Small Cap Value Report (11 Mar 2014) - EMR, SDM, DEMG

11th Mar '14 by Paul Scott

9 comments 17546 reads

Good morning!

Empresaria (LON:EMR)

Results for calendar 2013 have been issued this morning from recruitment group Empresaria. The headline figures look good, so to save re-typing them, here's a screen shot from the results statement:

So an improved profit performance on flat turnover, which seems to have been mainly driven by cost savings in Germany and Austria.

I usually like to check to see what the excluded items are in defining adjusted EPS, to determine whether or not I'm happy to rely on adjusted EPS. In this case they have excluded the following items;

* adjusted to exclude amortisation of intangible assets, exceptional items, gain or loss on disposal of business and movements in the fair values of options

Those look fairly sensible to me, so by stripping those items out the company probably has shown the true underlying performance of the business. The trouble is, companies are stretching these definitions, and many groups now report exceptional restructuring charges every year - so you could argue that restructuring is just ongoing, and a normal part of business.

Anyway, I'm reasonably happy with using 6.2p adjusted EPS as the benchmark figure to value the business on. Put it on a PER of about 12, to come up with what the business might be reasonably valued at, i.e. 72p.

The shares are actually up 11% to 54p this morning, so at first glance they look cheap.

The problem with Empresaria is that it has too much debt. They also have a highly questionable method of reporting it, which I just think is plain wrong. The company reports £5.8m in net debt, which sounds reasonable. However, they have excluded from that figure a further £9.4m in non-recourse invoice financing.

This is presumably where the group has signed over its debtors to a bank, on a non-recourse basis, and they then net off that debt against trade debtors. That is an incorrect accounting treatment, as far as I'm concerned. The principle of no netting off, is one of the fundamental accounting principles! You have to show both the debit and the credit, separately on the Balance Sheet, within trade debtors (for the invoices), and creditors (for the money owed to the Bank).

I've never seen any other company use netting…

Unlock with Email

Unlock with Google

Already have an account?
Login here

AlanJenkins2

11th Mar '14

Is the invoice financing included as a liability ? If so,how is it described ?

JakNife

For a company, invoices are an asset, they respresent an amount owed by the company's customers. There are two methods that a company might raise finance using them:

1. Borrow money secured against them. This is debt plain and simple.

2. Sell them on a non-recourse basis. This is what Paul suggests that Empresaria have done (I haven't checked).

The accounting treatment for 2 is that an asset has been sold and hence the asset leaves the balance sheet to be replaced by cash, hence no debt. This kind of product is being commonly offered at the moment, my bank routinely offers this kind of deal, its selling points are (A) the bank takes the credit risk on the invoices, (B) it permits our clients to extend the payment terms of their invoices to 90 days, which is where loads of companies seem to be heading and (C) it's off-balance sheet debt. Guess which point sells the deal!

If you look through the accounts of large companies you may see such deals described as "receivables financing", "receivables securitisation" or "factoring".

Thanks,Jaknife.Paul,something I don't understand,here.Why do you believe that the invoice financing should be included as debt,if it has been sold to the bank on a non-recourse basis ? Yes, I appreciate that if the facility were to be withdrawn,that would be a negative for EMR.

cig

I don't get in what way it's debt if it's properly non-recourse. Classic off-balance sheet debt of the problematic kind has future "repayment" obligations that are accounted for as expenses. This does not seem the case here.

Sure, if the facility is withdrawn there'll be tighter constraints on working capital, but then that could happen for a myriad other reasons, e.g. major clients or suppliers with bargaining power insisting on better payment terms in a downturn, which is also not (usually) accounted for in the balance sheet. It's also not quite sudden as it applies to new invoices as they come -- surely the bank cannot recall past invoices they've already paid, if the facility is indeed non recourse.

If you have two identical companies which differ solely because one borrows £20m of vanilla debt to finance expansion whilst the other sells £20m of receivables on a continuous ongoing basis then how do you compare the two? The latter company will have significantly better balance sheet/working capital/ROC ratios even though the two are identical.

You should always add back the receivables, and adjust the net cash in order to make the companies comparable.

If you sell receivables on a non-recourse basis,then receivables should be reduced,and cash increased.Total assets should be reduced,since you will have had to discount the receivables in order to sell them.Is that not what happened in the case of EMR's accounting treatment ?

kevanp

I'm with Alan here. If you sell your receivables, you have surely just switched one asset for another, cash — albeit at a discount.

JakNife, you yourself wrote:

"For a company, invoices are an asset, they respresent an amount owed by the company's customers. There are two methods that a company might raise finance using them:

1. Borrow money secured against them. This is debt plain and simple.

2. Sell them on a non-recourse basis. This is what Paul suggests that Empresaria have done (I haven't checked).

The accounting treatment for 2 is that an asset has been sold and hence the asset leaves the balance sheet to be replaced by cash, hence no debt."

But then you went on to refer to "off-balance sheet debt". How can no debt be off-balance sheet debt?

As cig wrote:

"I don't get in what way it's debt if it's properly non-recourse. Classic off-balance sheet debt of the problematic kind has future "repayment" obligations that are accounted for as expenses. This does not seem the case here."

You have the same problem if one of two otherwise identical companies manages to secure better payment terms than the other direct from their clients and suppliers (which is basically what's happening here, through an intermediary). Basically the guys who get better terms are better at managing their working capital, and it should show in the accounts.

Paul Scott

Hi,

Thanks for the comments, very interesting.

In my view, selling some of your debtors is always a form of borrowing, even if it is technically non-recourse.
So I would always add back the debtors and bank debt. As Jaknife says, if you don't do this, you cannot possibly make a meaningful comparison with other similar companies.

I've not seen any other Listed recruitment companies use non-recourse sale of debtors in this way. The others tend to use standard invoice discounting, where the full debtors and full creditors are correctly shown on the Balance Sheet. So it is essential to adjust Empresaria's accounts to the same accounting treatment in my opinion.

A lot of traders don't dig into the detail. So imagine you had only looked at the headline figures for Empresaria today - you would have said oh it looks really cheap on a PER basis, and there's very little net debt, so I'll buy some. Only later (after reading my report!) would you realise that there's a whacking great slug of additional, off Balance Sheet debt, which is highly material to Enterprise Value.

Investors can value the company how they like, I just think that it's my job to make sure that big issues like this, and pension deficits, are flagged up here, so that people are armed with the full facts & can then make an informed judgment.

Regards, Paul.

Small Cap Value Report (11 Mar 2014) - EMR, SDM, DEMG

Empresaria (LON:EMR)

Unlock the rest of this article with a 14 day trial

About the Author

Paul Scott

9 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...