After a decade of very unimpressive financial performance since...

After a decade of very unimpressive financial performance since its 2003 IPO, this company is at a very interesting juncture in its corporate evolution, with the business traction that commenced about 3 or 4 years ago seemingly now something permanent.

For context, this latest result - notably for the second-half of FY2018 - is quite something to behold, both in absolute terms, as well as in the context of the company's history, even the recent (4 years) history when the company has been demonstrating impressive organic earnings growth.

Because in JH2018 (the blue column) EBIT was 86% up on JH2017 and, as can be seen from the chart below, it was miles ahead of any other previous record half-yearly result for KME.  



Of course, one of the questions about this Godzilla-size second-half result that I ask myself is how a result could come in so much higher than management expectations which were struck just 3 weeks before the end of the financial year?

Because, recall that the update provided on 12 June 2018 referenced FY2018 EBITDA between $3.4m to $3.6m and NPAT between $1.7m and $1.8m.   As it happens, EBITDA came in at $3.84m, and NPAT at $2.02m, so well ahead of guidance that was provided at a pretty late stage of the period.  The arithmetic won't be repeated here, but it effectively means that, for the second-half, EBITDA came in 11% better than the higher end of the guidance range, and 22% higher than the lower end of the range; and NPAT came in a whopping 20% better than even the higher end of the guidance range, and a 31% higher than the lower end of the range.  And, as I said, this significant degree of out-performance is against guidance that was given just a few short weeks before year-end.

So, because that guidance was presumably struck based on the May, year-to-date, unaudited management accounts, what - I wonder - happened during the month of June that caused such an unexpected surge in second-half profits.

It certainly wasn't anything on the revenue line, because JH2018 Revenue was just 1% higher than JH2017.  The one thing that I can identify is a very low expense line relating to the item labelled "Royalties, Commissions and Other Direct Expenses" which, as a proportion of Revenue, collapsed in the second-half, to 23%; down from 32% in DH2017 and 34% in JH2017.

Now, while this figure has been declining over time, in JH2018, it took a very significant step down, as the chart below shows.



Whatever drove this, it has been the most significant driver of the earnings of the business in recent years, and having an understanding of what this metric does in the future is critical to being able to get a good sense for whether or not the strong earnings growth can continue.


And while it is difficult to be certain about this aspect, what is very certain is the great financial shape that the company is in now, with a record >$5m net cash balance (equivalent to almost 20% of the market value of the company).




This means that Current Assets (of which ~90% is cash) is today approaching the value of TOTAL Liabilities; which puts the company in rude financial health, and a long way from being in severe balance sheet duress some 5/6 years ago.




That a $30m company can, within a 5-year period, go from being in debt to the tune of $3m, to having net cash of $5m - without any recourse to shareholders for funds - and while paying out more than $2.5m in dividends, is quite a statement about the organic cash generating ability of such a company, I think.

Of course, the obvious question today is what does the management, of what is essentially a family-run business, do with all this new-found fiscal largess?

Allow it to simply build up over time?
I somehow doubt it.

And that is a bit of a concern for me.