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Ben Hoskin

The spectacular demise of Greensill Capital earlier this year was watched closely at 9fin.

We looked at names that confessed exposure to reverse factoring, although we note this list is potentially far from complete due to very limited disclosure requirements for the practice.

As a reminder, reverse factoring is the practice of suppliers receiving early payment on invoices from a financial institution, with the buyer on the other end of the invoice agreeing to send payment to the financial institution at a later date - thus the financial institution steps in to take on the counterparty risk for the price of a small haircut on the invoice it purchases from the supplier. A visual representation is shown below.

So a quick word on the working capital and cash conversion cycle implications of supply chain financing. As we noted in our review: “In and of itself, the practice makes sense - you don’t have to pay your supplier for a bit longer and you can keep that money to fund operations or investments”. We can understand the appeal, particularly in a pandemic year.

The obvious impact on cash conversion is the extension in days payables outstanding, which would help to drive down the cash conversion cycle in the case of the buyer (debtor in the commercial transaction) via longer supplier payment terms, in some cases for as long as 365 days.

So going back to the names we flagged in our report. Days Payable Outstanding rose between FY18 and FY20 for eight of the 12 names, with Telepizza, Piaggio and Samsonite exhibiting the most pronounced increases. These three - along with Groupe Casino and Nomad Foods - were the only names in the below chart to come in higher than industry averages, with the remainder in line or below the norm.

Piaggio’s 174.2 and 142.58 payable days for FY19 and FY20 respectively comes in higher than the Automotive Manufacturer sector average of 116.7 and 138.4-days (source: 9fin).

Telepizza and Samsonite were well above; the former posted days payable for FY19 and FY20 of 315 and 351-days (vs 140 and 182 Restaurants average), the latter 155 and 239 (vs 70 and 92 Consumer Durables average).

One noticeable trend were relatively larger increases between FY19 and FY20 for half of the names, perhaps understandable as suppliers relaxed payment terms to assist their customers during the depths of the pandemic - a trend discussed in our Q3 working capital analysis. Of course, an alternative driver could be a larger reliance on Supply Chain Finance during FY20.

The main issue with supply chain financing is summarised nicely by Marc Rubenstein in his Net Interest newsletter:

“The primary incentive to use supply chain finance is to make your balance sheet look stronger than it really is.” It’s an off-balance sheet obligation that is essentially debt; the company is using a financial institution to obtain a short-term interest-bearing loan.

There’s plenty of high-profile corporate failures related to the practice. Construction company Carillion collapsed in 2018 after supply chain finance allowed ~£500m of debt to be booked as “other payables”. Brighthouse, NMC Health, and Agitrade also went bust, having used reverse factoring. Many of these were counterparties of Greensill.

The lack of disclosure rules or guidance under both GAAP and IFRS makes this a minefield for investors when assessing the financial health of a company. To give an idea of the impact off-balance sheet working capital facilities can have on a company’s financial position (though these aren’t supply chain finance), try this extract from Raffinerie Heide’s FY19 report.

“Without the conclusion of these agreements and with all other conditions remaining unchanged, as of 31 December 2019 inventories would have amounted to approximately EUR 200.9m rather than EUR 35.8m, trade receivables to around EUR 184.0m rather than EUR 71.1m, cash and cash equivalents to EUR 2.7m rather than EUR 115.6m and trade payables to approximately EUR 292.2m rather than EUR 127.1m”

So if those facilities were withdrawn for any reason, the balance sheet is effectively rendered obsolete (note: one of these facilities was recently renewed for a lower principal amount, with one bank pulling their commitments).

Rubenstein goes on to discuss supply chain finance disclosure:

“It's something the accounting bodies are looking into. Last October, the Big Four accountancy firms wrote to the US Financial Accounting Standards Board pointing out that whereas typical payment terms with suppliers historically might have been 60 to 90 days, some entities today seek to negotiate payment terms with suppliers of up to 180, 210, or even 364 days, using supply chain finance as the bridge. Indeed, many companies using reverse factoring fail to disclose this, and those that do often have a single line buried deep in the notes, often without quantification.”

Telepizza is one of the more transparent firms in terms of exposure to supply chain financing, providing the amount of reverse factoring included in payables. 14.1% (or €12.8m) of trade payables were reverse factoring transactions as of December 31, 2020, as well as the length of payables extension (90 days).

With the fallout from the Greensill fiasco potentially far from over (Lex Greensill and David Cameron were grilled by MPs last week), disclosure is something that could and probably should move up the agenda of accounting bodies.

If you would like information about this, or any of our articles, please email team@9fin.com. 

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