VIC — Michael Castor

Notes on Cash and Accounting from the Value Investing Congress

By Travis Johnson, Stock Gumshoe, September 16, 2013

Michael Castor is a healthcare hedge fund guy, and he talked about accounting

He started out by sharing a couple names that he’s interested in — he thinks there is attractive valuation at Cardinal Health (CAH) and Select Medical (SEM)

And he says there is a compelling value in Aratana (PETX), a pet medicine company. He didn’t talk about it in detail, but it’s the one that might be worth looking at as a value investment — but he didn’t really go into those in detail, most of what he talked about is a stock that’s clearly a short candidate and cautionary tale about cash and accounting … and trades in Mexico, so it may not be of interest to all of you.

Example: Genomma Labs, trades in Mexico, market cap around $2.3 billion (30 billion Mexican Pesos)

Net income has grown every year … but cash has been shrinking and balance sheet has fallen considerably even excluding acquisitions. In five years they have cumulative net income of 5.2 billion, but the cash excluding acquisitions has been only a net of 255 million. Working capital is absorbing a huge amount of cash flow, and they have very bad cash flow from operations compared to net income.

Accounts receivable has sucked up a lot of that cash — which brings to mind a scenario where they’re booking sales by stuffing the supply chain. Investors complained so that cash moved from the accounts receivable to the “other assets” in the form of advertising relationships — presumably a benefit for their customers. Five billion pesos have essentially disappeared from the balance sheet at Genomma. So what’s going on?

Looking at their products, they have highly erratic and unpredictable sales from their leading products — including some huge spikes from specific products that couldn’t possibly have a market big enough. After investors complained, they stopped disclosing sales by product.

The money is going into huge increases in working capital, accounts receivable, higher cost of goods, questionable product penetration and highly fluctuating revenue. These kinds of accounting irregularities can be resolved either through restatements or acquisitions … complicated acquisitions let you obscure accounting irregularities.

He’s not necessarily alleging they’re doing something shady, but it’s a good example — always look to make sure that a company you think is earning a lot of money on the income statement is also generating cash on ...

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