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Bio assets: to sell or to hold?

By Ranganayi Makwata



“EVERYTHING is permissible — but not everything is beneficial’’.


Apostle Paul wrote these words in

one of his two letters to Corinth, addressing the issue of a Christian’s freedom on what, or what not, to eat.


Should a person do what he likes as long as he can prove that it is not illegal within the borders of his society?


While in day to day life, many will be quick to say yes; in business, the response may be different. Moreso if the company in question is public.


Last week we queried the wisdom behind reporting inflation adjusted accounts only, which is, by the way permitted by the Zimbabwe Stock Exchange and is in conformity with International Accounting Standard (IAS) 29.


Another trend becoming increasingly prevalent is that of booking huge revaluation gains on biological assets.


Listed agro-processing companies are the major disciples of this practice. This is permissible under IAS 41, they can argue.


The standard requires that a change in fair value less estimated point-of-sale costs of biological assets be included in the income statement for the period.


The argument here is that a change in physical attributes of an animal or plant directly enhances, or diminishes, economic benefits to the entity.


What is interesting is that this standard is not new although it has seen much use since the fortunes of the country reversed. The increased reliance on it by the agro-industrial companies at a time when revenues are declining is expected, though disturbing.


Revaluation gains boost their earnings. Period! However, whereas some revalue the biological assets sparingly, others are going for broke.


For instance, Ariston, which made an operating profit of $140 billion, before accounting for $215 billion finance costs, went on to record a before tax profit of $629 billion.


Without a fair value adjustment of $704 billion, Ariston could have ‘easily’ made a loss of $75 billion for the year ended September 25 2007. In fact the fair value adjustment was more than the turnover of $517 billion for the period. So in effect Ariston need not to have sold anything but just revalued the cattle, chicken, flowers and fruits, etc and would still have achieved analyst-forecast-beating profits. In this case any sales reduce potential revaluations.


Undoubtedly, booking huge revaluation gains — in some instances higher than operating profit while in extreme cases above revenues — blemishes the financial statements.


In valuing a transaction a conservative approach is recommended, in keeping with the accounting concept of prudence.


Essentially, the concept says that whenever there are alternative procedures or values, the accountant will choose the one that results in a lower profit, a lower asset value and a higher liability value.


Hence, undue optimism, as exhibited in financial statements of some local companies, can never be part of the quality for an accountant! Conservative investors view huge revaluation gains as some form of ‘earnings creation’. This route is often resorted to whenever the company is not generating enough profits from operations.


Analysts and investors alike always try to forecast a company’s earnings and trade on shares on the basis of these forecasts.


An unfavorable deviation of earnings from expectation is normally punished with a ‘downgrade’ on the price. As a result, companies are always hard pressed to ensure their earnings at least meet, or better still, surpass expectations, to avoid a backlash from investors.


The use of stock option schemes as an incentive to executives has also resulted in the latter having a keen interest in share prices. A low price usually results in the options expiring “out of the money”, a situation executives try to avoid.


Having said this, the question then is how far is attributable profit reliable as a measure of the economic performance of a company?


Still on the reporting season, Delta’s results for the six months to September 2007, remind one of the biblical story about Pharaoh’s strange dream.


Seven years of plenty and a similar period of famine came to pass, as Joseph rightly interpreted the dream. Equally, the brewer’s three months to June of strong margins were preceded by a tumultuous quarter to September.


A price freeze directive in June resulted in squeezed margins. The company had to engage in a survival mode, which it rightly dubbed ‘Project Thrive’ to steer the ship safely through the turbulent waters.


Costs had to be managed efficiently with focus being on growing the bottom line. Among the cost saving measures was the curtailment of distribution and supply chain expenses.


External freight hire services were reduced with intercity distribution of products being carried by rail.


The company also cut out what it termed “parasitic middlemen” preferring to push products straight to retailers.


Rising inflation and the resultant margin management policy in the first quarter saw demand for most products constrained further.


Volumes shrunk in tandem with reduction in aggregate demand, with barley based lagers coming off 4,9% while Eagle lagers slumped by 37,5%. Sorghum beer volumes remained limited, reducing by 16.5%, in the light of a dire maize shortage.


Lower than normal prices in the second quarter resulted in unprecedented volume increases. Eagle — population as jatropha — volumes were up 40%, with other lagers registering 16% uplift in sales units.


Delta maintained its strategy of pushing volumes in Eagle in a bid to release barley malt for exports. The contribution of Eagle to total lager volumes increased to 17% in September from 8% in the prior year. Turnover went up 16 339% to $6,9 trillion. Operating margins at 39,96% were down by a marginal three percentage points capturing the effects of price controls in the second quarter.


Earnings per share were booked at $1 302.07 up 12 973% and almost a quarter of it, $250, was paid as dividend. October 2007 performance was strong, epitomised by strong business recovery, cash flows and improved profit.


Revenues for the month amounted to $4,7trillion with the business currently generating around $500 billion cash a day.


Noteworthy, after “stripping” out the revaluation gains on biological assets as well as containers, EPS actually grew by 15 232% to $1 141, because of reduced tax.


If the business model is spot on, “earnings manufacturing” is not necessary, and the brewing giant proved it! Like Castle, it is a business balanced to perfection.

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