There are lessons to be learned from the sorry tale of Aero Inventory.
Describing Aero Inventory (LSE: AI) as a stock market darling is something of an exaggeration, but not a huge one. Floated on AIM in 2000, the business has steadily grown to the point where a full listing was on the cards. And, along the way, the company has acquired a certain niche stock market following.
Aero Inventory's business model calls for it to buy and then manage the spare parts inventories of major airlines, selling the parts back to the airlines as required, and deriving profitable economies of scale through bulk buying and improvements in inventory management.
I first became aware of Aero Inventory back in 2006. In an earlier life, I've seen companies earn good money from the efficient inventory management of spare parts: for a manufacturer, supplying spares is often a more profitable line of work than selling the original bus, truck, car or aircraft onto which they are fitted.
A P/E of what?
That said, the road to riches at Aero Inventory hasn't always been smooth.
The company depends on winning contracts with airlines for its growth, and fairly clearly, the flow of new contract wins will be uneven and lumpy. In March, for instance, the shares fell back after talks broke down with America's United Airlines over a $2.5 billion contract.
Contract wins also soak up capital, in order to buy the associated inventory. While profitable over the last five years, Aero Inventory's cash flow has been negative for each of those years -- with net cash outflow almost doubling between 30 June 2007 and 30 June 2008.
And while initially attracted to Aero Inventory by its extremely low P/E of just over 2 and PEG ratio of just 0.14, that negative cash flow was enough to put off fellow Fool writer Alan Oscroft earlier in the year.
Shock suspension
Alan was right to be cautious, although he probably didn't envisage events turning out as they have.
Having announced on 30 September that the company was pursuing a full listing, and that there would be a delay in the publication of the full year accounts, Aero Inventory dropped a bombshell on 26 October by following this up with an announcement that it had asked for its shares to be suspended.
New accounting systems put in place as part of the preparations for a full listing had raised some questions about a parcel of inventory acquired in 2008. The company's accounts for 2008 would need to be re-stated, and there would be a delay in producing the accounts for 2009.
What's more, as a result of this delay, the company would therefore breach its banking covenants through being unable to deliver audited accounts within the requisite time frame.
The news gets blacker
None of this was good news, of course. But the weekend press still had no difficulty in finding investors willing to go on the record as saying that the company's business model was still a good one, and that the problems seemed to be confined to a single Canadian contact.
But worse was to come. On Tuesday, the company made the following statement to the Stock Exchange via an RNS:
"The preliminary results of the ongoing accounting and stock reconciliation investigations show that the stock valuation issue highlighted in the previous announcement is now broader than first thought. The issue appears to involve not only the accounting book value of stock but also in some instances physical quantities. The Board is also reviewing the accuracy of recent financial reports provided to its banks. These reviews are ongoing and the consequences whilst being evaluated still remain uncertain."
Oh dear. It looked like heads would roll -- and sure enough, they did. Acting directors were duly appointed in place of chief executive (and founder ) Rupert Lewin, finance director Hugh Bevan, and chief operating officer Martin Dodge. The following day -- yesterday -- a terse RNS announced the resignation of FD Hugh Bevan. There have (so far) been no further announcements, and the shares remain suspended.
Crisis play, or crash and burn?
I have to say, the position doesn't look good. The business may well be snapped up by someone -- there are, after all, those supposedly lucrative contracts in place -- but existing shareholders would seem to be poised to take a significant hit, even if the company does survive.
A crisis play? If so, it's one for the brave, and much will depend on what the board of directors say in the coming days and weeks.
For investors not presently sitting with a portion of their portfolio in Aero Inventory, the débcle offers three important lessons.
- Even AIM shares with seemingly conservative business models and blue-chip customers can go belly-up. Diversify, to reduce the risk.
- If a P/E of just over 2 and PEG ratio of 0.14 seem too good to be true, they probably are. Buyer beware.
- Don't confuse profits with cash: Aero Inventory was profitable, but had an awful cash flow, with cash going to finance existing inventory, buy more inventory, and support a growing operations base. Never forget: ultimately, real profits throw off bankable cash.
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