MAHSING (8583) - Mah Sing Group Berhad (Stock Code:8583) – Strong Balance Sheet Or Just Accounting Gimmicks?



Mah Sing Group Berhad is one of the darlings of many investors in Malaysia, especially when it comes to property sector. This is not surprising given its strong brand name and its strong balance sheet, which compare favourably to other listed peers under Bursa Malaysia. While we recognise Mah Sing does have a strong brand name in the local market, is Mah Sing’s balance sheet as strong as generally perceived? In this article, we take a closer look on Mah Sing’s financial reports and explain how dubious accounting practise may distort our judgement.

Dissecting Mah Sing’s Financial Reports

At first glance, Mah Sing’s balance sheet is indeed superior as compared to many of the listed peers, sitting on a huge cash pile of RM838million and having only a total debt of RM907million , which in turn give rise to a near net cash position for the company (refers to net debt to equity ratio). Besides that, other credit metrics also look fairly strong on a relative basis. Something worth mentioning is that these ratios are calculated based on the data from companies’ financial reports without making any adjustment.
Chart 1: Credit Metrics of Various Listed Property Developers on Bursa MalaysiaSource: Bloomberg, BullBearBursa compilations. **Average value calculated by excluding outliers-UOA Development and Matrix Concepts
But are these ratios really a true reflective of Mah Sing’s financial position in reality?  After examining the footnotes of its latest financial reports, we found two major accounting practises that could be dubious, in our view:
  1. Classification of Perpetual Sukuk As Equity Instead of BorrowingChart 2: Perpetual Sukuk as a Component of EquitySource: Mah Sing’s 1Q17 Interim Financial Report.One can easily identifies there is a RM540million perpetual sukuk being classify as one of the components for equity in the balance sheet of Mah Sing’s financial reports. The key question is-what is this perpetual sukuk in reality? A closer look at the footnotes of Mah Sing’s Annual Report 2016 revealed that it represents more like a form of borrowings  than equity. Some important features of the perpetual sukuk include: 1) No fixed maturity, 2) Mah Sing has to option buyback these sukuk at the end of fifth year and thereafter, 3) Periodic distribution rate of 6.8% payable on a semi annual basis (interest payment), and 4) payment is rank ahead of preference share and shareholder (debt-holders are commonly being paid ahead of other stakeholders). While the feature (1) resembles equity, it is hard to argue against features (3) and (4) are not some common traits of borrowing. Chart 3: Salient Features of Perpetual Sukuk
    Source: Mah Sing’s Annual Report 2016.
Besides that, we have also found that the feature (1) might not hold true  given the heavy penalty imposed on Mah Sing, whereby the periodic distribution rate will be reset to a higher rate if it does not buy back the perpetual sukuk in the future. With this in mind, it is very likely that Mah Sing will buy back the perpetual sukuk before  31 March 2021 to avoid paying higher distribution rates and this means that this sukuk might not be as “perpetual” as it initially seems.
Chart 4: Distribution Rate Table for the Perpetual Sukuk
Source: Bondsupermart.com.

Effectively, classification of perpetual sukuk as equity instead of borrowing helps to lower gearing ratios (debt to equity, debt to asset etc), resulting a stronger balance sheet than it would be if it were to classify otherwise.
2. Classification of Periodic Payment to Sukuk As Distribution Instead of Interest
As mentioned earlier, by using perpetual sukuk as a source of financing, Mah Sing has to make a periodic payment of 6.8% per annum or equivalent to RM37million per annum to perpetual sukuk holder (6.8% multiple with RM540million). While this periodic payment looks like a form of interest payment, it is classified as  distribution (dividend alike) instead. This is also one of the key reasons why Mah Sing recorded a fairly low finance cost/cash interest paid on its income statement/cash flows statement. As a result, debt servicing ratios like EBITDA to interest/cash interest paid would be higher than in the case if it has classified the payment as interest.
Chart 5: Mah Sing’s Low Finance Cost/Cash Interest Paid

Source: Mah Sing’s 1Q17 Interim Financial Report.

Adjustment Made on Data

Given so, what should be done in order to get a better understanding on the company’s financial position? A quick way to do that is to reclassify the perpetual sukuk as borrowing by removing it from equity value (minus RM540million from equity) and adding it to long term borrowing. As a result, total borrowings would rise to RM1447million from RM907million while equity value would decline from RM3908million to RM3368million. Assuming cash and cash equivalents remains unchanged at RM838million, this would give rise to an adjusted net debt to equity ratio of 18.1% instead of a meagre 1.8%.
Similarly, finance cost/cash interest paid can be adjusted by adding back the RM37million paid to sukukholders every year. After adjustment, finance cost and cash interest paid would be RM38.7million and RM49.4million respectively. As a result, an adjusted EBITDA to cash interest paid would be 2.5x instead of 10.1x.
Conclusion
When it comes to financial statement analysis, it is always important to understand the story behind the number before using them as input for your investment decisions. Often times, if something looks to good to be true, always take additional steps to examine before assuming it is the truth.
Disclaimer: The views above are opinions based on facts and subjective judgement. We do not take any responsibility for any actions rely on the information discussed.

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