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Piotroski factors provide some insight into the likelihood of financial distress by examining trends in key accounting metrics over two years. If all nine point in a positive direction then a very low level of distress is indicated. Any score under five out of nine should make us wary.
I’ll use the latest annual report to 31st May 2018 along with the 2017 report.
- Is it profitable?
Yes, net income before exceptional items was £2m. One Piotroski point.
- Does it produce positive cash flow from operations?
Yes. Operating cash flow was £9.4m. Second Piotroski point.
Don’t be too impressed by that large cash flow number because £7.8m of it was the adding back of amortisation of intangible assets (a non-cash item) to the profit number. More than offsetting this, the firm spent £8.4m on new intangible assets (intellectual property) in 2018. This “product development” expenditure is capitalised on the BS as an intangible asset and amortised over 5 years.
Nevertheless, even though IP spend and amortisation are roughly the same, the company produces positive cash flow after we deduct £8.4m as well as the £0.5m investment in property plant and equipment.
- Has the return on capital employed figure improved?
Yes. Net income before exceptional items divided by beginning of year total assets was £2m/£60m = 3.3% in 2018 and £1.4m/£53.8m = 2.6% in 2017. Third Piotroski point.
But note the poor returns on BS assets – most of these assets (£33.2m) are intangible intellectual property, especially capitalised product development.
Net assets, after deducting payables of £9.8m, borrowings of £2.2m and £18.7m in pension deficit, are much smaller at £25m. But even if we used this in the denominator we find that Haynes earns a poor return on capital.
And the directors know it: I asked a very direct question at the AGM pointing out to Eddie Bell, Chairman, that what he had declared “a strong year” in his statement was, in fact, a weak year in terms of return on shareholder capital; and returns have been poor for five years. To his credit he acknowledged the problem and said they were determined to address it.
Talking to Eddie and other directors after the formal meeting I gained the impression that there is an informed, rational and rigorous debate taking place within senior ranks to address capita
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