Not all earnings growth are created equal. In itself, earnings growth can be either accretive or dilutive to value.
Achieving earnings growth is actually quite simple once you have a viable business model. As long as your return on capital is greater than your cost of capital, you can simply deploy more capital and earnings growth will ensue. This is particularly pertinent in a low rates environment. However, while your earnings trajectory is definitely upwards, the underlying quality of your earnings may in fact be deteriorating as your return on capital start to decline.
This appears to be the challenge facing Silver Chef after 10 years of phenomenal growth as a listed company.
Over the past 5 years, Silver Chef has consistently grown its headline earnings while maintaining its Return on Equity at around 20% – on the surface a very attractive investment:
However, its Return on Capital Employed is actually in steady decline:
So how has Silver Chef been able to maintain Return on Equity at c.20%? Through leverage of course:
Turning our attention to cashflow, Silver Chef has historically been cashflow negative due to its rapid growth which necessitates an accompanying expansion in its asset base. It has undertaken frequent capital raisings as a result.
The fact that Silver Chef requires capital to grow is not a bad thing in itself. However let’s look at the effectiveness of each incremental dollar of capital deployed:
And then let’s take a look at the operating cashflow generated as a percentage of rental equipment deployed:
Silver Chef is evidently a different business today to what it was between FY2012 and FY2014, despite superficially similar levels of earnings growth and returns on equity.
So what’s really going on underneath the polish?
A tale of two moats (or not)
Silver Chef’s hospitality business is a fantastic niche financing business offering a compelling value proposition for its customers while at the same time being extremely profitable for itself. This is where you want to be as a business.
At the core, Silver Chef is a lender that obtains funding from the markets (i.e. debt and equity) and lends it out to SMEs with the financed equipment as collateral.
The key here is that due to its narrow and deep niche focus in the hospitality sector, it has an extremely well-honed refurb and resell operation to deal with hospitality equipment returned by customers:
Consequently, the same collateral is worth a lot more in Silver Chef’s hands than it is in the hands of a non-specialised financier. This competitive advantage is the foundation of Silver Chef’s moat in the hospitality equipment financing sector.
However, its GoGetta business, which has sought to transpose the successful Silver Chef model to cater for commercial equipment financing generally (i.e. anything that is not hospitality, with a focus on the construction and transport verticals in recent years), is a completely different beast altogether being a relatively small player in a much larger market with no such competitive advantage:
Their respective Return on Assets tell completely different stories – with Return on Assets for GoGetta having essentially halved over the past 4 years:
Note that the numerators used in the chart above are exclusive of (1) group overhead costs (totalling $21.6m in FY2016); and (2) the $8.6m “free kick” from a change in accounting policy during FY2016 (detailed below, mostly relating to GoGetta). Once taken into account, the downward trend line between FY2015 and FY2016 would be significantly steeper.
The problem for Silver Chef investors is that GoGetta is growing much faster than its core hospitality business. As at the end of FY2016, GoGetta has grown to comprise roughly 50% of Silver Chef’s overall asset base:
Silver Chef’s management team are obviously aware of the problems within GoGetta and have undertook to “revert to a more sustainable growth rate”.
Pulling the accounting policy lever
Origination costs (i.e. dealer commissions) have spiked materially over the past year:
The “accounting policy change” lever was then pulled by the company.
Beginning in FY2016, Silver Chef modified its accounting policy from fully expensing its origination costs to capitalising it over the 12 months of a typical contract. The FY2016 impact of this change is as follows:
So Silver Chef effectively deferred $12.3m of its origination costs to the next year, getting a “free-kick” to its P&L that will persist indefinitely as long as Silver Chef keeps growing. To be fair, capitalisation of origination expenses is not wrong and is sometimes more sensible, but the issue is how Silver Chef has presented this to investors:
What Silver Chef is effectively saying here is that had the new cost deferral policy been in place all along, then Silver Chef’s FY2016 NPAT would be reduced by $3.7m (representing FY2015 origination costs that would have been amortised during FY2016).
However, the truth is that the cost deferral policy had not been in place all along. Simply, had the cost deferral policy change not taken place at all, Silver Chef’s FY2016 NPAT would have been reduced by $8.6m.
So despite Revenue and rental assets having increased by 29% and 53% respectively on a like-for-like basis, Silver Chef’s NPAT actually went backwards on a like-for-like basis.
Silver Chef’s recent trading update
And it is in this context we should view the November 2016 trading update where Silver Chef downgraded its earnings guidance due to a “material fraud event” with an estimated impact of $2.3m to Silver Chef’s FY2017 NPAT.
We should note that even exclusive of the “material fraud event”, Silver Chef is forecasting an underlying NPAT range for 1H FY2017 that is materially lower than the previous year, despite having presumably significantly more rental assets at work on its balance sheet:
And here are my issues with categorising the fraud event as a “one-off”. Firstly, is this indeed a single “event” given it has been described as “complex” and “across a number of low dollar value contracts“?
Secondly, if you’ve been the beneficiary of extraordinary loan book growth achieved on the basis that you “look for reasons to say ‘yes’!” and your customer proposition is that you are “more accommodating than other lenders” as follows:
Then shouldn’t risk management around fraud events be one of your core competencies as a lender?
Should this fraud event then be viewed less as an extraordinary event to be “normalised” out of our analysis, but more as a potential canary in the GoGetta mine to factor into our analysis?
Note: The above blog post constitutes the author’s personal views only and is not to be construed as investment advice in any shape or form. Being obviously passionate about the art of investing, the author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this blog post. Disclosure – I hold a short position in SIV at the time of publishing this article.
just under 56k shares shorted yesterday… pretty filthy to short the stock the day previous to releasing an article. looks like you traded through UBS.
Anthony Wilson
I’m actually flattered and humbled that you believe my obscure little blog can move the market. I don’t usually comment on my individual positions, but I will make an exception just this one time since you’re throwing around unfounded and false accusations. But NO IT WAS NOT ME. If you want to challenge my analysis and research I very much welcome a contrary view (I can DEFINITELY be wrong), that is what this blog is for, not personal attacks on people’s motives.
sorry – look like you traded through BTIG … my bad.
Great article. However, I do think that they are entitled to call a material fraud a one off event. The point you are making is really more to do with the quality of Go Getta’s earnings.
Thanks James. It just seems to me though as a lender, you should have to bear any losses if the risks, which you are being paid an interest margin to assume, eventuates.
Some talk going around this afternoon about the short interest that has appeared in this stock yesterday, the day prior to you publishing this article. It’s only because it is such an illiquid name that the transaction stands out so much. You admit to having a short interest in SIV, did you short close to 56k shares yesterday? The timing is amazing/suspicions
NO.
Hi Anthony and Mary
If the writer has backed his thesis by shorting with his own money, good for him. If the analysis is weak, or proves wrong, he’ll do his dough. If the analysis is right, he deserves it.
Either way, it makes for a much more interesting market.
Regards.
James
Seems like the critics of the post want to persecute a market participant who holds an interest in a stock and a view to back it up…exactly what these same critics do via their brokerage house “research” product (aka conflicted, outcome biased marketing spam) investor blogs/newsletters or on forums like livewiremarkets.com
Take Anthony Wilson for example, presumably the same Anthony Wilson from Wilson HTM (source: LNKD), who may have failed to make a few legally required disclosures in his post given he works for an AFSL licensed firm (if it is the same Willo that is):
1. Wilson HTM has earned a huge amount of fees for raising Silver Chef equity capital in recent years, including the $7.5m placement in September 2016, $30m entitlement offer in May 2016, $5.5m placement in October 2015 and $9m placement in March 2015 just to cover the last two years
2. Wilson HTM managed a fund which earned fees for investing in Silver Chef and was incentivised by the stocks performance
3. Wilson HTM currently has a “research” (marketing) Buy rating on Silver Chef
4. Which is intriguing given Wilson HTM has year to date purchased $9.2m worth of Silver Chef stock but sold $14.2m worth (source: Bloomberg). One assumes that Mr Wilson has been involved in secondary market transactions in this stock that have earned brokerage fees for Wilson HTM
So really there are three key differences between the blog post and the responses; firstly, the author is betting on a stock to decline, secondly he has made the appropriate disclosures and finally he actually possesses an ability to analyse a company and its financials objectively.
Of course if he was pushing a buy to his readers and long the stock then this would evoke a completely different response.
Best of luck.
WW
Disclosure: I have no position in this company but it looks pretty shit.
Happy not to hide behind Initials or acronyms Willy Wonker. FYI, they changed our name to Wilsons, am sure it cost a pretty penny to drop the HTM. However, now I can refer to myself as WoW (Wilson of Wilsons) rather than WoWHTM (which doesn’t roll well off the tongue or have the same pun punch line).
When accusing someone of shorting prior to releasing a bearish article I’m not legally required to do anything, I did not push a buy or sell, rather a personal accusation. New short positions in illiquid stocks stand out, clearly I’m not the only one who noticed. I appreciate the honesty in the response, and I like the article. The fact that Mr Moat actually responded is great, I’ll take the answer at face value and apologise, Sorry. GoGetta isn’t of the same quality as the original business, facts are facts, cant dispute it, I think that is well known.
Great to chat, this is what makes a market more enjoyable.
WoW
Appreciated Anthony. I would think I am not the only one out there with a negative view on SIV especially in context of the earnings downgrade 2 weeks ago. However, my view is not the only view and I would be more than happy to place any links to articles with a contrary view here so people can make their own informed decisions.
Your article about Silver Chef is an alarm to me. Thank you.
I also want to bring up and share several other issues that seem very alarming to me.
In its annual report, it says the working capital in FY16 deteriorates slightly due to GoGetta’s increasing amounts of arrears.
I find the word “slightly” is slightly inappropriate because this is the first time SIV’s balance sheet is not negative geared since IPO. GoGetta consumes too much capital. The faster it grows, the bigger capital it eats in the balance sheet.
What also bothers me is that Mr. English who I and maybe plenty of other shareholders put a lot of faith in has now stepped down. His return in 2014 Feb was to turn the GoGetta business. Though his past 2 years tenure did grow GoGetta significantly, the core problems (like what you said in your article: halved Return on Capital Employed) remain unsolved. If the mighty founder English cannot solve it, who can?
But what makes me wonder is that this is not the first or second year SIV’s been doing business with truckies under the GoGetta solutions anyway, why during the previous at least 7 years (from 2007-2013) everything looks okay and now in 2014 things started to turn sour…It doesn’t make sense… Unless they start pitching different varieties of truckies…
The third thing I don’t like is the LTI plan. EPS growth is definitely inappropriate for a credit fueled company like SIV, although the committee does has some sense to get a cap on it. ROE is better.
The last small thing might look like a bit conspiracy imagination to others but I have to say I don’t like the fraud announcement releasing timing. Why not releasing it earlier, say, before AGM so that minority shareholders, retail smug like me could get a chance to ask…Now my Allan English stepped down and happily continues to fight against poverty, leaving me fighting disappiontment after stupidly believing my analysis was sound and faithfully holding it 15 months…
To be fair, SIV still has a good and honest track record plus its Hospitality niche core business growing strong both in domestic and abroad.
But before the balance sheet is restored to the glory shape and there is sign showing Mr Damien’s attitude to GoGetta is no longer about grow grow grow, I will stay away and watch closely.
Anyway, I need to say thank you again about your article. It makes me think again.
Regards,
medici
Thank you Medici, I’m glad you found my article helpful in supplementing your own analysis of SIV. And thank you for sharing these additional insights (I’ve not been close to the company myself and have never attended an AGM so it’s all news to me). So what’s changed for GoGetta over the past 2 years? Well if you look at the very material spike in origination costs and the accompanying acceleration in loan origination, it would appear that there had been a significant reconfiguration of GoGetta’s sales channels.
Very interesting and concise analysis.
It can perhaps be developed further by valuing the hospitality business on a standalone basis?
GoGetta can surely be scrapped with limited restructuring costs…
“fraud event as a “one-off”. I can tell you it was not a once off event, in fact this company has been plagued with fraudulent deals for many many years both in the Silver Chef space and GoGetta and the concerns of these types of deals have been raised with the powers that be for many many years and have simply been ignored. It was only the opening of the flood gates when they introduced “light commercial” and were approving anything with a heartbeat did the problem grow so large that they could no longer sweep it under the rug. Even the “once off” event could have been dramatically reduced as the issue was raised when it was only a couple of deals across the line…..but again as the business has a “Sales” culture risk is simply ignored.