danger ahead cash flow

Danger ahead
Barbara Drury
October 18, 2006

http://www.theage.com.au/articles/2006/10/16/1160850872928.html?page=fullpage#contentSwap2

Electronic payments company ERG, Strathfield Group and animal antibiotic group Chemeq are similarly challenged, Hoffman says. All have made losses two years running and all have negative cash flow.

In addition, Strathfield and Chemeq have borrowings greater than shareholders' equity (total assets minus liabilities), another bad sign.

And if the boss has no faith in the business and hardly any stakeholding in it, investors should probably follow suit, he says.

Poor cash flow
The first sign of a company in trouble is often an operating loss. This is not necessarily a portent of doom because in an otherwise robust company losses can be temporary. But if the loss is accompanied by falling cash flow then investors should take a long hard look at the numbers.

Greg Hoffman, research director at The Intelligent Investor, says a loss-making company with negative cash flow will quickly become insolvent unless it can raise money from banks and shareholders. Hence, rising debts and deteriorating interest cover (the number of times a company's earnings before interest and tax cover its tax bill) are also reliable warning signs.

If the company continues losing money its bankers and shareholders eventually will say "no more" and the company will go belly up.

To illustrate the point, Hoffman has singled out four companies he believes are treading on too many corporate landmines for comfort.

Winemaker Evans & Tate lost $64 million in 2006 and $73 million the previous year. As at June 30 this year total debts of $169 million exceeded total assets of $140 million.

Evans & Tate's banker has given it some breathing space but Hoffman doesn't hold out much hope for its long-term survival in its current form.

Electronic payments company ERG, Strathfield Group and animal antibiotic group Chemeq are similarly challenged, Hoffman says. All have made losses two years running and all have negative cash flow.

In addition, Strathfield and Chemeq have borrowings greater than shareholders' equity (total assets minus liabilities), another bad sign.

ERG and Strathfield have issued hundreds of millions of shares in recent years as they struggle to survive.

According to Hoffman, corporate failures are seldom the result of a sudden misfortune. Instead, they tend to be the gradual and inevitable result of poor underlying economics, giving investors the clues to look for better opportunities elsewhere.

And if the boss has no faith in the business and hardly any stakeholding in it, investors should probably follow suit, he says.