AUPU - results review

A number of companies which are included in the private portfolio have reported results for the year ended 31 December 2010. I have (obviously) followed each of the results and will post some thoughts on at least some of them, beginning with AUPU (HK:477). AUPU's results were disappointing, falling well short of my expectations and, judging by the fall in the share price following the release of the company's results, well below the market's expectations as well. The company was one of the 10 largest percentage losers the day after the results were released. The shares currently trade at HK$0.86 compared to HK$1.15 pre announcement, my purchase price HK$0.99 (before allowing for dividends received).

The following are some observations from the results announcement:

Things I did not like

1. Revenue fell 3.2%. On a segmented basis, revenue was down across all geographic segments except for the relatively small Sichuan and export sections. On a product basis, the fall was confined to the dominant "bathroom master" product with the smaller product lines (e.g. bathroom ceilings) showing growth;

2. There was a very large jump in administration expenses (+18.7%);

3. The combined effect of the fall in sales revenue and the increase in administration expenses (other factors were less material) was a fall in NPAT (-13.8%) and a similar fall in EPS;

4. Historical favourable tax treatment came to an end in 2010. At least one group company has been granted high-tech status which gives more favourable tax rates, but I cannot tell to what extent that will off set the general loss of favourable tax treatment. Absent any better information, I have to assume that tax rates are likely to be higher going forward;

5. cash flow contracted dramatically. The company is paying out more in dividends than it is generating in operating cash flow. Add in investments, including associated entities, and the company's healthy cash balance has been materially eroded (-48%);

6. the company has invested a relatively large amount of money in an associated entity (the rational for which is not explained in any detail) and made a further large investment in what appears to be a venture capital fund (I generally prefer companies to focus on their core businesses);

Things I liked

7. the company remains a positive cash flow generator with operating cash flow exceeding investments by a healthy margin (although much less than in 2009). The age of collectibles fell slightly and inventory turnover time also reduced slightly, suggesting good cash flow management;

8. however, the level of inventory rose significantly (+27%). Together with the high dividend payout and the investments made, the increase in the inventory contributed to the reduction in the available cash balance;

9. the company is aware of the issues it is facing and appears to be taking steps to address them by (i) attempting to move up the value chain through innovation and branding (ii) expanding sales channels through a push to retail and engagement of more sales agents and (iii) diversifying its product range;

10. the company remains debt free;

11. management continue to hold meaningful shareholdings;

12. there were no references to connected transactions in the results announcement.

Conclusions

I can no longer regard AUPU as a value based investment. The EPS, cash flow and NAV are all currently too low for that. It will require a meaningful increase in profitability to make the current dividend sustainable - possibly the proposed final dividend is a signal that management expects improvement?

However, I do like the clean balance sheet, the positive cash flow generation and parts of the strategy to grow the business going forward. Given the clean balance sheet I am willing to give management the benefit of doubt with respect to the historic associated company investments and the post balance date venture capital investments. For the time being I will continue to hold.

Qualification, disclaimer and general CYA

Since I am neither a qualified investment analyst nor a professional accountant, I'm sure I have missed things and/or made mistakes and/or drawn erroneous conclusions - hence the "trainee" part of "traineeinvestor". Corrections from people who actually know what they are talking about are welcome.