Historical Accounting Policies and Balance Sheet Review - Somero Enterprises

As promised in the previous article, I have looked through Somero's accounting policies going back to the 2009 accounts to assess them for consistency and to look for any abnormalities in general.  I am pleased to say that there is little to report and as such the majority of this article will be used to have a quick look at Somero's current balance sheet instead.

Historical Accounting Policy

I think it is safe to say that the accounting policy disclosures have literally been copy and pasted from year to year, with the exception of a couple of changes in formatting.  Policy has not just remained consistent but, as far as I can tell, is completely unchanged since at least 2009.  I have not looked back any further than that but feel the value added in doing so would be limited.  I am really satisfied to see that the company has simply adopted a conservative, 'off the shelf' type of accounting policy and has committed to consistently reporting within that framework.  You would expect nothing less from what is, essentially, quite a simple business and any changing policy or unusual accounting for revenue in particular would have been a huge red flag for me.  From our perspective as investors, this makes year on year comparisons incredibly simple and gives us added faith that the management team are happy to report the results of the business as they are, whether good or bad.

Liquidity

With little more to say on the matter, I will move on to Somero's balance sheet now.  All in all, I am quite impressed and the balance sheet appears strong.  With 20% of total assets in cash, and 61% in current assets as a whole, the position appears to be quite liquid.  You may think, at first, that the increase in debtors and inventories is a sign of trading weakness (indeed, it sometimes is), but given the enormous growth in revenue over the same period I think that the increase is not at all unreasonable.  A current ratio of 3.27 and a quick ratio of 2 add further weight to the idea that the company is highly liquid and that it shouldn't have any problem at all in meeting it's short term liabilities.

Long Term Liabilities

As for long term liabilities, there aren't all that many to speak of with just over a million dollars in long term notes payable going forwards.  This amount gives us a debt to equity ratio (long term debt / equity) of about 3%, which is absolutely fantastic news for equity investors.  I really like to see conservative use of debt and feel that there is a lot of evidence out there to support the view that highly indebted companies are more likely to experience financial difficulty in a given situation.  The absence of commitments to creditors simply helps take pressure off the organisation so that they can just focus on what they do best.

Building on this point, if you look back over the past few years of accounts, you can see that the longer term debt figure has been steadily paid down and is getting to the stage now where the balance sheet is almost debt free.  In my eyes, this is a responsible use of funds and I think that the decision to do so is most likely to benefit shareholders going forward.

Equity and Forward Looking Analysis

With regards to shareholder's equity, we can see that treasury shares have increased by $355,000 during the period.  This is, again, great news for investors and should provide an additional source of return (assuming the buy backs continue) going forward.  A final balance sheet exercise that I like to perform is to have a quick think about how the balance sheet will look in a few years time, once earnings after the payment of dividends have been added to retained earnings.

Let's assume, for the sake of prudence and simplicity, that revenue and profits do not change at all over the next three years.  For each of those three years, the dividend payout ratio will remain as it is now, at about 11%, which provides a current dividend yield of 2.65%.  This would equate to net income of $43.6m over three years, of which $38.8m would be taken to retained earnings after dividends.  Given that book value is currently $30.8m, this would give an increase in book value of 126% over that three year period, corresponding to a CAGR of just over 31%.  Factor in managements stated goal to actually increase revenue and profitability significantly above the current level and you start to see the picture of a potentially great opportunity.  Oh, and don't forget the dividend yield and the potential for share buy backs to increase book value per share on top.

Given that the company is already trading at a relatively high PB multiple, it is hard to say what this potential growth in book value will mean in terms of share price performance, but I see no reason that an improved and more profitable Somero, a few years down the line, wouldn't warrant a multiple at least as high as that seen today.

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At the time of writing I do not hold a position in Somero Enterprises – LON:SOM

It is important to note that all opinions expressed in this piece are the opinion of the author only and do not, in any way, constitute investment advice.  Any individual seeking to make investments of any kind should conduct thorough proprietary research so as to fully understand the risks they are taking.