Environmental Resource Investment: Real value

By K.A. S. Perera

Environmental Resource Investment (ERI) has recorded a net profit of Rs. 510 m for the financial year 2010/11 compared to Rs. 108 m for the previous year. This is a substantial increase of 369%. Revenue has increased to Rs. 2,116 m from Rs. 233 m, which is a commendable increase of 805%. 

The following analysis based on certain assumptions for the next four years’ period indicate recorded net profits of Rs. 510 m represents only 15% of the actual profits and the actual hidden unrealised net profits amount to around Rs. 4,043 m annually with earnings per share of Rs. 13. It also shows staggering theoretical price of Rs. 348 on the basis of PE of Rs. 26.76 for the investment trust sector on 17 June 2011.

Due to the impossible task of determining a future sale price of a company coupled with the fact future sale price generally far exceeds valuation based on present earnings/net asset value due to other factors such as future value additions, goodwill, etc., no present day accounting standard could show hidden profitability on the type of investment objective of the ERI.

Many financial analysts, stock brokers and investors have failed to realise that the substantial profits have been derived from an insignificant income source, not the main income source, which is the sale of companies. 

Unlike other quoted companies, the main objective of ERI is purchase of quoted and unquoted inefficiently-run companies and those with other constraints such as inadequate finance and adding value by rehabilitating and selling in the stock market with a good margin.

Contribution to economy

It is significant that the main objective of the company is very unique compared to other quoted companies and would substantially contribute to national economy. Today except for ERI there is no specialised institution to rehabilitate sick companies. It should be stressed especially that banks attend to this function only for their customers, generally with limited involvement to protect their funds.

Today the company has acquired 12 companies excluding a stock broking arm, mainly comprising basic industries and IT-related companies for rehabilitation and ultimate sale. How successful the company has been in the rehabilitation of major companies is shown in the following example:

Ceylon Leather Products: Former Government-owned Leather Corporation, which was on the verge of collapse and even transferred to Default Board for the non payment of a small amount to the CSE, is now a holding company recording a net profit of Rs. 107 m for the financial year 2010/11 with an earnings per share or Rs. 4.28 and cash balance of Rs. 261 m.

Dankotuwa Porcelain PLC: This company originally owned by the Government was on the verge of liquidation and acquired by the company few months back recorded Rs. 9 m and Rs. 19 m for the third and fourth quarters of 2010/11. The company was able to reduce the losses from Rs. 94 m to Rs. 19 m during 2010/11 within a short period under the company control. This is an improvement of Rs. 75 m. 

It is significant that cash amounting to Rs. 276 m is still available for further development. The company is a national asset exporting under local brand matching best products in the world. The company is expected to record positive growth in the current financial year. Presently over 80% are owned by local and foreign institutions.

South Asia Textile Lanka (former Pugoda Textiles): The Government-owned textile company was privatised and later closed due to insolvency. Due to improvements made, it is expected that the company will turnaround during the current year. After improvement, the company is expected to be listed in the next financial year.

DNH Financial Ltd. stock broking company and assets-rich quoted company City Pharmacy are some of the 13 companies owned by ERI.

Actual profitability

Unlike other quoted companies, it is not possible to ascertain real profitability of ERI since it is extremely difficult to determine the date of sale of a company and purchase consideration. Accordingly traditional tools such as EPS and PE have no meaning to ERI since what has been quarterly shown represents profits of subsidiaries, stock broking company and short-term investments, which would be negligible compared to real income.

Therefore, in order to make a fair assessment of income, it is assumed that the net profit of five major investments have been arrived at by selling at a price 75% of the highest price recorded or to be recorded in the case of Pugoda Textiles as shown in the table during a period of four years.

In this exercise, income to be derived from other seven companies has been ignored.  Similarly future dilution of capital and income from future investments amounting to Rs. 40,055 m has been ignored. It is assumed that only ERI owns subsidiaries fully and other income and expenditure are static.

The ERI makes a unique contribution to the economy and apart from providing further incentives to ERI the Government should obtain assistance and advice from ERI to restructure loss-making State enterprises. Today ERI perform the most difficult task of rehabilitating industries in the country.

In the recent past ERI has been the most popular share among investors after earning huge profits and was the envy of many high cap companies due to these reasons and its performance under a new business module. Rivalry intensified when ERI climbed as the second highest cap company.

An undue prolonged inquiry into certain aspects of foreign investments of ERI centred on a matter of transparency has bought down the price to Rs. 55 from a 12-month high of Rs. 141 due to sheer ignorance of many investors/brokers and campaigns launched by rival quoted companies. 

What the investors/brokers should realise is that any shortcomings of ERI do not in any way affect its profitability, operations and future prospects in contrast to many massive privatisation scandals and recent judgments on robbing of public wealth amounting to billions of rupees.

Independent analysts believe the price of ERI should not have fallen below Rs. 120 after discounting for ongoing inquiry. On the basis of above analysis of ERI, it should have a minimum price level of Rs. 250.

The prices of Leather Products and Dankotuwa too started declining without investors/brokers realising that these are separate entities to an absurd level of Rs. 80 for CLPL and Rs. 43.50 for Dankotuwa from a high of Rs. 144. Analysts are of the view that price of CLPL and Dankotuwa should not have declined below Rs. 110 and Rs. 70 respectively under the circumstances.

Today 90% of the investors/brokers operate on a herd instinct and not based on fundamentals; which is why there is no wonder many shell companies with huge negative net assets have climbed even above Rs. 150. The ridiculously steep decline of prices of ERI and related shares should be viewed in this context.

(The writer is an Investment Analyst and Financial Consultant.)