Gunns: A forlorn hope

When CEO Greg L’Estrange took the pruning shears to most of Gunns assets resulting in a $457 million loss before tax for the year ended 30th June 2011, he must have hoped that he’d cleaned the slate and there would be no further bad news.

Alas this is not the case, as trading continues to disappoint and the book values of assets needs even more downward revision.

The market update issued 22nd Dec 2011  continues the pattern of Gunns being a little indirect with their disclosures.

Gunns have stated their underlying profit for the year before interest and tax is likely to be $30 million with 40% or $12 million likely to occur in the first six months. Underlying profit is a non statutory concept of profit designed to ignore one off and non-core items. Firms, especially rogue firms, take advantage of this concept and are able to pretend their underlying profit is still sustainable whilst recording massive statutory losses. In some instances it may be valid, in others the envelope is being pushed a little too far.

Gunns is revaluing some assets for its half yearly report. Often most revaluations are left for the full year’s accounts. The banks probably want to see an update. Gunns have stated that their net tangible asset NTA per share has fallen to 91 cents (from $1.04). This implies a loss of equity of 13 cents per share or a further $110 million in the first six months. Now if underlying earnings before interest and tax are $12 million and Gunns received $23.5 million for the disposal of the residual native forest harvesting rights which even Greg would be stretching to include in underlying earnings then the one off tangible asset write downs plus interest must be $145.5 million. Less, I almost forgot, the $5 million paid as dividends to the holders of FOREST hybrids.

To rephrase the above, the statutory loss before tax for the six months implied by the Media Release is $105 million. Included in that figure is $12 million of ‘underlying’ profit, a windfall handout from us taxpayers of $23.5 million and another round of asset write downs and interest of $140.5 million.

But it could be worse than that. So far we’ve only looked at the fall in the value of the tangible assets. The update referred to a revaluation of “rights to future cash flow from investment in MIS projects”. At 30th June 2011 $134 million had already been booked as income, $46 million relating to the income that had supposedly accrued when Gunns took over the management of Great Southern’s MIS schemes and which is listed as an intangible asset. So it’s likely that the commission income expected from MIS schemes has been ‘overbooked’. If the value of the management rights relating to Great Southern’s MISs existing at the time Gunns took over need to be revalued, that means a write off of the intangible asset of up to $46 million. Which further adds to the statutory loss already implied of $105 million, possibly making it $151 million in total.

Imagine a market update saying “Gunns announces a loss before tax of $151 million for the first half of 2011/12”.

Much better to say that “underlying earnings before interest and tax for the year (is) expected to be approximately $30 million”.

Who says Greg isn’t worth his $1 million pa?

It was hoped that one of the preconditions for obtaining a social license was an affirmetion to tell the truth, the whole truth and nothing but the truth. A forlorn hope. The update infers export hardwood woodchip volume for 2011/12 will be about 2 million gmt at a price around $200 per bdmt, but forgets to mention that most of that product is not Gunns’ but rather largely belongs to the long suffering Great Southern MIS growers and that Gunns is only entitled to a 5.5% commission as manager, almost all of which has already been booked as income.

Is there more bad news to come? Is the Pope a Catholic?

The softwood processing segment is struggling. At 30th June 2011 it had a book value of about $200 million. With an EBIT of $13.8 million for 2010/11 the business may have had a value of $100 million, roughly 7 times EBIT. The figure would now be less. The book value of the asset is at least $100 million too much.

Then of course there’s the pulp mill expenses that have been capitalised, which will total at least $240 million by the time site prep works are completed. Another asset write off?

Gunns has still got assets but it will still have enough debt once the existing facilities are partially rolled over so that cash from operations will probably be insufficient to survive.

Without a pulp mill, Gunns looks eerily like another FEA.