Australia’s largest private child care company, ABC Learning Centres, announced an 86% increase in profits and 150% rise in revenue this week after another year of stunning growth. However, the market was less than impressed with the result.

ABC’s 86% profit rise (from $45.5 million to $81.1 million) was primarily due to the company adding Australian child care centres and the acquisition of US-based Learning Care Group Inc in January. However, while ABC recorded a significantly higher headline profit figure, it also had more shareholders clamouring for their piece of the pie. After several equity raisings during the year, ABC’s paid-up capital increased from $636 million to more than $1.6 billion by 30 June 2006.

In its results announcement and presentation to shareholders, ABC headlined its announcement by stating an increased net profit result. Nothing wrong with that. However, given ABC’s significantly increased capital base during the year, a more important number for shareholders was the change in EPS. It is here ABC seemed to engage in some financial alchemy.

In its announcement, ABC stated that on a pro-forma basis EPS had increased by 76% during 2006. However, if you dig a bit deeper and look at ABC’s preliminary results, EPS increased on an actual basis from 23 cents per share to 27.7 cents per share, a rise of only 17%. The reason for the pro-forma result being vastly superior to the actual result was because in 2005, ABC’s pro-forma profit was $14.5 million less than its actual profit (due to the profit from the sale of child care licences being stripped out of the pro-forma result). That meant that when ABC wanted to compare EPS growth over the last year, using the pro-forma numbers it was starting from a smaller base. It seems that ABC is picking and choosing the best numbers to tell the market, regardless of whether those numbers are providing an accurate representation of the company’s performance.

Warren Buffett has in the past been a critic of reporting results on a pro-forma basis. He notes in his 2002 annual report that:

“If you’ve been a reader of financial reports in recent years, you’ve seen a flood of ‘pro-forma’ earnings statements – tabulations in which managers invariably show ‘earnings’ far in excess of those allowed by their auditors. In these presentations, the CEO tells his owners “don’t count this, don’t count that – just count what makes earnings fat.”

In a sense, ABC did the reverse – using pro-forma figures to provide a lower base upon which it compared the current year’s EPS. But the principle is the same: using pro-forma numbers may often provide an unclear picture as to a company’s true performance.

Even after the recent price fall, ABC is still trading on a lofty P/E ratio of 21. Despite a soft increase in EPS, the market is still happy to treat ABC like a growth stock. However, one wonders whether Eddie Groves can pull out another rabbit or whether the market will start to lose patience with the child care behemoth.

Peter Fray

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