Monday, July 18, 2011

ACHL - digging through the accounts of Asian Citrus Holdings

ACHL (Asian Citrus Holdings) is a food producer listed in both UK and HK (Hong Kong). It is an AIM-quoted stock, having floated for 6-odd years. ACHL runs orange plantations.

In 2010, 96% of its revenues were the sale of oranges themselves, less than 1% were due to the sale of self-bred saplings, and the remaining 3% were due to the sale of properties. By type of customer, 41% were to supermarkets, 34% were to corporate customers, 24% were to wholesale customers, and 1% were to "other". The company doesn't elaborate what "corporate" customers are; and I'm a little perplexed as to what that actually means. Maybe it refers to the supply of oranges to customers like juice manufacturers, but that is speculation on my part.

Looking through the accounts, I was unhappy to see that a lot of the profits are in the form of "fair value gains". According to note 2h of the accounts:
fair values of orange tree biological assets are based on the present value of expected net cash flows from the orange trees discounted at a current market-determined pre-tax rate
Well, isn't that just booking profits in advance? You can see the effect that value gains are having on the company's reports on profits from their 5-year summary statement:
       TOTAL  2010  2009  2008  2007  2006
PBT     2077   587   442   367   373   308
FVG      930   305   211   165   133   115
PBTX    1147   281   231   202   240   193
RATIO %   55    48    52    55    64    63
Figures quoted above are in RMBm (millions of CNY), except for the ratio, which is in percent. PBT is the profit before tax. FVG is the fair value gain. Both of these figures are in the accounts. PBTX is a self-computed figure, simply being PBT-FVG. RATIO is PBTX/PBT as a percentage. What are these figures telling us? They are telling us that management are upping profits by revaluing the worth of their orange trees, and in no small amount. Over the five-year period, profits were only 55% of those stated in the accounts, if you strip out these gains. The trend has been consistently downwards, too - an unwelcome sign for those with a prudent mindset. That didn't stop the auditors, Baker Tilly, from giving the company a clean bill of health, though.

Confirmatory evidence that accounting profits are far above cash flows can be obtained by looking at figures published by Digital Look. The figures they produce are:
       TOTAL  2010  2009  2008  2007  2006
OCF     1285   393   278   228   214   172
OP      2079   585   442   363   375   314
%         62    67    62    63    57    55
OCF is the Operating Cash Flow, and OP is reported operating profits. Both figures are in RMBm, as before. Expressed as percentages, we see that, on average, operating cash flows have been only 62% of operating profits. Not a good sign.

Average ROE seems very good, at 16%, as computed below:

       TOTAL  2010  2009  2008  2007  2006
NP      1999   585   440   399   318   257
TE     12176  3189  2905  2469  2108  1505
ROE%      16    18    15    16    15    17
NP is the net profit for the year, TE is the total equity. I obtained these figures from Digital Look.

However, the picture isn't so rosy if I strip out the FVG, and reduces the ROE to a more modest 10%. To obtain this figure I have subtracted the FVG from both NP and TE. Here's the computation:

       TOTAL  2010  2009  2008  2007  2006
NPX      1069  279   229   234   185   142
TEX     11246 2883  2694  2304  1975  1390
ROEX%      10   10     9    10     9    10
NPX, TEXT, and ROEX have the same meaning per the previous table, but with the X implying that the FVG have been removed.

The returns on equity have not been distorted by excess leverage, as the company has no non-current liabilities, and net cash of £289m, as reported by Sharelock Holmes for the latest interims. How comes the balance sheet looks so robust? Well, during the latest 5 year period, it had total net cash flow from operating activities (inflow) of 1231m RMB, investing activities (outflow) of 904m RMB, and financing inflows of 565m RMB.

Included in current assets are trade receivables of 2.5m RMB. However, 1.1m RMB of that are over 6 months old. Prudence would seem to dictate that at least some of this amount should be written off. However, the company has not done so, stating that it has collateral over these balances. Also included in current assets are "other receivables, deposits and prepayments" amounting to 17.1m RMB. The bulk of it, 11.1m RMB releate to amounts "expected to be recovered or recognised as an expense after more than one year". In the previous year, FY2009, the amount was 6.1m RMB. I don't know what's going here. Are they principally prepayments, or dilinquent debts? They do not appear to be material, though, as the company has 975m RMB in cash and cash equivalents alone, and it is only a small amount if it were written off (in FY2010 the profit before tax amounted to 587m RMB). 

The company has some related party transactions. In Novemeber 2009, the company entered into an agreement to buy fertiliser from Fujian Chaodo Group, which is 95% owned by Mr. Kwok Ho (100% if indirect holdings are included). Mr. Ho isn't on the board of directors, but Chaodo is a holding company of Huge market, which is a substantial shareholder of ACHL. In 2010, total related party transactions amounted to 48m RMB. Profits before tax amounted to 587m RMB (and remember, that's before we strip out the "fair value gain"). So that's about 8%. Although the company states that the supplies are at market rates, I believe one would be right to be nervous about how much influence the related parties seem to be having.



Anonymous said...

Superb investigatory work you've done here. Given the number of alleged China stock frauds in the US at present (eg China Media Express, Sino-Forest and Long-top Financial), I think this kind of analysis is absolutely essential for any company with its management or significant assets located in China. What you've found, even in this quite short report, are two factors I would consider to be major red flags; firstly the manner in which profits are inflated by fair value gains (a tactic used most famously by Enron); and secondly the related party transactions. The latter is always a particular concern for me, as unlike the fair value gains which can be adjusted for, it is impossible to the full extent of the implications for minority shareholders when significant related party transactions are occurring.

Keep-up the good work.

Mark Carter said...

I see that my post has generated a response over on Interactive Investor. Unfortunately, I can't post on that site, so I will summarise some of the poster's counterarguments here.

The poster is not alarmed about the BG (Bilogical Gains), stating that they are a legitimate form of accounting for agricultural companies. Stripping out BG does alter the PER from 7X to 16X, and the growth in EPS from 28% to 17%. So the company is not as great a bargain as just looking at the raw numbers. The poster felt that BG was a legitimate profit source, and should be recognised in the accounts. They rate it as a strong buy.

I would like to raise an additional concern about the company, which has been plaguing me for some time, but which I didn't mention originally. At 30 Jun 2010, ACHL reported inventories of 0.84m RMB and revenue of 812m RMB. Compare that to 30 Jun 2006, where they reported inventories of 1.17m RMB against revenues of 404m RMB. The big question in my mind is this: what is the explanation that despite revenues doubling, their inventory levels are actually down?

I think that a comment about revenue growth is also in order. Revenues grew from 668m in 2009 to 812m in 2010. That's 144m, or 22%. However, according to the cashflow statement, 144m was also used in investing activities, most of it due to "additions to construction-in-progress". The company also issued new shares in a placement, amounting to 328m. So although revenue growth is indeed impressive, you have to see it in context of investors pumping money into the company. You would have to make some kind of adjustment downwards to the growth rate to obtain a "organic" growth rate. What I mean by this, by way of analogy: if I put twice as much money into a savings account, then I'm going to receive twice as much interest. It doesn't mean that I'm earning twice the "rate", though.

Anonymous said...

1)ACHL embarked on a not very successful venture to build a fruit market and sell site to individual traders a few yeras ago. They have been gradually selling off the properties over a period of years. There is a time lag between when they report "sales" of individual properties and when they receive cash. Until cash is received the properties remain an asset on their books. IHMO this venture is a diversion from their main business and will eventually disappear in their accounts.
2) ACHL owns three plantations. One is mature, one is in its infancy and one is not yet planted up. New plantations require considerable investment in land preparation and tree planting before they become productive. ACHL is a youngish Company with aspiartions for a high growth rate, and such I'm not sure you would expect it to be able to generate cash in excess of its investment wishes
In 2010 ACHL raised two tranches of cash, one with a view to buying an additional plantation in China (which has not come to fruition) and one for the purchase of a juicing business which was completed around the turn of the year. The year end accounts will include 7 months results from the juicing Company.
I'm happy to comment further on the question of biological assets if you are still suspicious. Take a look at New Britain Palm Oil (NBPO) accounts to see accounts of a similar type of Company. ACHL is simply following required accounting practices. No doubt you have looked at the annual report where profits and EPS are reported both including and excluding biological assets.
Smiling mickey

Anonymous said...

Nothing creative about ACHL's treatment of Biological Adjustments ( BA ) in accounting. Infact its mandatory. All listed companies are required, under EU regulations, to apply International Accounting Standards (IAS) to their consolidated financial statements for accounting periods commencing on or after 1 January 2005. As required, ACHL must value the biological assets at market value and charge or credit the changes in an accounting period to profit and loss (IAS 41).

Whats more, when looking at cash conversion, clearly one must compare with the profits without BA set of figures. Then you will see its extremly good. Of course any PE and EPS calculations should also use the without BA figures, and ACHL is very transparent in stating these seperately.

Anonymous said...

The point about inventories is not at all suspect. I have seen it many times with listed palm oil companies. Just because the turnover is X, doesn't mean the inventory has to be a % of that every year at the accounting date. That assumption is flawed. It all depends on the timing of shipments of crop. Batches of crop will be continuosly shipped to clients of various sizes. If a big batch is awaiting shipment in store on the audit date, it will be in inventory. You can't conclude anything from variability of batches. The only thing I conclude is inventory is small and that to me says good logistics and fresh produce.

Anonymous said...

I've read your blog again.
You've been holed in the water re your suggestion that ACHL are over inflating their profits, by adding biological gains into their profit numbers (as they are required to report)
You've also been holed on the basis of your concern that cash flow is below published profits since it is quite simple to understand that the revaluation of trees does not generate cash.
Here's a few questions for you answer which might help you understand the business a little better.
What are the yoy growth rates of orange production (in tonnes)?
How much capacity is there to grow orange production from the plantations currently leased?
What are the historic profit margin trends at individual plantations and is there room for margin growth as volume increases?
Why are sales of saplings important to the Company despite small revenue.
Why are sales to Supermarkets important for ACHL?
Is China a net exporter or importer of oranges?
Is China's consumption/capita increasing?
What effect will the purchase of the juicing Company have on growth and profitability going forward?
You seem to be searching for problems in the accounts. Fine and dandy but you seem to lack a grasp of the excellent competitive position the Company has made for itself.

Anonymous said...

Perhaps you should do a little research into accounting standards and regulations before you start publishing your 'research' into individual companies.