Executive summary
This report analyses the
financials of Keells Food Products PLC (KFP) which is listed on the Diri Savi
Board of the Colombo Stock Exchange. The report analyses the financial
statements for 5 financial years from March 2019 – March 2023 for KFP. The
report comprises a horizontal analysis, a vertical analysis, a ratio analysis,
and a brief discussion about nonfinancial metrics.
The report identifies how the
company has fared through several economic and geopolitical crises such as
covid-19 pandemic in 2020-2021, and the recent debt default crises that
occurred in April 2022. Especially in the most recent year, the company was
affected by increased distribution costs due to rising fuel prices, import restrictions
creating shortages of raw materials, higher interest rates, and rapid inflation
driving both input prices and product prices. While the company has managed to
remain profitable, issues can be seen with working capital management,
leverage, and cash flows.
The report recommends better
working capital management tactics and leaner production management techniques which
could have improved efficiency.
1.
Business description
Keells Food Products (KFP) is a
company engaged in manufacturing processed meat items. The company was
established in 1982 and has grown to be the market leader in the processed meat
industry in Sri Lanka. Their Keells Krest and Elephant House brands are household
names popular among Sri Lankan consumers. The company has over 200 products
distributed via over 32,000 retail outlets
The company’s business model
encompasses operational efficiency and sustainability.
Figure 1 – Business
model
Source:
The company is a subsidiary of
John Keells Holdings PLC and is listed on the Diri Savi board of the Colombo
Stock Exchange. KFP has received many certifications and awards such as ISO
22000 and National Food Award for Excellence.
2.
Industry Overview
Through
traditional animal husbandry techniques, livestock has played a significant
part in Sri Lanka's agricultural environment for millennia and has become an
integral part of rural households' daily lives. With the meat business
developing as a key contributor, this technique has developed over time into a
potent instrument for rural development. Meat and its products have been an
integral part of the indigenous cuisine as a necessary supply of protein,
balancing out more conventional protein sources.
A complex
combination of religious, cultural, and economic elements affects the
development of Sri Lanka's cattle and meat business. The trajectory of the
sector has been defined by the dietary habits influenced by these factors.
Dietary constraints and preferences brought about by the coexistence of many
religious traditions in the nation have a considerable influence on the kinds
of animals raised.
The
consumption of meat and animal products has shown a rising trend over the past
several decades, reflecting shifting consumer tastes and lifestyles. Dietary
practices are changing as Sri Lanka continues to urbanize and modernize, with
meat playing an increasingly important role in the modern diet. The consumption
of meat and meat products is expected to continue to rise in the future,
continuing this trend.
Table 1 – Poultry production in Sri Lanka
Source:
Over the years, Sri Lanka's
poultry sector has seen growth and variations, with periods of rising and
falling output of both chicken and duck. The decline in production of chickens
and ducks in 2021 and 2022 may be brought on by a number of variables,
including the ongoing COVID-19 pandemic, changes in consumer demand, supply
chain interruptions, or other unanticipated difficulties.
3.
Horizontal / Trend analysis
Trend analysis refers to
analyzing a set of data over a period of time. Trend analysis helps to
recognize the patterns over a period of time, indicating upward or downward
trends and cycles.
In order to understand the trends
with KFP’s Income Statement and the Balance Sheet over the last 5 years (2023 –
2019), the figures were indexed to 2019 (i.e. base year was considered as
2019). Refer Annex II for full financial statements.
Table 2 – Trend analysis: Income Statement
Source:
As per the above table, the
revenues of KFP has shown in increasing trend. The company recorded 5% and 6%
topline growth in 2020 and 2020 from the base year 2019. In 2022 revenue shoed
a 34% growth while 2023 showed an exploding growth of 88% from the base year.
It is interesting how the company
has managed to slightly increase its revenues and profits during the COVID-19
pandemic (I.e. years ended March 2021 and 2022). In these years, most companies
indicated declining revenues and profits due to prolonged lockdowns and supply
chain disruption where food distribution was adversely affected. KFP
distributed its products primarily through its own Keells stores which has a
strong online presence which could have resulted in minimal impact to revenues.
The company’s cost of sales also
has shown an increasing trend. The cost of sales growth has outweighed the
growth in revenues as of 2023. Post COVID-19 pandemic and the economic crisis
started in April 2022 the company saw several key input prices rising due to
rapid inflation and exchange rate depreciation. Import restrictions also
resulted in shortage of several key inputs which lead to higher cost of sales.
The gross profit however has
increased despite the rising cost of sales. This shows company’s ability to
pass on the costs to the customers given its market leadership position.
Company’s bottom line however was
impacted by the rising selling, general and administration (SG&A) expenses.
Due to the rapid inflation and fuel prices experienced in 2022-2023 the company
saw a sharp increase in its SG&A resulting in operating profit declining
compared to the base year.
Finance cost also see a rapid
increase especially in 2023 due to the sharp increase in the interest rates
that were in effect since April 2022 policy rate hikes by the Central Bank of
Sri Lanka. This has lead to the sharp decline in profit before tax and profit
after tax in 2023.
On the Balance Sheet, current
assets and current liabilities show fluctuations over the last 5 years. Current
assets saw an increase in 2023 due to inventory buildup. Current liabilities
also saw a sharp increase driven by the loans and overdrafts. Total equity has
shown an increasing trend over the years. Non-current assets also have seen an
increasing trend due to adequate capital investments.
Refer table below for the balance
sheet.
Table 3 – Trend analysis: Balance Sheet
4.
Common size / Vertical analysis
Common size or vertical analysis
helps to understand the financial statements of a company proportionate to key
items such as revenues or total assets. It helps comparing and benchmarking
items relative to competitors or peers. It highlights the significant items in
terms of value and highlights any sharp changes in those items.
A common size income statement
was developed for KFP where all items were expressed as a percentage of
revenues. A common size balance sheet was developed where all items were
expressed as a percentage of total assets.
Table 4 – Common Size Analysis: Income Statement
Source:
Based on the common size
analysis, the gross profit has decline to 22% in 2023 from 29% in 2019. Selling
and distribution expense is a sizable item on the income statement that
accounted for 10% - 12% in the last 5 years except a sharp increase to 14% in
2020. Administrative expenses relative to sales has always been stable at 4% -
5%. Net profit saw a sharp decline to 0% of revenue. Except for 2023 and 2020,
net profit has been 7% - 9% of revenue.
Table 5 – Common Size analysis: Balance Sheet
Of the non-current assets, PPE is
the largest proportionate to total assets fluctuating between 40% - 55% of
total assets over the last 5 years. Inventories and receivables are sizable
current assets as indicated by the common size Balance Sheet. Stated capital
accounted for 30% - 50% of total assets over the last 5 years while non-current
liabilities ranged from 9% - 17% over the last 5 years. Trade payables have
always ranged between 10% - 15% of total assets. In 2023 bank overdrafts saw
sharp increase to 27% of total assets while it ranged between 5% - 7% in the 3
preceding years.
5.
Ratio analysis
Ratio analysis involves calculating
and interpreting financial ratios. Ratio analysis provide valuable insights
into understanding issues and red flags with a company. It is used for
performance evaluation, assessing financial health, risk management, improving
operational efficiency, and making strategic decisions. Given below is a ratio
analysis covering various aspects of KFP. Refer Annex I for formula and Annex
II for financial statements.
5.1 Profitability
Gross margin has slightly
declined in 2023 owing to the rising inflation, scarcity of raw materials and
higher input prices driven by significant exchange rate depreciation that
stemmed from the economic crisis. Prior to 2023, the company had always
maintained the gross margin between 25%-29% even during times of covid
pandemic. However, higher sales and distribution expenses due to increased fuel
costs and promotional activities in 2022 resulted in eroding EBIT, EBITDA, and
net margins for 2023. Higher finance cost was also the second most important
reason for declined profitability in 2023.
Table 6 – Profitability ratios
5.2 Activity ratios
Activity ratios measure the
operational efficiency of the company. The asset turnover has improved over
time which shows that the utilization of assets for income generating has
improved over time. The inventory turnover shows a declining trend which
indicates problems with inventory movement. A lower inventory turnover ratio
reflects a lower number of times the stock is being sold. Receivable turnover remained
somewhat stable over the last 5 years between 7.4x to 9.4x. This shows the
number of times that company collects cash from receivables.
Table 7 – Activity ratios
Return on Assets (ROA) and Return
on Equity (ROE) measures the profitability and efficiency. In 3 of the last 5
years (except 2023 and 2020) company has maintained a healthy ROA between 9.58%
- 10.46%. in the same periods the ROE
also has ranged within a healthy level of 14.46% to 15.46%. The two exceptional
years were where profitability was affected by adverse economic conditions. A
higher ROA and a ROE indicate that compared to the assets and equity invested,
the return has been higher.
5.3 Liquidity and working capital
Liquidity refers to the ability
to convert an asset into cash without significant delay and time. Liquidity
ratios measure the ability of a company to meet its short-term financial
obligations. Working capital refers to the difference between current assets
and current liabilities.
Current ratio reflects the
ability of current assets to meet current liabilities. KFP has always
maintained a current ratio above 1 which means there is adequate current assets
to meet current liabilities (i.e. sufficient liquidity and working capital).
Quick ratio measures the ability of he most liquid assets to meet current
liabilities. KFP has maintained the quick ratio also above 1 until 2022, seeing
a slight dip to 0.56x in 2023. Operating cash flow (OCF) to current liabilities
measures the ability of the OCF to meet current liabilities. Except 2023 in
other years it has remained between 0.45x – 0.63x.
Table 8 – Liquidity ratios
Receivables, payables and
inventory are major components of working capital. Receivable and payable days
indicate how long it takes for the receivables to be converted to cash and
payables need to be paid. Inventory days reflect the number of days inventory
is on shelves before being sold. KFP’s receivable days has remained mostly
stable between 38 – 49 days over the last 5 years. Payable days have fluctuated
between 36 – 55 days. Inventory days saw a sharp increase in 2023 and 2021 but
otherwise remained in 50 – 60 days level. In 2023 working capital cycle days
were higher due to higher inventory days.
Table 9 – Working capital ratios
5.4 Leverage
Leverage ratios measure the
company’s ability to meet the long-term financial obligations. It indicates the
capital structure of the company and how debt and equity comprise the funding
of assets. Debt to equity remained 16% - 19% between 2022-2020 with a sharp
increase to 59% in 2023. The increase in debt is attributable to the sharp
increase in bank overdrafts in order to fund working capital. Net debt refers
to debt net of cash and captures company’s ability to pay off debt with its
cash resources. Net debt to equity does not differ significantly from debt to
equity because the company does not have large cash resources to pay back its debt.
Table 10 – Leverage ratios
5.5 Z score analysis
Altman Z score analysis evaluates
the solvency of a firm. It helps to understand the possibility of financial
distress or bankruptcy based on the score value. A value of more than 3 is
considered healthy, while a value below 1.81 is considered unhealthy or likely
to go bankrupt. Over the past 5 years KFP has maintained a z score well above
3.
Table 11 – Altman Z Score
5.6 Cash flow analysis
Free cash flow is an important
measure to understand the sustainable cash position of a company. Free cash
flow refers to the operating cash flow net of capex and working capital
investment which are essential for long term sustainability of the company. Except
for 2023 and 2020, KFP has always maintained a healthy positive free cash flow.
The negative free cash flow in 2023 is partly attributable to the negative
operating cash flow resulting from large working capital investment compared to
other years. In 2020 there was a significant capex investment resulting in a
negative free cash flow. Refer below table for free cash flow.
Table 12 – Free Cash flow
EBIT to free cash flow measures
how efficient is the company’s operating profit (i.e. EBIT) to cover its free
cash flow requirements which is the sustainable cash flow. Except 2023 and 2020
which were affected by adverse economic conditions KFP has maintained a ratio
above 1 showing sufficient coverage. Operating cash flow to capex measures how
efficient is the operating cash flow to cover its capex requirements. Except
2023 and 2020 the company has maintained a ratio above 1. Capex to sales
measures how significant is capital spending relative to sales. In 2020 the
capex was significant at 12% of revenues but in other years it ranged between
2% - 5% Capex to free cash flow measures how significant is capex relative to
free cash flow. The ratio has fluctuated greatly over the past 5 years. Refer
below table.
Table 13 – Cash flow ratios
5.7 Du Pont analysis
Du pont analysis explains the
Return on Equity (ROE) by breaking it down to net profit margin, asset turnover
reflecting efficiency of asset utilization and Equity multiplier reflecting
leverage. By looking at the breakdown of ROE for KFP, it can be understood that
higher leverage and asset efficiency were dominant in the delivering the ROE
rather than the net margin.
Table 14 – Du Pont analysis
5.8 Investor ratios
The investor ratios show the
attractiveness of the company’s stock and factors in the investor sentiment and
market confidence on the company. the Price earnings (PE) ratio in 2023 has
significantly increased due to lower Earnings per share (EPS). Market price has
not significantly changed from 2022 to 2023 despite profits dropping 96%. A
higher PE indicates the company is potentially overpriced relative to its
earnings and could be less attractive compared to its peers. Price to book
ratio has remained stable between 1.4 to 2.0x over the last 5 years. Price to
sales also has been somewhat stable ranging from 0.6 – 1.13x in the past 5
years.
Investor ratios are mostly
meaningful when they are compared with peer companies or market metrics.
Table 15 – Investor ratios
Dividend yield has decline in
2023 as the company significantly reduced dividend per share to LKR 2 per share
from previous year’s LKR 9.5. This is in line with declined profits. Interestingly,
dividend payout still has increased reflecting that the company paid out a
larger proportion of its profits compared to other years, despite profits
dropping.
Table 16 – Per share data
6.
Nonfinancial metrics
The company reported some of the
non-financial metrics for the years 2023 and 2022. These metrics were reported
under intellectual capital, human capital, social and relationship capital and
natural capital. Non-financial metrics are important as they reveal company’s
overall health and sustainability giving a broader scope that are not covered
by financial metrics. Each of the aspects show the company’s commitment to
innovation, employees, suppliers and environment.
Table 17 – Non financial metrics
Source:
The company has significantly
increased its training hours to employees. Employee satisfaction has slightly
dropped in 2023 yet reflects 78% satisfaction. KFP has maintained its supplier
reach despite a slight reduction in distribution network and retail outlets. The
downsizing could reflect an effort to manage rising distribution costs. Company
has recycled more water and reduced the carbon footprint marginally.
7.
Conclusions and recommendations
It can be concluded that the
company has survived well through the challenging economic times such as covid
pandemic and the 2022 economic crisis. However recommendations for further
improvements can be made to operational and financial management aspects.
The company saw its profit
dropping by 96% to LKR 13.9Mn in 2023 from LKR 329.5Mn in 2022. This was mainly
driven by the significant increase in selling expenses by 66%. The annual
report identifies that the sharp increase in selling and distribution costs was
“due to fuel price hikes, vehicle maintenance costs, and increased resource
allocation for advertising and business promotion across various channels”. The
higher finance cost driven by higher interest rates in the economy was the
second significant reason affecting profitability. As the interest rates have
come down as of August 2023 and is expected to further ease, it can be
anticipated that the finance cost burden will ease going forward.
Despite the operating and net
profits dropping, the company has impressively increased the gross profits in
2023. This is despite the challenges stemmed from economic crisis started in
April 2022 that resulted in a sharp increase in inflation, import restrictions
creating shortages of raw material and a sharp depreciation of the rupee
resulting in imported inputs more expensive. The gross margins in 2023 only
fell by 4% from previous year (2023 = 21.15%, 2022 = 24.81%). As the market
leader this indicate that the company was able to pass on most of the rising
input prices to the customer without a significant loss of demand.
It is recommended that the
company look for alternative distribution channels such as online sales to
reduce the significant fuel cost associated with distribution which is affecting
the profitability.
It can be concluded that the
company had an impressive performance during the Covid pandemic despite many
challenges. The topline and bottom line both saw increases in 2021 and 2022 –
the years in which the effect of covid was mostly visible.
The company saw a sharp increase
in its debt burden in 2023 due a spike in the bank overdraft of LKR 1.1Bn (2022
= LKR 245Mn). This spike in overdraft to fund the working capital requirements,
resulted in deteriorated gearing position for KFP. It is recommended that the
company seek non-interest-bearing funding sources during a high-interest rates
environment. Some strategies such as extending payable days or shortening
receivable days could have helped working capital management better than interest
bearing liabilities such as bank overdrafts.
In 2023 inventory buildup was
significant as inventory increased to LKR 1.2Bn from LKR 585Mn in 2022. It is
recommended that the company seek more leaner production methods during
challenging economic times in order to reduce the burden on working capital. A
Just-in-time inventory management that is carefully executed could result in
lower inventory costs.
Overall it can be concluded that
although the company managed profitability through challenging economic times,
certain improvements to operational efficiency and financing strategy could
have yielded better results.
Annex I – Formula
Profitability ratios
Activity ratios
Liquidity ratios
Leverage ratios
Altman Z score
Working capital ratios
Cash flow analysis
Investor ratios
Per share data
Source:
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