Wednesday, 29 August 2007

Probiotec achieves prospectus forecast

Probiotec (PBP) announced FY07 results in line with prospectus forecasts as shown above. Whilst NPAT was 20% higher than forecast that is due to the prospectus assuming a 30% tax rate whilst PBP's actual tax rate because of prior years losses was 17.9%.

On the positive side EBIT, EBITDA and NPAT margins showed significant improvement. Despite taking on an additional 6% debt the company's debt to equity ratio has decreased from 85% at June 2006 to 62.7% as of June 2007. Interest cover also improved substantially from 2.7 times to 4.9 times.

As noted at the half year the company capitalizes some product development costs. Total capitalized costs were $1.4m for the full year. I asked management about these costs and it seems they have an 'infinite life' and unless impaired those costs don't have to be taken through the P&L at all.

I find that quite astounding, I've heard of capitalizing costs but they must be amortised through the P&L as the future cashflows from the asset are realized. Or if the future cashflows don't arise they will be written off against the P&L as a one-off abnormal or what is now called a 'significant' item.

It seems that because the asset is deemed to have an infinite life it doesn't need to be amortized. At least that is what I have been led to believe through my correspondence with the company. I will endeavour to clarify that tomorrow.

the reason I place emphasis on this is that if my initial understanding is correct a company can basically wipe costs from their P&L as if they never happened. Sorry but that's just plain wrong.

The company reiterated their forecast of 30% profit before tax (PBT) growth for FY08. As I noted when this forecast was first made, this does not require the company to grow at all in FY08.

A 30% increase on FY07 PBT comes to $7.9m, if we simply just double 2H07 PBT of $4.0m we get FY08 PBT of $8.0m. Thus the company doesn't need to grow at all to achieve it's forecast.

Considering that the recent acquisition of branded pharmaceuticals is expected to contribute materially to earnings in FY08 it would be disappointing if the company did not earn in excess of $8.0m PBT in FY08. Accordingly I have left my previously forecast NPAT at $6.0m for FY08 implying 20% growth at the NPAT level.

Probably the most disappointing aspect of the results was the complete absence of new information on the Phoscal litigation. Previously PBP announced that their liability in the Phoscal claim was between $2.2 - $5.0m. This is still a big unknown hanging over the stock.

Whilst the business is performing well by most metrics I find it hard to get enthusiastic about this stock with the pending litigation and the costs that aren't really costs. On top of that I feel that management are either untrustworthy, incompetent or both.

I continue to hold the stock as by my valuation of $1.11 based on reasonably conservative forecasts for next year is not expensive. However if Mr market offers me a reasonable exit price in the near future I may just take it.


grant said...

I've run into these "infinite" costs on a number of occasions, they are legal, but, as you say unethical.

They [no surprise] often get written down in rather large chunks at the most inoppotune moment and [no surprise] the share price follows post haste.

There are so many little loop-holes you need 3 pairs of eyes.

jog on

The Fundamental analyst said...

It's an absolute disgrace and a form of legalised fraud. It ensure that companies can manipulate their earnings. If they they come up short just capitalize some costs to make it up.