Report Card: Cavalier doesn't pull the wool over eyes

Friday 8th June 2001

If New Zealand wants to claw its way back up the global wealth ladder, the country has to produce more value-added goods and services. Instead of selling wool, we should be marketing carpets, people say.

Cavalier Corporation is a living embodiment of that vision as a company that last year sold more than $200 million worth of carpets and wool scouring services.

Its annual report has a no-nonsense style typical of those in the primary sector. While it may be short on glossy photos and flowery language, it offers a commendable depth of detail and frankness.

Much of the front half of the report is devoted to the managing director's report. Alan James spends 12 pages on the dynamics of the company and the events of the previous 12 months. He takes pains to place events and numbers in context, even when that takes the shine off some of them.

For example, he says "over the past three years, we have grown volume in the carpet business by 40% and profit contribution by 90%." Many reports would have stopped there but he continues, "part of this volume growth is cyclical, reflecting the fact that the New Zealand and Australian markets have come from trough to peak over the period."

This three-year period has given Cavalier the image among investors as one of the share market's success stories. Net profits have risen from $10 million in 1998 to $13.1 million in 2000 and its share price from $1.86 to around $5.50 this year.

However, its own report again shows this performance in context. Its graphs and trend statements display figures from the past eight years, rather than the usual five. These show the company did no better in 2000 than it did in 1994 or 1995, and by some measurements actually worse.

Sales of $218.4 million last year are higher than they have been in five years, but lower than the $250.1 million recorded in 1995. Earnings before interest, tax, depreciation and amortisation (ebitda) of $24.9 million don't quite meet that year's $25.2 million. However, net profit last year was a record $13.1 million, although this is entirely caused by $1.4 million less being paid out on interest costs.

Financial ratios show a similar variance. The return on shareholders' funds of 16.7% last year is well above recent years, but not 1995's 17.3% and only a slight margin above the 15.2% recorded in the previous two years.

However, these figures are misleading in that the company's leverage has been shrinking over the years. The percentage of shareholders' funds to total funds has grown from 45.9% in 1994 to 63.1% in 2000. Net interest bearing debt to equity has shrunk from 46% to 28%.

On another measurement, earnings per share, it is doing nearly a full cent better at 36.4c from its 1995 glory year.

Even ratios that it does not show, like current liabilities to current assets, show a company in a strong financial position. That ratio is 1:4.7 when 1:1 is generally considered adequate.

The strong bottom-line performance last year disguises the weakness of one of Cavalier's core operations, wool scouring. Two graphs tell the story. One shows wool scouring makes up more than half the company's asset base but, in the other, indicates that it provided less than 10% of operating profits.

This has been addressed in a post-balance decision to sell these low-margin assets. Again, the company delivers plenty of detail about the decision and its impact in a full-page note to the accounts.

While the report shows a company that in eight years has delivered minimal growth, it also gives strong indications that Cavalier now knows how to crank up a gear and start adding even more value.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. Website: www.mcewen.co.nz, Email: davidm@mcewen.co.nz

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