Demerara Distillers Limited 30 June 2007 Interim Report

Demerara Distillers Limited’s 2006 financial statements showed that cash and cash equivalents stood at an all time low. I commented that the stock is trading at a discount to book value, perhaps reflecting that dividend growth was not keeping pace with increases in earnings. With cash flow scarce, upping the dividend payout will be difficult. Increasing cash flow should be the first priority if the Group wishes to see its performance improve. In the intervening six months two things have happened: DDL’s share price has broken out of the relatively narrow trading range to which it has been confined since trading began on the local stock exchange and net cash and cash equivalents have improved since the year end. Further, cash generated from operations has increased an order of magnitude over the equivalent period one year ago, and both cash generated from operations and net cash provided by operating activities on a trailing twelve month (TTM) basis stand at their highest levels since interim reporting began. (See Graph 1)

On the downside, those subsidiaries with which the company shares an interest saw profit fall to the extent that the minority interests’ share of the net profit was a loss of $6.2m. According to the notes the minority interests include two subsidiaries: Solutions 2000 Inc, Demerara Distillers Hyderabad. The two associates, BEV Processors Inc and National Rums of Jamaica Ltd have been consolidated in accordance with IAS28 and are accounted for using the equity method. DDL is one of the largest and most widely held shares in Guyana. A strong performance by DDL’s shares has the potential to send a positive signal about the benefits of investing in shares to a wide segment of the population: and may bring some much needed interest in local stock. Although the market has seen large increases in prices, trading volumes have stagnated somewhat.

Performance for

the period (See Graph 2)

DDL’s share price finally broke out of its four year price range on July 16th. Heavy demand a few weeks previously resulted in the purchase of nearly all the outstanding stock offered for sale. The stock exchange operates a limit order book, which allows brokers to advertise the orders to which their clients have attached a limit (the maximum price for purchases and the minimum price for sales) for which no trade could be struck when the order first came to market due to the limit price being outside current trade prices. This mechanism allows clients who wish to trade on their terms to place orders so that a trade will be struck in the event that prices move in their favour. In DDL’s case outstanding offers to sell amounted to just 14,400 shares following the heavy trading two weeks previously (which saw 1.7m shares trade between them). On July 16th there was sufficient demand for all the remaining stock on offer on the board to be purchased, which pushed the price up to the highest price at which someone was prepared to sell (in this case $10). When supply returned in the following few weeks this had the effect of pushing down prices – indeed on the 20th August the price was back down to $8.3, before recovering to $9. This volatility reflects the illiquid nature of the market, small changes in sentiment can result in big price swings.

The Group’s financials were rather more stable, with revenue increasing by 8% to G$5.6B over the equivalent period one year ago and profit before tax increasing by a like percentage to G$621m, reflecting stable profit margins. The effective tax rate has increased from 27% to 31% hence net profit after tax increased by just 3% to G$432m. The share of profits in associates fell from G$41.9m for the six month period one year ago to G$20.8m. While administration expenses increased, selling and distribution costs decreased, in total these expenses increased by 5% to G$1.4B over the six month period one year ago. (See Graph 3)

Cash Flow (See Graph 4)

The cash flow statement pictures a much greater level of variation between the two periods: for the six month period cash generated from operations increased from just G$59.6m one year ago to G$970.8m. The key component of this change is the movement in stocks. Whereas one year ago stocks increased by G$633.8m, in the six months to 30 June 2007 stocks decreased by G$399.0m. This is likely reflective of an increase in sales due in part to Cricket World Cup 2007. It should be noted that increases in stocks are reflected as a revenue item in the profit and loss, hence it is possible for the profit in the two periods to be similar yet cash flows to be widely different. This is why a cash flow statement is so essential when interpreting financial statements. Though the regulations do not require a cash flow statement, DDL’s statements conform to IAS34, which does require a cash flow statement.

Financing

The Group’s financing activities utilised G$135m, with loans of G$506m drawn down and repayments of interest and loan capital of G$422m. The interim report does generate a question in respect of the six month period from June 2006 to December 2006: though loans of G$1.2bn were drawn down to June 2006 by the year end only G$552m had been drawn down. One assumes this was due to the early repayment of some of loans drawn down; it would have been clearer if this was shown as a loan repayment rather then netting off the repayment.

Conclusions

DDL’s performance is on the right track: it generated cash flow in excess of net profits and its cash and cash equivalents increased since the year end. The share price is now trading above its recent trading range and there is support for the shares in the market. At the current discount to book value the shares are starting to look attractive. The next six months will reveal the degree to which the improved cash flow was as a result of Cricket World Cup, whether the turn around in cash flow will continue and the extent to which the Group is able to distribute profits by way of dividends.

Clarification

In last week’s column I made reference to “the deadline” in respect of interim reports under the Securities Industry (Disclosure by Reporting Issuers) Regulations twice, however I did not make it clear I was referring to two separate deadlines. The first relates to the requirement to publish the interim report not later than four months after the end of the period to which it relates. The second requires the information to be published in at least two daily newspapers the day after approval by or on behalf of its board of directors. It is the second deadline which many reporting issuers fail to meet.

This writer has an interest in DDL by virtue of an associate being a shareholder.