Sino-Forest / Quality of Earnings (BAV, Monday, Week 10)

The Buy Story for Sino-Forest:
-- Better than competitors
-- Incredibly growth, booming demand
-- Good relationship with Chinese government

How good are the financial statements?
Lots of negatives:
-- Unclear how they make money.
-- Unclear how to value assets: impairment factors? control over assets?
-- Huge jump in A/R, concentrated customers, weird customers ("Affiliated Intermediaries").
-- No allowance for doubtful accounts.
-- Related-party transactions.
-- Weird tax position.
BUT:
-- Tons of cash ($1.2B)
-- Solid operating cash flow

Two sources of uncertainty:
GOVERNANCE: auditor moral hazard, Canadian accounting firm.
FINANCIALS: How good is earnings quality? Will revenue convert to cash?

Big takeaway:
Earnings quality analysis can raise concerns. But concerns are different from fraud allegations, and we usually can't discern fraud from financial statements alone.

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