Tabcorp, A Lesson in Financial Statement Analysis

Tabcorp Holdings [ASX:TAH] first half net profits plummeted 33 percent to $81.9 million. Profits were hindered by mount expenses in the second half of 2015. There were several one off items that contributed to the fall.

But two were most noticeable. First: $8.4 million to create a new sports betting business in the UK. It’s not so bad, building a business for the future means growth. Yet expenses are usually aligned with that growth.

Second: $7.2 million towards defending themselves against non-compliant claims. The specifics of the claims related to counter terrorism matters. Tabcorp failed to notify the government of more than 30 TAB accounts opened under false names. Along with false names, fraudulent credit cards for organised crime were discovered.

Of course news of declining net profits scared investors. Shares dropped as much as 4.87% this morning. Yet this may have been an overreaction. Tabcorp’s Chief executive, David Attenborough believes that balance sheet performance was a one off. And will be unlikely to reoccur for FY17.

Tabcorp Holdings

Source: Google finance

One off items are not reoccurring

A company’s financial statements can get confusing. It’s hard to really know if a business will be prosperous. Items within the balance sheet or income statement can be misleading or hard to interpret. Why don’t they make it simpler? Because the company wants to project itself in the best light possible.

And that’s why companies pay accountants. To make themselves look amazing to investors. However there are limits. Lying or grossly misleading figures can put professionals in serious trouble.

That’s why everything needs to be provided in a company’s financial statements. The confusing part is how accountants shuffle around items. But since they need to include all items sometimes it’s hard to paint a positive picture of the company. Take Tabcorp for example. They had multiple one off items on their balance sheet which caused net profits to fall. Yet these are the items that can be misleading when analysing companies.

What is a one off item?

A one off item is one that does not reoccur. For example, Tabcorp spent millions on defending themselves against non-compliant claims. But it won’t have to pay this amount again next year. Therefore this expense should not be factored into the true value of the company.

And it’s not just for expenses. The same goes for items that benefit the company’s financial position. A good example of this is an acquisition. If Tabcorp acquired another company, they would benefit from the increase in assets, along with other items.

By looking at Tabcorp after the acquisition you might think they have experienced tremendous growth. You’re right. But it doesn’t reflect the true value of the company. The next year Tabcorp may not acquire another company.

So when investor’s looks at Tabcorp’s performance growth compared to the previous year, they will be disappointed. It may look like a huge drop off. Yet this is not the case. The growth in assets was not reoccurring and therefore it should not be considered as such.

This is what Mr Attenborough tried to get across, stating: ‘We remain well positioned to drive future performance, maintain expense discipline and achieve 14 per cent return on investing capital FY17.

Yet his words went unheard. But removing one off items from financial statements could make you a better fundamental investor for the future.

Härje Ronngard,

Junior Analyst, Money Morning

PS: Investing in a declining market is hard. Even though stocks are getting cheap, poring over financial reports can be tiring. That’s why Money Moring’s Kris Sayce has done the hard work for you. According to Kris there are five stocks that could great returns for 2016.

In his report Kris will show you a sneaky way to play the Australian property market. And he’ll tell you why 2016 is the revival of the retailer. To get your free report today, click here.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

Money Morning Australia