Nomad shares were trading at 17.5 cents when I first checked their price on 30 January 2009. They closed at 75 cents on Friday 14 August 2009. An increase of 429%. That’s equivalent to around 800% per annum. Phenomenal, so what do the financials tell us?
As per the blog I wrote way back on 26 January 2008, Chapter 14 of the MFIG looks at how to analyse a company’s income statements (otherwise known to oldies like me as the Profit and Loss Statement, or just the P&L).
D&T’s first piece of advice is to “make sure margins remain at consistent levels if they are not actually rising”. Nomad’s net profit margin for the financial years ending 30 June 2007 and 2008 are:
FY2007 7.8%
FY2008 7.1%
Oh dear. They have failed the first test.
Net profit margin is net profit after tax divided by revenue. The book explains that shares trade off expectations and those expectations are based on trends. This trend is going the wrong way. We want the net profit margin either to stay the same or go up.
We also need to look at what is going on to get this result, so first to revenue:
FY2007 $208.7m
FY2008 $335.7m
Yes, you’re reading right. Nomad lifted their revenue by $127m or 61% in only one year.
An extraordinary result.
How did they do it?
They did it by buying two businesses. So actually, we have no idea whether it is extraordinary or not. They don’t tell us how much revenue was derived from the parts of the business that was in place at 30 June 2009 and how much came from the new businesses. We don’t now how much revenue the two new businesses made last year, so we have no way of judging whether this is good or bad. Damn, that is annoying.
Moving on, lets look at the net profit after tax (‘NPAT’ or “the bottom line”) in both years:
FY2007 $16.3m
FY2008 $24.0m
An increase of 47%, which by itself again you would think is impressive, but we just have no way of judging. We also see why net profit margin has fallen. If revenue has increased by 61% but profit has increased by only 47%, then the increase in costs must have eaten up the difference.
So what can we conclude from this? Either, the two businesses bought are not as profitable as Nomad in its original form or Nomad in its original form has not performed as well over FY2008 or both.
I don’t like it.
The market did not seem too fussed about it, however. The 30 June 2008 results were released on 24 September 2008. On that day, 2.8m Nomad shares changed hands, over ten times the daily average for the year prior. In spite of this, the price only changed by 2c per share on the day, closing at $1.65, compared to $1.67 the day before.
D&T’s second piece of advice is “make sure research and development expenditures aren’t getting shortchanged”. Unfortunately, we can’t check this because Australian companies don’t itemise research and development expenditures on the P&L. So we just have to move on.
D&T’s third piece of advice is “make sure the company is paying full income taxes. They say to do this by dividing the tax paid by the earnings before tax.
For Nomad, these rates work out at:
FY2007 31%
FY2008 32%
Which is a tad odd given the Australian company tax rate is 30%. Fortunately, they have a note in the financials which reconciles the tax paid back to a straight 30%. The issue is there are some expenses which are not deductible for the purposes of calculating taxable income. These include “Share based payments”, “entertainment” and “other”. These total less than 0.2% of all costs, so I’m not going to worry about them.
The book explains that the point of this is that if a company has carry-forward losses which are diminishing their tax rate, then these need to be taken into account when examining margins. This does not apply here.
D&T’s last piece of advice is “keep an eye on growth in shares”. This is because its not so much the net profit after tax that counts, it the net profit after tax divided by the number of shares, because that’s what its worth to you as a shareholder.
There’s a whole note in the financial statements about this and it looks more complicated that I would like, but lets wade through it.
At 30 June 2007, the balance of the number of shares issued was 116,466,124. So, with a NPAT of $16.3m, the earnings per share (‘EPS’) were 14 cents.
This seems a fairly straightforward calculation to me, so why do Nomad report the EPS as 18.9 cents per share?
At 30 June 2008, the balance of the number of shares issued was 135,273,708. So the profit is being shared between 16% more shares and the EPS on my calculation was 17.7 cents per share.
So why do Nomad report the ‘basic’ EPS as 19.7 cents per share and the ‘diluted’ EPS as 19.5 cents per share (the ‘diluted’ figure takes into account options).
Nomad’s calculation is based on using the weighted average number of shares over the year, rather than the number outstanding at the end of the year. I’m sure this has been the topic of countless papers and committees on accounting practice and numerous very learned people have determined this is the best method, but I don’t see how this helps me. If I was holding 100 shares at 30 June 2009, unless the company gave me more shares for free over the year, I will still hold 100 shares at 30 June 2010 and if the company had made the exact same profit, my profit would be down almost 14% on the year before.
So lets look at what the changes are over FY2008 and see what happened.
- 6 Sep 07: Issued 673,401 shares in part payment for one of the businesses they bought
- 26 Oct 07: Issued 457,042 shares under the dividend reinvestment plan, ie some shareholders elected to give back the cash they received as a dividend in return for more shares.
- 4 Mar 08: Issued 5.6m shares in part payment for one of the businesses they bought and on the same day, issued 105,076 shares under a share purchase plan
- 24 Apr 08: issued 706,992 shares under the dividend reinvestment plan.
So no-one got free shares (which is a good thing), and the EPS have increased 3.7 cents over the year for a person who held x shares at the start of the year and the same number at the end. This seems a good result to me, and quite a bit better than the 0.8 cents increase calculated under the weighted average method.
So the lesson here is, do your own EPS calculation.
What can we say at the end of it all. The company is generating slightly less revenue for the amount of money it is spending (return on cost has fallen), but in buying the new businesses, it took account of this in the price, so the net result to shareholders is positive? But how will this affect things going forward? Will Nomad bring the new companies up to speed or will they drag things down? Hard to say at this point.
Chapter 14 goes on to talk about P/E ratios. With an EPS of 17.7 cps (my calculation, lets call this the ‘spot EPS’) the P/E ratio at the sound of the closing bell on 24 Sep 2008 would have been 9.3. The book makes the point that the P/E ratio really doesn’t tell us much, but there is a rule of thumb that the P/E ratio should equal the percentage of the company’s earnings per share growth rate. So you can use this rule of thumb to determine whether a share is under- or over-valued. Unfortunately, you need to have a view on the growth rate. I don’t have a view, at least not yet. I also don’t have access (yet) to any analyst views, so I will just stick this in the back of my mind for now.
It all needs to be considered with a grain of salt, in any case. Going back to a year earlier, the 2007 results were released on 26 Sep 2007. With a closing price of $2.81, the P/E ratio based on earnings of 14 cps was 20. The actual growth in spot EPS was 26%. So using the rule of thumb, the shares were undervalued then at $2.81 and interestingly the shares reached a high of $3.40 on 31 October 2008, which gives a P/E ratio of 24. Unfortunately, it then started a steady decline, reaching a low of 15 cents on 27 January 2009, co-incidentally, just a couple of days before I checked the price. So, I don’t think this rule of thumb is going to be of great use to me.
Lets jump ahead and look at the 31 December 2008 results, where we find things have all gone horribly wrong. Firstly, there is a new expense item on the P&L called “Impairment of Goodwill”. Not being an accountant, just these words send shivers down my spine – what the hell is “impairment of goodwill”? Then it gets worse, the figure against it is $6.852 million. This is a big whack, leaving a bottom line of only $1.3m compared to $10.3m for the same period last year.
Looking through the note on this, it has to do with the valuation of goodwill, which they reassess every six months and as a result have come up with this figure of $6.852m. This says to me that they paid too much for the businesses they bought. But the share market was falling steadily during this same six months, so I'm not sure how much I can blame them for this.
Reading further we find out the even before the impairment of goodwill, profit is down 21%. The Net Profit Margin before the impairment of goodwill is 4.8%, quite a fall from 7.2% for the same period last year. Now this really is a big issue.
The fall in profit is attributed to “problems in the Nomad Modular Building division in WA” and the CEO of this division has “tendered his resignation”. Nomad Modular is not one of the new businesses they bought during the year, this is part of the original business, so it should be running like clockwork. The departure of the CEO just raises more questions than it answers. Is this just scapegoating for an event that was beyond anyone’s control? Are they letting required knowledge and experience walk out the door? They don’t provide enough detail to make an assessment.
So, in summary:
* the headline presentation of Nomad’s 2008 annual results, ie "we’ve made a 48% increase in profit", was misleading, it should have mentioned that the acquisition of two businesses contributed to this rather than leave it for the fine print, and
* based on the admittedly small window of performance I have assessed, I have no evidence that they can manage their business successfully. They made acquisitions that lead to write-offs and their costs have blown out cutting one third off their net profit margin.
These issues no doubt contributed to the fall in their share price from a high of $3.40 on 31 October 2007 to the low of 15 cents on 27 January 2009. But given the growth in the share price since then, something must now being going right for them. I will delve into this in a future post, however, in the next post I will go through their balance sheet.
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