Headroom & Cash Flow

Introduction:
I promised earlier i would give a very detail breakdown of the financials, I've been meaning to do this for a while but haven't had the time. Despite me holding shares in the company, I will give my best unbiased opinion of how the next six months will turn out. In order to do this i will also use figures presented in the Financial reports for the period ending Dec 2015 to back up these findings, please remember that these figures were audited by EY and approved by ASIC, as a result its my belief that they can be relied upon with a fair bit of accuracy.

Methodology:
It will be quite hard, perhaps even impossible to predict what NPAT Slater and Gordon will have for the period ending 31 June. Rather than me spending time and deriving a number which which will likely be significantly different to the actual results, i will instead look at cash flows and whether SGH can stay solvent for the period ending 31 June 2016.


The balance sheet can be used to predict cash flows for the remainder of the year. For instance we know that accounting principles dictate that Current Assets and Current Liabilities are those which will settle within 12months, any Assets or Liabilities which take longer than 12months to settle are classified as Non-Current Assets & Liabilities.

Analysis:

SGH Does Nothing (Scenario)
I want you guys to make one simple assumption. Assume that SGH will never again take on new cases, instead it will only pay its lawyers to unwind the current cases, hence no future cash flows other than those recorded in the balance sheet (I will remove this assumption as we go on).


In order for SGH to unwind its WIP of $429mil it needs to pay its employees $566mil over the next 12 months . The "payables" recorded in the balance sheet include paying staff for cases that have finalised (Receivables) and cases which have not been finalised (WIP).

As SGH will not be taking any more cases, we would expect SGH to have $509mil ($1,173mil - $664mil) in cash in a years time. Seeing as we only want to know how much money they will have in 6 months time, we'll make a simple assumption, which is that cases are evenly skewed, hence $254mil ($509mil/2 ) of cash will be coming for the period ending 31 June 2016. Please keep in mind, that this is not profit, SGH could have made losses making these cases, however, as i mentioned earlier my goal isn't to calculate how much profit SGH will earn (too hard), its how much cash will be available for them by June 2016.

Previously i asked you all to assume SGH does not take on any new clients, we noted that SGH would have $254mil in free cash flow for the period ending 31 June 2016 (6months) if no new cases were added. Now i would like you to assume that SGH continues to operate, keeping in mind that they will receive $254mil in cash regardless of what happens.

SGH Continues to Operate (Scenario)
Lets place our attention to the Comprehensive Income statement. This statement allows us to forecast SGH's future revenue and expenses.


The total Revenue From Australia and the UK division was $487mil, the revenue presented here has been added to the current balance sheet under Current & Non-Current Assets of the balance sheet. So instead of double counting assume that I have borrowed my friends time machine and have gone 6months into the future to obtain the above income statement (Ironically the future is very constant such that the figures are the exact same as the 31 Dec 2015 with a few adjustments)...

The above figures exclude the impairments and non-cash items as well as any one-off items such as the payments to former owners excluded. We see that $561mil of cash is left to the company with only $487mil entering the company, hence a shortfall of $74mil in cashflow (similar to what we saw for the period ending 31 December 2015).

If SGH does nothing, we are likely to see a repeat of the Dec 2015 financials. Lets instead assume that revenue remains the same and lets adjust the expenses for AG's OPEX cuts work. We see a different picture. $487mil of revenue will be coming in, with $446mil going out.. That is $41million of cash flows added. The above opex cuts are also reasonable, if anything we could probably shed advertising by another 20mil, i also did not touch admin or office expenses but cuts could be made there as well.

Possible Outcomes:

SGH Does Nothing + SGH Continues to operate (Opex Cuts succeed)
$254mil + 41mil = $295mil in CF (period ending 31 June 2016)

SGH Does Nothing + SGH continues to operate (Opex cuts fail).
$254mil - 74mil = 180mil in CF (period ending 31 June 2016)

SGH Does Nothing + SGH continues to operate (situation deteriorates).
$254mil -120mil = 144mil in CF (period ending 31 June 2016)

Headroom Improving:
Headroom improves regardless of which of the above scenario's occurs, hence SGH's statement "Slater and Gordon has more than $100million headroom within its banking facilities and this headroom is expected to increase as the financial year progresses" - 2016 Financial Year Update.

"The group had cash on hand of $51.9m and other borrowings of $10.3mil resulting in net debt (drawn debt facilities less cash and cash equivalent) of $741.4m and available liquidity of $119.3mil. - Financial Report 31 Dec 2016

Conclusion:
Although its close to impossible to estimate SGH's profit (hence the reasons for guidance being removed) I did however prove that the second half of the year will be extremely cash flow positive, helping to increase the bank headroom even under the worst case scenario. It will be interesting to see how things turn out in 6 months time. As i've mentioned previously, there is only one last catalyst preventing SGH from an upward break-out. That is whether the banks decide to call in the loans in a years time. Once that question is answered, there is nothing stopping me nor other fund managers from purchasing the stock.