Accounting Scandal on JEL Corporation (J16.SG)

I got to know about this company JEL Corporation (J16.SG) after one of my readers dropped me an email asking for help. This company has been halted for trading since 28-Sep-2007, due to accounting irregularities found by KPMG Forensic. As such, many are still holding on to their stocks and are unable to sell their holdings after 4 months.

This is one of the worst nightmares for long-term investors. So what exactly went wrong? Can retail investors anticipate such events and avoid buying into them? I ploughed through all their previous SGX announcements back-dated to year 2006 and concluded the following observations:

1. Year 2006 proves to be very promising as JEL captures more deals with prominent brands and directors have been purchasing the shares in the open market. In addition, Executive Chairman placed out his own shares to institutions.

2. However, things start to look cloudy during the start of Year 2007. New shares at $0.22 were placed out to investors Mr. Goh and Mr. Koh, raising about SGD 6.5 mil. There are no concrete plans as to how these proceeds are to be used, management highlighted that the proceeds will be used for working capital purposes.

3. Full earnings report for FY2006 was published on 26-Feb-2007. Though bottom-line seemed to improve by a good 18%, but it is a far cry from the 65% surge in revenue. The drastic difference in net margins raises a red flag. Some might argue we ought to exclude the one-time gain in operating income in FY2005 to compare the net profit improvement. Nevertheless, even by looking at the FY2006 figures, net margin is only 2.2%. A company with very low margins should be examined more carefully to ascertain the future profitability.

4. In FY2006 report, a dividend of SGD 5.8 mil is announced, which comes up to almost 75% of the 8 mil profit. This raises another question. Why did the company decide to give out such a high percentage of dividends? Why did the management make such a decision when the company is in a growing stage, with debt-to-equity ratio of more than 1, and it just raised working capital from share placements a month ago? Shouldn't the company retain more of its profits to assist in its growth? It seems to me the new placement investors are transferring their money to the major shareholders.

5. After looking at the cashflow statements of FY2006 and FY2005, it seems that net operating cash flow is always less than net profit, which raises another red flag. Net operating cashflow (OCF) tends to be higher than net profit since net profits include depreciation and amortization charges. Net profit in FY06 seems to be higher than FY05, but OCF still remains quite stagnant at SGD 4+ mil.

6. On 14-Jun-2007, management again intends to raise working capital by share placements of 20 mil shares at $0.33. First 10 mil shares were placed out successfully on 09-Jul-2007.

7. FY07H1 results were announced on 13-Aug-2007. Net profit were up 5.2% from the previous period to SGD 4.3 mil, but on closer look, other income made up SGD 5 mil, so the company actually made a loss in reality. OCF gets worse, though it might be due to the seasonality. OCF came in negative. It also shows that the company is a cash burner as the proceeds from the Jan 2007 placements have already been fully utilised in a short span of 6 months.

8. On 17-Aug-2007, Almaq Investment Group Limited decided not to subscribe for the 10 mil new shares. Caution must always be exercised whenever institutions decide not to go ahead with the share subscription. They probably have access to some information which retail investors do not have. This is the last red flag, which eventually triggered the trading halt of the company a month later.

I believe the above are clues, which question the management's capability and their propensity towards flawed reporting. In addition, it is advisable to avoid companies with market capitalisation less than SGD 100 mil, as depicted in JEL case. Such companies probably do not have a reliably long operating history and they might not be able to weather an economic downturn.

Even though we can scrutinise the figures reported in the earnings report and put in our best possible efforts to detect any creativity, we can never outsmart the management if they intend to cook their books. So in order to protect our capital, please bear in mind to invest only up to 20% of your assets in a single company.

Please note that my objective is to educate the public on identifying red flags in companies and exiting them timely. This post is definitely not to gloat over others' misfortunes in this JEL scandal. I sincerely wish that the truth be uncovered in the earliest time to redress the grievances of all JEL shareholders. Last but not least, I urge all retail investors to help one another by highlighting companies with possible traits of accounting frauds, thereby reducing the recurrence of such dire situations.