Just happened to check the stocksheet of Kentz (KENZ) and found the Beneish M score to be showing that there is a high chance of earnings manipulation.
I am sure that this wasnt the case a couple of months ago. What has changed? If so it would be helpful for the date of such changes to be recorded somehow?
Hi Intuitive,
Allow me to attempt to shed some light. If you click on the M-Score in the report it brings up a sub-panel which displays the breakdown of how the score was calculated. Kentz (LON:KENZ) pass every metric in the M-score except for two - one which measures "quality of assets" and the other which measures "accruals".
First, let me begin by saying that I don't think the quality of assets measure here is that useful. Here's what Stockopedia say about it:
"Asset quality is calculated by comparing current period with previous period for non-current assets less property, plant and equipment, divided by total assets. This measures the proportion of total assets for which future benefits are less certain. It is a possible sign of improper capitalization of expenses and cost deferral."
Now for Kentz in 2012 total assets were $706.2m and the non-current non-PPE assets were $36.88. In 2011 the total assets were $729.6m and the non-current non-PPE assets were $13.7m. Now indeed that is a big change in ratio but in absolute terms it's a relatively small asset change - the vast majority of the assets are still current ones. The change in non-current non-PPE assets is largely due to the fact that Kentz are now entering more JVs with local contractors so these assets are held on the book as a distinct equity holding rather than combined.
Now the accruals indicator is more interesting and more relevant I believe. Accruals, put simply, are profits that don't translate in to cash. They come up as other assets such as receivables and inventory. Here's Stockopedia's definition again:
"Excessive accruals may mean that managers are making discretionary accounting choices to alter earnings. This is calculated by raking the sum of the change in working capital, less the change in cash, less the change in current taxes payable, less depreciation and amortization, divided by total assets."
Now in this case, what this means is last year most of Kentz's profits showed up as working capital instead of cash. In their final results, Kentz provide some explanation for the large increase:
"Working capital at year end was US$223.3m, up US$34.5m or 18.3% on 2011 year end (US$188.8m). This increase is due to a combination of;
1. the strong growth achieved in the TSS business unit (up 32%) where working capital is primarily labour related and does not benefit from advance payments
2. the growth in the level of reimbursable work in the construction business unit (e.g., Gorgon MEI) and while welcome from a risk reduction perspective also means that these contracts do not attract advance payments
3. the continuing impact of the milestone payment terms on the Medupi contract which preclude invoicing for progress achieved until all elements of a particular milestone have been completed.
Current assets at year end were US$622.7m, down US$33.1m or 5.0% on 2011 (US$655.8m) primarily due to a reduction in trade and other receivables of US$26.9m. Current liabilities at year-end were US$399.4m, down US$67.6m or 14.5% on 2011 mainly due to a decrease of $82.7m in trade and other payables (including reductions in advances on contracts and accruals/ deferred income). This reflects a return to the level of current liabilities at December 2010 (US$400.3m) as contracts progress through their normal cycles."
Now to me this looks like a reasonable explanation and I'm comfortable with the working capital movements, however it's up to an investor to determine whether this does indeed look fair or whether it could be the sign of manipulation. It might be useful to look at other companies in the same industry to compare and see if big working capital movements from year to year are the norm or if this appears to be exceptional.
Hope this explanation helps,
CEV - a Kentz (LON:KENZ) shareholder.
