Larch Properties Limited ('LPL') specialises in construction of high-rise city centre office accommodation. It is an unlisted company, in which a venture capital company and an insurance company have small stakes, totalling 15% of the equity share capital.

 

There were several management changes in the company in 2021 and there was a new CEO appointed in July 2021. LPL has been badly impacted in 2021 by a lack of confidence in the city centre office property market following the continuing effects of the Covid-19 pandemic and many people being forced to work from home.

 

All revenue arises in the UK. The Board of Directors believes that revenue is falling due to a lack of consumer confidence and fears of the pandemic impact not abating any time soon. The Board, however, thinks that the company has weathered the storm and the future looks a lot brighter. As a result, the Board plans to invest significantly over the next few months in new city centre land on which to build state-of-the-art office accommodation.

 

The Board of Directors has produced a profit forecast and a cash flow forecast for 2022 that show revenue forecast at £68 million, and more land being purchased after 31 March 2022 using additional bank loan and overdraft facilities.

The financial statements for 2021 are as follows:

Income statement for the year to 31 December

	2021		2020
	£m		£m
Revenue	77.26		82.84
Cost of sales	65.28		69.20
Gross profit	11.98		13.64
Operating expenses
Administration	1.62		1.60
Sales and marketing	0.34		0.40
Depreciation - plant and vehicles	0.32		0.30
	2.28		2.30
Operating profit	9.70		11.34
Interest payable	1.40		0.20
Profit before taxation	8.30		11.14
Taxation	2.68		3.12
Profit after taxation	5.62		8.02
Dividends	3.36		3.28
Retained profit for financial year	2.26		4.74

Note:	2021	2020
Inventory detail:	£m	£m
Building plots	45.78	40.50
Raw materials	1.84	0.06
Work-in-progress	28.04	18.52
Finished office blocks	5.62	2.92
	81.28	62.00

 

 

Statement of financial position at 31 December

	2021		2020
	£m		£m
Non-current assets
Buildings	0.54		0.64
Plant and vehicles	2.34		1.58
Investments in joint ventures	2.22		3.02
	5.10		5.24
Current assets
Inventory (note)	81.28		62.00
Trade receivables	4.58		2.54
Other receivables	1.18		0.78
Cash at bank and in hand	0.50		10.96
	87.54		76.28
Total assets	92.64		81.52
Current liabilities
Bank overdraft	9.02		1.26
Trade payables	10.34		20.30
Other payables	5.62		5.42
Taxation payable	2.96		3.12
Dividends payable	2.24		2.18
	30.18		32.28
Non-current liabilities
Bank loan	8.02		0.50
	8.02		0.50
Total liabilities	38.20		32.78
Equity
Share capital (£1 nominal)	24.86		21.42
Share premium	11.74		11.74
Retained profits	17.84		15.58
Total equity	54.44		48.74
Total equity and liabilities	92.64		81.52

  

Cash flow statement for the year to 31 December

 

		2021
	£m	£m
Cash flows from operating activities
Operating profit	9.70
Add back: Depreciation	0.32
		10.02
Movements in working capital
Increase in inventory	(19.28)
Increase in receivables	(2.44)
Decrease in payables	(9.76)
		(31.48)
Cash generated from operations		(21.46)
Taxation paid		(2.84)
Net cash from operating activities		(24.30)
Cash flows from investing activities
Sale of buildings	0.10
Purchase of plant and vehicles	(1.08)
Sale of investments in joint ventures	0.80
		(0.18)
Cash flows from financing activities
Issue of ordinary share capital	3.44
New bank loans	7.52
Interest paid	(1.40)
Dividends paid	(3.30)
		6.26
Net cash movement in the year		(18.22)
Cash and cash equivalents at beginning period	9.70
Cash and cash equivalents at end of period	(8.52)
Net cash movement in the year	(18.22)

 

Additional information

Inventory of land has been increased deliberately in the second half of 2021 despite the downturn in demand, as the building plots have been acquired at what the Board regards as bargain prices. LPL held 14 building plots on 31 December 2021 compared to just 6 plots on 01 January 2021. Some of the building plots do not yet have planning approval so that construction can begin.

 

A confidential professional valuation instructed by the Board in December 2021 indicated that the market value of the building plots held was some £5 million below their cost. No provision for this was made in the financial statements for the year to 31 December 2021 as the Board believes that the diminution in value is not permanent.

To provide resources for this land acquisition investment, the Board had in place maximum banking facilities of £20 million but this facility is due for renewal on 31 March 2022. Bank borrowing is secured by a fixed charge over all the land plots owned by LPL and a floating charge over all other assets.

 

Required:

Assume that you act for an institutional investor that is considering investing in Larch Properties Limited.

Using whatever financial analysis you deem appropriate, prepare a report to evaluate whether you would recommend such an investment by the institutional shareholder. Show all workings.