to take into account the inherent business model flaws which would precipitate a full-scale rights issue, and apparently Management also "forgot" about the massive dilutive impact of such a fund-raising exercise on both earnings and (future) dividends per share. Some of the reasons for my divestment are stated below in point form for easy reading and reference.
1) Paid too high a valuation - This fact was apparent right from March 2006, when I first purchased the company at a high price of 81 cents (pre-rights). It was probably valued at around 8-9x historical PER at the time, and I had neglected the fact that it was in SCM and trading and was a high volume-based business, but more on that later. The rights shares issue back in March 2007 were offered at 52 cents, seemingly a juicy offer since my purchase price was a high 81 cents. In August 2007, I continued to purchase more at 61 cents to further average down my cost. This was till July 2008 when I added my last round of PAH at 44 cents, giving at least 8 good reasons for doing so. Since I could justify my purchase so succinctly, I could also figure out what I had omitted to make this such a glaring error. All my reasons and rationale had not accounted for the Balance Sheet weakness of PAH and its business model which I shall elaborate on later. Taking the FY 2009 net profit of HK$664 million, it's about S$132.8 million. Dividing this by 1.391 billion shares gives an EPS of about 9.54 Singapore cents. At the current price of 35.5 cents, the PER is about 3.72. This may seem undemanding at first but considering the dilutive effects of the rights issue, the share capital base will "expand" to 2.8 billion shares and EPS will be halved. Thus, it does not seem like such a bargain any longer.
2) Holding Company Effect - PAH suffers from this effect which means it derives most of its value from their investment in another company, namely China Fishery Group Limited (CFG), in which I am also vested. It holds a 64.1% stake in CFG and works closely with CFG in its SCM and Trading business. However, PAH itself does not have the hard assets which CFG has. This means that much of its valuation is derived from the valuation of CFG; and CFG is the main downstream revenue generator as it is the Company which catches the fish. Hence, PAH is involved in a very high volume-based business (not unlike Noble or Olam) in which net margins are very thin. In fact, it can be readily observed that PAH has a net margin of less than 10% based on FY 2009 results, while CFG has a net margin of 26% based on 1Q 2009 results.
3) Lack of Tangible Assets limits collateral for loans - The rationale for PAH to raise funds is to provide for working capital needs (see point 4 as well). Notice that the company had NOT managed to secure any funding through bank loans and the CEO commented that it was difficult to do so during this harsh credit crisis. Yet, a quick glance at CFG shows that CFG had recently (in 1Q 2009) obtained a US$60 million bank loan to finance its expansion into the South Pacific Ocean. The reason for this is the lack of tangible assets belonging to PAH which can be used as collateral for loans. Previously, PAH would have used shares in CFG as collateral to banks, but during this severe credit crunch, banks are more cautious when lending and would prefer tangible assets such as fishing vessels and inventory (such as fishmeal) as collateral, all of which are owned by CFG and not PAH.
4) No clear objective for Fund-Raising - Most companies which issue rights have some specific objective in mind. Capitaland and its REITS CCT and CMT raised funds to pay down debts and to act as "pre-emptive" capital for M&A opportunities (or so they claim). Other companies raise funds to (presumably) capture opportunities for expansion and growth as there are many assets out there selling at distressed levels. Such cash is vital for taking advantage of opportunities. PAH only said that the cash was to be used for working capital, which I assumed to be for normal operating expenses and for daily use. This implies that the Company was short on cash for the normal operations of the Company, and did not have a specific objective for the cash, which makes the fund-raising all the more suspicious. It is CFG which has the clear growth strategy, with its elongation of vessels, deployment of vessels to the South Pacific, as well as introduction of ITQ. Therefore, it can be clearly seen that CFG's business model is very different from PAH as it has high net margins, high cash generation ability and has clearer scope for expansion.
5) Lack of Catalysts for Growth - As mentioned before, much of PAH's "growth" can be attributed to its 64.1% stake in CFG; hence its "value" hinges upon the value of CFG. This in itself is a very risky proposition for investment as the Company itself has no objective, clearly-derived value for which one can make a value proposition. Its SCM business can be likened to a commodity business as SCM models are essentially the same, are volume-driven and suffer from thin margins. This fact, coupled with the lack of tangible assets and the Company's excessively high gearing, made for a poor investment choice.
Unfortunately for me, I had to learn from this mistake the hard way - by taking a substantial loss by selling at 34 cents per share. But this mistake actually offers me better insights as to how to value a company, what to avoid, things to watch out for and more facets to consider when assessing if a company is suitable for long-term investment. The cash call was a timely reminder to me that this mistake had been made 3 years ago, and finally the time has come to divest of this mistake before it became a full-blown debacle. The opportunity cost of NOT divesting can sometimes be greater than the actual financial loss from divesting sooner (rather than later). Because of my reluctance to take a larger loss on this earlier (Oct 2008 through March 2009), I also omitted the chances to recycle the cash to other more promising companies like Boustead and Tat Hong. Thus, my mistake is two-fold and I feel mortified.
Moving forward, I will seek out more opportunities to purchase under-valued companies at attractive prices and a decent margin of safety; and will pay special attention to Balance Sheets and business models, as well as the fact that the companies I own are supposed to provide me with money (through dividends) and NOT keep asking me to pump in money instead ! I shall endeavour to pick myself up from this mistake, dust myself off and move on. I treat this as a good (though painful) learning experience, and promise not to make a similar mistake in future.
Note: This realized loss will be reflected in my May 2009 portfolio review as an offset against realized gains (currently standing at S$12.8K) and I shall cease all coverage of Pacific Andes from now on. Readers can access archives for PAH but all further updates shall be confined to CFG (which I still own).
So one might ask - why is this the "nail in the coffin" ? Presumably, if I had wanted to increase my stake in PAH, I could have done so at 18 cents back during March 2009, but hesitated from doing so. In fact, a cursory glance at PAH's business model and financials would not leave one surprised as to the timing or magnitude of the rights issue. While I had previously added more PAH back in 2008 at a price of 44 cents, I had failed to take into account the inherent business model flaws which would precipitate a full-scale rights issue, and apparently Management also "forgot" about the massive dilutive impact of such a fund-raising exercise on both earnings and (future) dividends per share. Some of the reasons for my divestment are stated below in point form for easy reading and reference.
1) Paid too high a valuation - This fact was apparent right from March 2006, when I first purchased the company at a high price of 81 cents (pre-rights). It was probably valued at around 8-9x historical PER at the time, and I had neglected the fact that it was in SCM and trading and was a high volume-based business, but more on that later. The rights shares issue back in March 2007 were offered at 52 cents, seemingly a juicy offer since my purchase price was a high 81 cents. In August 2007, I continued to purchase more at 61 cents to further average down my cost. This was till July 2008 when I added my last round of PAH at 44 cents, giving at least 8 good reasons for doing so. Since I could justify my purchase so succinctly, I could also figure out what I had omitted to make this such a glaring error. All my reasons and rationale had not accounted for the Balance Sheet weakness of PAH and its business model which I shall elaborate on later. Taking the FY 2009 net profit of HK$664 million, it's about S$132.8 million. Dividing this by 1.391 billion shares gives an EPS of about 9.54 Singapore cents. At the current price of 35.5 cents, the PER is about 3.72. This may seem undemanding at first but considering the dilutive effects of the rights issue, the share capital base will "expand" to 2.8 billion shares and EPS will be halved. Thus, it does not seem like such a bargain any longer.
2) Holding Company Effect - PAH suffers from this effect which means it derives most of its value from their investment in another company, namely China Fishery Group Limited (CFG), in which I am also vested. It holds a 64.1% stake in CFG and works closely with CFG in its SCM and Trading business. However, PAH itself does not have the hard assets which CFG has. This means that much of its valuation is derived from the valuation of CFG; and CFG is the main downstream revenue generator as it is the Company which catches the fish. Hence, PAH is involved in a very high volume-based business (not unlike Noble or Olam) in which net margins are very thin. In fact, it can be readily observed that PAH has a net margin of less than 10% based on FY 2009 results, while CFG has a net margin of 26% based on 1Q 2009 results.
3) Lack of Tangible Assets limits collateral for loans - The rationale for PAH to raise funds is to provide for working capital needs (see point 4 as well). Notice that the company had NOT managed to secure any funding through bank loans and the CEO commented that it was difficult to do so during this harsh credit crisis. Yet, a quick glance at CFG shows that CFG had recently (in 1Q 2009) obtained a US$60 million bank loan to finance its expansion into the South Pacific Ocean. The reason for this is the lack of tangible assets belonging to PAH which can be used as collateral for loans. Previously, PAH would have used shares in CFG as collateral to banks, but during this severe credit crunch, banks are more cautious when lending and would prefer tangible assets such as fishing vessels and inventory (such as fishmeal) as collateral, all of which are owned by CFG and not PAH.
4) No clear objective for Fund-Raising - Most companies which issue rights have some specific objective in mind. Capitaland and its REITS CCT and CMT raised funds to pay down debts and to act as "pre-emptive" capital for M&A opportunities (or so they claim). Other companies raise funds to (presumably) capture opportunities for expansion and growth as there are many assets out there selling at distressed levels. Such cash is vital for taking advantage of opportunities. PAH only said that the cash was to be used for working capital, which I assumed to be for normal operating expenses and for daily use. This implies that the Company was short on cash for the normal operations of the Company, and did not have a specific objective for the cash, which makes the fund-raising all the more suspicious. It is CFG which has the clear growth strategy, with its elongation of vessels, deployment of vessels to the South Pacific, as well as introduction of ITQ. Therefore, it can be clearly seen that CFG's business model is very different from PAH as it has high net margins, high cash generation ability and has clearer scope for expansion.
5) Lack of Catalysts for Growth - As mentioned before, much of PAH's "growth" can be attributed to its 64.1% stake in CFG; hence its "value" hinges upon the value of CFG. This in itself is a very risky proposition for investment as the Company itself has no objective, clearly-derived value for which one can make a value proposition. Its SCM business can be likened to a commodity business as SCM models are essentially the same, are volume-driven and suffer from thin margins. This fact, coupled with the lack of tangible assets and the Company's excessively high gearing, made for a poor investment choice.
Unfortunately for me, I had to learn from this mistake the hard way - by taking a substantial loss by selling at 34 cents per share. But this mistake actually offers me better insights as to how to value a company, what to avoid, things to watch out for and more facets to consider when assessing if a company is suitable for long-term investment. The cash call was a timely reminder to me that this mistake had been made 3 years ago, and finally the time has come to divest of this mistake before it became a full-blown debacle. The opportunity cost of NOT divesting can sometimes be greater than the actual financial loss from divesting sooner (rather than later). Because of my reluctance to take a larger loss on this earlier (Oct 2008 through March 2009), I also omitted the chances to recycle the cash to other more promising companies like Boustead and Tat Hong. Thus, my mistake is two-fold and I feel mortified.
Moving forward, I will seek out more opportunities to purchase under-valued companies at attractive prices and a decent margin of safety; and will pay special attention to Balance Sheets and business models, as well as the fact that the companies I own are supposed to provide me with money (through dividends) and NOT keep asking me to pump in money instead ! I shall endeavour to pick myself up from this mistake, dust myself off and move on. I treat this as a good (though painful) learning experience, and promise not to make a similar mistake in future.
Note: This realized loss will be reflected in my May 2009 portfolio review as an offset against realized gains (currently standing at S$12.8K) and I shall cease all coverage of Pacific Andes from now on. Readers can access archives for PAH but all further updates shall be confined to CFG (which I still own).
Tuesday, February 24, 2009
China Fishery - FY 2008 Analysis and Comments
China Fishery (CFG) had released their FY 2008 financials some time back, and I had the chance to do a detailed review of the Company's financials. Suffice to say that I was not entirely happy with the numbers that I saw, and a few aspects of the financials caused me a considerable degree of worry and consternation. However, my fears were assuaged due to the fact that a lot of the debt in CFG's books had collateral tied to it (i.e. their fishmeal processing plants, fishing vessels and fishmeal inventories) and assured me that CFG could re-finance its short-term debt. I will be touching more on CFG's debt in the Balance Sheet review below. Perhaps astute readers out there can point out facts which I myself had over-looked when I decided to invest in this company. However, things change and the future is never certain; thus one must always question one's original premise for investing in a particular company.
Profit and Loss Analysis
In such uncertain times and in the midst of a severe recession, most investors would find it more prudent to scrutinize a Company's Cash Flow Statement and Balance Sheet rather than its Income Statement. This is because a strong Balance Sheet and regular and stable cash inflows can help a company tide through long downturns to emerge even stronger after that. CFG had managed to grow its top-line revenue by 13% from USD 406.4 million to USD 459.4 million. The rise in revenues was mainly due to higher catch volumes and higher selling prices for its fish with regards to its trawling division, which accounted for 74.7% of total revenue. The other 25.3% was made up of fishmeal operations and this created a minor drag on revenue as fishmeal prices softened during FY 2008 compared to FY 2007. A latest check on fishmeal prices from Copeinca's 3Q 2008 financial highlights shows that fishmeal prices averaged around USD 988 per metric tonne (MT), lower than the USD 1,100 to 1,200 per MT hit in FY 2007.
Gross margins dropped from 34.8% in FY 2007 to 32.3% in FY 2008. The main culprit was higher bunker fuel costs as the price of oil shot up to as high as USD 147 per barrel around July-August 2008. The ratio of fuel to total sales increased from 14% to 17.9% as a result of this. However, with oil prices slumping to below USD 40 due to the global recession, CFG should be able to regain their high margins again for FY 2009, barring unforseen circumstances.
Finance costs also rose slightly for the Company from USD 26.8 million to USD 31.2 million, a 16.4% increase. This was due to higher bank loans taken out during FY 2008 for the acquisition of fishing vessels and fishmeal plants. As the credit crisis dragged on and credit became tighter, the Company had also ceased their acquisition of assets until more clarity emerged. This will be discussed under future prospects and directions. As a result, net margins decreased from 21.8% to 20.5% (helped by a tax credit of USD 2.4 million from the recognition of tax losses carry forward by CFG Investment S.A.C.) and net profit rose just 6.5% from USD 88.5 million to USD 94.3 million. Using an exchange rate of 1 USD = 1.52 SGD, this translates to about SGD 143.3 million net profit. EPS is about SGD 18.3 cents and using the closing price of 60 Singapore cents as at February 24, 2009, this translates to a historical FY 2008 PER of 3.28 times.
Balance Sheet Review
Well, I have to admit CFG does not have one of the cleanest Balance Sheets around; after doing a quick comparison to companies such as Boustead and Tat Hong, I was forced to conclude that CFG's Balance Sheet represents a lot of risk and notwithstanding the fact that their trawling operations generate lots of operational cash inflows, the Management must make a sustained effort to reduce their gearing and improve their cash balance. A quick glance would show that the Company had debts amounting to USD 317.3 million for FY 2008 (bank loans + senior notes) of which about USD 60 million is up for re-financing within a year. Gearing is dangerously high at 43.6% debt to total assets and about 94.5% debt to equity ! The fact that the Company had a measly cash balance of just USD 7.7 million is of great cause for concern ! I will cover this aspect during the review of the Cash Flow Statement, and though this may be a timing difference, having so little cash in the face of so much debt is not something I like to see as an investor.
Current ratio actually improved from 1.05 in FY 2007 to 1.28 in FY 2008, mainly due to the increase in trade receivables and inventories, coupled with a large drop in trade payables. However, the worrying fact is that short-term debt increased in order for them to finance their acquisitions, and only the assurance of better cash inflows in future can make me feel more worry-free. Suffice to say this is a Balance Sheet which had me beleaguered for quite some time, but seeing that CFG and PAH have a good track record and are a major industry player, and that the CEO is prudent enough to manage inventories and debt; this has caused some of the worry to ease, though some doubts still linger which I will attempt to address at the upcoming Annual General Meeting.
Cash Flow Statement Analysis
A quick glance at their Cash Flow Statement shows that CFG generated healthy operational cash inflows of USD 65.4 million for FY 20008, down from USD 172.8 million for FY 2007. Knowing that their business is very cyclical and is based upon quota allocation and fishing seasons, one might attribute the changes in working capital to such seasonal fluctuations and the fact that the Company is gearing up for its first ITQ fishing season in 2009. The entire year's cash inflow is just about sufficient to cover the short-term debt which is due for re-financing (or repayment, assuming they have the cash to do so). I have no doubt that CFG can generate strong cash inflows from their trawling and fishmeal operations, but a major problem now is that they are paying out USD 28.4 million just in interest alone, so unless they reduce their debt quickly, a lot more of their cash flows will go into feeding the banks and bankers' salaries rather than being ploughed back into the business to generate higher ROE. This in itself is very worrisome.
For investing activities, CFG spent USD 57.5 million acquiring PPE which consists of fishmeal plants and fishing vessels. Note that part of this money may also be capitalized expenses resulting from the elongation of existing super-trawlers; thus CFG's growth is part organic and part acquisitive. Another USD 19.7 million was spent acquiring a subsidiary (which includes fishing permits as well). All in all, they spent significantly less in FY 2008 on investing activities as compared to FY 2007, when a massive USD 277.7 million was spent on acquiring PPE, subsidiaries, fishing permits and prepayment of charter hire.
For the financing side, more bank borrowings were raised to acquire assets, while the final dividend for FY 2007 paid came up to USD 12.6 milllion. The result was a net cash inflow of USD 8.8 million, and was lower than FY 2007's fund-raising efforts which saw issuance of new shares as well as bank borrowings totalling USD 96 million.
For FY 2009, my wish is to see CFG halt all acquisitions and focus their efforts on building up their operational cash inflows in order to pay down their bank loans (and possibly redeem some of their senior notes due 2013). During lean and tough times, organic growth may be preferred to acquisitive growth especially since the Company is already so highly leveraged. If CFG had a lot of cash on hand and no debt, I would encourage more asset acquisitions at fire-sale prices. Because of the fact that they have so little cash and such high borrowings, I would rather the Company focus on cash generation, in order to avoid the risk of ending up as another "Ferrochina".
By the way, another indication that the Company is cash-strapped is the declaration of a share dividend (scrip instead of cash) of 6.03 Singapore cents per share. I see this move being purely cosmetic as the Company can choose NOT to declare a dividend and cause dilution to EPS, so I will bring this issue up at the AGM too.
Disappointing though the above sounds, I do still have faith that the Management Team can steer the company to better times with their growth plan, assuming nothing drastic occurs in the meantime.
Prospects - ITQ Implementation
The long-awaited ITQ (Individual Transferable Quota) system will be in place in Peruvian waters in the first fishing season of 2009. This was issued by the Peruvian Government on June 28, 2008 and places individual limits of capture per vessel instead of having a quota for a specific specie of fish. A maximum limit of capture will be set and vessels will not need to "race" to catch as much as fish as they anymore. This was the case for the old system called the "Olympic" quota system, in which the Ministry of Production decides the total quota for the country and each vessel owner must then rush to maximiser share of the total quota. The fishing season then ends when the quota has been achieved.
For the ITQ system, each vessel can catch the allocated quota at heir own discretion. There are several advantages with regards to the ITQ as compared to Olympic system:-
1) There will be better rationalization of plants, fishing vessel fleet and personnel as scheduling becomes more efficient and effective. Previously, during the "race" to catch as much as possible, it would have been difficult to plan for and allocate vessels to maximise catch. However, under the ITQ, this would now be possible. The result is better economies of scale and hence lower cost of goods sold (translating into higher gross margins).
2) There will also be significantly improved utilization of assets as a result of the economies of scale. The projection by Copeinca (a major competitor of CFG) is that EBITDA will increase 30-40% as a result of this.
3) The quality of fish and fishmeal will also improve as there is no rush to catch as much as one can, thus compromising on the quality of catch due to the race for quantity. This would translate into higher selling prices for the fish and fishmeal and again improves gross margin.
4) The ITQ system will also continue to ensure that fish populations are sustainable and do not deplete too quickly.
However, one thing to note is that the full effects of the ITQ system will probably not be felt until FY 2010.
Prospects - Fish Demand and Fish Prices
Worldwide fish demand is expected to remain consistent with moderate growth as the global recession kicks in. The move towards more healthy diets means that more will start consuming fish instead of red meat; however this effect is likely to be mitigated by the loss of wealth in affluent countries as a result of the economic crisis; therefore the income effect may cause people to temporarily downgrade to cheaper alternative sources of protein, thus neglecting fish. However, I do not see a major negative impact for this as fish consumption should remain relatively steady and demand should stay resilient despite the growing recession.
As for fish prices*, consumers will start to switch to alternative species in the more affordable range and this will boost sales volume, though margins are likely to stay constant. Expected worldwide deflation may also cause prices to drop, though a >10% drop is not likely and should not be prolonged. It is expected that fishmeal prices should stay steady at around USD 1,000 per MT in the near term, with the long-term trend showing a steady increase.
Prospects - Deployment to South Pacific
CFG had mentioned deploying super-trawlers to the South Pacific which is currently relatively unexplored and has untapped fish resources. CFG was in the midst of upgrading their super-trawlers in FY 2008 and perhaps this was one reason why they could not ahieve full potential during FY 2008. As of year-end 2008, two super-trawlers had been deployed to the South Pacific Ocean and more (exact number unknown) will be deployed there in FY 2009. This has to be confirmed with Management during the AGM.
Falling oil prices will also benefit these super-trawlers which are able to increase their hold capacity after elongation (I checked this during the last AGM). Naturally, being larger, they will consumer more fuel than non-upgraded super-trawlers so the fall in bunker prices will benefit CFG greatly, plus the increased hold capacity means more fish can be stored for transport to the nearest fishmeal processing facility.
The Future - Krill ?
Apparently, during an interview with The Edge Singapore (August 18, 2008 issue), Ng Joo Siang mentioned that he thinks there might be big demand for krill some day. This is a minute marine bio-organism which can be found in the Antarctic in large numbers. They are at the bottom of the food chain (whales eat them in abundance) and there have been warnings by conservationists that removing them from the food chain may severely impact other species and cause a catastrophe in terms of bio-diversity. Notwithstanding this, the potential for krill is good because it can be made into krill oil and krillmeal for animals and is also rich in Omega-3 fatty acid. In some news reports, krill is also being tested for use in skin care products !
Thus, I will be bringing up the subject of krill to the Management to see if there are any plans underway to harvest this new species, and the potential for growing this business.
*Note: Fish prices relate to prices of Peruvian anchovies as well as Chilean Jack Mackerel.
I will provide another update for the Company come AGM time. In the meantime, I expect to hear more news of the scrip dividend scheme and hopefully it will allow me to average down my cost without me having to cough up extra funds.
China Fishery (CFG) had released their FY 2008 financials some time back, and I had the chance to do a detailed review of the Company's financials. Suffice to say that I was not entirely happy with the numbers that I saw, and a few aspects of the financials caused me a considerable degree of worry and consternation. However, my fears were assuaged due to the fact that a lot of the debt in CFG's books had collateral tied to it (i.e. their fishmeal processing plants, fishing vessels and fishmeal inventories) and assured me that CFG could re-finance its short-term debt. I will be touching more on CFG's debt in the Balance Sheet review below. Perhaps astute readers out there can point out facts which I myself had over-looked when I decided to invest in this company. However, things change and the future is never certain; thus one must always question one's original premise for investing in a particular company.
Profit and Loss Analysis
In such uncertain times and in the midst of a severe recession, most investors would find it more prudent to scrutinize a Company's Cash Flow Statement and Balance Sheet rather than its Income Statement. This is because a strong Balance Sheet and regular and stable cash inflows can help a company tide through long downturns to emerge even stronger after that. CFG had managed to grow its top-line revenue by 13% from USD 406.4 million to USD 459.4 million. The rise in revenues was mainly due to higher catch volumes and higher selling prices for its fish with regards to its trawling division, which accounted for 74.7% of total revenue. The other 25.3% was made up of fishmeal operations and this created a minor drag on revenue as fishmeal prices softened during FY 2008 compared to FY 2007. A latest check on fishmeal prices from Copeinca's 3Q 2008 financial highlights shows that fishmeal prices averaged around USD 988 per metric tonne (MT), lower than the USD 1,100 to 1,200 per MT hit in FY 2007.
Gross margins dropped from 34.8% in FY 2007 to 32.3% in FY 2008. The main culprit was higher bunker fuel costs as the price of oil shot up to as high as USD 147 per barrel around July-August 2008. The ratio of fuel to total sales increased from 14% to 17.9% as a result of this. However, with oil prices slumping to below USD 40 due to the global recession, CFG should be able to regain their high margins again for FY 2009, barring unforseen circumstances.
Finance costs also rose slightly for the Company from USD 26.8 million to USD 31.2 million, a 16.4% increase. This was due to higher bank loans taken out during FY 2008 for the acquisition of fishing vessels and fishmeal plants. As the credit crisis dragged on and credit became tighter, the Company had also ceased their acquisition of assets until more clarity emerged. This will be discussed under future prospects and directions. As a result, net margins decreased from 21.8% to 20.5% (helped by a tax credit of USD 2.4 million from the recognition of tax losses carry forward by CFG Investment S.A.C.) and net profit rose just 6.5% from USD 88.5 million to USD 94.3 million. Using an exchange rate of 1 USD = 1.52 SGD, this translates to about SGD 143.3 million net profit. EPS is about SGD 18.3 cents and using the closing price of 60 Singapore cents as at February 24, 2009, this translates to a historical FY 2008 PER of 3.28 times.
Balance Sheet Review
Well, I have to admit CFG does not have one of the cleanest Balance Sheets around; after doing a quick comparison to companies such as Boustead and Tat Hong, I was forced to conclude that CFG's Balance Sheet represents a lot of risk and notwithstanding the fact that their trawling operations generate lots of operational cash inflows, the Management must make a sustained effort to reduce their gearing and improve their cash balance. A quick glance would show that the Company had debts amounting to USD 317.3 million for FY 2008 (bank loans + senior notes) of which about USD 60 million is up for re-financing within a year. Gearing is dangerously high at 43.6% debt to total assets and about 94.5% debt to equity ! The fact that the Company had a measly cash balance of just USD 7.7 million is of great cause for concern ! I will cover this aspect during the review of the Cash Flow Statement, and though this may be a timing difference, having so little cash in the face of so much debt is not something I like to see as an investor.
Current ratio actually improved from 1.05 in FY 2007 to 1.28 in FY 2008, mainly due to the increase in trade receivables and inventories, coupled with a large drop in trade payables. However, the worrying fact is that short-term debt increased in order for them to finance their acquisitions, and only the assurance of better cash inflows in future can make me feel more worry-free. Suffice to say this is a Balance Sheet which had me beleaguered for quite some time, but seeing that CFG and PAH have a good track record and are a major industry player, and that the CEO is prudent enough to manage inventories and debt; this has caused some of the worry to ease, though some doubts still linger which I will attempt to address at the upcoming Annual General Meeting.
Cash Flow Statement Analysis
A quick glance at their Cash Flow Statement shows that CFG generated healthy operational cash inflows of USD 65.4 million for FY 20008, down from USD 172.8 million for FY 2007. Knowing that their business is very cyclical and is based upon quota allocation and fishing seasons, one might attribute the changes in working capital to such seasonal fluctuations and the fact that the Company is gearing up for its first ITQ fishing season in 2009. The entire year's cash inflow is just about sufficient to cover the short-term debt which is due for re-financing (or repayment, assuming they have the cash to do so). I have no doubt that CFG can generate strong cash inflows from their trawling and fishmeal operations, but a major problem now is that they are paying out USD 28.4 million just in interest alone, so unless they reduce their debt quickly, a lot more of their cash flows will go into feeding the banks and bankers' salaries rather than being ploughed back into the business to generate higher ROE. This in itself is very worrisome.
For investing activities, CFG spent USD 57.5 million acquiring PPE which consists of fishmeal plants and fishing vessels. Note that part of this money may also be capitalized expenses resulting from the elongation of existing super-trawlers; thus CFG's growth is part organic and part acquisitive. Another USD 19.7 million was spent acquiring a subsidiary (which includes fishing permits as well). All in all, they spent significantly less in FY 2008 on investing activities as compared to FY 2007, when a massive USD 277.7 million was spent on acquiring PPE, subsidiaries, fishing permits and prepayment of charter hire.
For the financing side, more bank borrowings were raised to acquire assets, while the final dividend for FY 2007 paid came up to USD 12.6 milllion. The result was a net cash inflow of USD 8.8 million, and was lower than FY 2007's fund-raising efforts which saw issuance of new shares as well as bank borrowings totalling USD 96 million.
For FY 2009, my wish is to see CFG halt all acquisitions and focus their efforts on building up their operational cash inflows in order to pay down their bank loans (and possibly redeem some of their senior notes due 2013). During lean and tough times, organic growth may be preferred to acquisitive growth especially since the Company is already so highly leveraged. If CFG had a lot of cash on hand and no debt, I would encourage more asset acquisitions at fire-sale prices. Because of the fact that they have so little cash and such high borrowings, I would rather the Company focus on cash generation, in order to avoid the risk of ending up as another "Ferrochina".
By the way, another indication that the Company is cash-strapped is the declaration of a share dividend (scrip instead of cash) of 6.03 Singapore cents per share. I see this move being purely cosmetic as the Company can choose NOT to declare a dividend and cause dilution to EPS, so I will bring this issue up at the AGM too.
Disappointing though the above sounds, I do still have faith that the Management Team can steer the company to better times with their growth plan, assuming nothing drastic occurs in the meantime.
Prospects - ITQ Implementation
The long-awaited ITQ (Individual Transferable Quota) system will be in place in Peruvian waters in the first fishing season of 2009. This was issued by the Peruvian Government on June 28, 2008 and places individual limits of capture per vessel instead of having a quota for a specific specie of fish. A maximum limit of capture will be set and vessels will not need to "race" to catch as much as fish as they anymore. This was the case for the old system called the "Olympic" quota system, in which the Ministry of Production decides the total quota for the country and each vessel owner must then rush to maximiser share of the total quota. The fishing season then ends when the quota has been achieved.
For the ITQ system, each vessel can catch the allocated quota at heir own discretion. There are several advantages with regards to the ITQ as compared to Olympic system:-
1) There will be better rationalization of plants, fishing vessel fleet and personnel as scheduling becomes more efficient and effective. Previously, during the "race" to catch as much as possible, it would have been difficult to plan for and allocate vessels to maximise catch. However, under the ITQ, this would now be possible. The result is better economies of scale and hence lower cost of goods sold (translating into higher gross margins).
2) There will also be significantly improved utilization of assets as a result of the economies of scale. The projection by Copeinca (a major competitor of CFG) is that EBITDA will increase 30-40% as a result of this.
3) The quality of fish and fishmeal will also improve as there is no rush to catch as much as one can, thus compromising on the quality of catch due to the race for quantity. This would translate into higher selling prices for the fish and fishmeal and again improves gross margin.
4) The ITQ system will also continue to ensure that fish populations are sustainable and do not deplete too quickly.
However, one thing to note is that the full effects of the ITQ system will probably not be felt until FY 2010.
Prospects - Fish Demand and Fish Prices
Worldwide fish demand is expected to remain consistent with moderate growth as the global recession kicks in. The move towards more healthy diets means that more will start consuming fish instead of red meat; however this effect is likely to be mitigated by the loss of wealth in affluent countries as a result of the economic crisis; therefore the income effect may cause people to temporarily downgrade to cheaper alternative sources of protein, thus neglecting fish. However, I do not see a major negative impact for this as fish consumption should remain relatively steady and demand should stay resilient despite the growing recession.
As for fish prices*, consumers will start to switch to alternative species in the more affordable range and this will boost sales volume, though margins are likely to stay constant. Expected worldwide deflation may also cause prices to drop, though a >10% drop is not likely and should not be prolonged. It is expected that fishmeal prices should stay steady at around USD 1,000 per MT in the near term, with the long-term trend showing a steady increase.
Prospects - Deployment to South Pacific
CFG had mentioned deploying super-trawlers to the South Pacific which is currently relatively unexplored and has untapped fish resources. CFG was in the midst of upgrading their super-trawlers in FY 2008 and perhaps this was one reason why they could not ahieve full potential during FY 2008. As of year-end 2008, two super-trawlers had been deployed to the South Pacific Ocean and more (exact number unknown) will be deployed there in FY 2009. This has to be confirmed with Management during the AGM.
Falling oil prices will also benefit these super-trawlers which are able to increase their hold capacity after elongation (I checked this during the last AGM). Naturally, being larger, they will consumer more fuel than non-upgraded super-trawlers so the fall in bunker prices will benefit CFG greatly, plus the increased hold capacity means more fish can be stored for transport to the nearest fishmeal processing facility.
The Future - Krill ?
Apparently, during an interview with The Edge Singapore (August 18, 2008 issue), Ng Joo Siang mentioned that he thinks there might be big demand for krill some day. This is a minute marine bio-organism which can be found in the Antarctic in large numbers. They are at the bottom of the food chain (whales eat them in abundance) and there have been warnings by conservationists that removing them from the food chain may severely impact other species and cause a catastrophe in terms of bio-diversity. Notwithstanding this, the potential for krill is good because it can be made into krill oil and krillmeal for animals and is also rich in Omega-3 fatty acid. In some news reports, krill is also being tested for use in skin care products !
Thus, I will be bringing up the subject of krill to the Management to see if there are any plans underway to harvest this new species, and the potential for growing this business.
*Note: Fish prices relate to prices of Peruvian anchovies as well as Chilean Jack Mackerel.
I will provide another update for the Company come AGM time. In the meantime, I expect to hear more news of the scrip dividend scheme and hopefully it will allow me to average down my cost without me having to cough up extra funds.
Saturday, November 15, 2008
Corporate Results Announcements
As I have a serious lack of time, I will not be doing reviews for ALL my companies which have released results recently, but will just focus on one or two. I've realized that it takes a lot of effort to analyze and post all the analysis here on my blog, when actually one should be more concerned with the long-term prospects of the businesses rather than staying too focused on quarterly results. That is the domain of analysts, whose job is just to churn up reports based on short-term forecasts (yes, 1-year price targets are considered short-term !).
Tat Hong Holdings Limited
Tat Hong released their 1H FY 2009 results on November 12, 2008. Revenues for 2Q 2009 rose 15% but this was offset by higher COGS (increase of 20%), resulting in gross profit increase of only 5%. Profit for 2Q 2009 dipped 3% from 2Q 2008; but looking at half-yearly figures, net profit increased a decent 25%. The Company declared an interim dividend of 3.5 cents per share, payable on December 12, 2008. At my purchase price of 71.5 cents, this represents an interim yield of 4.9%. I will be doing a more detailed review of Tat Hong's financials and prospects in due course, as I have quite a bit to say about their various divisions and also for their regional prospects in the longer-term (up till FY 2012).
Swiber Holdings Limited
3Q 2008 revenues surged 186.5%, while COGS increased an even heftier 247.3%, resulting in a 68.4% rise in gross profits. As a result of lower exceptional items for 3Q 2008, net profit fell 7.4% while profit attributable to shareholders fell 18.7% on quarter. For 9M 2008, profits increased a healthy 58.9% to US$47.1 million, and this already more than covers the entire FY 2007 profits. During bear markets, analysts love to focus on the negatives, and I am sure the "surprise drop" in profits of 18.7% on quarter will be mentioned many times. Putting things in perspective, the lumpy nature of contracts and the increase in headcount and administrative expenses as a result of business expansion into the region probably added quite a bit to Swiber's cost structure, as did the finance expenses on their bank loans and bonds. While this is not good for the company in the short-term, in the longer-term their asset-light strategy and their larger spread of vessels will help to snare them larger contracts which are hopefully long-term (e.g. is the CUEL 5-year contract for US$50 million per annum).
Their Balance Sheet is healthy with gearing at about 1.06 and current ratio >1, thus there is no immediate cause for worry as their debt is not due till FY 2011. Their cashflows from operating activities is also healthy at US$19 million for 3Q 2008, though the bulk of their cash inflows still came from the raising of more banks loans worth US$74 million. Still, there is probably more visibility now in terms of operating cash inflows, and the Company will take a more cautious stance towards expansion, and has put their deep-water plans on hold until oil prices firm up in future years. Prudence will see the company through these lean times, and they should emerge stronger and more ready for challenges by FY 2010. I will NOT be writing a detailed review on Swiber.
Using US$47.1 million at an exchange rate of 1.50 to the USD, EPS is about 16.76 Singapore cents per share for 9M. If annualized, EPS will be about 22.35 Singapore cents. At today's closing price of 61 cents, this values the company at a mere 2.73 times PER.
Pacific Andes (Holdings) Limited
Revenues for 2Q 2009 dipped 4% while gross profit dripped 12.6% due to higher fuel costs and also the supply chain management division getting disrupted due to the Olympic Games. Net profits decreased by 16% on quarter and about 16% for 1H 2009 too. However, due to PAH's increased stake in CFG, profits attributable to shareholders rose 18.5% on 1H FY 2009 compared to 1H FY 2008. Management has reported that fish product prices have risen 10-20% due to increased demand during the economic slowdown (hey, people still have to eat fish right ?). Due to the deployment of less fishing vessels to the North Pacific, they suffered a temporary drop in fishing volume which will be made up in 3Q 2009 (4Q 2008 for China Fishery).
Higher fuel costs were also cited as one of the reasons for the fall in profits, which was largely in line with what I expected. Fuel prices have since dropped to around US$56 per barrel and are likely to remain low for as long as the recession does not blow over. Thus, this should ease the gross margins for CFG's fishing division. Catalysts for profit growth in 2H FY 2009 will include measures taken by CFG to fish for more catch and also for deployment of their elongated vessels to the North and South Pacific. In CY 2009, higher total allowable catch (TAC) is also expected as fish supplies have remained healthy due to sustainable fishing practices. There will be NO further review from me for PAH's 1H FY 2009 results.
China Fishery Group Limited
Revenues for CFG were up 3% for 3Q 2008 and 8.4% for 9M 2008. However, net profit dipped by 28.1% on quarter due to the problems mentioned in PAH's review - higher fuel costs and deployment of vessels to defer catch volume till 4Q 2008. As a result of these, lower volumes of fish were caught even though prices had risen. Gross margin for 9M 2008 was high at 34%, while net margin was a respectable 22%. The Group managed an 11% rise in 9M net profit to US$78 million. Assuming oil prices remain at current levels, and CFG replenishes the fish which they had failed to catch in 3Q 2008, this means that annualized profits should hit about US$104 million. Using exchange rate of 1.50 to the USD, annualized EPS will be about 20 Singapore cents. Using closing price of 61 cents, FY 2008 PER is just about 3 times. Considering their revenues are consistent and recurring (unless the ocean runs out of fish !), this is a very low valuation for a good fishing company to trade at, which is one example of Mr. Market's mood swings.
Net cash from operating activities was a healthy +US$42 million for 3Q 2008, and +US$60.1 million for 9M 2008. Net increase in cash was US$23.2 million for 9M 2008 after factoring in acquisition of PPE and subsidiaries. Net gearing improved to 92.9% from 108.3% as at December 31, 2007. Prospects are decent for CFG as they are expanding their number of vessels and also elongating their existing ones to increase the fish hold capacity. When the ITQ is implemented in Peru in FY 2009, this should provide a further boost to prices as quality of catch will improve. I have also noted the Chairman Ng Joo Siang's plans to eventually branch out to catching krill by FY 2010 and hope that they can implement this as an additional revenue stream. I hope to get more updates on this at the next AGM. Meanwhile, I will provide no more further analysis on CFG until the FY 2008 results are out some time in Feb 2009.
Boustead Singapore Limited
Boustead released a decent set of results today, underscoring their slow but steady growth in all divisions despite the economic downturn. Since I will be doing a more detailed review of Boustead's 1H FY 2009 results, I shall not say too much during this post. Suffice to say that the Company has grown all divisions decently, and has a net cash position of S$117.6 million. They have declared an interim dividend of 1.5 cents per share (a yield of 2.6 cents based on my purchase price) which is payable on December 18, 2008. On a comparative basis, after removing one-off items, net profit attributable to shareholders improved 30.2% to S$15.2 million.
One must note that the Company usually does better in 2H of the financial year and shows weaker financial results in 1H. Thus, due to their lumpy project nature of their revenues, it will not be wise to annualize their net profit to derive a valuation as it would be misleading. Also note that the sale of a leasehold property will net the Company another S$200 million in 2H 2009, and this should result in a very decent final dividend for FY 2009. I will be doing a detailed breakdown in a future post for Boustead, and discuss possible strategies which the Company may take to grow their top and bottom line.
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Stay tuned for more posts coming on Investment Sins, as well as a continuation of the Behavioural Finance series. I am also planning a future "Your Money and Your Brain" series after reading the book by Jason Zweig, to draw out snippets to illustrate the fascinating relationship between money and our own brains.
As I have a serious lack of time, I will not be doing reviews for ALL my companies which have released results recently, but will just focus on one or two. I've realized that it takes a lot of effort to analyze and post all the analysis here on my blog, when actually one should be more concerned with the long-term prospects of the businesses rather than staying too focused on quarterly results. That is the domain of analysts, whose job is just to churn up reports based on short-term forecasts (yes, 1-year price targets are considered short-term !).
Tat Hong Holdings Limited
Tat Hong released their 1H FY 2009 results on November 12, 2008. Revenues for 2Q 2009 rose 15% but this was offset by higher COGS (increase of 20%), resulting in gross profit increase of only 5%. Profit for 2Q 2009 dipped 3% from 2Q 2008; but looking at half-yearly figures, net profit increased a decent 25%. The Company declared an interim dividend of 3.5 cents per share, payable on December 12, 2008. At my purchase price of 71.5 cents, this represents an interim yield of 4.9%. I will be doing a more detailed review of Tat Hong's financials and prospects in due course, as I have quite a bit to say about their various divisions and also for their regional prospects in the longer-term (up till FY 2012).
Swiber Holdings Limited
3Q 2008 revenues surged 186.5%, while COGS increased an even heftier 247.3%, resulting in a 68.4% rise in gross profits. As a result of lower exceptional items for 3Q 2008, net profit fell 7.4% while profit attributable to shareholders fell 18.7% on quarter. For 9M 2008, profits increased a healthy 58.9% to US$47.1 million, and this already more than covers the entire FY 2007 profits. During bear markets, analysts love to focus on the negatives, and I am sure the "surprise drop" in profits of 18.7% on quarter will be mentioned many times. Putting things in perspective, the lumpy nature of contracts and the increase in headcount and administrative expenses as a result of business expansion into the region probably added quite a bit to Swiber's cost structure, as did the finance expenses on their bank loans and bonds. While this is not good for the company in the short-term, in the longer-term their asset-light strategy and their larger spread of vessels will help to snare them larger contracts which are hopefully long-term (e.g. is the CUEL 5-year contract for US$50 million per annum).
Their Balance Sheet is healthy with gearing at about 1.06 and current ratio >1, thus there is no immediate cause for worry as their debt is not due till FY 2011. Their cashflows from operating activities is also healthy at US$19 million for 3Q 2008, though the bulk of their cash inflows still came from the raising of more banks loans worth US$74 million. Still, there is probably more visibility now in terms of operating cash inflows, and the Company will take a more cautious stance towards expansion, and has put their deep-water plans on hold until oil prices firm up in future years. Prudence will see the company through these lean times, and they should emerge stronger and more ready for challenges by FY 2010. I will NOT be writing a detailed review on Swiber.
Using US$47.1 million at an exchange rate of 1.50 to the USD, EPS is about 16.76 Singapore cents per share for 9M. If annualized, EPS will be about 22.35 Singapore cents. At today's closing price of 61 cents, this values the company at a mere 2.73 times PER.
Pacific Andes (Holdings) Limited
Revenues for 2Q 2009 dipped 4% while gross profit dripped 12.6% due to higher fuel costs and also the supply chain management division getting disrupted due to the Olympic Games. Net profits decreased by 16% on quarter and about 16% for 1H 2009 too. However, due to PAH's increased stake in CFG, profits attributable to shareholders rose 18.5% on 1H FY 2009 compared to 1H FY 2008. Management has reported that fish product prices have risen 10-20% due to increased demand during the economic slowdown (hey, people still have to eat fish right ?). Due to the deployment of less fishing vessels to the North Pacific, they suffered a temporary drop in fishing volume which will be made up in 3Q 2009 (4Q 2008 for China Fishery).
Higher fuel costs were also cited as one of the reasons for the fall in profits, which was largely in line with what I expected. Fuel prices have since dropped to around US$56 per barrel and are likely to remain low for as long as the recession does not blow over. Thus, this should ease the gross margins for CFG's fishing division. Catalysts for profit growth in 2H FY 2009 will include measures taken by CFG to fish for more catch and also for deployment of their elongated vessels to the North and South Pacific. In CY 2009, higher total allowable catch (TAC) is also expected as fish supplies have remained healthy due to sustainable fishing practices. There will be NO further review from me for PAH's 1H FY 2009 results.
China Fishery Group Limited
Revenues for CFG were up 3% for 3Q 2008 and 8.4% for 9M 2008. However, net profit dipped by 28.1% on quarter due to the problems mentioned in PAH's review - higher fuel costs and deployment of vessels to defer catch volume till 4Q 2008. As a result of these, lower volumes of fish were caught even though prices had risen. Gross margin for 9M 2008 was high at 34%, while net margin was a respectable 22%. The Group managed an 11% rise in 9M net profit to US$78 million. Assuming oil prices remain at current levels, and CFG replenishes the fish which they had failed to catch in 3Q 2008, this means that annualized profits should hit about US$104 million. Using exchange rate of 1.50 to the USD, annualized EPS will be about 20 Singapore cents. Using closing price of 61 cents, FY 2008 PER is just about 3 times. Considering their revenues are consistent and recurring (unless the ocean runs out of fish !), this is a very low valuation for a good fishing company to trade at, which is one example of Mr. Market's mood swings.
Net cash from operating activities was a healthy +US$42 million for 3Q 2008, and +US$60.1 million for 9M 2008. Net increase in cash was US$23.2 million for 9M 2008 after factoring in acquisition of PPE and subsidiaries. Net gearing improved to 92.9% from 108.3% as at December 31, 2007. Prospects are decent for CFG as they are expanding their number of vessels and also elongating their existing ones to increase the fish hold capacity. When the ITQ is implemented in Peru in FY 2009, this should provide a further boost to prices as quality of catch will improve. I have also noted the Chairman Ng Joo Siang's plans to eventually branch out to catching krill by FY 2010 and hope that they can implement this as an additional revenue stream. I hope to get more updates on this at the next AGM. Meanwhile, I will provide no more further analysis on CFG until the FY 2008 results are out some time in Feb 2009.
Boustead Singapore Limited
Boustead released a decent set of results today, underscoring their slow but steady growth in all divisions despite the economic downturn. Since I will be doing a more detailed review of Boustead's 1H FY 2009 results, I shall not say too much during this post. Suffice to say that the Company has grown all divisions decently, and has a net cash position of S$117.6 million. They have declared an interim dividend of 1.5 cents per share (a yield of 2.6 cents based on my purchase price) which is payable on December 18, 2008. On a comparative basis, after removing one-off items, net profit attributable to shareholders improved 30.2% to S$15.2 million.
One must note that the Company usually does better in 2H of the financial year and shows weaker financial results in 1H. Thus, due to their lumpy project nature of their revenues, it will not be wise to annualize their net profit to derive a valuation as it would be misleading. Also note that the sale of a leasehold property will net the Company another S$200 million in 2H 2009, and this should result in a very decent final dividend for FY 2009. I will be doing a detailed breakdown in a future post for Boustead, and discuss possible strategies which the Company may take to grow their top and bottom line.
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Stay tuned for more posts coming on Investment Sins, as well as a continuation of the Behavioural Finance series. I am also planning a future "Your Money and Your Brain" series after reading the book by Jason Zweig, to draw out snippets to illustrate the fascinating relationship between money and our own brains.
Saturday, May 17, 2008
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.
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.
Thursday, May 01, 2008
China Fishery Group – AGM Highlights and Snippets
I attended China Fishery’s AGM which was held on April 28, 2008 (4 p.m.) at Raffles Hotel Level 3 Function Room. Incidentally, Banyan Tree were also holding their AGM there and it was a little confusing at first because Banyan Tree had all their banners out in full force and I thought I had mistakenly stumbled into the AGM of another company.
The crowd trickled in slowly and by the time the AGM started, there were about 30+ people in the room and by then, it was announced by the hotel that there would be a “fire drill” and “sorry for the inconvenience caused”. It turned out that the fire drill was somewhat unconventional as it meant a power failure during the middle of the AGM, causing all lights to go out and the microphones to be unworkable. Nevertheless, this had the effect of amusing the shareholders and Management rather than distracting them, and I was pleasantly surprised that Management was able to make do with an uncomfortable situation and still carry on with the Meeting.
What was special about this AGM was the use of an official poll to tabulate results of votes, rather than the usual “show of hands” which is highly inaccurate. CFG are adhering to proper high standards of corporate governance by introducing this, even though it meant a 15 to 20 minute delay as the votes were being tallied and counted. In the meantime, Management was candid enough to invite questions from shareholders on the business and on the financials. After the meeting, I approached Mr. Dennis Chan (Finance Director) and Mr. Ng Koo Kwee (Executive Chairman) for a chat about CFG’s plans and prospects.
Chat with Mr. Dennis Chan:-
1) Upgrading of Supertrawlers – The three upgraded supertrawlers will be deployed to the South Pacific Ocean by 2H FY 2008 to increase the catch volume and also to tap relatively untouched waters. Mr. Chan mentioned that upgrading was done so that the supertrawlers would use less bunker fuel (hence saving costs as oil prices are climbing) and also increase the fish hold capacity of the vessel (thus increasing top line). Three more will be deployed to the South Pacific by 1H FY 2009, thus increasing the number of supertrawlers there to six. All the upgrades are funded by internal operating cash flows.
2) Expansion of Fleet – When asked about the company’s plans to grow its business, Mr. Chan did not rule out securing more VOA (Vessel Operating Agreements) and he said that if the price was right, of course CFG would like to increase their vessel fleet through a fifth or even sixth VOA. However, these VOA must come at a reasonable price as the cost of assets to be acquired in Peru had already risen nearly 100% due to the consolidation in the fishing and fishmeal industry there. He also said that CFG is unlikely to acquire more fishmeal plants from now on, and will be focusing more on acquiring more vessels to boost margins and revenue growth.
3) Interest Rate on Senior Notes – I mentioned that the interest rate on Senior Notes was 9.25%, which was actually very high. Mr. Chan said that Peru’s effective tax rate is about 37%, thus the effective interest rate which CFG was paying on these senior notes comes up to only about 6+%; thus this was still affordable and the fact that CFG has strong operating cash flows means that Management is not worried about not being able to pay down the debt gradually and the principle in 2013. In fact, a share buyback program was just approved at the EGM, but Mr. Chan said that it makes no sense to buy back your own shares using cash when cash can be better deployed to pay down debt. He does not rule out the possibility of slowing paying off the Notes when CFG has accumulated a sizeable cash balance. After all, he maintained, if not for the acquisitions of VOA and additional fishmeal plants, the company would be in a very strong positive cash flow position; and should remain so from FY 2009 onward.
Chat with Mr. Ng Joo Kwee:-
4) Fishmeal Prices – Mr. Ng expects fishmeal prices to trend upwards over time. He said that prices are now hovering around US$950 per tonne, but they hit a peak of about US$1,200 per ton some time last year. He thinks prices will stabilize and slowly climb as fishmeal is an important component of animal feed and the demand will always be there. He also advised shareholders to look for fishmeal resources on the Internet to keep track of fishmeal developments and prices. Fish oil is an essential component of fishmeal and I confirmed that CFG was also producing this product.
5) Steam-Dried versus Flame-Dried Fishmeal – Since it was announced that steam-dried fishmeal would fetch better prices and margins as compared to flame-dried fishmeal, I proceeded to ask Mr. Ng if any of the recent plant acquisitions would be converted to steam-dried variety so as to command higher ASP. Mr. Ng said that the manufacturing and production facilities required for steam-dried fishmeal were very different from those of the flame-dried variety; hence the same plant could not be used to produce both unless the equipment was overhauled. That said, he did assure that one of the plants was being converted from flame-dried to steam-dried.
6) Probable Contingent Liabilities – I also asked about whether CFG may be exposed to possible lawsuits and litigation for offenses such as damaging the environment or over-fishing. Mr. Ng laughed and assured that the impact would be non-existent at best; minimal at worst. He mentioned that each vessel was tagged with a GPRS-like device in order to track the locations of each vessel as it went trawling. This was to ensure that the vessels did not stray from the designated fishing zones, thus there was no danger of “accidentally” fishing in protected waters.
7) Regarding Expanding the Business – Mr. Ng mentioned that CFG would continue to look for suitable opportunities to expand the business by buying up smaller companies with fishing vessels. He said that the industry was very fragmented and only the larger players could afford to survive as they had the “holding power” to keep inventory of fish to wait for more favourable prices. The larger players were literally “gobbling up” the smaller companies and this meant that their competitors were also growing along with CFG. Thus, even though CFG was the sixth largest fishing company in terms of capacity, other competitors were also expanding.
8) Cash is King – Mr. Ng concluded our chat by emphasizing that it was better for CFG not to be overly aggressive in their acquisition due to the sub-prime crisis. He did not want to gear CFG excessively and mentioned that having enough cash was very important. CFG prefers to take a prudent approach to expanding over the next few years so as to slowly integrate their operations; instead of doing a fast-track expansion which may drain the company of cash and resources. This is something I would personally prefer as well – steady, consistent growth instead of quick and explosive growth only to fizzle out later.
Overall, the atmosphere was cordial and professional and the Chairman was friendly and stayed back to take questions from several shareholders. I certainly hope to see the company growing earnings steadily (10-20%) per annum while keeping up their dividend policy. Looking at the Ng family’s track record in building up PAH and PAIH, I have much less to worry about.
I attended China Fishery’s AGM which was held on April 28, 2008 (4 p.m.) at Raffles Hotel Level 3 Function Room. Incidentally, Banyan Tree were also holding their AGM there and it was a little confusing at first because Banyan Tree had all their banners out in full force and I thought I had mistakenly stumbled into the AGM of another company.
The crowd trickled in slowly and by the time the AGM started, there were about 30+ people in the room and by then, it was announced by the hotel that there would be a “fire drill” and “sorry for the inconvenience caused”. It turned out that the fire drill was somewhat unconventional as it meant a power failure during the middle of the AGM, causing all lights to go out and the microphones to be unworkable. Nevertheless, this had the effect of amusing the shareholders and Management rather than distracting them, and I was pleasantly surprised that Management was able to make do with an uncomfortable situation and still carry on with the Meeting.
What was special about this AGM was the use of an official poll to tabulate results of votes, rather than the usual “show of hands” which is highly inaccurate. CFG are adhering to proper high standards of corporate governance by introducing this, even though it meant a 15 to 20 minute delay as the votes were being tallied and counted. In the meantime, Management was candid enough to invite questions from shareholders on the business and on the financials. After the meeting, I approached Mr. Dennis Chan (Finance Director) and Mr. Ng Koo Kwee (Executive Chairman) for a chat about CFG’s plans and prospects.
Chat with Mr. Dennis Chan:-
1) Upgrading of Supertrawlers – The three upgraded supertrawlers will be deployed to the South Pacific Ocean by 2H FY 2008 to increase the catch volume and also to tap relatively untouched waters. Mr. Chan mentioned that upgrading was done so that the supertrawlers would use less bunker fuel (hence saving costs as oil prices are climbing) and also increase the fish hold capacity of the vessel (thus increasing top line). Three more will be deployed to the South Pacific by 1H FY 2009, thus increasing the number of supertrawlers there to six. All the upgrades are funded by internal operating cash flows.
2) Expansion of Fleet – When asked about the company’s plans to grow its business, Mr. Chan did not rule out securing more VOA (Vessel Operating Agreements) and he said that if the price was right, of course CFG would like to increase their vessel fleet through a fifth or even sixth VOA. However, these VOA must come at a reasonable price as the cost of assets to be acquired in Peru had already risen nearly 100% due to the consolidation in the fishing and fishmeal industry there. He also said that CFG is unlikely to acquire more fishmeal plants from now on, and will be focusing more on acquiring more vessels to boost margins and revenue growth.
3) Interest Rate on Senior Notes – I mentioned that the interest rate on Senior Notes was 9.25%, which was actually very high. Mr. Chan said that Peru’s effective tax rate is about 37%, thus the effective interest rate which CFG was paying on these senior notes comes up to only about 6+%; thus this was still affordable and the fact that CFG has strong operating cash flows means that Management is not worried about not being able to pay down the debt gradually and the principle in 2013. In fact, a share buyback program was just approved at the EGM, but Mr. Chan said that it makes no sense to buy back your own shares using cash when cash can be better deployed to pay down debt. He does not rule out the possibility of slowing paying off the Notes when CFG has accumulated a sizeable cash balance. After all, he maintained, if not for the acquisitions of VOA and additional fishmeal plants, the company would be in a very strong positive cash flow position; and should remain so from FY 2009 onward.
Chat with Mr. Ng Joo Kwee:-
4) Fishmeal Prices – Mr. Ng expects fishmeal prices to trend upwards over time. He said that prices are now hovering around US$950 per tonne, but they hit a peak of about US$1,200 per ton some time last year. He thinks prices will stabilize and slowly climb as fishmeal is an important component of animal feed and the demand will always be there. He also advised shareholders to look for fishmeal resources on the Internet to keep track of fishmeal developments and prices. Fish oil is an essential component of fishmeal and I confirmed that CFG was also producing this product.
5) Steam-Dried versus Flame-Dried Fishmeal – Since it was announced that steam-dried fishmeal would fetch better prices and margins as compared to flame-dried fishmeal, I proceeded to ask Mr. Ng if any of the recent plant acquisitions would be converted to steam-dried variety so as to command higher ASP. Mr. Ng said that the manufacturing and production facilities required for steam-dried fishmeal were very different from those of the flame-dried variety; hence the same plant could not be used to produce both unless the equipment was overhauled. That said, he did assure that one of the plants was being converted from flame-dried to steam-dried.
6) Probable Contingent Liabilities – I also asked about whether CFG may be exposed to possible lawsuits and litigation for offenses such as damaging the environment or over-fishing. Mr. Ng laughed and assured that the impact would be non-existent at best; minimal at worst. He mentioned that each vessel was tagged with a GPRS-like device in order to track the locations of each vessel as it went trawling. This was to ensure that the vessels did not stray from the designated fishing zones, thus there was no danger of “accidentally” fishing in protected waters.
7) Regarding Expanding the Business – Mr. Ng mentioned that CFG would continue to look for suitable opportunities to expand the business by buying up smaller companies with fishing vessels. He said that the industry was very fragmented and only the larger players could afford to survive as they had the “holding power” to keep inventory of fish to wait for more favourable prices. The larger players were literally “gobbling up” the smaller companies and this meant that their competitors were also growing along with CFG. Thus, even though CFG was the sixth largest fishing company in terms of capacity, other competitors were also expanding.
8) Cash is King – Mr. Ng concluded our chat by emphasizing that it was better for CFG not to be overly aggressive in their acquisition due to the sub-prime crisis. He did not want to gear CFG excessively and mentioned that having enough cash was very important. CFG prefers to take a prudent approach to expanding over the next few years so as to slowly integrate their operations; instead of doing a fast-track expansion which may drain the company of cash and resources. This is something I would personally prefer as well – steady, consistent growth instead of quick and explosive growth only to fizzle out later.
Overall, the atmosphere was cordial and professional and the Chairman was friendly and stayed back to take questions from several shareholders. I certainly hope to see the company growing earnings steadily (10-20%) per annum while keeping up their dividend policy. Looking at the Ng family’s track record in building up PAH and PAIH, I have much less to worry about.
Sunday, April 27, 2008
China Fishery Group - FY 2007 Annual Report Highlights
Sorry for the lack of updates - life is getting busier and I took the liberty of taking a short vacation to "chill out". Though one is a full-time investor at heart, one cannot practically devote too much time to investing; otherwise other aspects of life will be neglected. Money is, after all, simply a means to an end, and not an end itself.
Since the AGM of CFG is tomorrow (April 28, 2008 4 p.m. at Raffles Hotel), I shall post some of the highlights of the Annual Report after browsing. I will attempt to capture some of what goes on during the AGM proper in another separate post.
1) The Group's blended margins have dropped year-on-year. GP margin has fallen from 38.2% in FY 2006 to 34.8% in FY 2007. Net margins have fallen from 30.7% to 21.8% year-on-year (Page 4). This is due to the debt financing of the Peruvian operations and also the structure of the 4th VOA (which Management is negotiating to change right now). As a result of expansion, net margins have fallen but I feel this is tolerable for now as it is part of CFG's plan to expand their operations significantly. Once everything stabilizes, margins should start to creep up again as Management has a good track record of improving margins.
2) Trawling grounds will be extended to the South Pacific to increase CFG's area of influence and open up new catch areas. This is a promising development as it may open up new species and fish sources for CFG to tap on. Management plans to deploy 3 super-trawlers there in FY 2008, wit the intention to send more in FY 2009. The cost of upgrading was US$40 million which was funded through strong internal operating cash flows, and will increase the fish hold capacity for each vessel (Page 8).
3) Prices for fishmeal are expected to stabilize and trend upward slowly as aqua-culture will be heavily promoted by the Chinese government. Fishmeal is an important component of feedstock and will continue to show strong and sustained demand (unlike certain energy sources which may rise rapidly in popularity and later "fizzle" out due to unsustainable demand or a new alternative source).
4) CFG intends to streamline their new fishmeal plants and vessels to achieve better economies of scale. Management has stated their intention to acquire more fishmeal vessels if possible, and I will clarify what other plans Management has to expand their fishmeal operations during the AGM/EGM.
5) It remains to be seen how CFG is planning to move towards repaying their 9.25% senior notes (which in my opinion, is an obscenely high interest rate to be paying !). But from a glance at their operating cash inflows, I at least have some assurance that they are reaping good cash flows from their trawling and fishmeal operations, and that their investments in equipment, plants and vessels is going to be a one-off thing (at most stretching over 2 financial years). VOA acquisition may still continue, however, and hopefully the Group has thought about how to finance this. This is another point to bring up during AGM - the possibility of a 5th VOA ?
6) Another point I plan to raise is whether expenses/costs will increase in line with business expansion, or will they increase over and above the business growth ? If such is the case, we may witness more margin squeeze. Management should give sufficient assurance of cost control and give examples of how operations are being "stream-lined" and "consolidated" to ensure smooth synergies between trawling and fishmeal. Also, the rapid increase in head count and staff strength will undoubtedly add manpower and overhead costs. If this is a one-off thing related to the expansion into Perucian fishmeal, then it is acceptable. But if costs remain persistently high with no visible increase in productivity or economies of scale, then Management has to rethink their strategy moving forward.
7) Note 4 on Capital Risks Management is a new note (it is also in Swiber's AR) and suffice to say the auditors are getting more and more zealous in quantifying risks. They have detailed tables and explanations about the effects of currency fluctuations on profits as well as interest rate changes. I won't go into too much detail as this Note is very technical, but only wish to mention that CFG is locked into many fixed rate loans (bank loans and notes), thus their exposure to floating interest rates is minimal and is quantified in the Note 4b ii as US$258,000. At the rate things are going, I may soon have to review extensive disclosures just to determine if the Group is exposed to unnecessary risk; hopefully the auditors will decide when TOO much disclosure is deemed onerous to the shareholder and limit their facts to the necessary. I realize this statement may sound controversial but it may be a case of too much information (info overload).
8) Under Note 9 (Page 57), the amount of VAT recoverable is US$13.5 million, up about three times from last year's US$3.5 million. It will be good to ascertain the nature of this receivable.
9) Inventory has almost doubled in terms of fishmeal (US$19.3 million in FY 2007 compared with US$10.5 million in FY 2006). This can be found in Note 11 Page 58. It will be helpful to know if this is merely a temporary backlog of fishmeal, a timing difference or if there is a genuine problem in selling off their inventories.
10) Note 15 Page 62 - Interestingly, under Intangible Assets, fishing permits are treated like land in that they are assumed to be in force in perpetuity (no finite term). Hence, there is no amortization applied to these permits and CFG is permitted to state them at cost in the financial statements (not net book value). Let's hope this continues to be the accounting treatment for fishing permits, otherwise it will be a very unpleasant surprise to suddenly see amortization on fishing permits some time in the future.
11) The part about goodwill on acquisition is rather technical and complex and I will reserve comment until after the AGM as I currently do not see a problem with this. Suffice to say that all these numbers and explanations pertain to CFG's acquisitions during FY 2007.
12) Under Note 36 Page 86, CFG has contingent liabilities amounting to US$3.87 million for various legal claims against them. They have made a provision of US$1.459 million being amounts that they deem to be likely to materialize as liabilities. Shareholders should also raise the question of whether there might be further environmental effects of over-fishing or fishing in certain areas in South America which may precipitate more potential lawsuits. If so, can the company vigorously defend these lawsuits and what will the liability be ?
Comments are welcome on the above points, or if readers think there are other points to be raised for discussion and analysis.
Sorry for the lack of updates - life is getting busier and I took the liberty of taking a short vacation to "chill out". Though one is a full-time investor at heart, one cannot practically devote too much time to investing; otherwise other aspects of life will be neglected. Money is, after all, simply a means to an end, and not an end itself.
Since the AGM of CFG is tomorrow (April 28, 2008 4 p.m. at Raffles Hotel), I shall post some of the highlights of the Annual Report after browsing. I will attempt to capture some of what goes on during the AGM proper in another separate post.
1) The Group's blended margins have dropped year-on-year. GP margin has fallen from 38.2% in FY 2006 to 34.8% in FY 2007. Net margins have fallen from 30.7% to 21.8% year-on-year (Page 4). This is due to the debt financing of the Peruvian operations and also the structure of the 4th VOA (which Management is negotiating to change right now). As a result of expansion, net margins have fallen but I feel this is tolerable for now as it is part of CFG's plan to expand their operations significantly. Once everything stabilizes, margins should start to creep up again as Management has a good track record of improving margins.
2) Trawling grounds will be extended to the South Pacific to increase CFG's area of influence and open up new catch areas. This is a promising development as it may open up new species and fish sources for CFG to tap on. Management plans to deploy 3 super-trawlers there in FY 2008, wit the intention to send more in FY 2009. The cost of upgrading was US$40 million which was funded through strong internal operating cash flows, and will increase the fish hold capacity for each vessel (Page 8).
3) Prices for fishmeal are expected to stabilize and trend upward slowly as aqua-culture will be heavily promoted by the Chinese government. Fishmeal is an important component of feedstock and will continue to show strong and sustained demand (unlike certain energy sources which may rise rapidly in popularity and later "fizzle" out due to unsustainable demand or a new alternative source).
4) CFG intends to streamline their new fishmeal plants and vessels to achieve better economies of scale. Management has stated their intention to acquire more fishmeal vessels if possible, and I will clarify what other plans Management has to expand their fishmeal operations during the AGM/EGM.
5) It remains to be seen how CFG is planning to move towards repaying their 9.25% senior notes (which in my opinion, is an obscenely high interest rate to be paying !). But from a glance at their operating cash inflows, I at least have some assurance that they are reaping good cash flows from their trawling and fishmeal operations, and that their investments in equipment, plants and vessels is going to be a one-off thing (at most stretching over 2 financial years). VOA acquisition may still continue, however, and hopefully the Group has thought about how to finance this. This is another point to bring up during AGM - the possibility of a 5th VOA ?
6) Another point I plan to raise is whether expenses/costs will increase in line with business expansion, or will they increase over and above the business growth ? If such is the case, we may witness more margin squeeze. Management should give sufficient assurance of cost control and give examples of how operations are being "stream-lined" and "consolidated" to ensure smooth synergies between trawling and fishmeal. Also, the rapid increase in head count and staff strength will undoubtedly add manpower and overhead costs. If this is a one-off thing related to the expansion into Perucian fishmeal, then it is acceptable. But if costs remain persistently high with no visible increase in productivity or economies of scale, then Management has to rethink their strategy moving forward.
7) Note 4 on Capital Risks Management is a new note (it is also in Swiber's AR) and suffice to say the auditors are getting more and more zealous in quantifying risks. They have detailed tables and explanations about the effects of currency fluctuations on profits as well as interest rate changes. I won't go into too much detail as this Note is very technical, but only wish to mention that CFG is locked into many fixed rate loans (bank loans and notes), thus their exposure to floating interest rates is minimal and is quantified in the Note 4b ii as US$258,000. At the rate things are going, I may soon have to review extensive disclosures just to determine if the Group is exposed to unnecessary risk; hopefully the auditors will decide when TOO much disclosure is deemed onerous to the shareholder and limit their facts to the necessary. I realize this statement may sound controversial but it may be a case of too much information (info overload).
8) Under Note 9 (Page 57), the amount of VAT recoverable is US$13.5 million, up about three times from last year's US$3.5 million. It will be good to ascertain the nature of this receivable.
9) Inventory has almost doubled in terms of fishmeal (US$19.3 million in FY 2007 compared with US$10.5 million in FY 2006). This can be found in Note 11 Page 58. It will be helpful to know if this is merely a temporary backlog of fishmeal, a timing difference or if there is a genuine problem in selling off their inventories.
10) Note 15 Page 62 - Interestingly, under Intangible Assets, fishing permits are treated like land in that they are assumed to be in force in perpetuity (no finite term). Hence, there is no amortization applied to these permits and CFG is permitted to state them at cost in the financial statements (not net book value). Let's hope this continues to be the accounting treatment for fishing permits, otherwise it will be a very unpleasant surprise to suddenly see amortization on fishing permits some time in the future.
11) The part about goodwill on acquisition is rather technical and complex and I will reserve comment until after the AGM as I currently do not see a problem with this. Suffice to say that all these numbers and explanations pertain to CFG's acquisitions during FY 2007.
12) Under Note 36 Page 86, CFG has contingent liabilities amounting to US$3.87 million for various legal claims against them. They have made a provision of US$1.459 million being amounts that they deem to be likely to materialize as liabilities. Shareholders should also raise the question of whether there might be further environmental effects of over-fishing or fishing in certain areas in South America which may precipitate more potential lawsuits. If so, can the company vigorously defend these lawsuits and what will the liability be ?
Comments are welcome on the above points, or if readers think there are other points to be raised for discussion and analysis.
Wednesday, February 20, 2008
China Fishery - FY 2007 Analysis and Review (Part 2)
To continue the second part of my analysis and review, I will be touching on the Cash Flow Statement (CFS) and also discussing some strategies which CFG will be undertaking in order to boost their business and grab a larger market share. Some of the points discussed are worthy of debate as to their effectiveness, but the idea is to put them out on the table so that they can be objectively analyzed and commented on, so please feel free to criticize each point constructively.
Cash Flow Statement Analysis
Operating cash flows were healthy for FY 2007, with a net cash inflow of US$173.9 million. This is mainly due to the higher volume of business (which generates higher cash flows) and also a decrease in other receivables and prepayments, which caused a net cash inflow on the indirect method of preparing cash flow statements. The decrease in other receivables resulted in a net cash "increase" of US$51.8 million compared to a decrease of US$38.0 million for FY 2006. There was also an increase in trade payables which resulted in a net cash inflow of US$19.0 million compared to less than US$1 million inflow for FY 2006. This would indicate that CFG is getting better credit terms from its suppliers as the increase is significant (about 10% of net operating cash inflows). Readers should also take note of the adding back of interest expense (which is essentially a profit and loss item and is non-cash) of US$25.5 million and deduction of actual interest paid of US$20.8 million. There is thus a net cash inflow of about US$4.7 million as a result of the difference between accrual accounting and cash outflow recognition. The expense which was recognized in this period will probably be paid out in the following FY 2008, so US$25.5 million is a good gauge of FY 2008's probable cash outflows for interest expenses. Overall, interest expenses and income taxes have increased significantly which is not surprising considering the increased amount of bank loans taken by CFG and the expansion of their Peruvian operations which necessarily entails higher tax expenses.
Note that CFG has, for 2 consecutive financial years, incurred a strong net cash outflow when it comes to investing activities. This is due to their aggressive expansion into Peru and Peruvian fishing grounds which involves purchasing more vessels, fishmeal plants and a dock. Readers can check out the previous announcements from FY 2006 through till October 2007 for a summary of their acquisitions. The bulk of the spending was on purchase of PPE, fishing permits and prepayment of charter hire. Thus, CFG incurred a net cash outflow for FY 2007 of US$281.3 million, slightly higher than the outflow of US$208.1 million for FY 2006.
For financing activities, CFG has also issued in January 2007 (through a secondary offering) 29 million shares at S$3.98 (US$2.58) per share, raising gross proceeds of US$74.82 million. Net proceeds are thus reflected as US$72.9 million as some part of the proceeds would have to be paid to the placement agent. CFG also took on additional borrowings of US$23.3 million (note this is a NET figure) in order to bolster their expansion plans. All these activities resulted in a net cash inflow of US$68.7 million, which was lower than FY 2006's inflow of US$240.9 million. However, this was due to the issue of senior notes in FY 2006 of US$216 million due 2013. Hopefully, in time, CFG can slowly repay the loan and reduce their gearing so as to rely less on debt, as the current credit crunch could prove dangerous for highly leveraged companies.
In summary, it will be a positive sign to see higher cash inflows from operating activities in future to offset the repayment of bank loans and purchase of PPE. This should only kick in once CFG properly establishes a firm foothold in the fishmeal market in Peru and South America. I anticipate that Management's strategic plan should take at least 3 to 5 years to crystallize and realize its full potential.
Strategies and Future Plans
CFG has lofty plans for the future as their expansion goes underway, and they plan to become a dominant player in the global fishing industry in time to come. I do not have the exact statistics for their position within global fishing giants, but suffice to say they are in the Top 10 and are striving to improve their market share and also their margins. CFG currently have a fish hold capacity of 9,395 cubic metres and have increased their fishmeal processing capacity from 381 tons/hour to 545 tons/hour. This is 6.1% of the total processing capacity in Peru.
According to CIMB's report dated January 16, 2008, Russian authorities have announced an increase in the TAC (total allowable catch) for Alaskan Pollock to 1.46 million tonnes from 1.31 milion tonnes. This would imply that CFG is allowed to catch more and with their expanded fleet, they should be able to achieve this without too much additional effort. Russia's Federation Council has also approved an amendment to laws to double the term of renewable quota shares to 10 years from the current 5 years, and this provides more stability and long-term visibility for fishing companies for their strategies fo the long-term.
Fishmeal prices have also stabilized and CFG should see prices slowly trending upwards as commodity prices are steadily increasing across the board. Higher inflation of 11% in China will also push up selling prices and provide some support for the current US$950 per tonne price. In the long-term, prices should trend upwards slowly but steadily and CFG also has plans to acquire more fishmeal processing plants to allow their vessels to unload their cash more quickly and seamlessly.
Management at CFG are also on the lookout for more potentially earnings-accretive acquisitions of fishmeal plants and vessels; and are also searching for additional VOA which will increase their vessel fleet and allow them to catch more fish. In 2Q FY 2008, the Group will deploy 3 new upgraded and elongated super-trawlers to the South Pacific Ocean to increase catch volumes. This ocean is still relatively untapped by CFG and represents new fishing grounds for them.
The 4th VOA is also currently being re-structured from a daily rental hire to a prepaid charter hire which will weigh less on the Income Statement.
All these developments will come under scrutiny during the company's upcoming AGM in April 2008. I will be engaging the Management on these issues and hope to obtain satisfactory responses. At the same time, it will also be good to obtain the latest business update from the horse's mouth itself.
To continue the second part of my analysis and review, I will be touching on the Cash Flow Statement (CFS) and also discussing some strategies which CFG will be undertaking in order to boost their business and grab a larger market share. Some of the points discussed are worthy of debate as to their effectiveness, but the idea is to put them out on the table so that they can be objectively analyzed and commented on, so please feel free to criticize each point constructively.
Cash Flow Statement Analysis
Operating cash flows were healthy for FY 2007, with a net cash inflow of US$173.9 million. This is mainly due to the higher volume of business (which generates higher cash flows) and also a decrease in other receivables and prepayments, which caused a net cash inflow on the indirect method of preparing cash flow statements. The decrease in other receivables resulted in a net cash "increase" of US$51.8 million compared to a decrease of US$38.0 million for FY 2006. There was also an increase in trade payables which resulted in a net cash inflow of US$19.0 million compared to less than US$1 million inflow for FY 2006. This would indicate that CFG is getting better credit terms from its suppliers as the increase is significant (about 10% of net operating cash inflows). Readers should also take note of the adding back of interest expense (which is essentially a profit and loss item and is non-cash) of US$25.5 million and deduction of actual interest paid of US$20.8 million. There is thus a net cash inflow of about US$4.7 million as a result of the difference between accrual accounting and cash outflow recognition. The expense which was recognized in this period will probably be paid out in the following FY 2008, so US$25.5 million is a good gauge of FY 2008's probable cash outflows for interest expenses. Overall, interest expenses and income taxes have increased significantly which is not surprising considering the increased amount of bank loans taken by CFG and the expansion of their Peruvian operations which necessarily entails higher tax expenses.
Note that CFG has, for 2 consecutive financial years, incurred a strong net cash outflow when it comes to investing activities. This is due to their aggressive expansion into Peru and Peruvian fishing grounds which involves purchasing more vessels, fishmeal plants and a dock. Readers can check out the previous announcements from FY 2006 through till October 2007 for a summary of their acquisitions. The bulk of the spending was on purchase of PPE, fishing permits and prepayment of charter hire. Thus, CFG incurred a net cash outflow for FY 2007 of US$281.3 million, slightly higher than the outflow of US$208.1 million for FY 2006.
For financing activities, CFG has also issued in January 2007 (through a secondary offering) 29 million shares at S$3.98 (US$2.58) per share, raising gross proceeds of US$74.82 million. Net proceeds are thus reflected as US$72.9 million as some part of the proceeds would have to be paid to the placement agent. CFG also took on additional borrowings of US$23.3 million (note this is a NET figure) in order to bolster their expansion plans. All these activities resulted in a net cash inflow of US$68.7 million, which was lower than FY 2006's inflow of US$240.9 million. However, this was due to the issue of senior notes in FY 2006 of US$216 million due 2013. Hopefully, in time, CFG can slowly repay the loan and reduce their gearing so as to rely less on debt, as the current credit crunch could prove dangerous for highly leveraged companies.
In summary, it will be a positive sign to see higher cash inflows from operating activities in future to offset the repayment of bank loans and purchase of PPE. This should only kick in once CFG properly establishes a firm foothold in the fishmeal market in Peru and South America. I anticipate that Management's strategic plan should take at least 3 to 5 years to crystallize and realize its full potential.
Strategies and Future Plans
CFG has lofty plans for the future as their expansion goes underway, and they plan to become a dominant player in the global fishing industry in time to come. I do not have the exact statistics for their position within global fishing giants, but suffice to say they are in the Top 10 and are striving to improve their market share and also their margins. CFG currently have a fish hold capacity of 9,395 cubic metres and have increased their fishmeal processing capacity from 381 tons/hour to 545 tons/hour. This is 6.1% of the total processing capacity in Peru.
According to CIMB's report dated January 16, 2008, Russian authorities have announced an increase in the TAC (total allowable catch) for Alaskan Pollock to 1.46 million tonnes from 1.31 milion tonnes. This would imply that CFG is allowed to catch more and with their expanded fleet, they should be able to achieve this without too much additional effort. Russia's Federation Council has also approved an amendment to laws to double the term of renewable quota shares to 10 years from the current 5 years, and this provides more stability and long-term visibility for fishing companies for their strategies fo the long-term.
Fishmeal prices have also stabilized and CFG should see prices slowly trending upwards as commodity prices are steadily increasing across the board. Higher inflation of 11% in China will also push up selling prices and provide some support for the current US$950 per tonne price. In the long-term, prices should trend upwards slowly but steadily and CFG also has plans to acquire more fishmeal processing plants to allow their vessels to unload their cash more quickly and seamlessly.
Management at CFG are also on the lookout for more potentially earnings-accretive acquisitions of fishmeal plants and vessels; and are also searching for additional VOA which will increase their vessel fleet and allow them to catch more fish. In 2Q FY 2008, the Group will deploy 3 new upgraded and elongated super-trawlers to the South Pacific Ocean to increase catch volumes. This ocean is still relatively untapped by CFG and represents new fishing grounds for them.
The 4th VOA is also currently being re-structured from a daily rental hire to a prepaid charter hire which will weigh less on the Income Statement.
All these developments will come under scrutiny during the company's upcoming AGM in April 2008. I will be engaging the Management on these issues and hope to obtain satisfactory responses. At the same time, it will also be good to obtain the latest business update from the horse's mouth itself.
Monday, February 18, 2008
China Fishery - FY 2007 Analysis and Review (Part 1)
China Fishery (CFG) released its FY 2007 results on February 14, 2008 and they were largely in line with expectations, except that at a glance, it can be seen that costs have increased significantly as compared to revenues. This resulted in an 84.5% increase in net profit on the back of a 160% increases in revenues. I will be analyzing the financials using my usual method of moving through the Income Statement, Balance Sheet and Cash Flow Statement in order to gain a holistic overview of how the company has fared in terms of capital allocation and profit generation. Finally, I shall touch on strategies which the company may be employing to grow their business further in FY 2008 and also CFG's long-term prospects.
Income Statement Analysis
As a result of the increase in the scope of their activities, CFG's revenues have increased by 160% from US$156 million in FY 2006 to US$406.4 million in FY 2007. Recall that the company had secured their 3rd and 4th VOA (Vessel Operating Agreement) in early 2007, which helped to increase their fishing catch volume by increasing their trawling fleet size from 14 to 23. Their expansion in Peru and penetration into Peruvian fishing grounds through the acquisition of 16 purse seine fishing vessels and 3 fishmeal plants also helped them to build their numbers strongly. Throughout FY 2007, they concentrated on building their fishmeal processing capability by acquiring (among other assets) a canning plant, fishing vessels and a dock; and their most recent acquisition was on October 10, 2007 when they purchased their 7th fishmeal processing plant. Readers can look into more detail by reading through their press releases on SGXNet, but the crux of what I am trying to say is that CFG has expanded very aggressively in FY 2007 which justifies such numbers. One testament to their rapid expansion is also the massive increase in costs, especially for cost of sales and vessel operating costs which increased 732.8% and 152.4% respectively.
The establishment of the Peruvian fishmeal operations in its first year obviously took its toll on CFG's margins, as the incremental costs needed to set up new operations would be high when compared to a lower base. I anticipate that when economies of scale kick in, CFG can then better streamline its costs and enable synergies to be achieved among its operations. Gross profit margin fell from 38.2% in FY 2006 to 34.8% in FY 2007 as a result of the aforementioned reasons. It will be important to watch out for CFG's results in 1Q FY 2008 and 2Q FY 2008 to see if they have managed to keep costs under control and restore margins; otherwise it could be the case where higher revenues do not justify the higher costs.
Selling expenses also increased by 738.6%, again due to the low base used for FY 2006. Now that CFG has taken on a new business unit (i.e. fishmeal operations) as compared to just trawling in FY 2006, selling expenses have understandably increased as well. Finance costs are a worrying aspect of the business as these are likely to persist as a result of the issue of their 9.25% Senior Notes due 2013; but this can be argued to be a necessary evil in order for them to expand their operations and acquire assets to build their vessel fleet. If one takes a glance toward their Cash Flow Statement (CFS), it can be seen that they are generating very healthy cash flows of US$173.9 million from operating activities. Thus, I do not forsee any immediate problems in servicing this long-term debt, and CFG has indeed shown that they can deploy capital efficiently in order to grow their operations. What may not be immediately apparent are the economies of scale which are necessary to restore margins to respectable levels, and I shall be watching out for how Management controls costs, as well as to engage Management in conversation during the AGM on plans to grow the business. For information, net margins fell from 30.7% in FY 2006 to 21.8% in FY 2007.
Balance Sheet Analysis
As CFG has a rather complex and detailed Balance Sheet, I shall attempt to run through various sections of it one by one to enable easy understanding; and to avoid using overly technical accounting explanations as, after all, I am analyzing CFG from the perspective of an accounting analyst.
Current Assets for CFG have decreased from US$167.8 million as at Dec 31, 2006 to US$120.7 million as at Dec 31, 2007. As explained in Note 1, this was mainly due to the decrease in the balance owing from the arrangers of the first three VOA. Cash and bank balances also fell from US$57.7 million to US$20.6 million due mainly to the cash outflows from investing activities (I will elaborate more when analyzing the CFS in Part 2). The current portion of deferred charter hire increased as a larger portion of it became "current" from "non-current", thus providing a small boost to current assets. Current Ratio for FY 2007 was only 1.01 compared to 3.46 for FY 2006, due to lower current assets and significantly higher current liabilities.
Current Liabilities increased nearly 300% from US$48.4 million to US$118.9 million mainly because of the increase in bank overdrafts and current portion of bank loans. The CFS states that about US$23.32 million was borrowed from the bank during FY 2007 to finance the acquisitions which were made during the financial year, and thus total bank loans (adding current and non-current) came up to US$67.32 million for FY 2007 compared to US$42.3 million for FY 2006. Total debt to equity ratio stood at 112.7% for FY 2007 compared to 228.8% for FY 2006; but CFG reported debt to total assets ratio which they stated at 44.9% as at December 31, 2007. In terms of liabilities, CFG has its senior notes which significantly bumps up its total liabilities. One must remember that the purpose of these notes is to enable them to acquire assets to boost their fleet and capture a slice of the Peruvian Anchovy catch, as well as increase their fleet of supertrawlers and purse seine vessels. Even though value investing principles would eschew avoiding companies with high debt, my personal view is that I have faith in Management being able to grow the business for so many years, and that they will eventually be able to reduce their liabilities. One indication of this is in the CFS which I will touch on in Part 2.
One would realize by now that total long-term liabilities did not increase much year-on-year. In fact, it was more a case of an increase in current liabilities as a result of bank borrowings which worsened the current ratio and caused the higher debt-to-equity ratio. With strong operating cash flows, CFG should be able to gradually reduce their reliance on loans and generate more FCF to fund their operations. Of course, it would have been nice if CFG had a "war chest" of cash such as Boustead has, but the nature of their capital intensive operations in terms of expansion into Peru and South America necessitates the use of debt, and I will not argue against this as it is an alternative way of financing growth rather than relying on equity which will dilute shareholders.
In Part 2 of my review, I will touch on the CFS and also CFG's plans and strategies for growing revenues, margins and profits for FY 2008.
China Fishery (CFG) released its FY 2007 results on February 14, 2008 and they were largely in line with expectations, except that at a glance, it can be seen that costs have increased significantly as compared to revenues. This resulted in an 84.5% increase in net profit on the back of a 160% increases in revenues. I will be analyzing the financials using my usual method of moving through the Income Statement, Balance Sheet and Cash Flow Statement in order to gain a holistic overview of how the company has fared in terms of capital allocation and profit generation. Finally, I shall touch on strategies which the company may be employing to grow their business further in FY 2008 and also CFG's long-term prospects.
Income Statement Analysis
As a result of the increase in the scope of their activities, CFG's revenues have increased by 160% from US$156 million in FY 2006 to US$406.4 million in FY 2007. Recall that the company had secured their 3rd and 4th VOA (Vessel Operating Agreement) in early 2007, which helped to increase their fishing catch volume by increasing their trawling fleet size from 14 to 23. Their expansion in Peru and penetration into Peruvian fishing grounds through the acquisition of 16 purse seine fishing vessels and 3 fishmeal plants also helped them to build their numbers strongly. Throughout FY 2007, they concentrated on building their fishmeal processing capability by acquiring (among other assets) a canning plant, fishing vessels and a dock; and their most recent acquisition was on October 10, 2007 when they purchased their 7th fishmeal processing plant. Readers can look into more detail by reading through their press releases on SGXNet, but the crux of what I am trying to say is that CFG has expanded very aggressively in FY 2007 which justifies such numbers. One testament to their rapid expansion is also the massive increase in costs, especially for cost of sales and vessel operating costs which increased 732.8% and 152.4% respectively.
The establishment of the Peruvian fishmeal operations in its first year obviously took its toll on CFG's margins, as the incremental costs needed to set up new operations would be high when compared to a lower base. I anticipate that when economies of scale kick in, CFG can then better streamline its costs and enable synergies to be achieved among its operations. Gross profit margin fell from 38.2% in FY 2006 to 34.8% in FY 2007 as a result of the aforementioned reasons. It will be important to watch out for CFG's results in 1Q FY 2008 and 2Q FY 2008 to see if they have managed to keep costs under control and restore margins; otherwise it could be the case where higher revenues do not justify the higher costs.
Selling expenses also increased by 738.6%, again due to the low base used for FY 2006. Now that CFG has taken on a new business unit (i.e. fishmeal operations) as compared to just trawling in FY 2006, selling expenses have understandably increased as well. Finance costs are a worrying aspect of the business as these are likely to persist as a result of the issue of their 9.25% Senior Notes due 2013; but this can be argued to be a necessary evil in order for them to expand their operations and acquire assets to build their vessel fleet. If one takes a glance toward their Cash Flow Statement (CFS), it can be seen that they are generating very healthy cash flows of US$173.9 million from operating activities. Thus, I do not forsee any immediate problems in servicing this long-term debt, and CFG has indeed shown that they can deploy capital efficiently in order to grow their operations. What may not be immediately apparent are the economies of scale which are necessary to restore margins to respectable levels, and I shall be watching out for how Management controls costs, as well as to engage Management in conversation during the AGM on plans to grow the business. For information, net margins fell from 30.7% in FY 2006 to 21.8% in FY 2007.
Balance Sheet Analysis
As CFG has a rather complex and detailed Balance Sheet, I shall attempt to run through various sections of it one by one to enable easy understanding; and to avoid using overly technical accounting explanations as, after all, I am analyzing CFG from the perspective of an accounting analyst.
Current Assets for CFG have decreased from US$167.8 million as at Dec 31, 2006 to US$120.7 million as at Dec 31, 2007. As explained in Note 1, this was mainly due to the decrease in the balance owing from the arrangers of the first three VOA. Cash and bank balances also fell from US$57.7 million to US$20.6 million due mainly to the cash outflows from investing activities (I will elaborate more when analyzing the CFS in Part 2). The current portion of deferred charter hire increased as a larger portion of it became "current" from "non-current", thus providing a small boost to current assets. Current Ratio for FY 2007 was only 1.01 compared to 3.46 for FY 2006, due to lower current assets and significantly higher current liabilities.
Current Liabilities increased nearly 300% from US$48.4 million to US$118.9 million mainly because of the increase in bank overdrafts and current portion of bank loans. The CFS states that about US$23.32 million was borrowed from the bank during FY 2007 to finance the acquisitions which were made during the financial year, and thus total bank loans (adding current and non-current) came up to US$67.32 million for FY 2007 compared to US$42.3 million for FY 2006. Total debt to equity ratio stood at 112.7% for FY 2007 compared to 228.8% for FY 2006; but CFG reported debt to total assets ratio which they stated at 44.9% as at December 31, 2007. In terms of liabilities, CFG has its senior notes which significantly bumps up its total liabilities. One must remember that the purpose of these notes is to enable them to acquire assets to boost their fleet and capture a slice of the Peruvian Anchovy catch, as well as increase their fleet of supertrawlers and purse seine vessels. Even though value investing principles would eschew avoiding companies with high debt, my personal view is that I have faith in Management being able to grow the business for so many years, and that they will eventually be able to reduce their liabilities. One indication of this is in the CFS which I will touch on in Part 2.
One would realize by now that total long-term liabilities did not increase much year-on-year. In fact, it was more a case of an increase in current liabilities as a result of bank borrowings which worsened the current ratio and caused the higher debt-to-equity ratio. With strong operating cash flows, CFG should be able to gradually reduce their reliance on loans and generate more FCF to fund their operations. Of course, it would have been nice if CFG had a "war chest" of cash such as Boustead has, but the nature of their capital intensive operations in terms of expansion into Peru and South America necessitates the use of debt, and I will not argue against this as it is an alternative way of financing growth rather than relying on equity which will dilute shareholders.
In Part 2 of my review, I will touch on the CFS and also CFG's plans and strategies for growing revenues, margins and profits for FY 2008.
Friday, October 12, 2007
China Fishery – Acquisition of Fishmeal Plant in Chimbote, Peru
On October 10, 2007, China Fishery (for which Pacific Andes now owns 63.9% of) announced the acquisition of their seventh (7th) fishmeal processing plant in Chimbote, Peru for US$15.3 million. The Group already has two other plants in Chimbote but this is the first plant which is capable of processing both steam-dried and flame-dried fishmeal within the same facility. This would prove beneficial in terms of efficiencies and economies of scale. The plant has a processing capability of 103 tonnes per hour, for which 60% is for steam-dried fishmeal and 40% is for flame-dried fishmeal.
Steam-dried fishmeal is considered a higher quality product than the flame-dried variant (this could be because of the way it is prepared ?); thus it can command a higher market price, which implies higher margins. The fact that the new plant is 60% dedicated to steam-dried fishmeal is comforting and shows that Management was looking out for this factor when considering the acquisition. According to the press release, producing steam-dried fishmeal is also more energy-efficient and thus will lead to better cost savings as well as environmental benefits. The acquisition will increase CFG’s fishmeal processing capability to 549 tonnes per hour, of which 220 tonnes will be exclusively for steam-dried fishmeal. Since these offer higher margins, I expect the Group to gradually shift production towards this higher margin product in order to boost earnings.
The plant also contains a cannery (for canning the fishmeal), an ice plant and 44,500 square metres of ocean-front land for future expansion. The last point is important as it allows the plant to be expanded and extended in future, in case the production volume for fishmeal needs to be ramped up. With this acquisition, the time taken for the fishmeal to be brought to the coast for unloading by trawlers and vessels can be reduced as CFG already has 6 fishmeal plants along the coast. This reduction in turnaround time means that the trawlers and fishing vessels can be put out to sea more quickly in order to improve their catch; and it will help to optimize the supply chain. Chimbote, being the largest fishing port in Peru, will help to aggregate and consolidate the Group’s resources and assist in achieving better economies of scale.
The Group is currently looking out for more plant acquisition opportunities and leasing opportunities in order to scale up their operations more effectively. Currently, CFG already owns over 5% of the total vessel capacity available to the industry. If the Group makes more meaningful acquisitions, it can serve to improve margins significantly, in addition to CFG’s current refurbishment of the super-trawlers to elongate them (so as to increase their hold capacity).
PAH is set to benefit directly from this acquisition as they now own 63.9% of CFG. The financial results for 1H FY 2008 should be out by mid-November 2007.
On October 10, 2007, China Fishery (for which Pacific Andes now owns 63.9% of) announced the acquisition of their seventh (7th) fishmeal processing plant in Chimbote, Peru for US$15.3 million. The Group already has two other plants in Chimbote but this is the first plant which is capable of processing both steam-dried and flame-dried fishmeal within the same facility. This would prove beneficial in terms of efficiencies and economies of scale. The plant has a processing capability of 103 tonnes per hour, for which 60% is for steam-dried fishmeal and 40% is for flame-dried fishmeal.
Steam-dried fishmeal is considered a higher quality product than the flame-dried variant (this could be because of the way it is prepared ?); thus it can command a higher market price, which implies higher margins. The fact that the new plant is 60% dedicated to steam-dried fishmeal is comforting and shows that Management was looking out for this factor when considering the acquisition. According to the press release, producing steam-dried fishmeal is also more energy-efficient and thus will lead to better cost savings as well as environmental benefits. The acquisition will increase CFG’s fishmeal processing capability to 549 tonnes per hour, of which 220 tonnes will be exclusively for steam-dried fishmeal. Since these offer higher margins, I expect the Group to gradually shift production towards this higher margin product in order to boost earnings.
The plant also contains a cannery (for canning the fishmeal), an ice plant and 44,500 square metres of ocean-front land for future expansion. The last point is important as it allows the plant to be expanded and extended in future, in case the production volume for fishmeal needs to be ramped up. With this acquisition, the time taken for the fishmeal to be brought to the coast for unloading by trawlers and vessels can be reduced as CFG already has 6 fishmeal plants along the coast. This reduction in turnaround time means that the trawlers and fishing vessels can be put out to sea more quickly in order to improve their catch; and it will help to optimize the supply chain. Chimbote, being the largest fishing port in Peru, will help to aggregate and consolidate the Group’s resources and assist in achieving better economies of scale.
The Group is currently looking out for more plant acquisition opportunities and leasing opportunities in order to scale up their operations more effectively. Currently, CFG already owns over 5% of the total vessel capacity available to the industry. If the Group makes more meaningful acquisitions, it can serve to improve margins significantly, in addition to CFG’s current refurbishment of the super-trawlers to elongate them (so as to increase their hold capacity).
PAH is set to benefit directly from this acquisition as they now own 63.9% of CFG. The financial results for 1H FY 2008 should be out by mid-November 2007.
Thursday, August 16, 2007
Pacific Andes - 7.9 Point Richter Scale Earthquake in Lima, Peru
This is an urgent update as I have received news about a major earthquake in Lima, Peru. As of this writing, 330 people have been reportedly killed by this earthquake, and a tsunami alert has also been set off just to warn people of possible tsunamis hitting the coastal areas. Pacific Andes and CFG have substantial operations in Peru (fishmeal operations) and so far the companies have updated that they are NO casualties and the main office (80 km north of the epicentre) is doing fine. As communication lines are down, it will take some time before contact can be established with the other offices and plants within Peru. However, I anticipate limited damage for PAH and CFG's operations as their plants were not located close to the quake centre. Still, this is one of those events called "act of God" which no value investor can predict with certainty !
Let us all say a prayer for those who died in this tragedy and also wish those injured a speedy recovery. Life is a lot more precious than the pursuit of money and profits, sometimes I feel ashamed of myself for being such a capitalist prick......oh well we are Singaporeans after all and are so driven by money and wealth that sometimes we fail to see people struggling to survive and get by in such disaster zones. I will strive to do volunteer work when I get older, just to give something back to society.....
Straits Times Index - Drop of 243.43 points within 2 trading days to 3,152.16
This is a special post on the above, which illustrates vividly the effects of a crisis on financial markets. Within just 2 trading days, the STI has lost what it took 4 months to gain. What people don't realize in general is the volatile nature of markets and how important sentiment can be in the functioning of markets. Liquidity is another concern, of course, and if this dries up further we should see more bloodletting and more chances to buy good companies on the cheap.
Dear readers, I urge you to take this sharp correction as a reminder that you should ALWAYS purchase with a reasonable margin of safety; otherwise the steep drop in prices will be all the more painful psychologically for anyone to bear. All humans have a greater loss aversion (about 2x) as compared to reward satisfaction, which means we feel the pain of a loss more than twice the enjoyment of a gain. Thus, during this turbulent time, I would expect more people to sell low and those who have been playing on leverage to feel the sharp prick of the double-edged sword. Take this volatility as a lesson learnt that money is never easy to make consistently in the market, and that value investing helps to buffer against such times by ensuring that you get a decent return (it does not have to be exceptional) on your investment.
Good luck to all investors, and may you all find more good bargains in this market.
This is an urgent update as I have received news about a major earthquake in Lima, Peru. As of this writing, 330 people have been reportedly killed by this earthquake, and a tsunami alert has also been set off just to warn people of possible tsunamis hitting the coastal areas. Pacific Andes and CFG have substantial operations in Peru (fishmeal operations) and so far the companies have updated that they are NO casualties and the main office (80 km north of the epicentre) is doing fine. As communication lines are down, it will take some time before contact can be established with the other offices and plants within Peru. However, I anticipate limited damage for PAH and CFG's operations as their plants were not located close to the quake centre. Still, this is one of those events called "act of God" which no value investor can predict with certainty !
Let us all say a prayer for those who died in this tragedy and also wish those injured a speedy recovery. Life is a lot more precious than the pursuit of money and profits, sometimes I feel ashamed of myself for being such a capitalist prick......oh well we are Singaporeans after all and are so driven by money and wealth that sometimes we fail to see people struggling to survive and get by in such disaster zones. I will strive to do volunteer work when I get older, just to give something back to society.....
Straits Times Index - Drop of 243.43 points within 2 trading days to 3,152.16
This is a special post on the above, which illustrates vividly the effects of a crisis on financial markets. Within just 2 trading days, the STI has lost what it took 4 months to gain. What people don't realize in general is the volatile nature of markets and how important sentiment can be in the functioning of markets. Liquidity is another concern, of course, and if this dries up further we should see more bloodletting and more chances to buy good companies on the cheap.
Dear readers, I urge you to take this sharp correction as a reminder that you should ALWAYS purchase with a reasonable margin of safety; otherwise the steep drop in prices will be all the more painful psychologically for anyone to bear. All humans have a greater loss aversion (about 2x) as compared to reward satisfaction, which means we feel the pain of a loss more than twice the enjoyment of a gain. Thus, during this turbulent time, I would expect more people to sell low and those who have been playing on leverage to feel the sharp prick of the double-edged sword. Take this volatility as a lesson learnt that money is never easy to make consistently in the market, and that value investing helps to buffer against such times by ensuring that you get a decent return (it does not have to be exceptional) on your investment.
Good luck to all investors, and may you all find more good bargains in this market.
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