Exceptionals swelling corporate bottomlines...
...when recurrent earnings only matter
By Mano Sabnani, Business and Financial Consultant
First published in TODAY
15-16 Feb 2003

The 2002 corporate results season is in full swing and prudent investors are, naturally, seeking to stay on top of the the news. Each market day, a slew of companies emerge with their preliminary statements on performance in the past year. Investors and analysts scramble to see if the companies concerned have lived up to their expectations.

Of paramount interest are recurrent earnings and the outlook for the current year.

Some years ago, one of the problems in the statements of results was the tendency for listed companies to hide exceptional or extraordinary losses.

These involved write downs of properties and other assets, foreign exchange losses and
other one-off negative events. Accounting practice did not require them to include these items above the bottomline in the profit and loss accounts, and most did not do so.

So, while a company may have achieved improved recurrent earnings over the previous year, its balance sheet could have been severely deflated by a large, say, foreign exchange loss. But this item was usually only included as a foot note in the preliminary unaudited accounts and, at times, featured only in the final, audited accounts released much later. Journalists and analysts would sometimes highlight these "hidden" items, for the benefit of investors.

This went on for some time until revised accounting standards were introduced where exceptional items had to be featured above the bottom line i.e. before the company arrived at its PATMI or Profit After Tax and Minority Interests. But there are problems in this approach, too. At times, the effect has been to confuse investors as to the actual, sustainable performance of the company.

Take some of the corporate financial results released in the past fortnight. It has not been easy, without the input of research analysts, to assess the core performance of companies such as Keppel Corporation, the CapitaLand group (including Raffles Holdings and the Ascott Group), Huan Hsin and Nera Telecoms. Why?

Because each of these companies have had exceptional items included in their consolidated PATMI, either in the past year or the year before. That makes their
results for the two years not strictly comparable but in the form presented, investors could easily be misled into concluding that the companies did better than they actually did or worse than the actually did. Mind you, the companies are not solely responsible for the misconceptions, as media reports also play a part. The companies could also argue that they are merely following accounting guidelines.

Basically, in the case of Keppel, its core, recurrent performance for 2002 was actually better than the PATMI numbers suggested, as the previous year had included huge one-time gains from the sale of Keppel Bank to OCBC. This time around, the marine diviision had done very well but not enough to boost the group PATMI (inclusive of exceptionals) to the level of the previous year. So, on the face of it, it appeared the Keppel goup profits had actually dropped from 2001 levels.

Likewise, in the case of Raffles Holdings and the Ascott Goup, both listed entities and major players in the hotel and service apartment businesses respectively. Raffles sold a major part of its flagship Raffles City complex in the previous year while Ascott has been busy divesting its shopping centres. Both have reinvested some of the proceeds in their core businesses. But the exceptional gains arising from their massive asset disposals have had the effect of distorting PATMI and earnings per share as reported.

Ultimately, investors who bother can get to the core, sustainable earnings and do their comparisons. But many walk away with wrong impressions of the companies, not helped by reports in the financial press which suggest steep rises or falls in earnings, without factoring out the exceptional items.

Take for example the report yesterday (friday 14th Feb) on mainboard-listed Huan Hsin Holdings. The group's plastics segment did very well, pushing overall sales up by 50 per cent to $171 million. However PATMI was flat at $21.6 million because the previous year's results included exceptional foreign exchange and tax rebates amounting to $7.2 million. These "bonuses" were not available this year; hence the distorted picture that Huan Hsin's profit margins were under pressure.

Another example is Nera Telecoms. It reported yesterday a 58.5 per cent jump in net profit to $21.5 million for its full year to Devember 2002.even though turnover dropped 27.4 per cent to $166.6 million. Closer scrutiny however shows that its bottomline or PATMI was swelled by a one-off $15.3 million gain from the sale of a part of its electronics subsidiary, in connection with the listing of that company, Nera Electronics.

What investors would be interested in, is the recurrent earnings capability of each of these companies, and that means focus should be on Profit After Tax and Minority Interests but BEFORE Exceptional Items. The revised accounting standards advocate that PATMI be presented both before and after exceptionals, for clarity.

SembCorp Industries appears to be moving in the right direction, with its results out last week. It clearly explained that PATMI before exceptional items grew 12.6 per cent from $149.4 milion in 2001 to $168.3 million in 2002. The improvements came mainly from four of the key businesses, namely Utilities, Marine, Logistics and Environmental Engineering.

On the other hand, there were big exceptional items arising from the sale of Singapore Computer Systems and Singapore Food Industries and one-time write-offs and provisions arising from land reclamation and sewerage projects undertaken by its engineering and construction arm. PATMI, including exceptionals, grew 15.5 per cent over 2001 to $200.9 million.

But this PATMI after exceptionals is clearly not as important as PATMI before exceptionals for anyone trying to assess Sembcorp's real earnings in the past year and the group's potential for growth in the future. The signal from Sembcorp is actually a good one. It suggests that the core businesses are doing well and that even Engineering and Construction will be turning around this year. The exceptionals were necessary but they are history and will not recur.

But even Sembcorp is guilty of highlighting the less important figures. Group Corporate Relations chose to highlight that PATMI had grown 16 per cent to $201 million and that ROE or return on equity was 16 per cent, above the threshold of 12 per cent. But this is a one-off bottomline profit and as Sembawang has forecast flat profit performance for the current year, does it mean the group is looking to achieve only $168.3 million in 2003? In any case, when the time arrives to release 2003 results next year, it is likely that the group will take pains to point out that this year's PATMI was after including exceptional gains from the sale of SFI and SCS shares.

The sceptics will point out that it was Sembcorp's parent, Singapore Technologies, that helped in enabling Sembcorp to report a net exceptional gain for 2002. It was the main buyer of the SFI shares, for example. Perhaps it could come to the aid of its offspring again in the current year.