Business Page – On the Line - Annual Report Demerara Distillers Limited -2005

Sunday, May 28th, 2006

Introduction:

Business Page today turns its focus on the Annual Report of Demerara Distillers Limited, a leading conglomerate and public company which holds its Annual General Meeting on June 2 2006, over five months past the financial year end. The notice by the Secretary is dated May 8, 2006 which is beyond the date prescribed under section 58 of the Securities Industry Act (SIA) for the submission of the Annual Report to the Securities Council (SC). Following a court decision on a matter brought by the company against the SC on its 2004 Annual Report the under-resourced SC appears unwilling or unable to execute its mandate under the Act even on procedural issues such as late filing, a recurring problem faced by this company.

Some of the issues facing the company and the group are of a recurrent or continuing nature and cover the range of legal, regulatory, accounting, transparency, policy and governance matters. For example the company continues to ignore accounting requirements that its insurance arm Demerara Fire and General is a subsidiary and should be accounted for as such; the company has failed to honour an obligation given to the court with respect to certain disclosures under the Companies Act 1991; has failed to account for a gain of US$1.1 mn. on a Hamilton Bank loan buy-back and has international ambitions that severely test its capabilities.

Limited scope:

But this review is limited by constraints of space and will focus on the operations of the company and its subsidiaries which this column has questioned on 'business model grounds' (see Sunday Stabroek December 14, 2003). It is worth noting that despite the claimed internationalisation of the company and the group, Guyana accounts for 85% of revenue and close to 100% of the profits of the group with all but one of the international companies failing to justify their existence and investment

The company is one of Guyana's leading public companies and describes its principal activities as Manufacturing, Trading and Services. Its flagship is a stable of alcoholic products which despite the seven consecutive Gold awards at the International Wine and Spirit Competition are marketed with mixed success across a number of regional countries and continents. The group has invested heavily over the past ten years with Capital Employed having more than trebled while Profit after Tax has increased by a meagre 5 % from $729mn. to $763 mn. before any account for inflation. Indeed in real terms and using key indicators such as return on assets and return on shareholders funds, the group's performance ten years ago was almost twice as good as it is now.

Profitability / efficiency indicators -Demerara Distillers Limited

Source: 10 Year Review - DDL Annual Report 2005

The group's performance in the second half of 2005 was appreciably better than the first half results announced in an undated interim report issued by the company and received by this columnist on October 31, 2005, the deadline for the publication of those results under the SIA. During the six months January to June 2005, turnover was $5.1 bn. with a gross profit percentage of 38% but in the second half of that year turnover increased to $5.7 bn. and gross profit as a percentage of sales increased to 44% - a historical high that warrants some explanation.

In a year described by the Chairman as a 'most difficult year in the history of the company', profit before tax increased by just 3% on increased sales of 11%. The increase in the pre-tax profit of $39mn., was swallowed up by an $80 mn. increase in the tax charge with the result that profit after tax fell from $803 mn. to $763 mn. and earnings per share from $1.04 to $0.99. In a statement that seems to confuse cost (what is paid) with value (what is received), the Chairman explained that but for increases in the cost of molasses and fuel which according to him more than doubled in terms of value during the year, profits would have been some $600 mn. more. Not only is this statement not supported by available data on these commodities, but it would suggest that the company would have earned a gross profit of close to 48% which defies all historical experiences.

Expansion results:

Over the years, this column as well as the columnist in his capacity as a shareholder has raised a number of issues of concern in this company including the strategic direction in which the management-controlled board has taken the company with an expensive expansion programme that cannot be justified by the consistently poor showing of a number of subsidiaries and brings into question the quality of the company's Strategic Plan first mentioned in 1993 and referred to again several years later. The group's liabilities and debt servicing with interest and other finance costs approach half a billion dollars on overdraft and loans of $3.4bn.

The performance of the company and its subsidiaries set out in the table below shows that six of the subsidiaries and an associated company recorded losses in 2005 with the company and five of its subsidiaries recording a profit. This is how they performed.

Profitability record - DDL and its subsidiaries/ associated company

Source: Annual Reports - Demerara

Distillers Limited

Guyana based companies

The successes......

DDL - The turnover of this company which is the parent of twelve subsidiaries accounted for 79% of group turnover, 93 % of profit before tax and 99% of profit after tax. Its gross profit percentage was 42% compared with 44% in 2004 suggesting that the Chairman's estimate of the profit effect of fuel and molasses price increase of $600mn. was unrealistic.

Demerara Shipping - This company reported profit of $94 mn., an increase of 16% over the previous year and some $5mn. more than the company earned in 2001.

Distribution Services Limited - This trading company reported profit of $44 mn., an increase of 47% over the previous year but just $1mn. more than the company earned in 2001.

Topco - This company that had an injection of $500 mn. over the past three years and which was expected to make a 'significant leap forward' in 2005 barely managed to maintain profits of $8.4 mn., just half of what it earned in 2003. At this rate it would be decades before the company could justify the investment when the benchmark is 5 years.

...... and the failures

Solutions 2000 - As it did in the previous year this company again recorded a loss of $4.5 mn. This company was acquired from two directors in what appeared to be a conflict of their fiduciary duty as directors with their personal interest. In 2003, the Chairman was evasive when asked about the basis on which the purchase price was determined or to identify the directors involved. This matter prompted a complaint to the accounting regulator the Institute of Chartered Accountants of Guyana, which has shown a disgraceful lack of interest in pursuing the matter.

Demerara Contractors Limited - Another company with an interesting history, DCL had a loss of $2.5 mn., making it four out of five years in which the company has recorded losses and one can only wonder about the justification for its continued existence.

Decipher International Inc. - The second of the IT companies in which the group is involved, Decipher too has recorded losses, in this case $25 mn., following a loss of $21.7 mn. in 2004. The Chairman reported that this project which is geared towards assembling qualified medical 'transcriptionists' will continue into 2006 at a total cost of $120 mn. Does this mean that the company will spend in 2006 some $75 mn. more on training? No doubt shareholders would be asking themselves what kind of retention arrangements are provided for in the contracts with the trainees and how soon the company is expected to recover the $120 mn. investment.

Overseas

Successes...

Breitenstein Holdings BV - This European group with two subsidiaries in Netherlands and four in the UK had sales of close to $1.5 bn. and profit of $40 mn., a net profit percentage of 2.73 %.

Demerara Distillers US Inc - This company which is the beneficiary of hundreds of millions of deferred expenditure could only make G$1.3 mn. or US$6,500 for the entire year, about the same as in 2004. It is also of more than passing interest that there is no indication that the company proposes to enter the Canadian market where the company's former Managing Director and now Vice President International Marketing now resides with his family.

Demerara Distillers (TT) Limited - For the third successive year that subsidiary has reported losses, this time of $11 mn., just less than the loss in 2004. The notes to the financial statements indicate that it carries on trading operations in Trinidad but yet shows nil sales. What can possibly be the logic of having a subsidiary in this twin island republic when a distributorship through a national company would seem to be a win-win situation?

Demerara Distillers (St Kitts-Nevis) Limited - Here again the company which is described as manufacturing suffered losses for three consecutive years, making it four out of five. Given the CSME, the practical closure of the sugar industry in that country, the question of economies of scale and what amounts to self-competition, the retention of this subsidiary seems hardly sensible.

The directors' report juxtaposes Corporate Governance and the CARICOM Single Market and Economy (CSME) and proudly boasts that the directors and management recognised the challenges of the CSME 'many years ago'. Clearly they did not translate that recognition into opportunities and profits.

Demerara Distillers Hyderbad Limited - The company reports its 50 % share of the losses at $20 m. on sales of $5mn., down from $14 mn. in 2004. The operation in India is conducted through a joint venture in which the company appears to participate through its Chairman who has just been awarded a national award from that country. The Indian experiment goes back to 1993 when the company announced that it was in a joint venture with an Indian company to build and operate a distillery in Maharastra 'to serve the Indian market, the Pacific Basin, the former Soviet Bloc and Africa'. It took the company several years to admit that its initial investment could not go through because it was a 'dry state' but that was all the information the company was prepared to offer.

Once again the company is reporting difficulties in that country and one has to wonder whether sentiment is not getting the better of judgment with that investment.

There is no mention of the experience in China to which the company had made its first shipment in November 2004 and where the Vice President had visited on several occasions. In 2004 the company had also announced more than doubling of its branded El Dorado sales and the development of new markets in Mexico, Russia and the Middle East.

The company appears to have failed to register the DDL trade mark in any of those countries - inexplicable for a company with a vision of 'global tentacles' by 2012.

Conclusion:

The results show that the DDL group is over-extending itself and the weaknesses are beginning to show. It will be paying $0.01 per share more in dividends than it did last year but with its cash position in negative, it will almost certainly be going further into overdraft.

The Chairman is one of Guyana's best ever businessmen but that does not make his judgment infallible and it is unrealistic to expect him to carry indefinitely the same workload he has been carrying for decades. To agree to post in a non-DDL country its de facto number two is clearly a major mistake which has had little compensating benefits with the domestic sales far outstripping foreign sales both in dollar as well as growth terms.

If this company wishes to remain strong and competitive, it needs a major realignment of its ambition with its capabilities. World class, prize-winning products need equally excellent direction and execution.