Uncovering A Company's Problems.

valuelife said...

From your articles, I can see you are very good at uncovering companies' problems/weaknesses. Mind to share how u did that?? Since many so-called investors just can see the pros/strengths most of the time.

Let me share one long old tale with you.

It's called Ze Funky Chicken.

There once was a listed company called Comsa Farms. Recently it was one of the company that was delisted!

Yes, it's all back tracking at this moment of time and some would argue that such back tracking theory has its flaws because we are simply looking back at Mr.Hindsight.

However, perhaps if you would indulge in my writings (most of the writing here are based on what I had written a couple of years ago) for now.

1. Let's take a look at Comsa financial track recrd.

From the above table, we can see that from fy2000-2002, there was some sort of growth.

However, signs of danger surfaced in 2003 in my opinion. For its fiscal 2003. Yes the sales revenue was increasing BUT the classical AVOID sign was there. Look at the table above. Sales dropped to 10.452 despite the drastic increase in sales. And the net margin dropped from 13.09% to 5.94%.

For its fiscal 2004. Sales revenue soared to 222 million. However, net earnings dropped again and worse still its profit margin is now a mere 4.43%. (see how important it is to know that sales revenue growth is such a NON-ISSUE?)

Did it made sense for an investor to invest in a stock whose earnings was clearly declining?

This for me was the biggest issue any investor has to ask themselves.

If the company simply wasn't making money or the company's earnings was declining, we know very well that there was something very wrong with the company or its business!

2. Searching for value? Ze asset issue.

Ok... let's have a look. In 2003.

For fy 2003 Comsa declared that it made 10.452 million. If one opens their earnings note for their fy 2003 Q4 ( Quarterly rpt on consolidated results for the financial period ended 31/3/2003 ), one would see two disturbing issues.

(1) Total debts increased from 148 million to 210 million.
(2) The cash flow statement included is simply a blur.

Any value in such an 'asset' back in 2003?

How about fy2004? Take a look at Comsa fy 2004 Q4 earnings pdf file here.

See how the inventory increased tremendously? (pg 2). Inventories increased from 63 million to 90.087 million.

Aha!

Simple logical question time!

This is a chicken business dude.

When the chicken inventory increased by so much in a single year, shouldn't one suspect something fowl? (:p)

And then... the biggest give way was so clearly stated.... in page 3.

look at the NTA section... do u see?

See how Comsa as early as in 2004 restated its NTA from 3.13 to 2.36?

Ahem!!!

Now given such mess in 2004... where one clearly saw declining profits, declining margins, increasing debts, surging inventory, restatement of NTA.... weren't there enough warning signs to avoid this stock??

How about 2005? Well, RAM on 28th January 2005 sounded a real warning on Comsa.

• The rating had been placed on a negative outlook in June 2004, to reflect the imminent weakening of the Group's credit fundamentals once it sank deeper into debt to finance its overdue sinking-fund payment.
  The assumption of additional debt would have further strained Comsa’s already precarious financial position - as highlighted by its weak operational cash flow of RM4.93 million vis-à-vis a debt of RM230.5 million as at Sept 30, 2004.

So could one have easily avoided the dangers in Comsa?

How?

And to educate ourselves further, let's study the issue of how Comsa Farms restated their earnings is really worth looking at. Let's see how these buggers did it!

Quarterly rpt on consolidated results for the financial period ended 31/12/2005

The restated earnings caused Comsa to report a loss of over rm110 million!

Here is a snapshot of the major adjustments in Comsa balance sheet.



(Click on the picture for a bigger view..)

As you can see the biggest adjustment was made in...

1. Inventory.

The adjustment of 90.273 million was made! So from an inventory balance of 98.301 million, Comsa's adjusted balance became 8.028 million!

Holy chicken!!! That's simply mind-boggling!

2. Trade receivables.

Comsa initially reported a trade receivable balance of 70.185 million. This figure is adjusted to 100.799 million!!

And the following announcement was made by Comsa explaining the adjustment.

(i) The adjustments to the inventories and biological assets are due to the adoption of International Accounting Standards ("IAS") 41 on 1 April 2005 and the related accounting policies. For further details, please refer to Note (I) (a) of the Restated Financial Results;

(ii) The adjustments to the consolidated revenue and cost of sales are due to the overstatements of sales and purchases, which have not been substantiated with valid invoices and other supporting documents;

(iii) The adjustments to trade receivables are due to the provision for bad and doubtful debts and the overstatement of sales mentioned in item (ii) above, whilst adjustments to trade payables are due to the overstatement of purchases mentioned in item (ii) above; and

(iii) The adjustments to the Property, Plant & Equipment ("PPE") are necessary to reflect the fair value of PPE as at the Said Dates.

Waaa.... consolidated revenue and cost of sales are due to the overstatements of sales and purchases which have not been substantiated with valid invoices! Holy chicken!!!!!

And the end result of this overstatement of sales... (from Comsa notes) (ahem! from 60.9 mil to just 9.9 mil!)

• The Group's revenue for the current financial period ended 31 December 2005 decreased to RM9.9 million from RM60.9 million in the prior financial period ended 31 December 2004 while the loss before taxation was RM110.2 million from a profit before taxation of RM2.5 million in the previous corresponding quarter. The decline in revenue and the loss was mainly due to the over-statement of sales during the period, loss on disposal of wholesale, retail, breeder and broiler operations and the provisions for bad and doubtful debt as disclosed in Note 7 of this section.

Truly incredible!

Wasn't the explanation made by Comsa insufficient?

So the areas to look out for.... overstating of sales, inventories and trade receivables, yes?

Overstating of sales is complex and not easy to spot but the tell-tale signs in inventories and trade receivables should never be ignored and discounted.

Remember the issues of inventory and trade receivable build-up?

And those that had been following Comsa for a while, Comsa has turned into deadly value trap because at one time, it was argued that Comsa used to be trading at a low price earnings multiple and it had always traded well below its NTA. See the dangers in investing based just on yardsticks?

Investing lessons yet again?

Hope you enjoy this write-up!


ps: here's a clip from The Wanderer.