Sri Trang Agro-Industry Public Company Limited dual listing in SGX

The company reports impressive profit in year ended 31 Dec 2009 at 2,256 million Baht, from 457 million Baht a year ago. A closer look at the P&L statement, however, reveal that the cost of sales as a percentage of revenue for 31 Dec 2009 was significantly lower compared to a year ago. In 2009, the cost of sales was 92.1% of revenue vs in 2008, when the cost of sales was 95.4% of revenue. That results in 3.3% of revenue going directly to gross profit in 2009! (3.3% of revenue is very large indeed, considering the fact that the operating profit margin is hovering at only 1.5% of revenue for past two years)

This is most likely an effect of FIFO cost flow method under rising prices of raw material: natural rubber (lower cost inventory is sold at higher market price), which generally is a poor representation of economic cost of operation in an inflationary environment. When the raw material cost stabilizes / decreases in future, the company will lose this FIFO cost flow advantage. The cost of sales will rise to the level that reflect the real economic cost of operation. This in fact has happened in Q3 of 2010, during which the cost of sales was 96.5% of revenue, compared to just 93.5% of  revenue in corresponding period of 2009. In Q3 of 2010, a full 3% of revenue is taken away from gross profit compared to the corresponding period a year ago. Understandably, the net profit for the 3 months ended 30 Sep 2010 fell compared to 2009.

Looking at the cash flow statement, in 2008, the company liquidated 2,242 million baht of inventory without restocking, and wrote down another 686 million baht. In 2009, the company purchased 5,057 million baht worth of inventory, and wrote up another 684 million baht. Consequently, the inventory carrying value shot up to 10,173 million Baht by the end of 2009 compared to 4,433 million Baht a year ago. We can conclude that the company has been increasing its inventory in last two years. For the first 9 months of 2010, however, the inventory value has fallen by 36 million baht, reflecting the fact that spiralling price of raw material may be ending soon.

The market has erroneously considered this FIFO advantage as sustainable, thus pushing up its price from around 4.8 Baht in the beginning of 2010 to a high of 41 Baht in mid-January 2011. The closing price on 21 Jan 2011 was 36.75 Baht. I expect the price to fall further when the effect of FIFO cost flow method wears off when the price trend of natural rubber stabilize / reverse, which may take another accounting cycle to see.