Finsbury Food - A Hidden Gem or Dog?

I first came across Finsbury Food (LON:FIF) in 2010 when they were at 16p a share, or at a market cap of under £10m. At first glance that valuation seemed ludicrous, they had decent cash flow, turnover of £170m, profits after tax of £3.29m, better still, they operated in niche areas of the cake business, all these areas to which they were, if not the market leader, one of the market leaders. That market share it must be added was growing, and though turnover and profits had marginally fallen from the previous year, considering the environment at the time, it seemed to be nothing but a blip.

However, one issue became apparent when looking at the balance sheet, they were heavily indebted, totally liabilities were actually near £78m, with current assets just £28m, which would not have been too bad, had the current liabilities contribution of that figure not been £50m, of which, £15m was debt. This again, may not have been too bad, for that £15m of bank debt could easily have been carried over, and was enough to cover the short fall of current assets over current liabilities, but the true problem arose from the other £25m of debt in non-current. This meant total debt was £40m, which created interest payments of £3m a year. When the times were good (I.e. pre-2009), cash flow easily covered this, paid down debt, paid dividends etc; however, after 2009, with fears over growth, debt of this high on a company Finsbury's size saw people rate it as if a certainty to go bust. After all, who would buy luxury foods, especially cakes, when the world was ending?

Well if today is to go by, a lot of people, for over that period Finsbury have continued to grow market share -- for example, in the total ambient cake market they have increased their share from 17.3% to 18.4% (a £909m per annum market) -- proven that the drop of turnover and profits of 2010 was but a blip -- turnover for 2011-2012 (mid year finals) was £208m, with operating profit of £9m and after tax profit of £5m -- and because of it have seen a re-rating of the share price from the 16p of 2010 to 38p now. To highlight an interesting quote on their website, they state:

Finsbury is the UK's number one supplier of premium cake, and second largest supplier of cake to the UK’s multiple grocers, with a 20% share of the total pre-packed cake market.

So everything seems good?

Well, the most important thing to do is look at the balance sheet, and compare it from 2009-2010 to now. At first glance, there seems little improvement, total liabilities are still in total £78m, of which the current proportion has now increased to £56m, though non-current has dropped by £5m to £23 thanks to the repayment of £5m in long-term debt (so in essence, they have just moved the trade and receivable elements around, allowing them to pay off some debt). However, it is not all bad, as current assets has increased to £37m. This means the gap of current assets over current liabilities has decreased by £3m over the last two years. But that is not much, which brings me to my qualm with the company, the one thing that has continued to make me question Finsbury as an investment case: CASH BURN.

They earn decent cash from their business, this is a given if you look at their history for the last five years, they can easily cover interest payments (as long as they remain at current rates); however, after is where the issue arises, expenditure from investing activities added to debt repayments leaves cash burn looking troublesome. More troublesome, cash flow in this period was down £1m versus last year. This saw cash at the last interims come in at just £63,000. As soon I saw this figure, the thought they are going to need a cash injection came to mind, and, low and behold, just recently they held one, raising £3.9m at 38p a share. Three directors took part in it, spending around £110,000 between them, and the directors hold a large portion of the company, with CEO Martin Lightbody alone holding over 30%, with combined director ownership standing at near 50%.

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Now here comes my issue, for near three years of growing the business, the actual financial position has improved by just £3m, that's £1m a year, and due to debt repayments, cash holdings (which were only improved in the first place after the 2008 crash thanks to debt drawdown's) continues to fall at a rate of about £1-2m a year. The placing they say is to help spur growth, but in reality is seems more of an attempt to tide the company over so they can continue the current status quo.

This is where my worry comes in, the management as substantial shareholders likely want to hold onto as much of the company as possible, hence, they likely will be very reluctant about staging rights issues, especially at the current low market cap of just £25m. In terms of value, this seems illogical, for if Finsbury raised £15-20m, and paid short term debt off, keeping £5m for cash balance purposes, current assets over current liabilities would immediately be balanced, cash burn would cease, and a return to dividend payments would be immediate.

All of this would likely see an immediate re-rating in the share price to likely between £70-100m, for we would have a market leading company with a strong balance sheet, dividends of likely £1m a year, much room and financial leeway for growth, more free float, less management owned, and a driven management team.

But without a more substantial rights issue to bring order to the balance sheet once and for all, it seems Finsbury are destined to continue to play a dangerous game, relying solely on markets remaining strong, growth continuing to come its way, and drip feed rights issues every now and then to keep them alive. All of this means a likely languishing share price for many years to come, which is sad, because this company has much to offer.