Oroton Group Limited (Oroton) have voluntarily appointed administrators to the company after the completion of its strategic review.
The strategic review process that commenced in May 2017 failed to secure a viable option for the company, leading to the appointment of administrators, Vaughan Strawbridge and Glen Kanevsky from Deloitte Restructuring Services as joint/several administrators of Oroton.
There had been some speculation that the Lane family, founder of Oroton, and Caledonia Funds Management CIO Will Vicars, would take the company private. However, this did not eventuate.
Though under significant operational strain for the past year, the most recent report from Oroton in September saw the company deteriorate into a death spiral, falling from a Strong Financial Health rating to Marginal due mainly to a significant deterioration in the company’s cash flow.
Operating cash flow in the business disappeared from $13.8 million twelve months ago to -$1.07 million. A negative operating cash flow is a drain on the business assets which can make it difficult to support ongoing business, particularly when the company exhibits weakness on the balance sheet. A failure to meet short-term commitments from internally generated cash flow often leads to disaster.
The change in the financial health rating for Oroton to Marginal was swift and occurred following the release of its most recent financials. Prior to then, though not investment grade, the company was in Strong financial health as cash flows remained robust despite the operational issues which saw revenues decline and declining Return on Assets (ROA).
However, the recently posted negative cash flow changed that view immediately. Operational issues led to the eventual deterioration in financial health and remind us that while a company may be healthy for a period if management doesn’t address its operational issues, the strain will eventually show and its demise subsequently sealed.
Oroton’s failure also reminds us of the importance of investors remaining diligent and proactive with the management of their portfolios. Specifically, in this case, when the fundamental risks that the company faced changed so quickly.
The retail industry scapegoat
Many will attribute the impact of a tough retail environment to the current state of Oroton, however, the business has exhibited declining growth figures since 2012 when the company’s ROA, Return on Equity (ROE), Revenue and Earnings per Share (EPS) started heading the wrong way. The company started its tightrope walk in 2015 when the first signs of business strain appeared, and despite a positive report in June 2016, it was closely followed by a further deterioration in their numbers.
From an income perspective, Oroton once had a history of paying an above-market grossed-up yield, however, with emerging operational issues, questions had to be asked about the sustainability of the dividends, particularly in the period between 2012 and 2014 when the company paid more in dividends per share than they were earning. Ultimately Oroton became a capital killer for income-seeking investors.
What is great today may be terrible tomorrow
While Oroton remains an iconic brand name, having had a presence in Australia since 1939, it does not guarantee that it will be successful, nor that it won’t fail. History is littered with strong Australian retail brand names that have failed under the strain of management not delivering and the company falling into poor financial health.
What ensures that a business can remain a household name in the future is not the size of its marketing budget. Rather it boils down to the fundamentals and quality of the business. Companies with high debt, poor profitability and negative cash flow will inevitably suffer the same fate as Oroton.
Once upon a time, Oroton proved itself as a worthy investment and was included in the Stock Doctor Star Stock universe on various occasions. During its tenure, investors who participated would have been able to capitalise on the gains that the company delivered.
Since its removal from Stock Doctor Star Stock classification in 2009, Oroton’s share price has fallen from $5.44 to the latest traded price of $0.435. Once again, this demonstrates the importance of choosing investment grade stocks from either a growth or income perspective based on Lincoln’s nine Golden Rules investment process. Otherwise investors are investing blindly and seriously risking loss. Oroton reminds us once again why prevention is better than cure when it comes to identifying a stock opportunity, with financial heath a key component of that.
The appointment of administrators is never an enjoyable experience; however, it is easily avoidable. Oroton, like many others in the recent past such as Ten Network, Dick Smith, Arrium Limited and Surfstitch, have been avoided by investors due to the quantitative methods that Stock Doctor employs. An unemotional and objective research process such as our Star Stock criteria, including Golden Rule One – Financial Health, will ensure investors can easily avoid such disasters.
Since its inception, Stock Doctor has accurately identified 94% of all corporate failures prior to their demise. Stock Doctor identifies the true financial health of all 2000+ companies on the ASX; delivering the confidence, control and peace of mind to construct and manage a rock-solid portfolio of the healthiest businesses on the Australian Stock Exchange.
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