Ostensibly, there wasn’t much to spook investors in RPC’s March year-end figures, with total provisions and other liabilities down 44 per cent year on year to £90.6m, while net cash flows from operating activities were up 40 per cent to £387m. Despite the surge of M&A activity, the group maintains that returns remain well ahead of the weighted average cost of capital.
But the accounting treatment that Mr Moran has been highlighting, namely the application of provisions for off-market contracts, enables companies to mask or distort returns through the creation of provisions on the balance sheet for acquired assets at the time of consolidation.
Theoretically, this practice can hide a multitude of sins if a company remains in the buyers’ circle and the treatment is employed repeatedly. But if the acquisitions dry up it should be easier to determine the effects of this treatment on cash flows.
RPC has previously stated that the dilutive effects of lower-margin acquisitions had periodically weighed on profitability; a more prosaic explanation, but one that’s just as difficult to quantify within the confines of a P&L statement.
Paul Moran did make the point that the recent first-quarter update referenced profits growing year on year, but not cash flows. At the March full-year, those flows had been underpinned by an adjusted operating cash conversion rate of 77 per cent, although that was down from 95 per cent in the previous year. Jamie Pike, chairman of RPC, complained that the group’s ability to pursue acquisitions is being hampered by “pressure on the market valuation and differing investor views on the appropriate level of leverage”. In other words, the Northern Trust critique has gained wider support.
If deals dry to a trickle, Mr Moran expects that a negative free cash flow trend could be apparent in the group first-half returns published in November. That would follow on from a 4 per cent decline in free cash flow at the year-end, although it’s conceivable that ongoing plans to hive off non-core businesses could eventually muddy the waters in this regard.
