Thursday, 21 February 2008

PBP 1H08 Result

Occasionally you get a company with finacial statments which are clear, simple and clean of any irregularites. Unfortunately PBP isn't one of them, but I'll get to that later, firstly let's take a look at PBP's 1H08 result.

As you can see, eps grew by a strong 58.3% from 1H07 on the back of a 38.7% increase in sales. Margins and interest cover also improved. Looks good on the surface, however 1H07 is the not the best comparison as the company didn't really click into gear until 2H07. The slide below is from the 1H07 Investor Presentation.

You can see at the bottom of the slide the profit drivers for the second half of 2007 were;

  • a very strong contract manufacturing book

  • significant contribution of new products, and

  • sales mix improvement towards higher margin products.
The company achieved those milestones with a strong 2H07 performance more than doubling profit from the first half. So let's compare 1H08 with 2H07.

Whillst Sales were up, EBITDA, EBIT and Profit before tax were all down from 2H07. NPAT and eps were significantly down because of the low effective tax rate of 11% in 2H07. However, even after normalising for tax, NPAT was lower in 1H08 than 2H07. Since sales were higher but the other aforementioned line items were lower, obviously margins deteriorated, which you can also see. Why did this happen?

(click on picture for a sharper image)

The image above shows a blowout in Sales and Marketing expenses compared to 1H07. Even compared to 2H07 sales and marketing expenses almost doubled from $2.1m in 2H07 to $4.0m in 1H08.

Obviously that Sales and Marketing expenditure has yet to pay off. However given that the company expects at least 30% in profit before tax for the full year it seems likely that they expect it pay off in the second half.

30% growth would imply $7.88m profit before tax for FY08. That implies profit before tax of at least $4.38m in the second half. That result will still only be 9.6% higher than that achieved in 2H07.

Of course the company could do much better than 30% growth but they don't give much reason to think so. Below is a slide from this years investor presentation. The company is much less specific about how they will drive 2H07 profit growth this year. Instead they offer some broad brush statements on future growth.

It also seems odd that the company reported profit before taxof $2.75m for the first 4 months of 1H07 as reported in an investor update in Novemeber and then only managed $0.75m for the remaining 2 months. Maybe the company spent heavily on marketing around this time? Or maybe consumers switched their spending habits to other discretionary items around Christmas?

In addition there are small question marks over the company's financial statements. More precisely it has to do with what has been omitted. The notes to the accounts do not break out revenue and expenses. They also don't show the amount of costs they have capitalised.

As I mentioned before capitalising costs can be justified, however PBP does something dodgy and says that some of their assets have 'infinite' lives. They capitalise the research and development costs as internally generated goodwill and then never have to amortise it because they say it has an infinite life. How many assets do you know that infinite lives?

They don't capitalise much (about $1.1m in prior periods) but it's enough to make the results look prettier. There may well be reasonable explanation to all the issues I have raised, I don't have the benefit of attending analyst presentations or have open door access to management. I did send off an email with my queries although I haven;t heard back from them.

On the positive side the company paid down some debt with their free cashflow and paid their first dividend of $0.01 unfranked.

The market seems to like the result with the share price rising 6%. However, I decided to sell my small parcel of PBP shares today. After brokerage I realised a 13% profit over a holding period of abot 15 months. Not great but not too bad given that the XAO is up just 4.4% over the same period.

In summary I'm uncomfortable with the lack of disclosure by management and I am somewhat skeptical, given the 1H08 report today, of the company's ability to deliver strong earnings growth. When PBP first announced their profit guidance of 30% growth in profit before tax for FY08. I noted at that time that 30% growth could be reached by simply doubling 2H07 profit before tax - implying no growth.

Thus I was expecting much better given the companies expanding range of products and shift to a higher margin mix of products. However today's result doesn't instill me with confidence that the company can do much better at all.

Given the low effective tax rate of 18% last year, whilst 30% growth in profit before tax sounds good, eps growth will be signifcantly below that with a 30% tax rate. Again the company may do much better than 30% growth. Just cutting back to 2H07 levels for marketing expenses would produce a much better second half. However rather than hold out for a better half I will look elsewhere for opportunities with more certain earnings growth.