Friday, August 22, 2008

Wrong call on sugar estate

I really hadn't planned to write anything on the sugar deal, as I am not very familiar with the agreement and divestment process. But after being encouraged to do so by some members of the public, I felt compelled to set the facts straight on the financial analysis surrounding the company, Infinity Bio-Energy (IB), not because I hold any brief for them, but because I think the message being sent from the analysis is incorrect. And I believe that it is necessary for proper information to be communicated to the public.

I don't believe that there was any wilful attempt to mislead the public but rather, there might have been some amount of misguided "exuberance" to follow what was written in Businessweek. I myself haven't read the article, and don't think I need to, as I find that in many instances our own Jamaicans analyse situations in a far superior manner to anything done overseas. We only have to look at the record of organisations like the IMF and also the fact that the US, with all its glorified analysis, had significant economic fallout caused by their inability to properly assess the effects of irresponsibly created securities.

As an accountant, I am also fully aware that our own accounting standards are superior to US GAAP. And I think I am qualified to say that, having completed the Master's in Accounting at UWI and the CPA in the US.

Incorrect analysis
The article that seemed to unnecessarily cause quite a stir in the media about the "sourness of the sugar deal" was, in my view as an accountant, a misleading, superficial analysis. It was suggested that IB has solvency problems, based on two points, namely (1) that they reported losses on their income statement; and (2) that the current ratio at March 31, 2008 stood at 0.8.

While this analysis may be prudent for someone comparing investment options for getting the best returns, or doing a review of management's performance, it is ill-conceived in my view to apply the same analysis to determine whether a company is capable of long-term success or not. And especially when the current operators of the sugar company (government) was doing nothing more than pumping taxpayers money in for political rather than economic reasons. I think everyone will agree that it is in the best interest of Jamaica to diversify these loss-making assets, as the poor taxpayers just cannot afford to continue in this vein.

Nor do I think that we can use the excuse of the past botched divestment transactions as a reason against the current efforts. Those divestments, I would agree, failed because the responsible persons at the time failed to prudently complete the divestment process, and as Jamaicans would say, "Don't use your fat to fry somebody else."

When one is trying to divest an asset, it is naïve to look only at the profitability of the company. And in fact, accountants today have long recognised that value in a company is better discerned from the balance sheet, as the income statement (which records profit/loss) is just a measurement of activities over the past year. In fact, whether a company makes a profit or loss does not determine the company's solvency. If we want a good indication of a company's solvency, then we must look towards the balance sheet and cash flow statement.

It is apparent to me that the Businessweek article was done by a non-accountant. I say this because no mention is made of the most important statement of any audited accounts, which is the Audit Report. This is the first statement that must be read, as it speaks to accuracy and any concerns, such as insolvency, of the institution being audited. If there was a solvency issue then the Audit Report would have pointed this out, as it has been doing in the Air Jamaica's financial statements for years. But of course one must go further to determine if insolvency is a possibility.

Balance sheet analysis
The statement that the current ratio is 0.8, when at least 1 is desired, is also irrelevant in this case. One could also look at the trend of the current ratio, which was 1.12 at March 31, 2007; 0.66 at September 30, 2007; and currently stands at 0.82. If one looks further into the current assets, though, one will see that the cash and cash equivalents actually moved from US$19.9 million in 2007 to US$34.6 million in 2008. In addition, the reason why the current ratio has decreased is because the interest on loans and borrowings has increased from US$18.5 million to US$90.2 million year over year. This, of course, is an indication that money came into the company through loans, and sure enough, if one looks under non-current liabilities you will see that loans increased from US$3.5 million to US$179.4 million. This is an indication that significantly more money has come into the company.

The company also has a healthy Equity Attributable to Shareholders of some US$419.5 million, up from US$278 million. Of this amount, over 75 per cent is represented by share premium, which increased by 50 per cent. This in itself is an indication that significant new resources came into the company over the period. The cash flow statement also shows that cash generated from operations moved from negative US$27 million in 2007 to positive US$54 million in 2008. This is a strong indication that the company's ability to generate cash is improving significantly. And as far as I know, companies never go bust because they make losses but rather because they have negative cash flows. Overall, the company managed to increase cash and cash equivalents by some US$14 million.

These numbers show that (1) the company is in no way insolvent; and (2) it obviously has the ability to generate cash. In addition, when one assesses an agricultural company it is important to look at the long-term prospects because of the nature of the business. Naturally an agricultural company invests up front more in long-term assets such as biological assets, goodwill and plant and equipment. It is always a healthy sign when a company can access long-term financing, and also invests in long-term assets, as one can almost be guaranteed of not only future earnings but also that lenders have faith in the long-term viability of the company.

It is always expected that companies in the agricultural sector will face losses in their first few years or so of operation as sugar cane, like other crops, do not grow overnight. Any expectation of immediate profitability must be because over the last 15 years or so we have developed an economy with a trading mentality and so expect immediate profits. The investment by IB is obviously a move to invest in the long-term productivity of the country, which will add to the quality of growth rather than growth based on construction and trading, to which we have become accustomed.

There is, of course, a lot more analysis that can be done on these financials, but space does not permit a full-scale analysis. In addition to the fact that it would take more time, which I don't think needs to be dedicated further.

If we are really concerned about the viability of the sugar deal, where we should be looking is at the expertise IB carries and the terms of the contract. The attempt to use financial analysis to say that the divestment to IB is faulty, can only be seen as a misinterpretation by persons not fully cognisant of financial statement analysis, and should not be taken seriously. If one is sick, then it is important to seek the assistance of a qualified doctor. Similarly, financial statement analysis must naturally be left to qualified accountants.

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