Something is afoot, page-56

"If you look at the TRS balance sheet at 31 Dec, current liabilities exceed current assets by about $13K. Usually companies like the ratio to be 2:1 the other way! This explains why TRS needs extra working capital."

@joharefi,

No, that's not quite the reason.


The only reason the Current Ratio (Current Assets-to-Current Liabilities) is now over under parity is because of the bringing of the lease liabilities on-balance sheet for the first time.

And the way this has been done is a bit misleading in that the Current portion of the lease liabilities is duly reflected as a Current Ciability, but the entire compensating balance sheet entry, namely the right-of-use of the asset that is being leased is, under AASB 16, recorded as a Non-Current Asset.

So, while there is virtually no change to Net Assets (i.e., Current Assets less Current Liabilities) under AASB 16, because Total Assets is increased by the same amount as Total Liabilities, on the Asset side of the balance sheet all of the increase is booked to Non-Current Assets, while the Liabilities side is increased both in Current and Non-Current terms.

This renders the Current Ratio now almost meaningless.

Until this accounting change, TRS's Current Assets exceeded Current Liabilities by far:



So, while TRS's solvency might now looked challenged compared to before this is really purely due to an accounting oddity; its the same company with the same capital structure and the same degree of financial obligation... except that whereas some of that obligation was recorded somewhere deep in the notes to the accounts, it has now being brought onto the balance sheet [*].

But from the point of view of commercial lenders, who would already have incorporated all the off-balance sheet commitments into their assessment of TRS as a credit risk, despite the Current Ratio seeming to go from 1.7x @ 30 June 2019 to just 0.9x @ 31 December 2019, the company is no less creditworthy today than it was six months ago. The Dec 2019 balance date Current Ratio (pre-AASB 16 impact) of 1.7x is right in line with the long-term average for the company.

So, that begs the question: what do they need the $25m for?

Sure, they have been dragging the chain a bit in terms of paying their suppliers: while December balance date Payables always end up being higher than at June balance dates (the Christmas effect), in this last half, the variance was even more pronounced (Dec 2019 Payables were $72m vs $44m @ June 2019). So they will need to play a bit of catch-up on that front.

But part of the new management team's stated focus is on rationalising inventories, which are now at record high levels of $118m (equating to stock turnover of 3.7 times for DH2019, compared to 4.2x a few years ago, when Sales were lower 10% to 15% lower than they are today... evidence of dis-economies of scale. Which shouldn't be happening.)

So we should see some $10m to $12m of Inventory reduction over the next 12 months, which will go a meaningful part of way to reducing Payables.

All this suggests to me that they will need to make a net investment in Working Capital of around $15m or $20m. Which could easily be funded out of the starting point of a $52m Net Cash balance, which is an all-time high for the company:




So, I have to say, I don't understand why they are raising fresh equity capital.

On the basis of my analysis, the business is more than adequately funded.

Under even the absolute worst-case scenario in which the company generates no free cash flow (before investment in working capital) over the current 12 months, after this capital raising it strikes me that they could very easily end up with more Net Cash when they report their DH2020 result.

Hypothetically:

Current Cash: $52m
Add: Equity Raising: $25m
Add: Free Cash Flow: Nil
Add: Reduction in Inventories = $10m
Less: Reduction in Payables = $30m

=> Net Cash @ DH2020 = $57m


And remember, lease liabilities have also been reduced significantly, as discussed in a preceding post.

Sure, they earnings are lower than they have been historically, but the company still very cash generative and the balance sheet is in the best overall financial health that it has been for some time.


Maybe they intend to reinstate the dividend with the final result.

But that would simply be a circular flow of capital: raising money from shareholders today and then duly handing some of it back to in 6 months' time.

In summary:

As I say, I can't understand the need for this capital raising.
(The good news is that its mechanism is via an entitlement offer, which means that shareholders can avoid being diluted. And there is an over-subscription option, too, of which I expect I will be availing myself.)


[*] I happen to believe that bringing lease commitments on-balance sheet is a sensible, and long overdue, measure because having them off-balance sheet has tripped up many an unsuspecting investor who was too lazy to read financial statements in their entirety, i.e., including the notes to the accounts. So this measure has enhanced transparency. My only criticism is the way that it has been done, i.e, the Current And Non-Current portions of the Lease Commitments being - appropriately - booked to Current and Non-Current Liabilities, but the entire Right-of-Use Asset - whether Current or Non-Current - gets booked to Non-Current Assets. This tends to create the kind of confusion as discussed above.