Red Flag alert?

2nd Chance posted its 1Q FY2009 results quite recently. Revenue and profits up by double-digit figures despite Hari Raya being in 1Q FY2008, which seems hearty considering the current climate. All 3 segments of business posted increases in profits, with the securities segment paper loss of $10 million charged to equity after 2nd Chance declared the near-term intention not to sell or purchase equities, thus classifying it under financial assets for sale.

Management kept to their promise, declaring an interim dividend of 2.5 cents, which at the price I bought, equates to about a 15% interim dividend yield, sticking to the declared dividend payments at which I could look forward to a total 20% yield. Sounds good, the market says, with the counter trading volume going up and trading price rising 7-8% compounded during Thur and Fri trading, bucking the overall downtrend. This came rather surprising to me as companies normally run up some time before the declaration of the dividends, so the markets must take the results and the sustained dividend yield as a positive for the share price to run up so sharply.

Time to rejoice? Not yet. Let's take a quick look at the financials.

1) There has been an increase of appoximately $16 million in short-term borrowings that are due in less than a year, which are backed by mortgages and assigment of rental proceeds. Assuming that of course the borrowings will not be repayed through the mortgages, how much of the rental proceeds can cover the short-term borrowings of $43 million? Rental proceeds at this moment are still little less than $1 million. Seems that the cash from operations is still healthy at around $4 million, but this amount is insufficient to cover the short-term loans, even if this $4 million is a quarterly figure and that retail businesses tend to pick up towards the start and end of the calendar year due to seasonal effects.

2) The dividend declared for this FY was 3.5 cents. At the current float, this amounts to around $10 million attributable to shareholders. However, the net cash at bank of around $1.6 million is largely financed by the additional $16 million short-term borrowings. Is it possible to sustain this high dividend distributions to shareholders without constant loans?


Agreed, one might argue that hey, 2nd Chance's gearing is at ~0.5X right now. This is relatively low compared to its peers. But it sure tweaks a few eyebrows to know that the current dividends are being sustained by borrowings from banks, even if the likelihood of securing loans is very high due to its low gearing.

3) medium term outlook has detoriated due to the political instability in Malaysia. Management has candidly revealed that the plans to expand to 100 stores in the next 5 years will have to slow down. Nonetheless, market share might improve as 2nd Chance has the financial resources to weather this slowdown more than the smaller fragmented retailers who do not have differentiated positioning. Furthermore, the business cycles of 2nd Chance tend to overlap i.e. gold prices are might continue going up as it is viewed as a safe store of value in tough times, so its gold business might see improved profits, although revenue might be another issue.


Nonetheless, 2nd Chance's boss, Mr Salleh, has proved to be relatively astute in investing in downturns, and has a large percentage holding of 2nd Chance shares. Looking on the bright side too, 2nd Chance recently requested for the mandate of shareholders to approve share buybacks. At this time, seems that the management might be finding shares at current valuations very attractive. Maybe the management knows something that we don't. Still, would seek clarifications before deciding on my next course of action.

Pays to look at your company's statements from time to time, to keep track of the latest ongoings and whether certain red flags are appearing or not. Shall wait and see.

Will try to look at Olam's very soon and post some comments regarding their recent set of statements. Traded slightly down due to management's warning for tough times ahead, despite posting a relatively good set of results. Will try to see how much the market is pricing in for a drop in commodities prices and post my verdict from there.