Over-reliance on quantitative valuation figures without grasping the intricacies of the Company’s operations might lead us down a slippery slope.
As mentioned in our earlier article, if we focused solely on just the P/B and P/E valuation, Eratat Lifestyle Ltd (SGX: FO8) might have appeared to be a steal. Assuming a market price of S$0.10/share before Eratat was suspended on Jan 30, 2014, they traded at a TTM P/E of only 1.63x and P/B of just 0.23x!
But a brief study of their financials would give us a totally different (Not the good kind) of perspective.
How Did This Value Trap Start?
From 2011 to 2013, the China apparel and footwear market were decimated due to competition and channel stuffing issues. This was right smack in the middle of Eratat’s market and they weren’t spared from the bloodbath as well. A wipe-out of 50% in market capitalization was a dime a dozen during this period with Eratat also joining in the fun with a halving of its market capitalization; also partially attributed to the pessimism with S-Chips that pushed valuations down in the same period.
This was when quantitative screens would have picked up on Eratat as a potential value play.
In their FY2012 Annual Report, their Net Cash/share was S$0.12. Their market price was approximately trading at this value. What this meant was that by paying S$0.12/share to buy Eratat, you would be paying solely for just its cash and get the rest of the company as a kicker.
Does Eratat seem too good to be true?
Well it was. Below are excerpts from their FY2012 Income Statement and Balance Sheet:
Some red flags that arose included:
1) Trade receivables were over 50% of their Revenue, which gave them a receivable days turnover of 195 days! Meaning that they took over half a year to collect their $ from customers! Over half a year doesn’t bode well no matter how one looks at it.
2) They had a rather small inventory given the size of their sales and receivables
3) The next development was after their 1Q2013 report. With close to RMB545mil of Cash in hand, why on earth did they propose a bond issue of approximately RMB100mil (At a discount to boot) at an interest rate of 12.5% (This is expensive) per annum! Unless the cash wasn’t really there!
4) This went on till their last Quarterly report (3Q2013), at this point in time they were still flooded with cash less liabilities of S$80mil (RMB584mil (Cash) – RMB175mil (Total Liabilities) = RMB409mil) and were trading at a market capitalization of only S$50mil! Whattttt?
5) SIAS even gave them an award for corporate governance in Nov 2013! Ironic on hindsight, given that they would be suspended for corporate governance related issues.
6) Finally the cards came crashing down, just 2 months after the award for corporate governance, Eratat requested for suspension of trading after defaulting on their bond interest payments. With RMB584mil in cash, they couldn’t even afford to pay interest of just RMB8mil (Semi-Annual Bond Payment)
7) The CEO was suspended and normally that doesn’t bode well
Value In Action
There is a reason why S-Chips tend to have a negative association for investors in these parts of the world. It would be conservative to say that Eratat would not be the last of such situations.
It always pays to pay attention to the details with the devil always being in the details!
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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Cheong Mun Hong’s personal capacity and do not in any way represent those of his employer and other related entities. Cheong Mun Hong doesn’t own shares in any companies mentioned above.
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