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QUALIPORT
By
As the saying goes, 'profit is a matter of opinion, cash is a matter of fact'. A crucial aspect of determining whether accounting profits are underpinned by cash is by checking movements in working capital. Companies heading for trouble often have worrying working capital characteristics, as their stock goes unsold, customers (debtors) refuse to pay and suppliers (creditors) demand earlier payment. Importantly, customers and suppliers often cause difficulties at listed companies long before management tells shareholders of the problem. Read more | more. In February 2002, a Qualiport article highlighted five fast growing companies whose cash flows spelled T-R-O-U-B-L-E. The table below summarises the subsequent share price performances. The two real disasters -- Health Clinic and Innovation -- are reviewed here. These days, finding growing companies that exhibit similar working capital worries is not an easy task. The bear market has witnessed the unmasking of numerous growth share pretenders, leaving investors all too familiar with many bad cash flow stories. Gyrus However, there remains the odd fast expanding business whose guzzling of working capital the market may not yet fully appreciate. One such firm is Gyrus (LSE: GYG), which describes itself a 'leading supplier of medical devices to reduce trauma and complications in surgery'. Gyrus has seen sales zoom from £6m in 1998 to £75m in 2003 and became profitable in 2001. The earnings growth momentum is expected to continue this year and next: But in 2001 and 2002, Gyrus reported significant outflows of working capital cash. Recent half-year results showed another outflow, though Gyrus does expect 'positive cash generation to continue throughout 2003'. Until there are notable improvements to working capital, investors would do well to stay away. At a 199p share price, a historic price to earnings ratio of 25 offers plenty of downside. Fountains What investors should seek are businesses with a cash flow fountain. A great example of what to look for comes from the accounts of supermarket William Morrison (LSE: MRW): Supermarkets like Morrison are obvious cash flow winners (customers pay at the till while suppliers get their money a few months later), and are identified by the accounts reporting large inflows of working capital cash. Of course, favourable working capital movements can also be found in less everyday businesses. The following three companies are not exactly be in the Morrison league of long-term profit growth and cash generation, but their recent accounts show many positives in the working capital department. 1. Ultra Electronics (LSE: ULE) Ultra designs, develops and manufactures electronic systems for the defence and aerospace industries. Earnings have increased 50% over the past five years, with solid working capital performances seen of late. 2. Kier (LSE: KIE) Kier's business involves construction, building maintenance services, PFI contract work and house building. Profits have more than doubled since 1999, with the dividend growing by at least 15% per annum. Recent profits have been supported by a prodigious cash flow. 3. Tribal (LSE: TRB) Tribal provides a range of white-collar support and consultancy services, predominantly for local government. After formation in 1999, profits have raced to £15m. Unlike most other fledgling businesses experiencing rapid growth, working capital has been managed well. Summary Good working capital management usually implies a company with competitive strengths. Quality businesses don't have unsold stock building up in the warehouse, they don't have to chase their customers for payment and they don't have suppliers banging on the door shouting for money. There are other factors to consider of course, but having maintained their earnings growth and kept a focus on cash during a time when many other companies stumbled, it's fair to say Ultra, Kier and Tribal possess a good degree of business quality. More: Shares That Lost You Money | Working Capital: Part 1 | Part 2 | FREE Annual ReportsCompany Share price Share price Change
25/02/02 03/10/03 (%)
(p) (p)
Health Clinic 186 0 -100
Innovation (LSE: TIG) 236 14.25 -94
Minorplanet (LSE: MPS) 308 116.5 -62
Sanctuary (LSE: SGP) 66 48.25 -27
Warthog (LSE: WHOG) 48 17 -75
FTSE 100 5100.7 4274.0 -16
Year to December 31 2001 2002 2003(e) 2004(e)
Turnover (£m) 50.3 75.0
Pre-tax profit (£m) 2.0 6.7
Earnings per share (p) 3.1 8.1 10.5 14.1
Year to December 31 2001 2002
Operating profit (£m) 1.5 8.3
Working capital
change (£m) (7.6) (7.9)
Year to February 2 2002 2003
Operating profit (£m) 229.8 262.5
Working capital
change (£m) 31.2 64.6
Year to December 31 2001 2002 2003(e) 2004(e)
Turnover (£m) 239.5 260.4
Pre-tax profit (£m) 27.1 29.9 33.6 37.6
Earnings per share (p) 30.4 33.2 36.1 39.7
Year to December 31 2001 2002
Operating profit (£m) 31.7 33.5
Working capital
change (£m) 3.2 3.5
Year to June 30 2002 2003 2004(e) 2005(e)
Turnover (£m) 1,369.4 1,417.7
Pre-tax profit (£m) 28.0 33.3 46.9 39.6
Earnings per share (p) 56.8 68.5 76.4 81.8
Year to June 30 2002 2003
Operating profit (£m) 26.2 33.9
Working capital
change (£m) 17.5 8.8
Year to March 31 2002 2003 2003(e) 2004(e)
Turnover (£m) 45.7 105.7
Pre-tax profit (£m) 8.1 15.4 21.3 27.1
Earnings per share (p) 13.3 17.8 21.9 25.3
Year to March 31 2002 2003
Operating profit (£m) 8.4 16.7
Working capital
change (£m) 0.5 2.6