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On the line – The Banks Group

Sunday, January 10th, 2010

Comment

Ram & McRae has identified and announced as one of the activities and initiatives for its 25th anniversary being observed this year, an award for the best Annual Report by any Guyanese company. The selection will be made by a panel of independent professionals from the business community, academia, the Guyana Bar Association, consumer representatives and the media.

In deference to the firm and in order to avoid any appearance of, or in any other way influencing that panel, Business Page and this feature will restrict its analysis of the annual financial statements and reports of public companies in Guyana to matters contained and disclosed in those reports and accounts. It will avoid identifying, as far as is consistent with a proper analysis of those reports, any defects or deficiencies, and will be less judgmental in its evaluation and interpretation of those documents. A consequence of this approach will be that the column will not be offering any public recommendations for addressing any perceived or actual deficiencies.

I hope that this does not detract from the interest which readers have shown in this feature over the years, which has on many occasions caused the column to be at odds with some of the companies.

Introduction
Today’s Business Page looks at the financial statements of the two operating companies of the Banks DIH group. The group comprises Banks DIH Limited (‘Banks’), the food and beverage giant, Citizens Bank Limited, a 51% owned retail bank and Caribanks Shipping Company Ltd, a dormant company. The financial statements of the group also include as an associate company B&B Farms Inc, a Guyana private company and BCL (Barbados) Limited in which Banks holds a 25% interest. The financial statements of the group do not treat as an associate Banks Holdings Limited, a company in which it owns 8.6% of its issued capital, has a director on its board and with which it had transactions valued at $150 million during 2009. On the other hand, Banks Holdings which owns 20% of Banks and which has two directors on the board of the Guyana company, treats Banks Guyana as an associate in its books.

Both the public companies in the group have as their accounting year-ends September 30 and will be holding their annual general meetings later this month – Citizens on January 19 and Banks four days later. The shareholdings in the two companies reflect an interesting contrast with Banks spreading 60% of its shareholdings among a vast network of private individuals, while in the case of Citizens, four shareholders own 82% of the shares with the remainder spread among about sixty smaller shareholders.

Banks will be presenting a regionally designed and produced high-quality, glossy report in which the Chairman and CEO waxes lyrical about the iconic role of the company in the landscape of Guyana. The report of the bank in contrast, is done with the standard cover in which only the year is different. One other issue of difference is the structure and contents of the reports of the two companies which have different governance structures, with Banks having an Executive Chairman, the American model, while Citizens has split the roles of Chairman and Chief Executive Officer, the European model.

Banks has eleven directors, five of whom overlap with the nine in Citizens. In both cases, all are male, even as this week’s Economist shows on its cover a blue-collar woman flexing her muscles and boasting “We did it!”


Source: Annual Report 2009

As the Chairman pointed out in his report, the net profit of the company passed the significant one billion dollar milestone for the first time in its history, with a 32% increase over 2008. Those profits were earned on increased turnover of 5% which would be slightly ahead of the official inflation rate for the country. Net operating costs rose by a smaller 2.1% compared with an increase of 4.9% in 2008 over 2007, but with staff costs increasing by just under 10%, about double the rate of inflation. Costs for key management increased by 13.07% while for other staff the increases averaged 10.69%.

A significant contributor to the better performance reported in this year, however, is a write-back of $474 million arising from a favourable settlement of an excise tax issue between the company and the Guyana Revenue Authority. In 2007 and 2008, the company made provisions of $183M and $291M for potential excise taxes and the published half-year report at March 31, 2009 showed a cumulative provision of $617M.

Reflective of that agreement, the Profit and Loss Account for the year shows a reduction in excise tax of $268 million over 2008 or an effective rate of 11.7% of sales compared with 15%. If the write-back, which is a non-recurring benefit, is excluded from the current year’s profit the net after-tax profit for the year would have been $813M. When compared to a profit for 2008 of $1,039M (adjusted for the excise tax provision made in that year), the company would have reflected a fall in profitability of 21.72%, despite the increase in sales.

Partly due to the write-back, all the profitability ratios show increases over the preceding year, but so too do the other ratios which are less, or not directly affected by the write-back, such as activity, liquidity and solvency ratios. Both current as well as long-term liabilities have declined while current assets have increased as have cash resources which increased by $481 million or 37% over 2008.

The average rate of tax charged in the accounts for the current year is 39%, a marginal decline over the previous year. Current year taxation has jumped from 34% in 2008 to 43% in 2009, with property, withholding and capital gains tax accounting for a smaller percentage this year (11%) than in 2008 (16%). High rates of taxes and the non-deductibility of Property Tax have been a major concern of this group and the manufacturing sector for decades, but such concerns have largely been ignored by the government and such groups as the National Competitiveness Strategy Council, in which the private sector has significant representation without any apparent comparable influence.

As a result of the attempt by a regional group to wrest control of the company and the company’s defence strategy, the company’s share price based on transactions reported by the Guyana Stock Exchange, has shown a high degree of volatility. During the year, the company’s share price fell from $10 to $9.50, or by 5%, and is now at its lowest point since September 2008.

Share price

Source: Guyana Stock Exchange

Citizens Bank Limited
It has not been a good year for the banking arm of the group. While Republic Bank and Demerara Bank with similar year-ends have been reporting record profits, and with the Guyana Bank for Trade and Industry likely to follow suit, Citizens has seen its profit decline during the year from $438 million to $391 million, or by 11%. Contributing to this decline is an impairment provision of $170 million for investments in Stanford International Bank and Clico Trinidad Limited, the region’s two financial catastrophes for 2009.

Because of the difference in the governance arrangements referred to above, Citizens presents both a Chairman’s and a CEO’s report, the latter offering details and insights on some operational issues of relevance not only to members, but to depositors and the wider public who see strength in a financial institution being reflected in numbers and profitability.

Interest income increased by 5% and other income by 31% while operating expenses increased by 11%. Net customers’ deposits had a small decrease during the year with increases in savings deposits of 24% and demand deposits of 11% while the usually high-value term deposits declined sharply by 32%.


Source: Annual Report 2009

Share price
In 337 sessions since the Guyana Stock Exchange began trading in 2003, shares in Citizens have only traded on 9 occasions, 4 of which were in the last year. Given so few trades the price at which shares would change hands in usually limited volumes is not an indicator of what other transactions may fetch. The records of the Stock Exchange show a trade in the shares in Citizens in December 2009 at a price of $45 up from $18 in June 2009.

Next week we will look at the increasing abuse of the Contingency Fund as part of the deteriorating financial management of the public purse.

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Revisiting Corporate Governance

Sunday, October 25th, 2009

Introduction
Even accountants can benefit from a periodic encounter with history and as this column revisits the never ending journey to arrive at the Nirvana of Corporate Governance, it is good that we recall a few facts. For example, that the modern quest for good CG began in the UK in 1992. And that the reasons for that search are at least as important as the initiators of the Cadbury Report – the Financial Reporting Council, the London Stock Exchange, and the accountancy profession.

The report came on the heels of the death of Robert Maxwell while cruising on the Canary Islands in 1990, which saw the spotlight coming down on his business empire. It soon emerged that like his modern day counterpart Bernie Madoff, he had been tampering with pension funds to service huge and expensive debt burdens. Like all Ponzi Schemes that one was doomed to failure and soon after, Maxwell’s companies filed for bankruptcy protection in the UK and US. At around the same time the Bank of Credit and Commerce International, at the time the 7th largest private bank in the world with assets of US$20 billion, went bust and lost billions of dollars for its depositors, shareholders and employees. Another company, Polly Peck, received a clean report from its auditors showing healthy profits one year only to declare bankruptcy the next.

Cadbury is sweet
The financial community and the accounting profession recognised that their reputation and that of London as a world financial centre was at stake. They had an interest to act – and so they did, initiating a report that by its very name – Financial Aspects of Corporate Governance – suggest this common interest. The name also confirms that the report was concerned only with the financial aspects of CG and it was left to others to take up the non-financial elements of corporate governance. That continuous effort has been taking place across the world from America to Africa and the most recent revision of the code on corporate governance is in South Africa with the King 3 Report on Corporate Governance.

Developments in Guyana have progressed far more slowly and some very fundamental issues remain to be addressed. We will deal briefly with these in today’s column, influenced by an event abroad which touches directly on an ongoing issue in Guyana – that of having the role of the chairman of the board and the company’s CEO being performed by the same person. But the search for an appropriate corporate governance model for Guyana is bigger and wider than this. There is no one-size-fits-all solution. The search has to be informed by and takes account of the social context and legal framework of the country.

One-man shows
Our very own constitution seems to feel that there is nothing wrong with combining a host of roles burdening us with an Executive President that chairs Cabinet but not accountable to the National Assembly or to the people other than by periodic elections. GECOM also has an entrenched Executive Chairman; while the private sector organisations have structures and chairpersons or presidents who for all practical purposes are also the CEO. To be fair, there is no hard evidence that splitting the functions automatically makes for a more successful company. As the Economist of October 17, 2009 reminds us, academics over the past two decades have produced more than 30 studies comparing the financial performance of companies that divide the two roles with those that combine them. Enron and WorldCom of which readers of this column are all too familiar both split the two jobs, and so too did the Royal Bank of Scotland and Northern Rock, which had to be bailed out in the 2008/2009 financial crisis in the UK.

Principle and pressure
The case for the splitting of the jobs which started with Cadbury is however based strongly on principle – some may even say theory – democracy, and widespread practice in Canada, Australia, much of continental Europe and Britain where 95% of companies in the FTSE 350 list have an outside chairman. The corresponding number among America’s Standard & Poor’s top 1,500 companies is 47%. Yet, the economic crisis that has hit and cost the US trillions has put the defenders of the joint role on the defensive. Earlier this year, shareholders forced Ken Lewis to surrender his second hat as chairman of Bank of America.

More recently, following on their success in persuading Sara Lee – the American global fast moving consumer goods company with one of the world’s best-loved and leading portfolios of food, beverage, household and body care products – to split the two jobs, the managers of (Norway’s) Norges Bank Investment Management which manages a state pension fund of $400 billion, are trying to persuade four American companies—Harris Corporation, Parker Hannifin, Cardinal Health Incorporated and Clorox—to do likewise. They may yet succeed.

Some companies are taking action rather than be pushed. One of the first things that some of America’s troubled banks, including Citigroup, Washington Mutual, Wachovia and Wells Fargo, did when the crisis hit was to separate the two jobs. It did not matter whether the losses they suffered could have been averted by separation or that their action may be purely cynical – something had to be done and the least cost option that offered up itself was the split.

A skit
Yet the theory or the logic cannot be dismissed and therefore bear repeating. It can well be demonstrated by a skit in which the chairman who instructs the company secretary on the contents of the Agenda, calls the meeting to order and soon calls on the CEO to present the report on operations for the preceding period. At that point the Chairman takes off one hat, puts on another and addressing fellow directors through the Chairman begins “Thank you, Mr. Chairman, …..”. Since the most informed and powerful person in the room is (also) the Chairman he then directs all the questions to himself. If the boss is chairing its meetings and setting its agenda, the board cannot discharge its basic duty under the Companies Act 1991, nor can it act as a safeguard against corruption or incompetence when the possible source of that corruption and incompetence is sitting at the head of the table.

Huge Personalities
There are only a handful of public companies in Guyana with a few of them having separated the functions of chairman and those of the CEO, mainly the commercial banks. Banks DIH, DDL, Stockfeeds and Guyana Stores have not, either because of history or in the case of the latter two because of the overwhelming stake the chairman and CEO has in the company. Messrs. Clifford Reis and Yesu Persaud are such huge personalities that it is hard to expect or imagine them other than as supremo, despite the potential dangers and obvious conflicts of interest. America has not ignored the problem and its boardrooms are now more democratic than they were when Jack Welch, described by Warren Buffett as the Tiger Woods of management, ran General Electric. To reduce the concentration of power and authority in one man (it is hardly ever a woman), more than 90% of S&P 500 companies have appointed “lead” or “presiding” directors to act as a counterweight to a combined chairman and chief executive. This person is invariably chosen from among the independent directors, referred to by Cadbury as Non-Executive Directors.

The problem for us is that there is no culture of independence and directors are more often than not selected rather than elected. If a vacancy arises on a board, the directors are empowered under the company’s rules and the law to fill it as a “casual” vacancy and on every case I know of, that person’s election is a formality at the next meeting of the shareholders.

And that selection is done under the majoritarian concept known in politics as winner takes all. In business once a shareholder controls the votes at the AGM, s/he has almost unfettered powers over the company, notwithstanding the minority protection mechanisms in the Companies Act. Better, or worse for the other shareholders, if the shareholder has 51%.

The independent director
Directors’ powers derive from section 59 of the Companies Act while their duties are set out under section 96 of the Act. This requires them to act honestly and in good faith with a view to the best interest of the company, including the interest of the employees in general as well as the shareholders. In a country where it appears that the President is unaware of the provisions of the Constitution, members of the National Assembly argue about basic procedures, and leading attorneys-at-law argue over whether a magistrate can hold a voir dire, it is not unlikely that the majority of directors may never read, let alone understand the Companies Act and the “fiduciary duty” the Act imposes on them.

Non-executive directors are mainly drawn from the shareholders’ other companies and the community to bring some particular expertise or even an element of acceptability to the company. Only the most sophisticated company encourages or tolerates real independence of its independent directors who are hardly ever known for engaging publicly in controversial issues.

The price of failure
Yet with a market for share trading that is far from transparent; a media that is generally not interested in or au fait with the jargon of investing; a consequently under-informed public and under-resourced regulators including in some cases professional bodies, the non-executive directors have an important duty and function to perform. Unfortunately conflicts of interest brought on by self-interest often mean that that function is not only not discharged but more seriously is often compromised. A most telling and very recent case of this compromising of the role and duty of the non-executive director involved a Chartered Accountant who one day after clearing key directors of a company of a complaint about financial impropriety, accepts a position on their board. That not only hurts the shareholders of the company but it undermines confidence in the company and loses further respect for the accounting profession.

There are of course other issues relating to corporate governance that will require attention. These include: their application to non-public companies and if so, how; whether or not corporate governance is better dealt with under principles or guidelines; whether the Companies Act and its administration will be improved by bringing into operation the Deeds Registry Act; the nature of sanctions given that they often hurt the small shareholders who are already victims; and whether there should be protection for whistle-blowers.

For us in Guyana, the dawn may have broken in 1992. We have made little progress since.

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On the Line: GBTI Half-year and Stockfeeds 2008

Sunday, August 23rd, 2009

Introduction
In today’s Business Page we look at two reports – one on full year 2008 of the Guyana Stockfeeds Inc, published under the Companies Act 1991, and the other the half-year report of the Guyana Bank for Trade and Industry (GBTI) published under the Securities Industry Act, 1998. Because of the significantly different nature of the operations and the nature of the financial information and period ends of the two entities, no useful comparisons can be drawn and the appearance of the two reports in the same column is entirely co-incidental. Indeed, if any comparison can be drawn it is the poor quality of the editing that goes into these reports, leaving major errors, sometimes in the financial statements themselves, at other times in the narrative reports and yet others in both. For GBTI some of these were pointed out in a guest column in these pages by Robert McRae CPA on the 2008 Annual Report of the bank.

Such errors are often attributed to difficulties with printers but neither the management nor the auditors can absolve themselves from their duty to members and the public to have annual reports and accounts that meet minimum quality standards.

Guyana Stockfeeds Inc.

Highlights

2009.08.23_table1

Despite what the Chairman referred to as “enormous challenges” the company recorded an increase in turnover of some 38% with sales of rice doubling while feed sales and hatchery sales increased by a more modest 29% and 21% respectively. As expected the Chairman was particularly pleased about the performance of the company’s brand of parboiled rice ‘Angel’ on the export Caricom market.

Of the net income for the year of $123M, after allowing for deferred taxation, the company proposes $60M in dividends or 49%. Dividends of $96M in respect of 2007, of which 50% is payable in additional shares, remain outstanding. The payment of dividends by the issue of shares was not effected as a result of a court matter with the National Industrial and Commercial Investment Limited.

How the company intends to fund the cash portion of dividends totalling over $100M is, however, not quite clear as the company’s liquidity position has deteriorated with the bank overdraft more than doubling to just under half a billion dollars and current liabilities other than dividends increasing over the 12-month period from $597M to $1,069M. Interestingly note 12 of the financial statements indicates that the company had exceeded its overdraft limit of $440M by more than $40M.

As is so common with public companies in Guyana, there is no mention in the annual report or the Chairman’s Report on the performance on the Stock Exchange of the company’s shares, although this may be entirely due to the fact that there is practically no trading in the company’s shares and that the company is developing into a family company with three of the top positions – CEO, corporate secretarial and finance – being held by members of the same family, which also holds some 69 million of the 80 million shares issued. This company is evidence of the permanent failure of the government’s privatisation policy, driven more by maximising short-term returns than long-term economic democracy. In all the government’s boast about macro-economic fundamentals, it does not appear to recognise that it has divested some highly profitable entities and has little to show for the proceeds. It is too late now for it to review the Privatisation Policy Paper issued under the presidency of Dr Cheddi Jagan, although it was under his presidency that we first saw the departure from policy under then Finance Minister Asgar Ally.

Accounting weaknesses
An observer of accounting and other disclosure requirements would find much of interest in terms of the contents of the Annual Report and the quality of the financial statements, even ignoring an obvious error of $400 million on the face of the balance sheet, which some may regard as the most important of the financial statements. These relate to the dating of the auditor’s report before the financial statements were even approved by the board, inconsistency in particulars about who the company recognises as key management personnel, disclosure about shareholdings, actuarial valuations and tax reconciliations.

That the company continues to pay US$50,000 management fees to a similarly named Trinidad and Tobago company for the payment of expenses on its behalf has continued to attract negative comments, since the logic and business purpose is not immediately apparent. On the other hand, the low effective tax rate suggests that the Revenue accepts the charge as reasonable having regard to the company’s business.

GBTI
In contrast to the financial statements discussed above, those of the GBTI are unaudited and cover the half-year only. In addition, there is no requirement for an Accountant’s Review or notes explaining the policies and judgmental matters relating to key financial statement items, and it is probably these limitations that explain the apparent lack of interest by the public and the business community in such half-yearly reports. Such statements should not be disregarded, since it must be assumed that they result from the accounting records prepared, subject to the limitations identified, in accordance with acceptable accounting standards.

Highlights

2009.08.23_table2

The bank’s performance for the half-year continues a run of excellent results not only for GBTI but indeed for all the commercial banks over the past three years. As the table above shows the bank has increased both deposits and loans, but with a barely discernible increase in the loan to deposit ratio. Our banks are performing so well that any observer of our banking sector would be bemused if told about a global financial crisis, although the anecdotal and empirical evidence is that the non-financial sector is having a lean time. We should therefore be anticipating with interest the publication of the 2009 mid-year report by the Minister of Finance which is unfortunately again late.

Net income before taxes has increased by a whopping 26% over the corresponding period in 2008, while the amount of $164.8M stated as Corporation Tax is the equivalent of 23% of net income. This represents a significant increase in corresponding equivalent percentage for 2008 when it was less than 9% and in the low teens for full-year 2008. This increase is so significant both for the corresponding period in 2008 as well as full year 2008 that we can only wait on the audited full year for some more evidence of such a dramatic swing over such a short period.

Tax policy
Robert McRae, CPA who did a guest column on the bank’s 2008 annual report had drawn attention to the bank’s effective tax rate and how little our economic managers seem to know or care about tax policy. A significant part of the problem is the VAT, a tax borne not by businesses but by consumers of goods and services. Guyana is stuck with a hugely miscalculated VAT rate that has masked any other concern that the government may have had about revenue collection.

In his column McRae had also raised the ire of the bank and the Bank of Guyana when he drew attention to a transaction between the bank and the Bank of Guyana, particularly in the context that the bank had for a second straight year had a significant deficit on its statutory reserve with the central bank.

The Bank of Guyana with unusual speed and generalisation reacted to the column but significantly has refused to answer some specific questions raised publicly by McRae. While commercial banks are, and indeed every person is, entitled to responsible financial reporting, they have a duty to respond to legitimate questions from the public on issues touching on their operations.

GBTI’s Chairman Stoby was noticeably pleased with the results and is upbeat about the bank’s performance for the second half of the year. Those results will certainly be eagerly awaited, but before then we will have some of the other banks including Republic Bank which has a September 30 year end. It will be an interesting period.

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On the line: Demerara Tobacco Company Limited Annual Report 2008

Sunday, June 21st, 2009

Introduction
The Annual General Meeting of the Demerara Tobacco Company Limited, the tobacco trading company was held on March 31, 2009 making it the first company with a calendar yearend to have presented its 2008 annual report to its shareholders. In fact its financial statements were signed off by the auditors within five weeks of the end of calendar year 2008, which is commendable, but with effectively one supplier and one customer the accounting workload is hardly demanding. The company saw sales increasing by 6.6% over 2007 and after tax profit increasing by 6.3%, an almost linear relationship. However, the rate of growth of sales has fallen over the past couple of years, when the increase in 2007 sales over 2006 was a more robust 16%.

Demtoco is a subsidiary of the British American Tobacco, plc of the United Kingdom, and its ultimate parent company is British American Tobacco plc, also a UK company. Several years ago the company closed down its manufacturing operations in Guyana and its products are distributed almost exclusively through Edward B. Beharry and Company Limited. The company’s operations are managed by a small team of a dozen persons headed by Chandradat Chintamani, an accountant by training.

Financial Highlights
20090621_table1

Despite its ever present concerns about smuggling, the company manages to produce gross returns on sales of 57% which is high by any standard, and its after-tax return on sales is an enviable 19%. The company enjoys a monopolistic position with none of the controls usually associated with monopolies, and it can and does increase prices at will. Because the company has very little in the way of assets and investments in this country its earnings per share of $39.67 represent 139% of its average net asset per share, or expressed another way, for every dollar of net asset the company has, it earns $1.39! And of the net assets of $510 million, a net amount of $136 million is lent to related parties! Compare that with a DDL, for example, where the earnings per share compared with average net asset per share for 2008 was 8.9% and for the Guyana Bank for Trade and Industry it was 21.0%.

New laws, old practices
Unlike earlier years the company no longer discloses its volume sales or changes in the level of volumes, which is probably due to the sensitivity of the tobacco industry to the serious health effects of the use of tobacco. Indeed just one week ago the indefatigable consumer rights advocate, Ms Eileen Cox, in her column drew attention to a public consultation on “Specification for the labelling of retail packages of tobacco products” hosted by the Guyana National Bureau of Standards (GNBS). According to Ms Cox a decision was expected on the new and improved Guyana standards for the packaging and labelling of tobacco products in Guyana.

Guyana is a signatory to the World Health Organisation Framework Convention on Tobacco Control, but as the Minister of Health admitted in 2005, while smoking has been an issue in Guyana “for years nothing has really been done about it.” The company’s stated marketing strategy is to meet the “preferences of adults.” It would have been good to believe that nicotine abuse is a juvenile problem.

Here are some statistics to prove otherwise.
• Tobacco use not only reduces life expectancy but also the quality of life
• The death rate is 2-3 times higher than among non-smokers
• It is estimated that it will cause 10 million deaths per year worldwide by 2020 (WHO website)
• 1.2 million deaths in Europe (The European Heart Network)
• 1.2 million deaths from smoking in Europe (The European Heart Network, 2000)
• 400,000 deaths annually in the US (Mayo Clinic)

What is worse is that as tobacco companies in the developed countries are faced with more stringent regulations at home, they focus their attention on the poorer developing countries, particularly in Africa. Strikingly noticeable is that many of those engaged in the production or distribution of alcohol and cigarettes – elsewhere as in Guyana – would not think of themselves using those products but see no inconsistency or irony in promoting their use by others. And while the industry faces restrictions on advertising the company still expended some $113 million on advertising in 2008.

To compensate for the restriction on advertising the company routinely carries out sales promotions for both retailers and consumers. The company’s marketing campaign is more subtle, and for it the Kick the Habit is in relation to energy conservation and the promotion of a low carbon economy, the newest bandwagon in town.

Returns
During the year the company paid three interim dividends totalling $22.27 per share and a special dividend of $15.00 per share. A final dividend of $15.85 dollars per share was approved by the shareholders at their March AGM bringing the total dividend per share to $53.12. The emphasis of a special dividend suggests, however, that this will not be a recurring feature. As usual the group gets more from the Guyana company than just its share of dividends, healthy (no pun intended) though these are and worth $873 million or 55% more than in 2007.

Management services, royalties and technical and advisory services have increased from $615 million to just over $700 million, an increase of 14%, more than double the increase in sales.

Share price
After an increase in the share price in the first half of 2008 the price actually reflected a small drop, but has been steady since August 2008. Despite this persons who see in the company’s performance only dollars and not the severe health risks would consider that they have done very well indeed.

20090621_table2

Source: The Guyana Association of Securities Companies and Intermediaries Inc., weekly trading reports

The government too would have been pleased with the amount of taxes collected with duty and excise taxes paid increasing from $1,608 million to $1,716 million or 6%, and corporation and property taxes of $960 million. The person who said that sin does not pay could clearly not have been referring to cigarettes and alcohol.

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On the Line: Demerara Distillers Limited Annual Report 2008

Sunday, June 14th, 2009

Introduction
In what Dr Yesu Persaud, Chairman of the beverage giant described as one of its most difficult and challenging years the group has experienced in recent times, the Demerara Distillers Limited (DDL) group reports a decline in pre-tax profit of 8.8% over 2007. For the parent company itself, the decline in pre-tax profit was 8.98% and is a measure of how significant its alcohol and soft drinks operations are to the group. In addition to the parent, the group comprises a mix of operating companies in Guyana, the Caribbean, Europe and India. It also has a 30% stake in BEV Enterprises Limited, 33.33% in National Rums of Jamaica Limited and 19.5% in Diamond Fire and General Insurance Company Limited. The parent company accounted for 73% of the group sales but 87% of profit after tax. Correspondingly, the subsidiaries accounted for 27% of revenue and together with the applicable share of profits of associated companies accounted for 13% of after tax profits.

The Chairman attributed the performance of the company and group to the problems facing the global economy and the impact on consumers “burdened by the Value-Added Tax introduced in 2007.” The directors of the company are however confident about the future and in June last year announced a $4.5Bn expansion programme extending into the first quarter of 2010, which has already caused a significant increase in the long-term debt of the company. In fact with the total debt for the company increasing during the year from $4.2Bn to $7.3Bn, its debt to equity ratio, a measure of a company’s ability to borrow and repay money, has jumped from 0.48:1 to 0.82:1. Capital expenditure in 2008 was $1.8Bn and much of the increased borrowings by the company went into financing a 17% build-up in inventory and a 75% increase in receivables. Such borrowings have come at a cost, and finance cost increased during the year from $490Mn to $561Mn. This equates to one out of every three dollars earned before interest and tax being used to pay interest. A further $56Mn of interest paid was not charged to the income statement but was capitalised as a cost of the related asset.

Falling returns
The further expansion in plant and machinery will of course lead to additional interest cost which has increased since 2002 when the Chairman announced a financial restructuring including a share issue to minimise financing cost. That has not materialized, and financing cost has continued to rise. In fact interest cover which measures the number of times interest is covered by profit before interest and tax is now 3, when at the time of the announced financial restructuring it was 5.6 times.

While the gross assets employed by the group have more than trebled in the past ten years, the return on those assets has fallen from 29.1% in 1999 to 9.4% in 2008 – the lowest it has ever been. Despite the decline in after-tax profits by 10.9% the directors are proposing to maintain a dividend of $0.40 per share, jarringly referred to as cents per share, which of course went out of existence in 1998. The total dividend payout for the year is approximately 39%.

‘What if’ reporting
An interesting and innovative inclusion in the Chairman’s report was what may be described as a ‘what if’ statement, in which the company suggested that had it not been for some global factors affecting fuel, net exchange loss movement and increase in provision for impairments the company’s profits would have been $903Mn higher, and that profit before tax would have been an implausible $2,585Mn, an increase of 14% on decreased sales of 10.38%. These are however real costs, and reflect the challenges which directors are expected to confront and mitigate.

The composition of the net exchange loss reflected in note 6 to the financial statements is itself interesting, as it is made up of Exchange losses of $488Mn and Exchange gain of $296Mn. This emphasises the inevitable risk of dealing in international currencies such as the euro and the pound sterling, which often move one way and then the other, the negative impact of which may be avoided by what is referred to as hedging.

Liquidity strains
The company and the group have also seen a substantial reduction in cash with the company’s cash resources reduced to $79Mn from $235Mn at the beginning of the year, and for the group from $298Mn to $107Mn. Current liabilities on the other hand, skyrocketed from $3.7Bn in 2007 to $6.7Bn in 2008, partly due to two major short-term loans taken as bridging finance for the capital expenditure in 2008. The position will abate in 2009 with the conversion of those loans into long-term facilities, but will continue to remain high with trade payables and bank overdraft exceeding $6Bn. Included also in Trade and other payables for the company is a huge amount of $2.242Bn, bringing total interest bearing borrowings to $8.354Bn. If this trend continues without compensating returns on investments, they will become a real drag on the company’s development.

One continuing concern about this company is the high level of its inventory and receivables. The company’s sales for the year declined by 11%, but its level of inventory which includes finished goods, raw materials and spares increased by 17%. And for the group the position was only slightly better. Revenue increased by 2.3%, but its inventory increased by 20%. Expressed another way, the company and the group have in stock at their written down value the equivalent of sales value of 14 months and 20 months respectively! Intuitively one would expect the company to have had a high level of inventory because of the aging of alcohol, but these numbers lead one to wonder seriously about the quality of the inventory held by the subsidiaries.

Sales too have come with hidden financing cost. While sales for the company show a decline of 10.4%, trade receivables went up by 46%, and for the subsidiaries the increase in sales of 67% was accompanied by an increase in their trade receivables by 34%. This latter position appears better than it really is because a major subsidiary – Distribution Services Limited – operates on a cash and carry basis.

Subsidiaries
The performance of the subsidiaries and associates was mixed, with Tropical Orchards Products Company Limited reporting after tax losses increasing from $6Mn to $50Mn. When the group announced a $500Mn investment in TOPCO in 2004 Business Page pointed out that based on a standard measure of investment appraisal such a level could not be justified. Regrettably that fear is being more than vindicated and since then TOPCO has returned a net loss to the group.

Another concern is the investment in India which continues to show losses, and it takes a certain level of faith to persist with this investment in the face of annual losses having to be carried by the rest of the group. China and South America with which the company flirted for a couple of years appear to have gone off the radar and already the company is learning what a difficult environment Jamaica is with its share of pre-tax profits in the Jamaican company declining from $56Mn in 2007 to less than $4Mn in 2008. On the other hand, bright spots are Demerara Shipping and Distribution Services locally, and the European, St Kitts and US operations.

Belatedly, the directors appear to have accepted that the purchase by the company of the controlling shares in Solutions 2000 was not a good investment after all. The company has lost its entire investment in annual losses and given the performance and outlook for Solutions, the company must consider itself lucky that it did not suffer a bigger capital loss. Interestingly it is only in the year of disposal that the company discloses that the controlling interest in the company was acquired from DDL directors Messrs Komal Samaroo and David Spence in 2000. The identity of the purchaser has not been disclosed.

Governance
One difficulty I have with some of the numbers presented for the subsidiaries is that all the subsidiaries are private companies subject to minimal statutory and governance obligations. In fact some of them operate in jurisdictions which do not require an audit and even locally the subsidiaries do not comply with the law requiring them to file annual returns and financial statements. It is unlawful and unacceptable that the local subsidiaries have not been filing their annual returns and financial statements, and the only financial statements seen in any of the files at the Deeds Registry are the annual reports of the group.

In preparing for the column I sent a note to fellow accountant Mr Loris Nathoo, General Manager, asking for the turnover and the names of the auditors of the subsidiaries. Since it relates to the subsidiaries of a public company this information should not be a matter of secrecy. However, the reply took the form of a letter from the company’s in-house attorney that did not respond to my request, but boasted of the “Company’s 2008 Report [being] incomparable to any other published accounts in Guyana and, indeed, in the region.” One has to wonder whether the writer is familiar with the annual reports of Neal and Massy or RBTT of Trinidad and Tobago or Grace Kennedy of Jamaica.

One might have expected awareness on the part of the directors that their note 22 on Segment reporting is not in compliance with paragraph 69 (a) of IAS 14, which requires that where a company chooses business segments as its primary reporting format it must disclose revenue by geographical location of the customers. That is where the risk lies and that is what segment reporting is designed to highlight.

One change in the financial statements is the inclusion of the insurance arm Diamond Fire and General Insurance Inc as an associated company in the results of the company. Dr Persaud claims that this change was based on the advice of the auditors and the Institute of Chartered Accountants of Guyana. Of course that does not reflect the fact that it was a ruling resulting from a formal complaint lodged by this columnist.

New Director
A related issue is that on the last day of 2008 the board appointed Mr Chandradat Chintamani, Chartered Accountant, as a director of the company. This appointment is considered coincidentally unfortunate since a committee of the ICAG headed by Mr Chintamani had very shortly before exonerated certain directors and the company’s auditors from my formal complaint that they had failed to account for a US$1.1Mn discount on a loan buyback from Hamilton Bank, which had gone into liquidation.

Conclusion
Apart from the announcement about the new investment the Chairman’s report is largely retrospective, and nothing is said about the outlook for the company and the group for the current year and beyond. Like with all the companies whose shares are traded on the local stock exchange, the company’s share price has remained steady, and with the recession in the developed economies appearing to have slowed, the group must be hopeful that it will return to growth in 2009.

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