Half year results are a shocker

Strewth.

Margin pressures overshadow revenue growth…

The first line of Alumasc’s half year results statement, is a lesson in understatement, which is ironic.

At its building products division profit margins are under pressure because of weak demand from the construction industry and continued investment, but the numbers, and the probable causes are less alarming than the situation at Alumasc Precision,  which manufactures aluminium and zinc castings used in motor vehicles, lawnmowers and the kind of hand dryers you find in public conveniences.

Last year Alumasc Precision brought in about a third of sales and half of operating profit.

But in the first half of this year sales of precision engineered products rose 19%, while operating profits fell from ''1.3m to ''0.2m. While we might have hoped that surging demand in one half of the business might compensate relatively weak conditions in the other, its actually made the situation far worse and overall earnings per share has more than halved since the same period in 2010.

My first reaction is not to panic despite the fact other investors did yesterday morning (the shares were down over 30% early on). My job is to look at the fundamentals, not the price, and take a long-term view.

This is the company’s explanation:

Higher than expected demand at Alumasc Precision Components caused unexpected capacity constraints and difficulty in keeping pace with customer expectations. This resulted in higher than expected costs, leading to a reduction in divisional operating profit from ''1.3 million in the first half of 2010 to ''0.2 million in the first half of this financial year.

Reading between the lines, those costs would have included overtime, freight costs, and dealing with customers whose orders were delayed.

The extent of the cost over-runs only began to emerge following a routine internal audit in December, and were not fully quantified until after a detailed inventory count at the half year end. This led to a significant non-cash write down in the value of inventory as at 31 December.

Although management’s planning and financial control have been inadequate, its tempting to write this off as a temporary problem a new divisional finance director appointed in January will help to put right. But its also possible more problems will be uncovered in the process, and the company may have damaged relationships with customers who may switch to rival suppliers.

Chief Executive Paul Hooper says the problems are being resolved and he expects profit margins at Alumasc Precision to improve in what remains of the second half of the year, but not enough to meet previous expectations.

At least in buying about ''35,000 of shares yesterday and lifting his stake in the company by nearly 10%, he’s backing his  words with some of his own money, but that still leaves me feeling uneasy.

The company’s many businesses are fairly autonomous and I’m wondering if the main board has sufficient control of its divisions. In 2008, Alumasc Precision revealed it had understated costs and therefore overstated profit and the value of inventory in the previous two financial years, a situation reminiscent of the current one.

It’s at times like this I reach for my two minute monologue to remind myself why I added Alumasc to the portfolio , and update the script to reflect the latest developments. Unfortunately I don’t yet have a script for Alumasc, or most of the other companies in the Thrifty 30, as I’ve only just started the essential work of writing down the investment case for every company in the portfolio and every company joining it in words an interested teenager can understand.

I’m feeling a little frustrated that events at Alumasc, Victoria, and Vp are distracting me.