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:
|2017 US$'000||2016 US$'000|
|Cost of goods sold||36,929,215||38,288,160|
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:
= 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:
= 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:
= Ending inventory - Beginning Inventory + Cost of goods sold
= 2,794,035 - 2,637,317 + 36,929,215
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?
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:
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.
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.
- A profitable company’s share price could still drop by a large amount.
- A company may be operationally efficient in its cash conversion cycle but its share price could still drop.
- A company share price could still drop by a large amount despite the fact that the market is in the bull run.
- It is important to look at the financials of the company and not just its earnings.
- Company pay huge dividends to make investors happy despite the right thing to do is NOT to pay dividends.
- 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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