Cash flow, and not cash, is king

  • Business
  • Saturday, 21 Mar 2015

IT was a joy listening to how seasoned businessman Tan Sri Francis Lau of the Leong Hup group talked about the poultry business. He rattled off the vital statistics of running the chicken business without a second thought, right down to the amount of feed per chicken per day.

He knew exactly the ideal size of a closed house to rear chicken, that each bird needed 110 grammes of feed per day, and the average life cycle, mortality rate and eggs to be produced. But beyond that, he pointed to an important cog in the machine that has kept his business empire, which spans across the Asean region, going.

It’s not the feedmills, the grain, the broilers or the people running the operations. It’s the cash flow. Doing business is all about cash flow, emphasises the man who is sitting pretty on a business empire that is easily worth some RM2.5bil.

What Lau is saying is hardly rocket science, but sometimes the reality of it tends to get lost in the good times and only hits us in bad times such as now.

The assets in the books, which include the cash a company holds, mean little if there is no strong generation of cash flow. What this means is the assets that a company has are illiquid, or even worse, the company has to borrow to even pay off its interest, or regularly undertake corporate exercises such as share placements or rights issues to raise funds to finance its capital expenditure works.

Such corporate exercises cannot go on. A time will come when the company has to monetise its assets or investors will lose faith in it.

Companies with such business models rarely command a premium from investors. In fact, more often than not, they are frowned upon.

The all-important element of cash flow and how it affects a business model cannot be made any clearer than looking at the current predicament being faced by 1Malaysia Development Bhd (1MDB). The state-owned strategic investment fund had assets to the tune of RM51.4bil in its books as at March 31, 2014.

Included in the assets are cash and bank balances of RM3.85bil and another RM12.89bil of investments that are deemed as “available-for-sale”. What this means is that the company is planning to sell assets to the amount of RM12.89bil, with the proceeds going towards beefing up its cash balance.

However, for all the assets it has and a huge cash pile that would have vaulted any other ordinary company to the top league, 1MDB has had to rely on a RM950mil standby credit facility from the Government – which it has drawn down substantially – to run its operations.

Last week, Second Finance Minister Datuk Seri Ahmad Husni Hanadzlah said in Parliament that some RM600mil had been utilised and that 1MDB would resolve its cash-flow problems by the year-end.

A standby credit facility is an amount of money that is made available to a borrower in case they need to utilise it. It’s quite common for companies to have a standby credit facility with financial institutions to help supplement their cash flow. This is especially the case for trading companies.

However, the cost can be high, depending on the credit standing of the company. A company with a poor credit standing incurs a high cost of having a standby facility, while banks offer good rates to companies with strong cash flows and large cash piles.

Another company that comes across as constantly searching for funds is Hibiscus Petroleum Bhd. It has raised close to RM500mil since its listing in July 2011 and has interests in a slew of oil and gas (O&G) fields, especially in Australia and Norway. Its total assets stood at RM545.19mil, including a cash pile of RM27.36mil, as at Dec 31, 2014.

However, the company, which started from scratch in the O&G industry, does not have any borrowings. It is now proposing to raise a further US$25mil via a placement exercise to fund its drilling works in the next one year.

The longer-term plan for Hibiscus is to have a producing O&G field, which would give it the cash flow needed to fund its exploration works. It hopes to have enough cash flow to fund up to three exploratory drilling wells, which is commendable for a junior O&G exploration company.

But the O&G business is capital-intensive and has seen only the big boys competing for a piece of the action in what used to be a lucrative industry. The industry is going through a slowdown, as oil prices have come down by half since June last year, hovering in the range of about US$55 per barrel for Brent crude.

Even until the end of last year, the O&G industry was seen as a sexy business and received a lot of attention. But now it is not the case.

So did the property and power plant businesses that were seen as core assets for 1MDB amid its bulging debt that had raised the red flag. Both these industries attracted a lot of attention and investments.

Companies such as the Leong Hup group which were involved in the less-sexy business of chicken and eggs, however, went largely unnoticed. Such companies expanded their business via cash flow from operations and some borrowings.

Leong Hup managed to get a private equity firm to take up a stake in it for close to RM500mil last month.

When there is a slowdown in the economy, it becomes quite apparent which businesses are formidable and hardy – the less-sexy ones of course.

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