For the benefit of those who have followed this discussion, and since this has been the main possible reason for concern encountered so far, I had a more in-depth look into the cash conversion issue.
The result is that I no longer see the buildup in Net Payables as something to worry about, and believe the underlying, recurring cashflow generation is an accurate reflection of reported earnings.
My reasoning and numerical findings are as follows.
First of all, do [Receipts from Customers] resemble [Operating Revenue]? The answer to this important question is yes, as the figures clearly show:
[Receipts from Customers]/[Operating Revenue]
FY2009: 99.10%
FY2010: 97.61%
FY2011: 97.57%
FY2012: 98.87%
FY2013: 99.99%
FY2014: 102.62%
FY2015: 98.19%
FY2016: 99.27%
Average: 99.15%
Secondly, do [Payments to Suppliers] resemble [Operating Costs]? The answer to this question too is affirmative:
[Payments to Suppliers]/[Operating Costs]
FY2009: 98.28%
FY2010: 98.48%
FY2011: 102.30%
FY2012: 99.70%
FY2013: 98.43%
FY2014: 101.62%
FY2015: 96.82%
FY2016: 99.41%
Average: 99.38%
The next question is, what component of [Receipts from Customers] is to be considered non-recurring, because of its being generated by movements in Working Capital? In order to answer this, we first need to look at what individual items of Working Capital are going to hit the Receipts line at the time they are settled.
The first thing that can be noticed is that [Receipts from Customers] have not been beefed up by a reduction in Receivables. Under Current Assets, the items that contribute to the Receipts line are Trade Receivables and Prepayments; the aggregate of these two items has steadily increased over time:
[Trade Receivables]+[Prepayments]
FY2009: 1.435m$ (4.30% of Operating Revenue)
FY2010: 2.690m$ (4.05%)
FY2011: 4.613m$ (3.34%)
FY2012: 7.034m$ (3.93%)
FY2013: 9.887m$ (3.60%)
FY2014: 14.949m$ (3.10%)
FY2015: 21.749m$ (3.15%)
FY2016: 24.876m$ (3.21%)
As the figures show, the buildup in trade-related Current Assets is both small and not growing, as a percentage of Revenue; therefore, I do not see anything concerning here.
Under Current Liabilities, there are two items that (somewhat counterintuitively) hit the Receipts line, namely Centre Enrolment Advances and Deferred Income; these represent cash advances from customers corresponding to future revenue that has not yet been booked as such; therefore, while a current liability is booked against them, as actual cash payments they still inflate the Receipts line.
The amounts are as follows:
[Centre Enrolment Advances]+[Deferred Income]
FY2009: 0.792m$ (2.37% of Operating Revenue)
FY2010: 2.737m$ (4.12%)
FY2011: 4.876m$ (3.53%)
FY2012: 7.221m$ (4.03%)
FY2013: 9.373m$ (3.41%)
FY2014: 17.277m$ (3.58%)
FY2015: 20.055m$ (2.91%)
FY2016: 18.492m$ (2.39%)
What we can see from here is that there has been a close correspondence between the buildup in receivables (due to revenue being booked but not yet received in cash) and the increase in cash advances (relative to revenue that has not yet been recognised). The offset between these two effects explains why [Receipts from Customers] and [Operating Revenue] have been matching so closely. Because the amounts involved are both small and not increasing, as a percentage of Revenue, I do not see this as being unsustainable.
If we now add Trade Payables, which hit the [Payments to Suppliers] line and therefore have an impact on Net Receipts, we have:
[Centre Enrolment Advances]+[Deferred Income]+[Trade Payables]
FY2009: 1.496m$ (4.48% of Operating Revenue)
FY2010: 4.407m$ (6.64%)
FY2011: 7.106m$ (5.15%)
FY2012: 11.738m$ (6.56%)
FY2013: 14.000m$ (5.10%)
FY2014: 24.248m$ (5.03%)
FY2015: 27.642m$ (4.01%)
FY2016: 26.026m$ (3.36%)
Taking the difference between this table and [Trade Receivables]+[Prepayments] shows the net movement in Working Capital that is trade-related, namely
Change in Working Capital (trade-related)
FY2009: 0.376m$ (1.13% of Operating Revenue)
FY2010: -1.656m$ (-2.49%)
FY2011: -0.776m$ (-0.56%)
FY2012: -2.211m$ (-1.24%)
FY2013: 0.591m$ (0.22%)
FY2014: -5.186m$ (-1.08%)
FY2015: 3.406m$ (0.49%)
FY2016: 4.743m$ (0.61%)
From which we can finally work out the adjusted [Net Receipts]/EBITDA cover ratio (inclusive of trade-related movements in Working Capital)
Adjusted [Net Receipts]/EBITDA cover
FY2009: 131.78%
FY2010: 70.83%
FY2011: 54.93%
FY2012: 85.07%
FY2013: 106.62%
FY2014: 93.11%
FY2015: 100.98%
FY2016: 99.47%
Average: 92.85%
Whereas, in absolute dollar amounts:
Adjusted [Net Receipts]-EBITDA differential
FY2009: 0.472m$
FY2010: -2.729m$
FY2011: -12.336m$
FY2012: -4.769m$
FY2013: 3.504m$
FY2014: -7.852m$
FY2015: 1.592m$
FY2016: -0.912m$
Total: -23.030m$
What I am inclined to conclude from these results is that:
1) Reported earnings are solidly backed by recurring operating cashflow
2) The cumulative shortfall between reported EBITDA and recurring cashflow (-23.030m$) matches almost perfectly the current level of Trade Receivables and Prepayments (24.876m$), which makes sense
In my previous analysis, though, I had stated that Net Payables (i.e. Total Payables minus Total Receivables) had reached a level of 65.90m$ as of FY2016.
The question that comes spontaneously, then, is where are these Net Payables coming from? The answer is that the Total Payables previously calculated included items that were not related to trade and, as such, had no impact on either the Receipts from Customers or the Payments to Suppliers line.
The detail of FY2016 Current Liabilities is as follows:
Trade Payables: 7.534m$
Centre Enrolment Advances: 8.260m$
Deferred Income: 10.232m$
Deferred Centre Acquisitions: 3.998m$
Dividends Payable: 22,951m$
Other Payables and Accruals: 35.872m$
Total Payables: 88.847m$
Items such as dividend accruals and deferred payments for acquisitions should not be taken into account when it comes to calculating recurring operating cashflow; therefore, the only item that remains to be investigated is Other Payables and Accruals.
Let’s have a look at the evolution of this particular item over time:
Other Payables and Accruals
FY2009: 1.145m$ (3.43% of Operating Revenue)
FY2010: 1.792m$ (2.70%)
FY2011: 3.694m$ (2.68%)
FY2012: 4.825m$ (2.70%)
FY2013: 10.330m$ (3.76%)
FY2014: 20.317m$ (4.21%)
FY2015: 29.388m$ (4.26%)
FY2016: 35.872m$ (4.63%)
Evidently, this item has been the main driver of the buildup in Net Payables. Unfortunately there is very little information on what is actually included in it, with the exception of the 2009 Annual Report, where it is said (page 64) that Other Payables and Accruals include accruals for annual leave. It is also said that the entire obligation is presented as current, since the Company does not have an unconditional right to defer settlement. However, the Company does not expect all employees to take the full amount of accrued leave within the following twelve months.
Assuming that accruals for annual leave are still the main component of this item (which seems like a reasonable assumption to me given that the size of Other Payables and Accruals hasn’t changed significantly as a percentage of Revenue), I think it can be fairly concluded that such an item should also be excluded from the calculation of recurring operating cashflows, as it has very little to do with trade. I suspect that entitlements to Long Service Leave may also fall under this category.
My personal conclusion from looking at these figures is that, once the items that are not related to trade are excluded from the Adjusted [Net Receipts]/EBITDA calculation, the underlying cash conversion capability of the Company is actually pretty good. That gives me the kind of extra comfort I wanted, to increase my position in GEM further on any future price weakness, as long as the overall fundamental picture remains intact.
All in my opinion only, I hope this was useful, and good luck to all holders.
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