Whose cash flow pipeline is choked? - Tips for investors to spot companies facing possible money woes Straits Times - October 14, 2008

NEWS that Singapore-listed FerroChina is insolvent has put the spotlight on other China-based firms here which may be hit by the current credit crunch.

Analysts say one tell-tale sign of possible money woes ahead would be negative cash flow - where a company spends more than it receives in revenue.

These companies tend to rely heavily on credit, which is becoming far more difficult to obtain in the financial crisis.

In FerroChina's case, it had, over the past 12 months, seen a cash flow shortfall of 1.57 billion yuan (S$338 million) - so it had no money left to pay dividends and pay off debt.

It was rendered insolvent last Thursday after disclosing it was unable to repay part of its working capital loans of 706 million yuan.

Some of the most hotly traded China stocks here also have what analysts call negative 'free cash flow'. They include China New Town Developments, frozen dumpling maker Synear Food Holdings and sporting goods maker China HongXing, data compiled by Bloomberg show.

However, these firms are not necessarily in financial trouble.

Analysts consider free cash flow in looking at a company's overall financial health. It reflects a firm's ability to generate cash after laying out money required to maintain or expand its asset base. It is the cash left after subtracting capital expenditure from operating cash flow.

If free cash flow is negative, it could be a sign that a company is making large investments, or that its customers have not been making payments on time.

Generally, it is normal to expect growing companies to have negative cash flow as they expand their businesses, and not all companies which have negative cash flow are necessarily in ill health.

However, the current financial turmoil and the drying-up of credit place these companies, which may be too heavily dependent on borrowing, in a more risky position, say analysts.

'There is a higher chance of these companies running into cash flow problems and financial difficulties. It may show they are having problems collecting money from receivables,' said Sias Research investment analyst Alan Lok.

'Negative cash flow for one quarter or two quarters may be okay, but not so for the long run,' he pointed out.

Said Kim Eng analyst Pauline Lee: 'I think there's a higher risk for companies which top the negative cash flow position. But investors have to look more closely at the type of financing, such as the tenancy of loans. For example, secured long-term loans will be less risky.'

This is because companies which have a disproportionate level of short-term loans may face difficulties refinancing the debt given the current circumstances.

The market will also be cautious in dealing with companies with very high debt gearing, Ms Lee said, as it deteriorates the financial health of the balance sheet.

'With the credit crisis, it is harder to get financing, and loan credibility will also be at stake.

'Negative cash flow means these companies need capital or debt to survive. So if you chop off any of these, they might not be able to survive operationally,' said another analyst, who requested anonymity. He also said certain kinds of businesses, such as those in the property sector, tend to run up higher negative cash flow, given the larger capital sums involved. And the size of the company is also a factor, he added.