Marine Harvest's Earnings Restatement Could Be Buying Opportunity; Use Caution

Jul.14.11 | About: Marine Harvest (MHG)
Marine Harvest (OTCPK:MNHVF) has restated its first quarter income -- and certainly not for the better. When I first analyzed the company’s first quarter results, the financials were not jaw-dropping but were also not bad by any stretch. You can read my original conclusions in this article; he restated numbers give me pause.
The company’s original earnings report showed a NOK606 million profit for the first quarter and a quarterly EPS of NOK0.17. These numbers were right in line with the company’s earnings in the first quarter of 2010. The restatement decreased EBIT by NOK399 million ($71.73 million) and reduced the company’s first quarter profits to NOK318 million ($57.17 million). This reduced the first quarter EPS to NOK0.09 ($0.01618). This is a 47% decline from the same quarter in 2010. The company’s operating cash flow was not affected by the error that led to the need for this restatement and remains at NOK1,036 million ($186.25 million). The company’s operational EBIT and operational EBIT margins were likewise not affected and remain at NOK963 million ($173 million) and 24.4%, respectively.
[Click all to enlarge]
Click to enlarge
Source: Marine Harvest
The need for Marine Harvest to make this restatement of financial results was caused by an error in the estimation of the fair value of biological assets. Marine Harvest provides information on this calculation in its press release (linked above):

Biological assets comprise eggs, juveniles, smolt, and fish in the seawater sites. Biological assets are valued at fair value less cost to sell, unless the fair value cannot be measured reliably. Broodstock, smolt, and small live fish are measured at cost less impairment losses. Live fish over approximately 1-1.5 kg is measured at fair value less cost to sell.

Effective markets for live fish do not exist so the valuation of live fish under IAS 41 implies establishment of an estimated value of the fish in hypothetical markets. The calculation of the estimated fair value is based on market prices for harvested fish and adjusted for estimated differences in accordance with IAS 41.18 b). The prices are reduced for harvesting costs and freight costs to the market, to arrive at net value back to farm. The valuation reflects the expected quality grading and size distribution. Further the valuation will take into account the stage in the life cycle, actual size and expected harvest weight of the fish. The change in estimated fair value is recognized in the statement of comprehensive income on a continuous basis, and is classified separately (not included in the cost of harvested biomass). On harvest, the fair value adjustment is reversed on the same line.

Thus, this reported loss of NOK399 million versus the previous earnings numbers was caused by a computational error in the formulas used to derive the fair value estimate. This is not an actual cash outflow for Marine Harvest. The company’s loss on its biological assets is a paper loss akin to a mark-to-market loss and has no impact on the company’s ability to generate cash for its investors.
Marine Harvest shareholders have taken heavy losses since the middle of May. This stock has been worst performer in my portfolio by an order of magnitude year to date. Marine Harvest hit its high of NOK7.00 on April 28 and since that time has fallen 46.85% to today’s price of NOK3.72. The ADR on the pink sheets has not fared much better. MNHVF.PK hit its three-month high of $1.34 on May 2 and since that time has fallen 48.73% to today’s price of $0.687.
Three-Month Marine Harvest Group Share Price on Oslo Bors
Click to enlarge
Three-Month Marine Harvest Group ADR Share Price on Pink Sheets
Click to enlarge
It is painful logging into my brokerage account day after day to find that my stake in Marine Harvest is worth less than the day before. It does appear that this decrease in the first quarter’s net income is a major reason for the falling stock price over the last several months. After all, net income is the most important metric for many (particularly institutional) investors. A near halving of the net income could cause their valuation models to assign a lower fair value to the stock. Their actions resulting from this could have caused the stock price to fall, much like what we are seeing. The magnitude of the stock decline is virtually identical to the fall in net income following the earnings restatement, which lends additional support to this theory.
Earnings restatements are never good things. In this case, though, this earnings restatement has not changed the company’s ability to generate cash. Ultimately, this is what means the most to me as an investor: A company’s ability to generate cash for me. It is also this cash flow and not net income that determines a company’s ability to pay dividends.
Marine Harvest reports its second quarter results on July 20. If the company can produce cash flow numbers in the second quarter comparable to what it had in the first quarter then the stock is tremendously undervalued at current prices. The company has, however, been facing significant headwinds during this quarter. They are strong enough to materially impact the company’s performance so some caution could be warranted. Needless to say, I will be watching this earnings call very closely.
Disclosure: I am long OTCPK:MNHVF.