Alumasc undone by poor financial control again

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.

Comments

Smells a bit like a cock up.

Possible scenario?
Sales team does deals that exceed capacity or are more complex than original thought. Production struggles to maintain pace and the usual failure occurs..... Quality control. Something suffers in production and at some point parts start returning from the purchaser. Cue a review, large write off of returned, completed & part finished stock. Perhaps some contract penalties too, for late delivery of re-worked or replacement parts.

This does happen (or similar scenarios) but it should not take until a half year audit for someone to figure out there is a problem and solve it with minimised losses. That is a sign of a poor control framework in the business.

Hi Bob, thanks for comments. It sounds like a very plausible scenario and I'm grateful to you for showing how cost-overruns could lead to a write off an inventory, something I was puzzling about. The fact that it seems to have happened before is worrying, especially as the business is decentralised.

Hi Richard, I have read your comment on Alumasc Precision and that of Bob with great interest. I agree with what you say but I can add a bit more down to earth info on what has possibly caused this to happen at this time. Yes the order books are full but the customer expectation on delivery and quality will be difficult to meet with the current depleted skilled workforce and management regime. The main reason for this is that there is just not the skilled team of shop floor competant people who know the casting process, (you could count these people on one hand). This will never be sufficient considering the many different types of castings made and the volumes required. The reason for this skills shortage is very simple, some have been made unjustly redundant, but more recently a good number have been hounded out of the company by the current incompetant management regime. These were very capable loyal people who had worked at Alumasc Precision for many years and had a wealth of experience between them, this also includes one very competant director!

You may ask how do I know this? Well I worked at Alumasc Precision for almost 30 years and was the high pressure foundry manager on two occasions, (I was made redundant in 2008 aged 64) but I still meet socially with many of the very disgruntled current workforce. The product starts life in the foundry so it needs all the skilled and experienced personnel possible to achive a quality casting without having to later rework or airfreight to the customer for late deliveries.

Lastly if more money was spent on the manufacturing equipment instead of expensive company cars this could also improve product quality.

Doug Ward

Hi Doug, thanks for your comments, although I’m very sorry to read them.

Since the building products division seems to be the main focus of senior management and its increasing importance has coincided with cock-ups at Alumasc Precision would the two divisions be better off separate? What benefit does Alumasc Precision get from being part of Alumasc? Arguably Shareholders benefit, if one part of the company supports the other when its doing badly, but Shareholders could just own shares in two separate companies.

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