Coastal Freight Ltd: assessing a bond investment from the annual report

What the ratios say

• Current ratio 1.9 → 1.3. A 32% fall in short-term cover in one year; the trust's cushion against a bad year has largely gone.
• Inventory days 62 → 95 and receivables days 45 → 58. Cash is being trapped in stock and debtors - collections and stock turnover have both deteriorated, so operating cash inflow is lagging reported profit.
• Payables days 40 → 70. The company is funding that working-capital gap by paying suppliers later. This is not a permanent source of finance: supplier credit runs out, discounts are lost, and it can precede a liquidity crunch.
• Debt : equity 0.4 → 0.9 and interest cover 6.2 → 2.4 times. Borrowings have risen sharply while profit covers interest only 2.4 times. A fall in earnings of roughly 58% would leave no cover at all.

The connection

Working-capital strain and higher gearing are the same story: the business has grown its balance sheet using short-term and long-term debt while cash conversion has slowed. That is why interest cover collapsed even before any profit decline - more debt, and profit that is not turning into cash.

Weight of evidence

The trend matters more than any single number. Most decision-relevant: interest cover of 2.4 times and the direction of debt. Next: the stretched payables, which signals cash stress. But the trust should insist on the statement of cash flows - it is the missing piece, since ratios built on accrual profit can flatter a company whose operating cash flow is negative. Note also that the NZD14m revaluation increased equity, so the reported 0.9 understates the growth in borrowings relative to operating assets.

Underlying profit

'Underlying profit' is a non-GAAP measure - it is not defined by NZ IFRS, so it is not directly comparable across companies and the company chooses what to exclude. Here the adjustment removes a gain (the NZD2.1m insurance settlement).

• Read the reconciliation to reported profit and check each adjustment: removing a genuine one-off is defensible for forecasting, but excluding items that recur annually ('restructuring' every year) reduces earnings quality.
• Note the direction: with the gain removed, underlying profit is lower than reported profit - the opposite of the usual profit-inflating use, which is mildly reassuring.
• The insurance cash is real and has already improved liquidity, so a ratio based on underlying profit understates cash received.
• The trust should use both measures, plus cash flow, and never rely on the headline alone; 'up 18%' should be checked against the comparative figures rather than accepted.

Contingent liability

Under NZ IAS 37 a probable outflow that can be measured reliably is a provision; a possible obligation is a contingent liability - disclosed, not recognised. Disclosure is only useful if quantified. 'Not expected to succeed' with no amount tells the trust nothing about downside. A leaky-building claim can be material relative to 2.4 times interest cover, and the assertion is management's, not a legal opinion. The trust should ask for the maximum exposure, legal advice, and whether insurers are involved, and treat the claim as a risk factor until quantified. The related-party loan of NZD3.0m is also relevant: cash lent to a director's company reduces group liquidity while the group itself is stretching payables.

Recommendation: do not invest on the information available; re-offer only if conditions are met.

Reasoning

The trust's own policy is that interest must be serviceable through a downturn. Interest cover of 2.4 times and falling fails that test: a modest earnings decline, or a single adverse outcome on the leaky-building claim, could threaten coupons. The combination of rising gearing, deteriorating working capital and stretched payables points to a company that may need to refinance on worse terms - which ranks ahead of, or alongside, bondholders.

Conditions that would change the answer

1. A statement of cash flows showing operating cash flow comfortably covering interest and capex.
2. A quantified maximum exposure on the leaky-building claim, with legal advice.
3. Reconciliation of underlying profit, and a check that the insurance gain is genuinely one-off.
4. Evidence the NZD3.0m director-related loan is on commercial terms, disclosed under NZ IAS 24, and being repaid.
5. Bond terms that compensate for the risk: shorter term, security or a covenant restricting further borrowing, and a coupon reflecting the credit risk.

Balancing judgement

There are positives - property revaluation suggests real asset backing, and the insurance receipt improved cash. If the analysis shows operating cash flow stable, the claim immaterial and the loan repaid, a smaller, shorter-dated, secured holding could be justified. Without those, a 500,000 dollar exposure against a 2.4-times interest cover is not prudent for a community trust whose capital is effectively permanent.