I’ll consider Orchard Funding’s (LSE:ORCH) financial stability by firstly looking at its vulnerability to financial distress and secondly it propensity to generate cash year by year.
Piotroski analysis
In 2000 Joseph Piotroski published research looking into the question of whether you could take a bunch of value shares and then separate out the strong from the weak using accounting ratios and measures.
The nine factors, taken as a whole, indicate where a company is along the spectrum, ranging from showing great improvements to its financial position at one end to exhibiting increasing financial distress at the other.
I’ll conduct Piotroski analysis on both year on year changes and secondly on changes between the latest half year and that of the previous corresponding HI.
Profitability factors
If the firm is profitable and produces positive cash flow it has a capacity to generate funds internally. A positive earnings trend suggests an improvement in the firm’s ability to generate positive future cash flows.
- Positive net income before extraordinary items? Orchard Funding made profits in the year to 31st July 2020 (£1.3m) and in the half year to 31st January 2021 (£0.5m) and so a score of ‘1’ is gained for both the annual analysis and the half-year analysis.
- Positive cash flow from operations? Cash generated from operations was £1.6m for the year and £0.64m for the half year. Orchard thus gains a score of ‘1’ for this factor for both the annual analysis and the semi-annual analysis.
- Positive change in return on assets employed in the business from the previous year? Profits were poorer in 2020 than 2019 and in the latest half year and so no Piotroski point here.
- Cash flow greater than profit? (so profits are not driven primarily by positive accruals, which may be ‘managed’). Orchard gains its third point here for both the annual and half-year analysis.
Leverage, liquidity, and source of funds
Measuring changes in capital structure (debt:equity ratio) and firm’s ability to meet future debt service obligations.
- Change in leverage over one year. Has the firm’s long-term debt reduced relative to its total assets? I’ll include all borrowings. 2020: £11.1m/£32.2m = 34%; 2019: £16.2m/£33.6m = 48%. One extra Piotroski point for the annual analysis. Half year: 2021: £10.7m/£35.5m = 30%; 2019: £14.2m/£36.2m = 39%. Another Piotroski point for the half-yearly analysis.
- Has the firm’s current ratio (current assets divided by current liabilities) improved? Annual: 2020: £29.7m/£14.2m = 2.1; 2019: £34.6m/£19.6m = 1.8. Loans granted to customers are double the amount borrowed from Barclays, etc. And the position improved over those years, so a fifth Piotroski point. Orchard could withstand a lot of customer default before its balance sheet was imperiled. Half year analysis: 2021: £32.2m/£16.7m = 1.9; 2020: £38.7m/£23.4m = 1.7. Fifth Piotroski point
- Has the firm avoided raising fresh equity capital (e.g. rights issue or placing)? Yes, so it gains sixth Piotroski point.
Operating efficiency
- Has the gross profit margin improved? Gross profit is a strange concept for a lender. If I take net interest income (interest received less cost of funding) then that rose from 85.5% in 2019 to 86.3% in 2020. For the half years it rose from 86.3% to 87.1%. Thus it gains the seventh Piotroski point for both the annual and half-year analysis.
- Has the ratio of turnover to beginning-of-the-year total assets improved? (This indicates greater efficiency in the use of its assets from either having fewer assets for a given level of sales or raised sales). Annual analysis: 2020: £4.6m/£34.9m = 13.2%; 2019: £4.9m/£32.5m = 15.1%. No Piotroski point. Half year: 2021: £1.9m/£29.9m = 6.4%; 2020: £2.4m/£34.6m = 6.9%. No Piotroski point.
An overall Piotroski score of seven is very good, so I conclude there is little indication of increasing financial distress.
What about cash flow?
Orchard has demonstrated excellent cash flow generation ……………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1