Share price plunged despite good cash conversion cycle

Company X3 (existing clients need to login to see the name) is a technology company listed in Hong Kong. It is a highly efficient company in terms of its cash conversion cycle but it has caused shareholders to lose huge amount of money over the past few years. The share price has plunged by more than 60% although the Hang Seng Index is up by 20%.

I will provide a possible reason for the large decline in share price.

The following are the extracted information about the company from its latest audited annual report[1]:

	2017 US$'000	2016 US$'000
Receivable	4,468,392	4,403,507
Revenue	43,034,731	44,912,097
Inventory	2,794,035	2,637,317
Cost of goods sold	36,929,215	38,288,160
Trade Payables	5,649,925	4,266,687

Calculation of Cash Conversion Cycle

I want to calculate how long the company on average takes from the time it purchases goods from its supplier and convert it to cash. This is known as the cash conversion cycle.

We first need to calculate the average number of days it takes to collect cash from its customers. This is called the days of sales outstanding which is given by:

DSO
= 365 days x average receivable / revenue
= 365 * (43,034,731 + 44,912,097)/2 / 4,468,392
= 37.62 days

Next, we need to calculate how long it takes for its inventory to be sold. This is known as days on inventory on hand and is given by:

DOH
= 365 days x average inventory / cost of goods sold
= 365 x (2,794,035 + 2,637,317)/ 2 / 36,929,215
= 26.84 days

Finally, we need to calculate how long it takes for the company to pay its suppliers. This is known as Days Payables and is given by:

Number of days payables
= 365 days x average payables / inventory purchased

But inventory purchased is not given in the annual report. So we have to estimate by using the following:

Inventory purchased
= Ending inventory - Beginning Inventory + Cost of goods sold
= 2,794,035 - 2,637,317 + 36,929,215
= 37,085,933

Therefore, number of days payable = 365 x (5,649,925 + 4,266,687)/2 / 37,085,933 = 48.80 days.

Thus, the cash conversion cycle is = DSO + DOH – Number of days payable = 37.62 + 26.84 – 48.8 = 15.66 days. The meaning of this is that on average, it takes 15.66 days for the company to create cash from the day it make its purchase from its suppliers. This is a good and it shows that the company is operationally efficient.

However, the company share price is dropping like nobody business. Over the last 3 years, the share price has dropped by 60%. The Hang Seng index is up by 20% as shown by the chart above. So what is the reason?

High debt?

There are many reasons why a share price could drop. Frankly speaking I do not know the exact reasons. But what I can speculate is because of the company’s high debt. Here is the balance sheet:

	2017 US$'000
Non-current assets	12,317,587
Current assets	14,868,387
Total assets	27,185,974
Non-current liabilities	4,756,906
Current liablities	18,333,846
Total liablities	23,090,752

It can be seen that the company is highly geared. It has a debt-to-asset ratio of whopping 85%. But what is interesting is that the majority of its debts are current liabilities. Only 30% of its current liabilities are in trade payables. The remaining current liabilities are not clearly explained in the financial report. In fact, there is even short position in a put option.

In terms of its current ratio, it is 14,868,387/ 18,333,846 = 0.81. A ratio below 1 means that the company does not have sufficient liquidity to pay for its short term debts.

High dividends

The company pays dividends at 5.87% per annum. This is based on the historical one year dividends divided by the current price. This sounds really good. But why does the company pay such high dividends when it could have use it to improve its current ratio? I think it has to do with trying to meet investors’ expectations. Many investors only look for dividends but they don’t care about the share price. So the company just pay dividends to make investors feel happy.

Conclusions

1. A profitable company’s share price could still drop by a large amount.
2. A company may be operationally efficient in its cash conversion cycle but its share price could still drop.
3. A company share price could still drop by a large amount despite the fact that the market is in the bull run.
4. It is important to look at the financials of the company and not just its earnings.
5. Company pay huge dividends to make investors happy despite the right thing to do is NOT to pay dividends.
6. Investors who chase after dividends without checking the company’s fundamentals are going to lose a lot of money. This is the rule of the game.

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