Case Study on Eratat Lifestyle Limited

Overview

Eratat is one of the most established brands in casual footwear apparel in the People’s Republic of China (PRC). Eratat is mainly engaged in the design, manufacture and distribution of lifestyle fashion footwear, and the design and distribution of lifestyle fashion apparel under its well-established eponymous brand name, “ERATAT”. Its products are sold across China in specialty stores or shop-in-shops through its distributors.

In 2008, it sponsored the Beijing Olympics theme song. In the same year, Eratat debuted in the Singapore Exchange in April 2008 at $0.30.

Currently, the share price is down a whopping 70% to $0.09. Its historical PE ratio stands at 1.5 and the dividend yield is at 5.5%. So, is this company a value investment or a value trap? Before we can make a decent conclusion, we have to look at the financials.

Financials

Eratat released its second quarter of 2013 (2Q 2013) results on 5th August 2013.

For 2Q 2013, the revenue was down 11.4% to RMB202.9 million while the net profit was down 3.4% to RMB26.5 million as compared to the previous year. On the balance sheet, it added RMB100.8 million to its liabilities due to issuance of bonds. It has a cash balance of RMB502.0 million. There was a net cash of RMB43.5 million used in operations in 2Q 2013 as compared to net cash of RMB42.3 million used in operations in 2Q 2012.

Let’s take a look at its financials from 2005 to 2012 (most figures sourced from DBS Vickers):

Income Statement

It can be seen that the revenue has been increasing consistently from 2005 to 2012, albeit with some down years. The annual growth rate is at 34%. The net profit has been growing at a rate of 38.3%. The gross profit and net profit margins are decent at 31.4% and 13.7% respectively.

Balance Sheet

The balance sheet shows a growing cash balance. However, the trade receivables have been growing considerably since 2005 as well. The annual growth rate is at 52.7%. This is much higher than the revenue growth rate of 34%. This triggers a red flag.

The trade receivable turnover days from 2010 to 2012 were at 100, 139 and 129 respectively. This is rather high. This means that the company takes around 4 months to collect its trade receivables from its debtors. There is an easy chance for the debt to turn bad.

The ROE is respectable at 14.9%, with zero debt. However, do note that the company took on debt in 2Q 2013 as mentioned earlier. This triggers another red flag. Why did the company take on RMB100.8 million when it is already flushed with so much cash?

Let’s turn our eye to the cash flow statement. The company generated RMB 145.4 million in free cash flow in 2012. This was a huge increase as compared to the figure in 2011. By analysing the cash flow, it can be seen that the change was mainly due to “changes in working capital”.

Cash Flow

On a side note, for Financial Year 2012, the company declared dividends of 2.5 RMB fen. With the earnings per share at 29.81 RMB fen, the dividend payout ratio was a mere 8.4%. Even though the company had so much cash, the payout ratio was so low.

Valuations and Conclusion

The historical price-to-earnings ratio is at 1.5 and the dividend yield is at 5.5%. The price-to-book  ratio is at 0.21.

We saw that the company had issued bonds even when it was loaded with cash. The dividend payout ratio was very low as well. Even though the company trades at a mere 1.5 times its historical earnings, a potential investor has to look into the cash balance deeper and question the moves by Eratat, before putting his/her own hard-earned money into the company.

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Cheers!

Sudhan, Business Analyst

Mind Kinesis Value Investing Academy

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