De La Rue – A Fine Example Of Kitchen Sinking

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A kitchen sink is, well, it’s that sink in the kitchen we use to clean up the plates and cutlery in. It’s also where any old remnants of what we cooked – or failed to cook correctly – get thrown in. We also have that phrase of throwing everything, including the kitchen sink, at a problem. Either will so as a lead to the meaning of “kitchen sinking”.

The idea being that new management, perhaps just a new CEO or an entire new team, comes into a corporation and suddenly just everything that possibly could, even vaguely, be considered to be a future problem gets written down in the books. We get told about that contract that might be a problem 18 months into the future, the one lame duck court case being pursued against the company, the possibility that banking covenants might be, maybe, breached at some future point. The unions might not agree to – well, you get the idea.

To be generous about this it means that the new management team is able to scrub the decks of all the stored up problems that the exiting management weren’t all that keen to mention for fear of their bonuses and stock awards. To be entirely uncharitable there’s a possibility that the new bonuses and stock awards will be triggered by the recovery from this new low point. Especially as some of those horrors newly revealed almost certainly won’t happen and can be written back into the accounts quietly at some point in the new reign.

The process is known, overall, as kitchen sinking:

“You’re saying: ‘Let’s just sweep up every piece of bad news we’ve got, put it all in one place, take all of the flak and deal with it at the same time,'” he says. “When you’re announcing the worst figures in your corporate history, you know it’s never going to be a page two story.”

Well, yes, although there’s always, in the financial markets, that thought that rather more gets thrown in there than really has to be thrown in there. That quote above was about Tesco. This headline here is about Standard Chartered:

Everything and the kitchen sink for CEO Winters’ Standard Chartered

If you’re going to release bad news get it all out in the open. With that definite potential flavour of releasing perhaps more than is actually real bad news in order to establish a new and low baseline from which to judge future developments.

At which point, De La Rue (DLAR:LN, DLUEY:US), the quoted bank note printer over in the UK.

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De La Rue from London Stock Exchange

Not the most prepossessing of stock price charts to be sure. The company certainly has its problems. The bank note printing business has more competition in it than it used to. They managed to lose the printing contract for the new – ex-EU – British passports to a French firm of all things. Digital money is becoming more important, cash less so. Perhaps the icing on the cake was that they printed money for Venezuela and failed to get paid for it – an £18 million bad debt. You’d think you could just sorta keep some of the money back and use it to be paid but that’s not quite how it works. And, of course, given the Venezuelan inflation rate that wouldn’t work in this case anyway – the notes might well have been worth less than their printing cost on their way out the door. Don’t forget this did happen in Zimbabwe, the last lot of $100 trillion notes weren’t worth the price of the ink to print the next lot.

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Not necessarily worth the ink used to print it

But is the situation really as bad as is being said? When Tesco had that little problem over revenue recognition for shelf space every other possible future problem came out of the woodwork at the same time. Almost, but not quite, every piece of land they owned which might or might not get planning permission was valued as if it definitely wouldn’t. Standard Chartered did much the same, musing on only lightly potential problems as well as known and obvious ones.

So, De La Rue, the latest results, the first after the arrival of the new CEO and team, these are being a tad overdramatic or not? We are in the presence of kitchen sinking or merely the clearing of decks? This is something we must all make our own minds up about of course but indications are there. For example, the press briefings and thus the newspaper reports talk about how the company might breach banking covenants:

Reporting first-half figures that showed a slump into the red and a danger of breaking banking covenants because of spiralling debts, Kevin Loosemore, the chairman, told the stock market: “We have concluded there is material uncertainty that casts significant doubt on the group’s ability to continue as a going concern.”

Material, going concern, being codewords for there’s a possibility we might go bust. And, of course, there always is a material possibility that any company will go bust, that’s the nature of free market capitalism. It’s “how” material that matters.

Other reports become more blood curdling:

De La Rue, the company that prints the UK’s banknotes, has said there is a risk that the firm will collapse if its turnaround plan fails to work.

Well, yes, there is such a risk, but how much of one?

A warning that there is a “material uncertainty over its future” has knocked another 24pc off the banknote printer’s shares, meaning more than two thirds has been wiped from its value since the start of the year.

At which point we should try reading the actual accounting and stock market release rather than the press release as filtered through journalists. That stock market release containing this, to me at least, entirely fascinating little piece of information:

As at the 28 September 2019 the Group’s net debt was £170.7m and the net debt/EBITDA ratio adjusted for the basis of the banking covenant was 2.72 times, both of which are significantly higher than previously forecast.

OK, yes, stretching at least the banking covenants and so material risk as a going concern and all that. But this:

As a result, Group net debt increased to £170.7m at 28 September 2019, from £107.5m at 30 March 2019. This net debt position does not include the benefit of proceeds of £42m from the sale of International Identity Solutions, which were received after the end of the reporting period.

Ah, they’ve already sold a part of the company to reduce that debt level and bring them well back into their banking covenants. Not only that, they’ve already received the money. That net debt level is as of the accounting date, as it should be of course, but it’s not really quite reality however closely it adheres to accounting standards.

At which point we have what I at least consider to be our answer. Sure, De La Rue’s got problems, the basic business is facing more than just the occasional headwind. But we’re also more than a little kitchen sinking here. All that talk about banking covenants without emphasising that we’re talking more about a timing issue over the end of the accounting period than anything else being our little clue.

As a result of all of this I’d say that De La Rue is worth a little punt myself. For at least part of the wave of bad news – note that this is my opinion and my opinion only – is a resetting of expectations to a nice low level against which we’re all now going to measure the future performance of the new management team. That is, kitchen sinking.

The larger lesson here is yes, certainly, companies do get into trouble, some of them go bust. But predictions of when they’re about to from incoming management, or even mutterings that they might do so without some radical surgery, need to be examined a little more closely. For there is this temptation for the new regime to dump any and every possible problem in the lap of that old and ousted management team. Those problems, as they resolve themselves, making the new look remarkably better than the old.

Of course, it could be that the company really is going to go bust and that only the herculean efforts of the new team prevent it. But the very fact that we’ve even got this phrase about kitchen sinks shows that it’s a prevalent enough strategy that we need to consider it in each and every case.

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james morgan

Not sure I’d put any money into them right now. They’ve been losing lots of money even when you take that sale into account.