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On 9th July 2019, the Board of directors of London Biscuits (LB) announced that the company has entered the Practice Note 17/2005 status, PN17 issued by Bursa as it has become insolvent due to its inability to fulfil its loan repayment of a tiny sum of RM9.83m.
LB will have to undergo the exercises to comply with the requirements of Bursa, first to submit a regularization plan to Bursa for approval, and regularized its condition within 12 months; failing to do so will result in suspension in trading list securities, de-listed from the market or both.
Few foresaw this coming as LB has had positive in earnings over all these years. The reasons being the huge and continuous build-up of receivables, i.e. money owed by customers, and the incredible huge and persistent expenses in buying plant and machineries year after year as explained in my previous article on “The last bite from London to Holland” below,
https://klse.i3investor.com/blogs/kcchongnz/214166.jsp
These were all revealed from the balance sheet of LB since more than 10 years ago. But how many people look at the balance sheet of a company before following the touting of interested parties in the buying a stock? My hunch is that there is hardly anyone, and those who talk about balance sheet are being scorned and laughed at. However, I would think the balance sheet, not the income statement, is the most important piece of information one must first look at before buying any stock, especially from those touted in the internet space, absolutely!
Here I would like to share with you another simple analysis of the balance sheet which is crucial to avoid heavy losses in investing/speculating on a stock, the liquidity risk and the financial strength of a company, using LB’s latest balance sheet as on 31st March 2019 as an example.

Liquidity risk
Liquidity risk is the risk that a company may be unable to meet short term financial demands. This usually occurs due to the inability to convert its current assets (CA) to cash within a short period of time of less than a year to fulfil short-term obligation in current liabilities (CL).
Table 1 below shows the liquidity ratios for LB as on 31st March 2019
Table 1: Liquidity risk
LB
BM
Current ratio=CA/CL
1.1
<1 .5="" p="">
Quick ratio=(CA-Inventories)/CL
0.8
<1 .0="" p="">
Interest coverage=EBIT/Interest
2.4
<3 p="">
Cash flows coverage=CFFO/Interest
NA
NA
The liquidity or solvency risk of LB can be considered as very precarious with current ratio and quick ratio which excludes inventories as they are hard to sell to realize its true value quickly, well below the minimum benchmark (BM) as shown in Table 1. The worst is it has no cash flows to pay for its interest charge.
This problem has been prevailing since more than ten years ago and it has improved somewhat in the most recent couple of years with a few rights issues and private placements, but it is still far from satisfactory. It is hence no surprise that it is unable to meet its short-term obligations and hence have to declared insolvency as it was unable to pay its loan of just RM9.83m.

The debt problem
A company can issue shares or borrow money from banks or investors to carry out its business. Each has its advantages and disadvantages and the managers has to decide how best to fund the operations. It is a shareholder value enhancing act if management can earn a return higher than the costs of capital; for example, if the management can earn a return of 10% from borrowings at an interest rate of 6%. Otherwise, it is a shareholder value destroying act if it earns only 4% return from the business paying an interest rate of 6% from borrowed funds. That has been exactly the problem with LB.
Borrowed money has to be repaid with principle and interest. When there is an economic or financial crisis, company which over borrowed may find it tough to fulfil its debt and interest obligation. That would place the company at risk of bankruptcy.
Table 2 below shows LB has borrowed too much in relation to the equity it has, with high gearing and high financial leverage. In contrast with the short-term solvency problem, the debt problem has been deteriorating with total debts increased by 70% to RM387m, and total debt-to-equity ratio doubled from two years ago.
Table 2: Financial strength
Long term financial strength
LB
BM
Total liability/Total equity
1.2
<1 p="">
Total debt/Equity ratio
1.0
<0 .5="" p="">
Financial leverage=TA/TE
2.2
<2 p="">
Again, this telltale sign has been around for years. Anyone who has made a study of the balance sheet would never have invested in this stock.
That is in the past now. The more pertinent question now for the existing shareholders and the potential punters on LB is the question below,
[Posted by KerLee Tan > Jul 9, 2019 7:57 AM | Report Abuse https://cdn1.i3investor.com/cm/icon/trans16.gif
Hi anyone can help to advise if the NTA still reliable and will the company able to payback shareholder with NTA price if it's going bankruptcy or fully shutdown afterall?]
My view given below, as a usual, has nothing to do with the future price movement of LB, as I have no crystal in front of me and hence no idea at all about it. We will focus on the balance sheet on what LB owns and what it owes, and the quality of what it owns.

The quality of assets of London Biscuits
As on 31st March 2019, LB has a total asset of RM846m, and a total liability of RM465m, giving it a net asset or equity of RM381m. With an outstanding number of shares of about 247m, net asset per share is RM1.54. If LB is liquidated, investors will get back that RM1.54 per share, which is belonged to the common shareholders. Tomorrow, if you go to the market to buy 100000 LB shares at 21.5 sen with RM21500, when LB is liquidated, you will make RM146000, more than 500% gain! LB, Life is Brilliant!
But let us not get too excited first and think before going to the market to grab whatever LB shares you can from the market.
Table 3 in the Appendix and Figure 1 below depicts the current distribution of assets of LB.
It can be seen from the pie chart that the bulk of LB’s assets is in the property, plant and equipment, PPE (53%), and Receivables (38%). PPE is RM452m, or RM1.83 per share and Receivables amounts to RM322m, or RM1.30 per share. The cash of RM8.8m could not be withdrawn to pay for the loan as it is restricted by a larger bank overdraft. The market value of its investment in Khee San is probably not worth much now as its share price has tanked too in tandem with LB, and the more you sell, the faster the share price tanks. It is also hard to liquidate inventories to get the cash required as inventories are not that liquid. But how come LB was unable to collect just RM10m from its RM322m in Receivables to pay back the loan on demand by the bank to avoid the loan default?

What about the RM452m in PPE? Do you think it even worth a tenth of it on liquidation? In the last financial report, the auditor has in fact made a qualified statement on the worth of the PPE as they were unable to verify the true value of those PPE. I have had my head full of dew water wondering how a biscuits company with an annual RM10m profit requiring RM452m in PPE to do its business.
Just taking the two major assets of LB, PPE and Receivables, which total is worth RM3.13 per share, if they are worth just 50% of their book value, the net asset net asset of LB will fall to zero, and that is the value shareholder will get on liquidation. In my opinion, both are worth much less, and especially PPE, which I doubt is even worth a tenth of its value on liquidation. I am sure a rational investor of LB shouldn’t hope for the liquidation of LB as, if LB is still an ongoing concern, there is still an option value.
However, according to the Cockroach Theory, whenever a company announces some bad news to the public, like qualification from auditors, and default in loans repayments, there may be more bad news that have yet to be revealed. This is because whenever we see one cockroach in our cabinet, there tends to be many more cockroaches hiding at the back of that cabinet.
There have been companies which slipped into PN17 status and recovered and strive after regularization. One example is IRCB, now renamed Comfort Gloves. The other is RGTBHD. But there were very few of them. Most went into oblivion and de-listed forever and investors lost all their money.
Can LB recover? I really don’t know except making an educated guess. Never say never in life.
I hope this analysis answers the question asked by KerLee Tan above. It is what I think and please be reminded that I may be wrong, and I did get wrong before.
Read, understand and know how to interpret the balance sheet, besides the income and cash flows statement, is very important when deciding whether to invest in a stock. It will definitely help you to avoid investing in a lemon and lose big. Besides, balance sheet can also help you to find some quality companies with moat to invest in. I have done that before and hope I have time to write more about them to share in the near future.
There is no short cut to investing success. In order to avoid the pitfall of investing which happened to most people, and obtaining satisfactory return for building long term wealth, one has to learn and apply the language of business when investing in the stock market. It is by treating investing in a stock as investing in part of a business that one will have a higher probability of success.
If you are interested, and willing to spend some time and a small fee to learn in a structured manner and with personal guidance, please email me at,
ckci3invest.gmail.com
If you are interested in a copy of my eBook on personal finance and investing, you may email me too. This is free.

KC Chong

Appendix
Table 3: Asset distribution of London Biscuits
Assets
Amount
Percentage
Per share
Cash
8843
1%
0.04
Receivables
322476
38%
1.30
Inventories
20750
2%
0.08
PPE
451713
53%
1.83
Others
10903
1%
0.04
Investment in associates
31140
4%
0.13
Sum
845825
100%
3.42
Total liabilities
-464462
 
-1.88
Net assets
381363
 
1.54


https://klse.i3investor.com/blogs/kcchongnz/214995.jsp
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