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How Investors Can Understand 1 Crucial Aspect Of QAF Limited’s Business: Inventory Management

QAF Limited (SGX: Q01) is a food production company. Its business activities include bakery operations, pork production, food processing and distribution, and more.  Some of the more prominent consumer food brands the company has in its portfolio are Gardenia, Cowhead, and Farmland.

The company may be interesting to some investors because of its long-term stock market performance; over the past five years, its stock price is up by 127%.

As a food producer, QAF processes raw ingredients into food products, which are generally sold to customers on a credit basis. As such, the company’s operations require a significant amount of working capital.

Working capital is defined as current assets minus current liabilities. As of 30 September 2016, QAF has working capital of S$142.5 million.

Given QAF’s working capital requirements, it is important that the company handles this aspect of its business well.

Inventory management represents one facet of working capital. In here, I want to assess how well QAF has been managing its inventory over its last five fiscal years. To do so, I will study two things: (1) Changes in the company’s inventory value compared to changes in revenue; and (2) Day sales of inventory.

Changes in inventory value

The ideal case here is to see inventory levels that decline while revenue increases. If not, we’d want to see inventory levels ebb and flow along with revenue.

Here’s a chart showing QAF’s revenue and inventory over its last five fiscal years (the company’s inventory value includes the value of livestock):

QAF revenue and inventory value
Source: QAF’s annual reports

From 2011 to 2015, QAF’s revenue and inventory have changed by 2% and minus 7%, respectively. In other words, the company’s inventory value has declined despite an increase in revenue.

Day sales of inventory

Put simply, day sales of inventory (also known as inventory days) indicates the average number of days a retailer takes to clear its inventory. For example, a day sales of inventory of 50 means there’s an average of 50 days between a retailer buying inventory from its supplier and selling the inventory to customers. Ideally, what we want to see is a stable or declining day sales of inventory.

The metric is calculated with the following formula:

(Closing inventory) / (Cost of sales) x (365 days)

The chart below plots QAF’s day sales of inventory from 2011 to 2015:

QAF inventory days
Source: QAF’s annual reports

What’s worth noting here is that QAF’s day sales of inventory has declined from 99 in 2011 to 90 in 2014 before increasing again to 95 in 2015.

A Foolish conclusion

In sum, we can observe that QAF’s inventory management has improved over the period under study with both the value of its inventory and day sales of inventory declining.

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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 contributor Lawrence Nga doesn’t own shares in any companies mentioned.