On 28 May 2012, one of Australia's leading providers of building maintenance and technical services, Hastie Group, went under.  While most investors were shocked by the news, smart investors with a keen knowledge of fundamentals already knew the warning signs. Hastie was high risk.

While the administrators attempt to sort through the wreckage, the blame game has already begun in earnest.  Hastie executives are blaming reluctant banks for refusing to go along with the latest in a long string of debt restructuring efforts.  Investors are pointing the finger at the company’s auditor, Deloitte & Touche.  The former Leighton Holdings Executive brought in to save Hastie Group is now decrying the multiple mistakes of previous management.

In the midst of all this over 2,000 jobs may be lost, and the holders of Hastie ordinary shares have lost precious savings.  Investors faced the risk and now they will pay, and pay dearly.

Forgetting about the blame game for the moment, should any investor with a stake in Hastie be all that surprised?  While no one can predict the future with certainty, were there warning signs indicating the risks with investing in Hastie were simply too high? Can we learn to spot another Hastie in the making?

Many investors rely on analyst opinion.  Since they are professionals, we assume they know more than we do and would certainly sound an alarm of impending doom.  The Hastie story provides an ideal case study to test that assumption and to perhaps learn how to add our own analysis to the mix.  If you are willing to put in the time, you have access to many of the same numbers and business events the analysts do.

The following table uses data from InvestSmart to summarise analyst ratings for Hastie group over the past year and a half.  We eliminated some months where there was no substantial change.  Here is the table:

Analysts, in theory, have more indepth knowledge on a company and more resources on hand.  As you can see from the table, in October 2010 analysts were uniformly positive - but then clouds appeared on the horizon. 

Retail investors are not all financial wizards but there are three things analysts evaluate that investors should understand.  Hastie’s troubles were predictable, although the company's ultimate demise may not have been. 

Here are the three areas of note:

Debt and Gearing
Cash Flow
Management Changes

Some claim that Hastie's troubles centred around accounting irregularities totaling $20 million dollars.  It was this blow that sent the company over the edge. 

However, there were indications that Hastie had been standing at the edge for some time. 

Certainly investors are angry with Deloitte & Touche for not uncovering the fact that the books had been cooked; but a string of earlier warning signs should have been ample reason for retail investors to sell, regardless of what the analysts had to say.

The Hastie tale can be summed up simply.  Prior management took on too much debt acquiring companies, and rising expenditures from these acquisitions - which were not integrated - ate up available cash.  The new management brought in to stem the tide couldn’t.  It’s that simple. 

The truth is Hastie had been struggling with debt for years, dragging shareholders through multiple debt restructuring schemes, capital raisings, and three separate trading halts associated with them.  Here is the picture worth a thousand words about Hastie:

The timeline of events afforded multiple opportunities to get out and preserve capital.  Before we review some of those events, let’s take a look first at the company’s revenues, profit, long term debt, and gearing over the last three years.

Hastie’s fiscal year runs through June with results generally released in August.  The 2010 result showed a 35% drop in profit; long term debt was high and gearing was at levels many would argue are verging on dangerous.  The net interest expense cover, which indicates the number of times the company could pay the interest on its debt via available cash, was declining but still enough to convince some to hang on.  Those who fled in early September 2010 got out for around $15 a share, split adjusted.

Investors who agreed with the 6 analysts with BUY recommendations on HST in October of 2010 may have felt comfortable with the company’s cash position, given management was proclaiming a strong balance sheet.  Their comfort was misplaced.  Here are some cash flow numbers for Hastie over the last three years:

By the time the company reported in August 2011 the picture had gone from troubling in 2010 to desperate in 2011.  The negative numbers for investing cash flows usually represent acquisitions and we know this to be true for Hastie.  Negative numbers in financing cash flow generally come from dividend payments and share buybacks coupled with repayment of debt principal, which is exactly what Hastie was doing.  Borrowing new money to pay off old is often a recipe for disaster.  Negative cash flow speaks for itself. 

Investors who knew when it was time to take a loss could have looked at the troubling 2011 numbers and gotten out in September and October 2011 for $0.93 instead of the $0.16 the company was trading for near the end.  At that point they could see Hastie was relying on financing cash to operate and was in dangerous territory in regards to keeping current with interest payments.  Most experts will tell you to stay away from any stock with a net interest cover less than 1.5 and Hastie’s was 1.35.

A walk through Hastie’s ASX announcements over the past two years show events that - when taken together - should have raised red flags.  As far back as June 2009 the company resorted to a capital offering totaling $77 million to pay for its expensive tastes in bolt-on acquisitions.  That could have been the first dot on the board; followed by other events that when connected spelled trouble.  Here are some of the other “dots:”

1 July 2010 Refinance of term debt facilities until 2013
7 December 2010 Hastie Group Limited – Price Query –Shares Fall with No Apparent Explanation
23 December 2010 Bank Facility Agreement Update
16 February 2011 TRADING HALT Suspension from Official Quotation Pending Restructuring Negotiations
11 April 2011 REINSTATEMENT TO OFFICIAL QUOTATION
20 May 2011 Hastie updates market on capital restructure
8 June 2011 Progress update on potential recapitalisation
14 June 2011 TRADING HALT until 17 June Pending Company Announcement
14 June 2011 Hastie Group announces comprehensive recapitalisation and debt facility restructure to strengthen its balance sheet and provide financial flexibility to support organic growth
17 June 2011  Hastie Group announces successful completion of institutional entitlement offer and conditional placement
12 July 2011 Hastie Group announces successful completion of Retail Entitlement Offer
25 July 2011 Hastie recapitalisation complete with new syndicated debt facilities providing funding until FY14 and FY15
19 August 2011 RESIGNATION OF GROUP MANAGING DIRECTOR and CEO
10 October 2011 Appointments of Interim Chief Executive Officer and Chief Financial Officer
8 February 2012 Retirement of Chairman and Appointment of Interim Chairman
27 March 2012 Price Query regarding Intraday Share Price Drop
11 April 2012 MARKET UPDATE – REVISED SYNDICATED FACILITY AGREEMENT SIGNED
13 April 2012 Hastie Group Limited TRADING HALT
13 April 2012 FURTHER DETAILS IN RESPECT OF REASONS BEHIND TRADING HALT REQUEST
17 April 2012 HASTIE GROUP LIMITED SUSPENSION FROM OFFICIAL QUOTATION Pending Resolution of Middle East payment dispute
4 May 2012 APPOINTMENT OF NEW CHIEF FINANCIAL OFFICER
7, 11, 15, 25 May Market Updates
25, 28 May 2012 RESIGNATION OF NON-EXECUTIVE DIRECTORS
28 May 2012 Appointment of Voluntary Administrators

There are so many troubling items in this tale of woe it is hard to know where to begin.  Debt restructuring and capital raisings can be positive in the long run, but again and again?  Announcement of agreement followed by revisions and endless updates should not inspire confidence in even those investors who get a thrill from high risk ventures.  Of the three trading halts in 14 months the last should have put the final nail in the coffin.

In the midst of this sad saga, Hastie Group Limited requested a trading halt pending an announcement being made “following the Board’s consideration of issues which arose overnight in respect of one of its joint venture projects in the “Middle East”, in particular a threat to call bank guarantees by the Builder.

The shares were suspended on 17 April, never to trade again.  The Middle East dispute headed for the courts but when the final market update unfolded on 25 May with the revelation of internal fraud, Hastie Group took its last breath as a publicly traded company.

Throughout all this the management changes should have alarmed everyone.  The first was the CEO who retired shortly after the recapitalisation agreement was reached.  Within six months the Chairman of the Board left and shortly after that the recently appointed CFO left to be followed by some company directors.

There will be other Hastie Groups in the future.  Retail investors would do well to rely on three critical ratios when considering an investment or reviewing an existing holding.  Cash is King they say, and companies with adequate cash flow usually survive.  Here are the ratios:

Cash Flow to Debt Ratio
Operating Cash Flow/Sales Ratio
Cash Flow Coverage Ratio

Cash Flow to Debt Ratio

Cash flow is the difference between revenue generated and received by a company and revenue going out in expenditures.  The Cash Flow to Debt Ratio is a broad ratio measuring the company’s ability to meet debt obligations in a given period, usually a year.  Debt obligations include both the total long-term debt and the part of that debt payable in the time period as well as short-term debt, due in full during the year.  Here is the formula for the ratio:

Cash Flow (CF) to Debt Ratio = Operating Cash Flow (OCF)/Total Debt

Operating Cash Flow/Sales Ratio

How well does a company translate its sales into cash?  The Operating Cash Flow (OCF)/Sales Ratio gives an indication.  Here is the formula:

OCF/Sales Ratio = OCF/Net Sales or Revenue from Sale of Goods and Services.

Cash Flow Coverage Ratio

This ratio measures a company’s ability to meet or “cover” debt due in the current year with its current cash flow.  Here is the formula:

Cash Flow Coverage = Operating Cash Flow/Short Term Debt

You’ll find operating cash flow on the companies Statement of Cash Flow and short term debt on the Statement of Financial Position.

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