PBT: Big data, bigger accounting adjustments

The word “trading statement” is typically the intro line to a horror movie on the JSE at the moment.

Companies need to release a trading statement when they have reasonable certainty that the results for the upcoming reporting period will differ by at least 20% (up or down) from the prior period. Think of it as either an early celebration or an early warning system for shareholders.

Trading statements aren’t common things, as most successful companies only grow earnings by 10% – 15% every year. At the moment of course, it’s anything but business as usual. Awful trading statements are practically a daily occurrence, but today we had two beacons of hope in the telecoms and technology industries.

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One was Blue Label Telecoms, whose expected growth in earnings this year is mainly a function of how awful their performance was last year. After taking huge impairments on investments in Cell C and Oxigen India, it would’ve been hard to do worse even under Covid-19 realities.

The other trading statement was far more interesting, issued by a company you’ve never heard of called PBT Group. PBT in financial circles usually stands for “Profit Before Tax” which is an apt coincidence for this company.

A small cap with heart

PBT expects earnings to be around 60% – 75% (in round numbers) higher than last year. That’s remarkable.

With a market cap of R190m, it’s certainly not the biggest company around. Like so many other so-called small caps (shorthand for small market capitalisation), PBT suffers from two things:

  • A zig-zagging share price chart with several days at a time of little or no trade in the share
  • A stubbornly low P/E ratio

Part of the problem for small caps is lack of liquidity in the share. Small caps don’t have the levels of trade seen in larger companies, which can scare away institutional investors and impact the valuation negatively. Unsurprisingly, there are no big-name asset managers on the shareholder register of PBT.

However, there is more liquidity than I expected, with directors only holding 21% of the shares. So, if you want a slice of the pie, you should be able to get it at least within a couple of days of making the decision.

What does the pie do?

Like many other pies, some of the filling is tasty and some of the crust is burnt.

Data analytics, artificial intelligence, data governance, business intelligence, application development…the list goes on. All the buzzwords are there. This is a business for tomorrow, not a leftover from yesterday.

It’s not just a South African shop, either. PBT has made a habit of following its clients offshore and expanding into interesting countries, with operations in Australia, Ireland and the Netherlands as well.

Unless you’ve been living under a rock and missed Tito’s hippopotamus speech about how broken South Africa is, you’ll recognize this as a decent opportunity. It’s important to note that PBT hasn’t always fared well overseas, disposing of its Middle-East operations recently.

PBT Group generated R590m revenue for the year ended March 2019, 81% of which is home-grown in South Africa. In that year, the Group made just over R33m profit after tax from continuing operations, a reasonably healthy 5.6% net profit margin.

The 2018 result may scare you though, as PBT lost R139m thanks to a R127m impairment of the group, which is basically a complicated accounting write-down of “goodwill” based on original expectations of performance vs. reality. A similar amount was received in cash though, so it was really an accounting anomaly linked to group restructuring and certain disposals.

Nobody said accounting was easy.

Follow the cash

The R51m profit before tax for 2019 only translated to R36m pre-tax cash flow from operations, due to a number of accounting adjustments being included in profits.

The problem with accounting is that it is insanely complicated in its quest to be simple and understandable to shareholders. Looking at operating cash flow each year is the safest and simplest way to assess profitability, especially when a company is restructuring and disposing of assets.

Post-tax cash from operations was R26.6m, a number you’ll find on the Statement of Cash Flows, which is 4.5% of revenue. This operating cash flow margin is well worth calculating whenever you think about investing in a company, because it gives you a real sense of the quality of earnings and the management of working capital in the group. Remember, you need to compare companies in similar industries and look at the trend over time.

Other points worth noting

PBT’s financial and strategic disclosures aren’t as detailed as one might like, which is typical of small companies. The interim results released in November make a comment around “high correlation between the Group’s earnings and cash flow conversion” and then proceed to give no details of cash flow numbers at all, which is annoying. The joys of looking at AltX-listed companies instead of JSE Main Board.

There was also iffy press in recent years over governance issues, specifically company resolutions for share repurchases. That’s not great.

The group has implemented a self-funded B-BBEE transaction i.e. they funded their B-BBEE partners into the deal vs. guaranteeing debt from a bank. That’s a vastly superior structure to the ones put in place by many companies 10 – 15 years ago, which inevitably only make money for the bank (like the horrific City Lodge deal that has now matured at the worst possible time).

Keep an eye out for the detailed results

PBT certainly isn’t a JSE blockbuster, which is why you haven’t heard of it before. It seems to have walked a complicated road to get to this stage, with operations in various countries and corporate restructures.

Cutting through all the noise suggests that this is a profitable company playing in a fascinating industry. I will look out for the full results that give details on the expected jump in earnings, because my worry is that it might be a function of accounting rules rather than true cash flow.

If the cash is there though, then it’s a terrific result in difficult times and points to a brighter future for the group. The share price jumped 4.5% today, suggesting that the market is ready to believe in that future.

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