Fleetwood Corporation – The Numbers Tell The Story by Sandon Capital

Fleetwood Corporation (FWD) recently released its FY16 result. As we expected, the result was poor with the company reporting a loss from continuing operations and a much larger loss when discontinued operations are taken into account. Furthermore, despite the company’s commentary that it “generated very strong operating cash flows”1, our analysis indicates that underlying operating cash flow was negative. The company proclaims that “Our objective is to outperform financially by providing genuine value”2. Continued excuses for poor performance, deflecting from the real issues that need to be addressed and promising improvement that never seems to arise are the antithesis of this objective.

Fleetwood Corporation

It is clear to us when we analyse the financial statements that little self-help is occurring to reverse the fortunes of the company. The financial performance of loss making businesses continues to deteriorate, in our view working capital management is extremely poor, underlying cash flow is negative and despite commentary to the contrary, it doesn’t appear that meaningful costs are being removed from the business. The sanguine commentary and outlook from the company is sharply at odds with the disappointing financial results. We view this as indicative of a board and management who have yet to accept the reality of the current predicament into which they have steered the company. We believe rapid and meaningful changes in strategy are required to stem further shareholder value erosion.

The increased segment disclosure highlighted the dire performance of the RV Manufacturing business and reinforced our view that losses in this business must be addressed immediately. The company has already been afforded the luxury of 3+ years to turn the business around, and despite ongoing promises of improvement and an end market that continues to grow strongly, the red ink continues to flow. The increased segment disclosure also highlighted that the Parts & Accessories business was barely profitable whilst operating with a tangible asset base of almost $30m. We believe this business may hold more value to an alternative owner.

[drizzle]In our opinion, the company has avoided making difficult decisions in the hope that macro driven improvements in underlying markets will ultimately drive a turnaround in financial performance. A business that relies on the economy to drive its fortunes cedes all control over its existence to exogenous forces and is ultimately doomed to fail. This is most obvious in the RV Manufacturing business where the underlying market has been strong, yet financial performance continues to worsen, with the company continuing to blame the fallout from the global financial crisis for the poor performance of the business. Meanwhile, competitors continue to improve their product offering, advertise aggressively and take market share.

We believe many of the problems outlined above are the result of deficiencies at management and board level. The company has now been without a designated Chief Financial Officer (CFO) since current Managing Director, Brad Denison, was promoted from that position over two years ago. We see the deteriorating working capital position and lack of cost control as being KPI’s of a CFO role. We are concerned that the lack of a CFO is having a detrimental impact on the business and we are also concerned at the lack of ‘checks and balances’ that occur naturally when a designated CFO is in place.

Of further concern is that glaring issues within the company have not been identified and addressed by the board. In our experience, management and boards who have been unable to see value destruction coming are poorly equipped to make judgments for a turnaround. They are typically invested in the way things were rather than the way things are.

Fleetwood Corporation – Key Issues

1. Operating Cash Flow Extremely Weak

The company claims to have “generated very strong operating cash flows during the year”3, yet some simple analysis shows this not to be the case. Operating cash flow was reported as $66.977m in the statement of cash flows, however this included $62.2m of proceeds related to the sale of the Osprey Project (settled in July 2015). Furthermore, an examination of Note 34.2 in the Annual Report shows that operating cash flow was boosted by $9.792m from discontinued operations. When we adjust for these two non-recurring items, we calculate that underlying operating cash flow was negative $4.952m.

Fleetwood Corporation

In addition, underlying operating cash flow was significantly below what we calculate it should have been based on the company’s reported earnings. Using net profit plus depreciation & amortisation as a simple P&L proxy for operating cash flow, we calculate underlying operating cash flow should have come in at close to A$8.6m, significantly above the negative $4.952 that we estimate was the true underlying operating cash flow. We attribute much of the $13.5m shortfall to poor management of working capital, which we discuss in more detail below.

2. Working Capital Management is Extremely Poor

We view working capital management as a critical performance indicator that is largely within the control of management. Unfortunately, Fleetwood’s track record in this area is less than exemplary. Excluding the receivables related to the sale of Osprey from the FY15 receivable balance, net working capital increased by $6.2m (15%) in FY16. Expressed as a percentage of revenue, net working capital increased from 15.7% to 16.6%. Of particular concern to us is that net working capital as a percentage of sales has continued to increase in four out of the last five years and is well above the long term average over the past 15 years. If the company were able to reduce net working capital as a percentage of sales to 12%, A$13m of working capital would be converted to cash, not insignificant for a company capitalised at ~A$120m.

Fleetwood Corporation

3. Poor Management of Costs

The FY16 preliminary final report stated that “operational changes have seen the company…significantly reduce operating costs”. It is incongruous to us that a company can claim to be reducing costs when earnings are declining at the same time revenues are rising.

In FY16, we estimate that Fleetwood Corporation’s EBITDA was down almost 12% despite revenues increasing more than 8%. The adjustment we make in the table below relates to the way the Osprey sale agreement has been structured. Whilst the detail has not been disclosed by the company, it appears to us that the company is forced by accounting standards to record revenues which are then offset at the finance cost line. We have no problems with this accounting treatment as the net impact on earnings and cash flow is nil. However, it does serve to inflate EBITDA and an appropriate adjustment needs to be made. We have estimated this impact at $2.5m and reduced EBITDA by the same amount in the table below.

Fleetwood Corporation

The numbers above, taken directly from the financial statements, demonstrate that costs increased in FY16, not reduced as per the company’s commentary in its Preliminary Final Report. Reported costs were up by almost 9% in FY16, led by significant increases in material, sub-contractor and other costs which were only partially offset by small reductions in employee

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