Accounting Snags\' Stock Price Has Been Cut

Accounting

Snags' stock price has been cut in half the past few years. Investors are concerned that almost every reliable measure of the company's financial health has declined in that period. The worst area is with profitability, as the company's margins have declined sharply at all levels. If current trends in profitability persist, Snags will lose money in FY2013. Along with the decline in profitability and therefore investment returns, other ratios have also suffered. The company's operating efficiency remains poor to mediocre, its liquidity has improved but only because of inventory and receivables sitting longer than usual, and the gearing ratio has increased as the company has borrowed to offset the decline in operating cash flow.

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This report will focus on the areas of concern with respect to the profitability, efficiency, liquidity and capital structure of Snags Ltd. Financial ratios will be used as the basis of this analysis. All of the ratios are attached. The first set of ratios will be the liquidity ratios.

The company's liquidity ratings have improved over the past three years, from a current ratio of 2.18 in 2010 to 4.62 in 2012. However, the company has no cash, and all of its current liabilities are in inventory and receivables. Escalation in receivables and inventories highlights that the company is having trouble collecting from its customers, and having trouble moving goods. Indeed, in this industry the current ratio in 2012 places it as a middle performer, and the quick ratio as a low performer, so the company cannot take much solace in having improved liquidity ratios.

With respect to long-term solvency, it is worth knowing that the gearing ratio for Snags is over 2, and has been higher in the past couple of years than it was in 2010. The company has steadily added to its debt burden, while the value of shareholder's equity has grown at a much slower rate. The gearing ratio was in the middle of the industry, but is creeping towards the upper level of the industry, something that is not a positive development.

Profitability is perhaps the biggest concern for investors. Over the past three years, all of the margins have declined steadily and significantly. The company used to have superior margins, but now the gross margin is average for the industry, and the net margin is below the industry average. This decline, combined with the increased gearing, has to be of concern for investors.

Another important set of ratios is the efficiency ratios. The receivables turn is presently at its worst level in three years, but the inventory turnover is at its best level. At 55 days, the inventory turnover has the company as a middle performer. The asset performance is terrible, at less than once per year. The inventory turnover puts the company as one of the worst firms in the industry, despite the improved performance.

For investors, the returns that Snags has recorded are not particularly strong. With rapidly declining profits, the returns have gone from respectable to terrible in the past three years. Surely investors have noticed this dramatic decline in the bottom line. The firm used to record superior return on equity (ROE) and mid-range return on assets (ROA). Today Snags sits near the bottom of the industry on both measures.

Summary of Findings:

Snags Ltd. has seen its margins tighten at all levels, and this has had adverse effects across its business. With tighter gross margins, the company is generally less profitable, to the point where it is barely profitable at all. Expenses have risen much more quickly that sales, compounding the problem. With less money coming in from the company's sales, it has been forced to borrow more, and this has expanded the gearing ratio to a relatively unhealthy level. In addition, operating efficiency ratios are not favourable, as the company has allowed too much inventory and receivables to stockpile, rather than cash.