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Fragrance Group Limited’s Earnings: What’s Next After Seeing A Huge Drop In Profit?

Fragrance Group Limited (SGX: F31) had reported its fiscal fourth quarter results for the financial year ended 31 December 2014 yesterday.

Over the past few years, Fragrance Group, a major real estate developer based in Singapore, has been busy restructuring its business.

In 2012, the company spun-off its hospitality business to Global Premium Hotels Ltd (SGX: P9J). Then, in the third quarter of 2014, Fragrance Group announced yet another possible spin-off, this time of its Australian real estate business.

Fragrance Group is not content with just carving out its businesses however – just last month, the company had teamed up with Aspial Corporation (SGX: A30) in a 50:50 joint venture to acquire LCD Global Investments Ltd (SGX: L38), a property developer which also runs hotels, resorts, and serviced apartments amongst other real estate-related businesses.

With all these as a backdrop, let’s dig into Fragrance Group’s latest set of results and see (1) how it has performed, and (2) how the aforementioned deals might affect its business – for good or for bad – going forward.

The results

For the whole of 2014, Fragrance Group recorded a 10.9% increase in revenue to S$519.5 million. But, lower selling prices for property units in 2014 had weighed down on the bottom-line, starting with a 10% dip in gross profit from S$184.3 million a year ago to S$166 million.

An increase in operating expenses and the log of much lower fair value gains in 2014 had resulted in a big decline in net profit from continuing operations; the figure was S$158.8 million, down 30.4% from S$228.1 million seen a year ago.

Interestingly, Fragrance Group’s earnings announcement stated that part of the increase in operating expenses was due to higher performance bonuses to directors. This has happened despite the big fall in profit which I just mentioned.

After accounting for results from Fragrance Group’s discontinued operations, the company’s total profit for the year was S$163.8 million, down 34% from a year ago. Fragrance Group shareholders’ stake of that pie was S$156.4 million (after catering for share of profits to minority interests), down 25% from a year ago.

Fragrance Group continues to operate with high leverage. At end-2014, the company’s net debt (total borrowings net of cash) to equity ratio at stood at 89.5%; it was nearly 91% at end-2013.

Despite the high leverage, the company’s interest expense for 2014 was only S$8.3 million, which is tiny compared to revenue of more than S$500 million. This might make it seem like interest expenses would not be much of a problem for the firm. But there’s actually more to it beneath the surface.

Thing is, investors have to bear in mind that a large portion of the interest paid out in cash by property developers are usually capitalised as part of their asset base. It’s a similar case with Fragrance Group; a glance at the company’s cash flow statement would reveal that the firm actually paid out S$24.2 million in cash as interest for the whole of 2014.

This can be an important point to note when it comes to thinking about property developers’ real financial strength and liquidity constraints.

What’s next?

With 99.9% of Fragrance Group’s 2014 revenue coming from Singapore, the health of the property market here would naturally be of focus.

Unfortunately, there are no signs of a recovery taking place in Singapore’s residential real estate market any time soon. As per Fragrance Group’s commentary on its future outlook, “prices of private residential properties decreased by 1.1% in fourth quarter 2014, following the 0.7% decline in the previous quarter. This was the fifth straight quarter of price decline.”

Fragrance Group’s Australia-based business is still tiny in the scheme of things, but its spin-off might still be a good way for the company to raise some much-needed cash to strengthen its balance sheet.

But that said, the potential buyout of LCD Global may still require Fragrance Group to take on yet more debt given the former’s implied total value of S$348 million at the offer price of S$0.33 per share. For some perspective, when the takeover was first announced, Aspial and Fragrance Group had a collective 29.3% stake in LCD Global.

All told, if the two deals – the spin-off of the Australian business and the acquisition of LCD Global – are done, Fragrance Group would be left with only its Singapore-based real estate development business and a partial stake in LCD Global.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim does not own any companies listed above.