The 13^th 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 the company is in the business of manufacturing and trading of iron and steel products which has an all-time high price of ~Rs.443 in 2012 and now last traded price at Rs.1.59.

In the first instance this company having a huge sales growth. But PAT has huge volatility.

So, we go deeper ….

Here, we can see that debtor day and inventory days are growing rapidly and assets utilization & return ratio are falling.

I would like to go further detail of it.

Here, we can see that CFO is very volatile with cumulative CFO of FY09-12 is Rs.-20 cr whereas cumulative PAT is Rs.88 cr so that CCFO<CPAT which indicates that the company has a working capital issue which we have seen in debtor days and inventory days also.

The company shows good depreciation cover because of the capitalization of assets. One can improve depreciation cover either through improving EBIDTA or by reducing depreciation. If an asset is capitalized then it is not expensed in the same year the asset is purchased. So that here the company has selected to reduce a depreciation.

Actual Journal entry of depreciation

Depreciation A/C Dr

            To Accumulated Depreciation or Fixed Assets A/C

Here, depreciation charge at income statement which will reduce the bottom-line of the company. And also added to the accumulated depreciation or directly reduces from the fixed assets so that value of fixed assets gets reduced.

But what happens when the company has decided to go for capitalization of depreciation

Fixed Assets A/C Dr

            To Cash A/C

Here, the value of fixed assets gets increased rather than getting it reduced and cash will directly getting reduce with that amount. The income statement does not have any impact it which resulted in reduces depreciation expenses and improves bottom-line.

So that when the company is making a capitalization of depreciation then we have to look at the FCF rather than just check CFO. And when we go for FCF then it’s negative in all the periods. Capitalizing an expenditure enhances current profitability and increases reported cash flow from operations. Capitalization of depreciation will increase the value of assets which is not a part of CFO but it’s a part of CFI so that FCF will provide us a better picture.

Also, the company does not have any interest cover.

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 –

Financial Shenanigans

Quality of Earnings

The Financial Numbers Game

Creative Cash Flow Reporting

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. 

The eighth 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 the company in the business of technology infrastructure management services which has an all-time high price of ~Rs.1221 in 2010 and now last traded price at Rs.0.90.

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 ….

Controlled debtor days, good fixed assets turnover ratio, high return ratios. Now, no chance to not getting tempted.

I would like to go further detail of it.

The company continuously having a lower CFO compared to PAT. Also, when we take cumulative CFO V/S cumulative PAT then it was Rs.182 cr of CCFO v/s Rs.422 cr of CPAT. So that company able to generate good profit with good growth but that does not able to convert into the cashflow.

Now, we check the tax rates then as per Cashflow its lower tax rate compared to the income statement which creates a cautious sign. It may be possible that profit has been artificially boosted.

If we look at the common size balance sheet then the majority part of the assets side was other assets which have receivables are most but what others? Is this a manufacturing company or a finance company where fixed assets are lower and other assets are higher?

We can see that changes in reserves are higher than changes in PAT. So again, look it as a suspicious. Because when a company pay a dividend from profit then reserve gets reduce and not pay dividend then remain the same. But here it’s increasing.

Now if we look at the FY10 and FY09 reserve constitute then ~Rs.10 cr has increased in securities premium which is due to amalgamation, the capital reserve has increased of ~Rs.9 cr, the general reserve has increased of ~Rs.19 cr and P&L account has increased of ~Rs.59 cr. Such kind of difference was there in all of the years, this creates a question that every year company is getting involved in the M&A or issuing new shares? previous annual reports not available.

Don’t just get blinded with growth & few numbers but focus on cash which is real & every possible aspect.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.