Forest is growing again

These factors were weighing heavily on the share price at the time and they still are. It's selling at a 71% discount to its 38c per share asset backing, making it one of our classic 'cigar butt' picks - a tough business trading at a very cheap price.

Overextended

Forest Enterprises has about 18,000 hectares of forests under management. After a good year in 2000 the company set out on an aggressive expansion plan and over extended itself, incurring losses over the past two years.

But management believes the company has turned the corner. Yes, the results for the year to 30 June 2002 were a big improvement on last year but the company still recorded a $2.5m loss due to restructuring costs. Without the one-off costs it was still only a breakeven year at best.

Refinancing of short-term debt and sales of surplus land has reduced the immediate financial pressure. In fact, Forest has $6m in the bank from the sale of assets. Or at least it did have at 30 June, but more on that shortly.

The company has also received good news with further changes to tax laws that will help in selling its products. In fact, positive operating cash flow was recorded in the fourth quarter.

Still, we were disappointed to see no further asset sales in the last quarter and that borrowings had increased by another $1m. The fourth quarter, traditionally at least, should be a good period for the industry as people invest in timber plantations before 30 June to get the tax deductions. That's why negative cash flows in the first half of the financial year are the norm.

So what can the company do to improve its share price? Luckily, Forest Enterprises has a number of options to get back on track.

Options

It can continue to sell surplus land and use the cash to pay down borrowings. Lower debt levels would certainly reduce the company's financial uncertainty. Or it could sell its $28m loan book. Forest Enterprises lends funds to investors when they purchase woodlots from the company, effectively becoming the banker as well as the grower.

But no, Forest has decided on a third option - an acquisition. In August the company purchased a 'state of the art' sawmill in Tasmania for $6m.

Directors believe the purchase will allow Forest to become a 'truly integrated forestry company'. We're no experts in the forestry business so we'll have to give the directors the benefit of the doubt that they've bought well. But making an acquisition when cash is scarce concerns us.

The company is already at its borrowing limits and we'd have preferred the safer option of selling assets and reducing debt, especially when the company has overextended in the recent past. That's why the stock scores the highest of risk ratings.

Were it not for the steep discount to asset backing we'd avoid this company. But, given the 71% discount to NTA, we're sticking with SPECULATIVE BUY.