Hi friends, I am handling valuation a company which maintains a negative FCFF. This is because the company has borrowed too much debt to finance its inventories. According to my calculation, the inventories day is around 500 days (horrible!). Thus, calculating value of the enterprise, I’ve got a NEGATIVE value. I just wonder whether is something wrong although this is a very good company with high gross margin and net profit margin? Could you help to explain?
i looked at a commodity wholesale company a few years ago which would buy softs from farmers and sell it to reputable companies like Kraft for a small margin. It was also in a growth stage so it would need to take on massive debt to fund its working capital. are you sure it has 500 inventory days. That would suggest its holding inventory for 1 1/2 years before it sold it. I don’t know what type of company this is but it doesn’t strike me as an efficient business model. Why does it need such large inventories? The wholesale company I looked at also had negative FCF but investors understood that this company was in a growth stage. The key issues for this company was: 1) Was it exposed to the value of the inventory? 2) What are days receivable? 3) What is the credit quality of its customers? 4) What was its interest rate risk? In the end I decided against the company as it seemed more of a trader than structurer. I hope this helps you in your evaluation.
Well, have you interview the company yet? FCFF is negative now, however, and hopefully one day, FCFF can become positive (debt is paid down, or company get more efficient). How far did you go out in your FCFF estimation?
Hi friends, Thanks for your quick response. I’ve discussed with the company and found that they are in growth process and maintained a high stock level for its new subsidiaries whereas these subsidiaries have not generated cash yet. In the future, the amount of inventories will not be changed much (Delta Inventories); it means, WC will not be changed much whereas the income will increase tremendously. I therefore can generate a positive FCFF. Thanks for your feedbacks again. Nice day.