Turnover has increased 10% since 2009 even if this is at the expense of a drop in the gross margin earned which has fallen from 35.0% to 32.7% which has resulted in only a marginal increase in the absolute value of gross profit. The decline in gross margin could be due to a changing sales mix or to a higher cost of sales for fair-trade clothing. In addition the price of clothing is largely dependent upon cotton prices which have been increasing rapidly in recent times. CVB has managed to control administrative expenses which have actually fallen. Sales and marketing costs have increased by 10%, which is in line with revenue.
The profit for the year margin has dropped from 3.2% to 1.8%. This is mainly as a result of the decrease in the gross margin but is also affected by the increase in finance costs and the losses generated by the associate. CVB has taken on short term borrowings and this has increased finance costs. The average rate of lending has also increased from 8.6% to 11.0%. This could be the result of the short term borrowings being more costly than the term loan or it could be that the short term borrowings were significantly higher during the year - which is potentially more concerning. Either way, the entity has low gearing and should look to secure more long term funding rather than relying on a short term facility.
The return on capital occupied has fallen from 6.7% to 6.0% due to falling returns and the revaluation and investment in PPE. The increase in PPE may not yet have generated returns, however the revaluation has improved total comprehensive income which otherwise would have been significantly lower than 2009. I don't think we should rule out this being a deliberate attempt to boost the TCI as on the face of it the business seems to be hitting a downturn.
Financial position
The main issue for CVB is management of working capital. Inventories days have increased from 118 to 168 days. Given that CVB operates in the retail sector, having inventories in stock for another 50 days is likely to be problematic and lead to obsolescence of out of trend items. If this movement was in isolation it could indicate that CVB were stock piling the new fair-trade items to meet expected future demand, however given that there are other signs of overtrading this is more likely to be an unfavourable movement.
The increase in payables indicates that CVB are using trade payables as a means of funding working capital. It is collecting receivable amounts at the same rate, which is what would be expected for an entity in the retail sector, but payables are being settled 43 days later than in 2009. This policy will not be well received by the market especially now that CVB is being supplied by fair-trade operators.
The current ratio, although reduced from 2009 is at 1.3, however the removal of the inventories highlights the cash crisis that CVB is facing. The quick ratio has droped to 0.5 and CVB must seek additional funding immediately.
The gearing of CVB indicates a comparatively low risk entity with gearing of 26.7%, however the fall in the interest cover from 4.0 to 2.5 would be a concern for any lender. CVB is potentially paying more for the short-term borrowings and there is the added risk that these amounts are likely to be repayable on demand. It would be essential for the entity to secure long-term finance to ensure it can trade for the foreseeable future. If higher returns were expected from trading activities this would help the interest cover. In addition, possibly selling the associate investment could generate some cash, although this may not be lucrative given it is currently loss-making.
Position in the market
Based on the latest share price, the P/E ratio of CVB is 5.4, a slight reduction from the P/E of twelve months ago which was 5.7. The share price has fallen by 40% over the same period which indicates that the stock market has reacted to the decline in profitability, resulting in overall stability in the P/E.
Recommendation
Based on the financial information presented I would recommend not investing until further investigation is conducted. The business has a cash and working capital crisis which the directors must commit to resolving immediately to ensure the business can continue as a going concern.
(b) Further financial information that may be useful
The monetary statements used in the analysis are already out of date as the year end was 9 months ago. Therefore it will be important to obtain and consider any information that CVB has published since then, such as quarterly reviews, half year accounts, profit warnings etc.
Details of the held for sale assets and details of the items being sold to determine if this is the result of a change in trading focus or an attempt to raise cash.
The details of the long-term financing and the state of relationships with current lenders may help assess the likelihood of securing additional funding in a short timescale.
Details of the dividend policy and history of dividend payout to assess future expected returns.
Details of the associate company to establish if the associate has had a one-off expense creating a loss or is in a downturn and likely to continue loss-making.
The forecasts for future trading would help assess the directors' expectations for the forthcoming period and for the fair-trade business