Let’s take the really bad news first. AIM listed Patisserie Holdings (CAKE) shares have been suspended following an announcement of “potentially fraudulent accounting irregularities” which will significantly impact the company’s cash position. The CFO, Chris Marsh, has been suspended.
Media reports suggest there may be shortfall of as much as £20 million. The auditors are Grant Thornton which won’t improve their reputation much but as the company’s year end is September they may not yet have looked at last year’s results. According to the interim accounts in March they had cash of £28.8 million on the balance sheet and showed positive cash flow. Is this going to be another case of even the cash vanishing? I hope not.
Patisserie mainly operate cafes and should in essence be a simple business. Taking another look at their accounts, the only suspect item in March was possibly the £63 million in “plant, equipment, fixtures and fittings” at cost and another £16 million in leasehold improvements. In March they were trading from 206 stores so that suggests £380,000 invested in each store ignoring subsequent depreciation. Is that realistic? After depreciation there was £42 million on the balance sheet.
There was also £11.6 million in trade receivables (they sell cakes via Sainsbury’s for example) which I guess might be suspect. Or is it another Tesco case which is currently in court where payments from suppliers were incorrectly recognised? The last Annual Report says this under revenue recognition: “The Group has multiple revenue streams, with revenue received from wholesales, online sales, vouchers and third party funded discount schemes”. The Audit Report also said ““revenue recognition has been identified by the audit team as a significant risk”. This caused me to ask a question on this at their last AGM and you can see my report on it here: https://www.sharesoc.org/blog/company-news/revenue-recognition-patisserie-valerie-utilitywise-cryptocurrencies/ . I concluded that there was unlikely to be a problem in this area but perhaps I was wrong. With the shares suspended we shall just have to wait and see.
Luke Johnson, a well known commentator on the financial scene, is the Executive Chairman of the company and a major shareholder – he holds 38% of the shares. But he has lots of other business interests. Has he taken his eye of the ball?
Audit Reviews
Coincidentally the Government BEIS Department and the FRC have announced that Sir John Kingman is going to extend his review of the audit profession to cover how audit firms are procured. In addition he will be looking at how the interests of the users of accounts can be promoted by ensuring quality, rigour, independence and scepticism among auditors. I am certainly in favour of that although it seems likely the focus will be on larger companies rather than AIM ones. In addition the Competition and Markets Authority have launched an investigation into the audit market amid suggestions that the big four audit firms have formed an oligoply.
Telford Homes
Another announcement this morning was from Telford Homes (TEF). They are a housebuilder mainly focused on “lower cost” homes in East London. They have also moved into the “build to rent” sector as houses have become unaffordable to buy for many people in London.
I put “lower cost” in quotes because if you read the announcement their definition of “affordable” is houses that cost £540,000 on average. But they do admit that they still have to shift 25 homes priced at over £600,000. Just to explain how mad the house price market is in London, a simple calculation of affordability will suffice. I always used to think that a mortgage to income multiple of 3 was reasonable, although it seems some companies are offering 4 or 5 times now after taking into account the current low interest rates. But even on a multiple of 4, that means a first-time buyer with little deposit has to have an income of over £130,000 per annum to buy their “average affordable” home.
And what do you get for your money? The announcement mentions their new development at Gallions Point. A quick look at a map tells you that appears to be between the flightpath of City Airport and Beckton sewage works in East London. It’s not even a short cycle ride to the City Canary Wharf from there. You’ll no doubt get an apartment with a good view of the Thames though.
House prices have been mad in London for a very long time and that might continue to be so. Certainly Telford Homes depends on it. The company still expects to increase first half profits over the previous first half and are proposing to increase the dividend.
I am of course a holder of both Patisserie and Telford Homes shares.
Brexit
The FT printed a response to my letter in yesterday’s edition. The latest correspondent suggested I wished to “shut down debate” on Brexit which is not exactly true although some might have interpreted my previous comments as an attack on the whingers. Certainly I think many people are tired of the subject and simply wish the Government to conclude the matter, but my letter was actually on the false analysis and factual errors of previous correspondents. If folks wish to continue to debate the issue of Brexit, I have no issue with that, but to fill the pages of the FT with it when I pay for the publication to cover real news, is somewhat annoying.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
Re Patisserie Valerie, Lee Ginsberg the NED in charge of the Audit at CAKE has been NED in charge of Audit at Mothercare, Softcat, Trinity Mirror and On The Beach – surely anyone would say he is “overboarded”. How can he cope with all these roles especially if all reporting at same time of the year? It looks like he has taken his eye off his responsibilities at PV – has he been providing the challenge to the Executive that a good Non Exec should?
PV’s Board has not been refreshed since Lee Ginsberg joined in 2014 so the Board have probably been rather cosy and perhaps Group Think set in. This certainly can lead to complacency and in a rapidly growing coming this can be dangerous. They have no diversity, no women on the Board which is strange since a high proportion of their customers are women.
The PV Board was fit-for-purpose when they had a market cap of £40m and they have certainly proven a model AIM company in terms of growth, profits and share performance. However, I suggest their Board has not been fit-for-purpose when they were expanding to a market cap of £448m.
Some pressing questions:
• Should a company like PV not have an Independent Chairman rather than an Executive Chairman who owns 38% of the company? He also has lots of other business interests so has he taken too much for granted with the company’s controls?
• Has the Board suffered from “Group Think” since they have not refreshed it since 2014?
• Why do they have no diversity on their Board?
• They haven’t carried out annual Board Reviews (as per the Governance Codes) – would this have helped identify potential problems?
• Have their two Non Execs been too busy with their other interests to keep their eye on the ball and challenge the Executive?
The PV Board clearly needs a shake-up although one could conclude that the horse has at least partially bolted.
The trade receivables were mainly prepaid rent and rates according to the accounts not amounts owing from customers which was c.£0.5m (You can see this in the notes to the accounts). GT would have recognised revenue as a sig audit risk as there is a requirement under the auditing standards that revenue is a presumed significant risk – so this nothing unusual.