my relationship with fun is strained

My initial attraction to this stock much like most relationships was very superficial. It had a great P/E ratio, great dividend yield and had grown profits significantly over the past couple of years. So, I jumped right in for an average price of around 20c :( It has obviously fallen pretty significantly since then, which is really my own fault for not checking whether there was any real substance to it.

At a current P/E of around 6.4 this looks attractively priced. However, it's also a good lesson in why you should read the detail in the financial reports. By adjusting the P&L to underlying earnings it's a pretty different picture.

NPAT $13,962
Less:
Gain on early settlement ($3,272)
FV adjustments on hedges ($1,962)
FX variances ($ 173)
Underlying NPAT $8,555

At Underlying NPAT of $8.555 P/E ratio balloons out to 12.4. Which if the new business strategy and acquisition work as anticipated is still not bad, but a very different figure to the P/E of 6.4 as calculated on statutory NPAT.

Also, a quick look at the cashflow, shows the business managed only 0.84c/share in operating cashflow and paid a similar amount out in stay-in-business capital expenditure. Now, why they decided this was a good year to start paying dividends equivalent to 1c/share was a good idea is beyond me. Actually, It was probably to attract investors back by becoming a dividend paying stock once again. All it has really served in doing is delaying a full recovery. I would have much rathered see the dividend money go towards paying down debt or reducing the amount raised via the most recent capital raising.

It currently trades at around 7.5 EV/EBITDA, which is ok for a quality company, but IMO kind of expensive for a risky-ish turnaround story.

So, why haven't I cut my losses and moved on yet?

Essentially, because I want to see the next set of financials before I pull the trigger. I could still be persuaded to stay a little longer.

A closer inspection of the cashflow reveals that one of the main reasons that operating cashflow was so poor was due to a ~$9.3m (or 1.45c/share) increase in inventories. Normally a worrying sign for a business and a key indicator of obsolescence of stock, this could be the case for FUN. However, another explanation may be that it is a consequence of the new strategy of moving from being a distributor of toys to a manufacturer and the acquisition of Chill. I'm hoping it's the later.

If FUN can maintain it's current levels of inventories, it could potentially generate cash of around 2.5c/share (and increase of 250% on FY13) which would equate to a cash yield of around 15% on current market cap. Now, if they are generating that sort of cash you would assume that debt is being paid down (A stated management objective), which would then increase operating cashflow further through decreased interest expense. Of course if you assume some profit growth in FY14, it is not too unrealistic to expect operating cash flow of between 2.5-3c/share in FY14. I'd be pretty happy with that.

Probably a largely unnoticed positive of FUN is it's quite substantial carry forward tax losses of around $54m. These losses should allow for tax free profits for at least the next three years. FUN also has a fairly healthy franking account balance. This effectively means for 3 years (my estimate), FUN will be able to distribute profits to shareholders tax free, and those dividends will only be taxable to the shareholder at their marginal tax rate in excess of the corporate rate (30%). Not that tax should ever be the basis for an investment decision, but it is a nice little perk.

If I had my time again I wouldn't have invested in this stock, but now that I'm in I'll stick around a little longer. It's definitly got its (significant) risks, both structural and financial, but it could return a decent speculative profit if it overcomes them.