On the Line – Demerara Distillers Limited Annual report 2002

Introduction

In the same week that Guyana announced the historic opening of its Stock Exchange which Business Page unreservedly welcomes, two of the country’s top companies were making the news neither of which was particularly positive. The Stabroek News broke the story of a fraud of a yet-to-be determined amount at Banks DIH which less than a month ago published its half-yearly interim financial report in which Chairman Clifford Reis spoke glowingly of that company’s ‘efforts to improve shareholders value by Good Corporate Governance as well as maintaining a high level of Corporate Ethical Standards’. And Demerara Distillers Limited sent shareholders notice confirming that their Annual General Meeting for the second year running was outside of the period allowed by the Companies Act and the Securities Industry Act. Today’s Business Page reviews the financial statements and the reports of DDL including consolidated financial statements which shareholders will consider at the company’s Annual General Meeting on Friday July 25, 2002.

The information sent to shareholders is presented in two separate parts, one of which deals exclusively with the Report of the Directors and Auditors and the financial statements of the company and its subsidiaries while the other deals with corporate information, the Chairman’s Report etc. There is no report of the Managing Director reflecting the company’s corporate culture and the executive role of the Chairman. With the recent activation of the Securities Industry Act, public companies are now required to include ‘in or with the directors’ annual report’ a number of matters some of which DDL has addressed in the notes to the financial statements while others are in the report of the directors. Members of the company and the public interested in checking for compliance with accounting, legal and securities legislation should therefore read the two parts as a single document.

The activities of the group include companies involved in rum manufacturing, shipping, construction, food processing, information technology and distribution. This column’s criticism made last year that the Report, “does not present information on these companies in a comprehensive or consistent manner to allow for a proper evaluation of their performance” has been addressed and in the case of each subsidiary the Chairman has disclosed its turnover and pre-tax profits. It should be pointed out that a better measure of profitability would be the profit after tax.

Financial Highlights

We summarise below the financial results of the company and its subsidiaries which are extracted from the audited accounts included in the Report and offer some indicators which may be useful to readers.

Profit and loss account

Net sales for the company for the year increased by $1,151Mn or 19% over 2001 while the profit before tax decreased by $10Mn or 1%. Dividends, however, remained at the 2001 level of $231Mn. Once again the company continues to mis-understand the method under which dividend is computed and refers to percentage rather than an absolute amount per share. All the major profitability indicators showed slight decline from the previous year except for earnings per year. Return on gross assets again fell for the eighth consecutive years and raises questions about the company’s strategies. Similarly, operating profits as a percentage of capital employed was even worse with declines for the past nine years!

The contribution of the subsidiaries to turnover was 18% compared to 22% in 2002 despite the opening of a new subsidiary and significant favourable movements in the rates of exchange affecting some of the subsidiaries. For the group’s domestic operations, turnover fell by 8.4% but increased by 66% on the foreign market. The profitability of the domestic operations is however much healthier at 17.4%, down from 19.4%, while the profitability of the foreign operations of the company was a mere 2.4%, a slight increase from 2.2% in 2001.

Balance sheet

Despite decline in returns on both capital employed and gross assets, the company continues to invest in fixed assets. Net fixed assets increased by 40% during the year while working capital at the end of the year decreased by 17% and current liabilities increased by 25%, from $1,973Mn to $2,463Mn. Cash resources remained healthy but fell by $35Mn from 2001 while inventory increased by 6%. Based on information disclosed there was no indication that there is any provision for stock obsolescence suggesting that the company would be able to recover the full value of its inventory.

Both the balance sheet and profit and loss statements raise serious doubts about the group’s investment and currency transactions since it is clearly not getting the type of returns which investors would expect.

Currency Risk

As ‘one of the few Caribbean companies which has (sic) established a base overseas and has subsidiary companies in Europe’ (extract from the Report), both the company and its subsidiaries would have substantial amounts of foreign currency transactions. Indeed note 18 to the financial statements indicates that over forty percent of the group’s gross revenue is derived from foreign markets. It is incredible that the financial statements make no reference to currency risks or give any indication of the assets and liabilities which are denominated in foreign currency

particularly since there is every likelihood that the group has several loans repayable in foreign currency. Borrowings total G$1.7Bn with interest rates linked to US Prime, Libor and Guyana T/Bill rates. These simply cannot be local currency, arms’ length rates.

Conclusively, the cash flow statement discloses ‘Exchange (gain)/loss on loans of G$2.3Mn. but this disclosure falls short of the requirement that the total exchange differences included in the net profit or loss be disclosed.

Without any indication of the level of influence of foreign currencies, it is difficult to conclude on the effects that these have on the financial statements. The shareholders will be unable to assess the continuing value of their shares where any movement in exchange rates takes place.

New subsidiaries

According to the report, the Group incorporated Demerara Distillers (US) Inc. during the year. According to the statement of changes in equity, this company has opening losses of $57M which it charges directly to retained earnings. If this is indeed a loss incurred by the newly incorporated entity, this should have been charged to the group's profit and loss account instead of taken directly from reserves. The implications would have been that the group would shown a $693.5Mn profit instead of $751.7Mn down from $792.6Mn in 2001. This would have severely impacted on the group’s earnings per share. The difference between net earnings of the group and the company is becoming increasingly hard to justify in light of the substantial turnover of the subsidiaries which account for 19% of the consolidated turnover but only 10% of profitability. This would have been even worse at the losses of the subsidiary been charged to the profit and loss account.

Segment Reporting

In general, segment information disclosures in Guyana’s public companies require an overhaul. Information is usually presented for industry (business) segments and geographical segments where they distinguishable and subject to differing risks and returns.

The Financial Statements disclose segments for Trading, Manufacturing and Services and also discloses geographical segments of ‘Domestic’ and ‘Foreign’. Business Page however believes that foreign is too wide to be considered a single segment. The company has subsidiaries in the Caribbean, Europe and more recently, the United States. Each of these markets is subject to different risks and returns and it would have been helpful to present the information using these segments. For example with the emphasis on the EU, it has to be hoped that at least for the information of the directors, they are provided with information to allow them to measure performance in the major operating markets.

A very significant issue is the loss of associate company, BEV Processors Inc., which reported a loss of $20.8Mn. The Chairman is however optimistic that the company will rebound and return to profitability in the current year.

Deferred expenditure

The group continues to expend on its El Dorado trademark and states that expenditure thereon is deferred and amortised over a period of 10 years. During the last two years a significant amount has been spent on the trademark and the notes to the financial statements state that this was in relation to markets in Europe and the United States.

The narrative component of the note remains unchanged from the previous year despite an increase in deferred expenditure of $192Mn. No separation is given of the amounts charged to the profit and loss account as opposed to amounts expended during the current year. This is vital information if one wishes to consider the propriety of carrying forward expenditure which should only be done in defined circumstances instead of charging them to the year’s profit which is considered a more prudent approach.

To be continued