Business Page – July 13th, 2003

Demerara Distillers Limited Annual report 2002

Introduction  

Today’s column starts with an apology for a correction to certain of the percentages shown in the profitability tables which were presented in part one of this commentary.
Profit after tax of the company increased by 8% and should not have been shown in brackets which indicated a decrease, while the percentage returns on assets and equity were shown as numbers instead of percentages. We apologise for the misleading data and reprint the information hereunder.

 

Profitability    

Company

 

Subsidiaries (effective)

 

2002

2001

2000

 

2002

2001

2000

Net Profit Margin (%) 

9.17

10.09

11.00

 

4.58

9.41

5.08

Return on assets (%) 

10.96

12.79

15.94

 

11.93

15.49

14.00

Return on equity (%) 

19.75

21.22

20.42

 

23.20

28.45

25.08

Earnings per Share (in $) 

0.87

0.81

0.69

 

0.16

0.22

0.15

We now conclude our review of the Financial Statements and Chairman’s and Directors’ Reports.

Performance of Subsidiaries

Last week’s column referred to the substantial charge of $57M for the US subsidiary incorporated in 2002. This was not reflected in the Profit and Loss Account but taken directly to the Statement of Changes in Equity while the Annual Report on page 21 states that the entity’s “Revenue for the period was $26M and pretax profits of $10M”. The question facing the ordinary reader is determining whether the US subsidiary made a loss or a profit while the more discerning reader will wonder at the questionable and unusual treatment of the loss in the financial statements.

Shareholders cannot help but be concerned with the performance of the group’s local subsidiaries and must find the explanations for declining profits by the Chairman as entirely unsatisfactory and stretching the limits of credulity. Of the five local subsidiaries addressed in the Chairman’s Report all but one of them performed considerably worse than they did in 2001, the exception being Demerara Contractors and

Engineers Limited the only company whose turnover is not disclosed but which managed to reduce its ‘loss’ from $13.5Mn. to $7.7Mn. Demerara Shipping Company Limited experienced a 17% decline in turnover which seems inconsistent with the 52% fall off in profits even if one accepts the assertion that 80% of shipping costs are fixed.
Distribution Services Limited, an entity which accounts for 10% of group sales and which is not as heavily dependent on electricity as the manufacturing subsidiaries but negatively impacted by fuel prices had a “marginal” increase in turnover, but an increase nonetheless, yet has a 41% decline in profits! Surely the impact of “parallel illegal trade” that “continues to affect legitimate authorized distributors” should be more evident in the form of declining sales rather than such a dramatic decline in profitability.
Topco also had a marginal increase in turnover but because of the price increases in fruit and electricity, that subsidiary suffered a 30% reduction in the level of profits. Yet for this subsidiary which accounts for just over 1% of sales, the company has announced a half a billion dollar investment which using as a benchmark a payback period of five years would need to produce a return of $100Mn per annum - an increase of over 1300% - a stretch even for the ‘legendary’ management of the group.
For the group, the story of the past ten years which covered some of the best economic performances at the national level, has been one of increased sales and investments and decreasing returns on profitability and shareholders’ funds. During the past ten years turnover has almost trebled while profit after tax had increased by less than double. Similarly capital employed has increased by 400% while the operating profit as a percentage of capital employed has declined from 40% in 1993 to 16% in 2002.
It is hoped that the Group’s diversification strategy coupled with its significant capital expansion plans has not placed a strain on available management resources that is reflected in an inability to monitor all the holdings of the group thereby resulting in declining performance.

Return on Assets


The Chairman’s report refers to funding for modernisation which will come from WIRSPA/ EU sources and will be matched dollar for dollar, presumably by internally generated funds. Neither the funding requirements nor the nature of the funding are outlined and this makes it difficult for an investor to determine the accretive value of what is undoubtedly a significant investment. This is particularly important when one considers the substantial increases in gross assets employed over the years and the inverse relationship of these increases to the returns generated.
Over the past two years the group had new loans of $2.1Bn and increases in short-term creditors of $1.26Bn which were used to fund its business activities including new fixed assets of $2.8Bn. While the recently established stock exchange will take some time to achieve market sophistication, the declining performance of the group can adversely affect its cost of funds. Its effective control of Trust Company Guyana Limited, and Demerara Bank can also lead to a conflict of interest.

Governance

The Annual Report makes the usual obligatory reference to corporate governance and specifically mentions for the first time in the group an Audit Committee which is headed by Mr. Chanderballi Bisheshwar FCCA who was appointed to the Board following the last Annual General Meeting. There is however no indication of the terms of reference of this Committee or how it functioned during the year. Questions with respect to the composition of the various committees and their role with regard to governance issues are left unanswered.
Comparisons with Banks DIH are appropriate given that company’s similar disclosures with regards to committees of the Board and corporate governance generally. Inclusion of this kind of information would provide shareholders with some level of comfort that the company adheres to the Principles of Good Governance and Code of Best Practice (“the Combined Code”). This omission is further compounded by the non-disclosure of information relative to Directors’ remuneration as is required under the Companies’ Act 1991 and International Accounting Standards.
This column has lamented the strategy of the company to embark on a number of ventures via private companies outside of the vision of the shareholders of the public company. Companies need to demonstrate that transparency is not only an issue for governments but for the private sector as well.

Related Parties

This column is not convinced that all related parties as defined by IAS 24 are identified in the financial statements. We believe that Diamond Fire and General Insurance Inc.is a related party and even perhaps a subsidiary, the definition of which under IAS 27 is based on control. The 2000 annual report of DDL had stated that “DDL was the vehicle for the launching of Diamond Fire and General Insurance Company on December 18, 2000, which embraces a number of other shareholders. DDL has 19% Equity in the Company.” Neither the 2001 nor the 2002 financial statements carried any reference to this entity.
Erroneously, the Annual Report seems to limit its definition of a related party company to a company whose Chairman is also the parent company’s chairman. But if that limited definition is accepted, couldn’t the Institute for Private Enterprise Development (IPED) be considered a related party.
The effect of these defects compounds the fact that the Group continues to disclose only limited information on related party transactions. Transactions with Demerara Bank Limited and Trust Company (Guyana) Limited are disclosed “net” which could mislead the reader who is left guessing about the level of transactions.
Under Corporate Governance in the Directors Report, the directors state “Directors’ shareholdings and any dealings with the company have also been fully disclosed.” In fact, the financial statements exclude information on the emoluments paid to executive directors and make no statement as to whether the directors have shareholdings in subsidiaries. Readers will remember that a year ago, Business Page alluded to a situation where certain directors of the company held shares in Solutions 2000. When DDL acquired that company no disclosure was made and the lack of any indication of continuing shareholdings confirms our view that this company was acquired from directors.
Business Page firmly believes that good corporate governance includes not only structures but culture, transparency, suitable accounting policies and accountability. The Directors have adamantly refused to respond to questions submitted in writing by this columnist who is also a shareholder in the company and as noted earlier seem to adopt some very aggressive accounting policies. We have already mentioned the direct charge to reserves but cannot ignore the fact that the group has 6 months inventory and no provision for stock losses. It also continues to defer expenditure on acquisition of the El Dorado trademarks in the USA and Europe. These are usually “one off” expenses and this treatment certainly requires some explanation. As a matter of interest, in 2001 the Chairman reported that El Dorado is now available in five US states. This year he reports that “El Dorado is gradually getting space in five states” - hardly any progress or justification for deferral of the expenditure.
Further evidence of this type of bold accounting is the failure of the company to disclose as a contingent liability a claim by the Guyana Revenue Authority for over $1Bln of unpaid consumption tax. Even if the directors are confident of winning the case the significance of the amount warrants disclosure.

Conclusion

DDL as a company and group remains profitable and its exports are increasingly gaining international stature because of their quality. Unfortunately however Business Page cannot say that this quality has been evident in the areas of governance and strategy and the Directors have a duty to respond to these concerns. We note with interest that shares of the company were offered on the stock market at $7.50 but no trades were executed at that price. Business Page does not consider as cause for concern the fact that the company’s stock has not had willing takers on the stock exchange. However the Guyanese investor may not be as unsophisticated as some might think. They need to see better results and need to be taken into the confidence of management. As recently failed companies in the US have shown, the stock market can bring home some cruel realities.