“Accounting is useless. Backward-looking”

But if you had analysed this footnote, you would have avoided a 90% drawdown

It’s 2019. Green hydrogen promises to revolutionise the world.

You went all-in. $1,000,000 of NEL NO. The world’s leading hydrogen technology company.

By the end of 2020, you have almost $6,000,000.

~150% return per year!

Quality compounder! Let’s launch a fund! (Cringe)

Today, you’re left with only $400,000.

93% drawdown.

This quality compounder has turned into a value trap! (Cringe again)

While management waxed lyrical about strong insatiable demand during Q4’20 earnings call, they buried damning clues inside their 2020 annual report.

If you had only paid attention to their accounting footnotes, you could have dodged a huge bullet.

Let’s dig in.

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Nikola drove NEL’s rally

Pun very much intended.

The now-bankrupt hydrogen truck maker had grand plans to build a nationwide hydrogen fueling network in the US.

Nikola selected NEL as a primary equipment supplier, creating massive future revenue projections for NEL.

To meet ‘surging demand’, NEL started building a new factory at Herøya.

This was reported in the financial statements as additions to assets under construction during 2019 and 2020:

Source: NEL (2020)

The devil lies in the footnotes

What I missed out, and which was later pointed out to me by one of the smartest analysts I knew, was the impairment of assets under construction in 2020.

This was the damning clue:

Source: NEL (2020)

Many investors dismiss impairment. ‘Non-cash’ and ‘non-recurring’. Why bother?

But they are missing out on the serious implications. Management only impair assets when future demand deteriorates more than expected.

To oversimplify, impairment = asset cost - value in use¹

Value in use = how much management forecasts the asset will earn over its useful life.

When future demand weakens more than expected, value in use falls below cost. That’s when management needs to impair the asset.

An impairment is essentially management’s confession that demand has weakened beyond expectations

In management we trust?

Let’s return to NEL.

Starting late 2019, the company was ramping up construction of a major new factory.

In Q3’20, management impaired almost 10% of asset under construction.

Yet, during the Q4’20 earnings call, management boasted of a “strong order backlog, more than 90% up from the same quarter last year”

What would you do?

Coming up next

Next week, I’ll be back with 2 to 3 more interesting ideas.

I’ll then analyse the most voted idea from my last post.

Right now, that’s Nine Entertainment (NEC AU). Greggs plc (GRG LN) is the runner up.

Haven’t voted yet? Check out my last post: Yet Another 2 Interesting Opportunities

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Disclaimer

This publication is for informational, educational, and entertainment purposes only and does not constitute financial, investment, legal, or tax advice. The content herein is a record of my personal research and investment process, and all analysis, forecasts, and opinions expressed are solely my own.

I make no representation or warranty, express or implied, as to the accuracy, completeness, or timeliness of the information provided. The stock market is highly volatile, and my forecasts, estimates, and assumptions may prove incorrect.

I am not acting as your financial advisor or fiduciary. You should not rely on any information in this publication to make investment decisions. Under no circumstances will I be held liable for any direct, indirect, or consequential losses or damages arising from your reliance on the content of this publication.

At the time of publication, I do not hold any positions in the companies mentioned in this article, either long or short. I may change my views, predictions, or personal portfolio positioning at any time without notice.

Notes

1. Accountants, please don’t stone me.

I know this is a gross over-simplification. We need to consider recoverable amount, fair value, etc.

Heck, there’s even a difference between US GAAP and IFRS on when we should test for PPE impairment.

But not many analysts enjoy a full-blown accounting lesson, so I’ll stick to my over-simplification!