The ninth part of Series “Once a darling, now an evil”. This series is based on the companies which were once upon a time darling of the market and now, it has wiped out the majority of all those gains. I am trying to put some of the number-crunching facts by which we have identified ongoing issues in the companies and have saved our wealth.
I am starting this part with one of an India-based Education company which has an all-time high price of ~Rs.1025 in 2008 and now last traded price at Rs.1.20.
On the first instance this company having huge sales and profit growth. This creates a temptation to buy with missing out of the opportunity. But after the series of articles, we know to not get tempted with sales & PAT growth.
So, we go deeper ….
Huge debtor days, declining fixed assets turnover ratio, high RoE% but if we look at Debt/equity then it’s also increasing which tell us that higher RoE% is due to the higher leverage.
I would like to go further detail of it.
If we look at the common size balance sheet then the majority part of the assets side was other assets which have receivables & Cash are most but what others? Also, cash getting reduces and borrowings getting higher. Is this a service company or a finance company where other assets are higher? Also, when a company growing at a higher rate then what is the need of higher borrowings after using good cash balance?
The company got debt on a 2-3% rate. Curious and that is also at the time of higher interest rate.
Company has FCCB which is a more dangerous kind of foreign debt.
We can see that sales growing rapidly but provision for doubtful debts not growing.
The company needs to make provisioning for the doubtful receivables which have two entries – one goes to the income statement and other goes to balance sheet.
On Income statement
When we make a provision for the doubtful debt then increases to the doubtful debt provision goes to the income statement as an expense vice-versa, if decreases into the provision then it will be added to the profit to the income statement.
On Balance sheet
Provision for doubtful debt is getting reduced from the receivables on the assets side of the balance sheet.
So, less provision will boost up your profitability.
Also, when we look at the annual report then the company has made investment worth of ~Rs.70 cr in subsidiaries and from those company generate just ~Rs.24 cr in sales and ~Rs.1 cr in PAT which is just a 1.43% on investment. The company almost doubling investment into the subsidiaries every year.
Also, the company has ~Rs.187 cr worth of contingent liabilities which was ~65% and ~262% of sales and PAT respectively. If this will arise the company’s profitability will be gone for a toss.
The company requires to have a high capital employed for generating high sales growth with negative FCF, this having a better chance to get blow up.
Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.This series contains learning from books –
Quality of Earnings
The Financial Numbers Game
Creative Cash Flow Reporting