Category: Investing

Aditya Birla Fashion and Retail – Good Brands don’t equal Good Business?

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion.

  • NSE: ABFRL is one of India’s largest fashion retail companies with Madura (premium) and Pantaloon (value) house of brands.
  • ABFRL’s brands include household names that capture the entire gamut of discount and premium customers, including in-house and foreign brands such as Van Heusen, Peter England, Global Desi and Forever 21.
  • ABFRL has the ownership / perpetual license of its brands unlike competitors like Future Fashion and Retail and Shoppers Stop. Intangible Assets.
  • These intangible assets however are not translating into improved ROCE (Return on Capital Employed) and this is not a source of competitive sustainable advantage
  • We can blame the industry structure and the value conscious Indian buyer who prefers substitutes to brands when it comes to discretionary spending such as apparel. The discount disruption by online players like Myntra and Amazon has spoiled the buyer and changed industry structure.
  • We can also blame the huge debt on its books and asset-heavy (rent is 600 crore) model of its brick and mortar retail format, which leaves little in terms of EPS for stock price appreciation.
  • To give you a sense of the enormity of debt, the company reported post-merger, a Goodwill of 1795 crore (which includes Pantaloons, Madura and Forever 21) but the debt with accrued interest stood at 1881 crore.
  • Premium brands do not necessarily lend to margins – Compare ABFRL with Kewal Kiran that manufactures discount brands such as Killer Jeans. Kewal Kiran has an OPM of 15% while ABFRL with its premium brand portfolio clocks under 10%. What matters more is getting the right product-market mix and returns on operating assets.
  • Even in the same omnichannel format, COGS is 93% of sales while Future Lifestyle Retail (Central, Brand Factory etc.) manages costs more efficiently (COGS 90% of sales).

Thoughts on the post-Merger Future

  • Investing decision depends on 2 factors –
    • How you feel the Industry Structure will evolve, i.e. will it move towards omnichannel or stay focussed on heavy discount online sellers?
    • How will the post-2015 merger between Madura and Pantaloons play out in terms of producing operational synergies?
  • If Industry moves towards omnichannel presence it will benefit ABFRL due to its presence across segments and geographies. However Amazon has recently tied up with Shoppers Stop and this will provide stiff future Omnichannel competition.
  • The Madura (menswear) component of ABFRL business is EPS accretive but the Pantaloons (womens/kidswear) business is loss-making. The future depends on how effective the turnaround of Pantaloons will be.
  • The future depends on the effectiveness of operational synergies arising out of the merger between Madura and Pantaloons (See below)
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In 2015, Madura merged with Pantaloons under ABFRL (after de-merging from AB Nuvo), this raised margins and asset turnover temporarily but it is again going down, i.e. Merger is still not creating synergies

Thoughts on Relative Valuation

  • Enterprise Value / Net Operating Revenue and EV / EBIDTA ratios are both twice that of Future Lifestyle, which is reasonable given the Debt to Equity of ABFRL is also twice that of Future Lifestyle. This seems to indicate Market is not giving a premium to ABFRL over Future Lifestyle inspite of its “premium brands”. The brands also in turn are not giving any incremental ROE benefit to ABFRL.
  • The market is not discounting future operational synergies from the Madura / Pantaloon merger. Perhaps it doubts the execution capabilities of AB group (Other group companies like Grasim, Hindalco haven’t created investor wealth) or is just put off by the debt on books.
  • Both Future Lifestyle and ABFRL will be beneficiaries of a secular uptick in consumer growth due to operational leverage but Future Lifestyle may benefit much more (See below).
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As opposed to ABFRL, Future Lifestyle has lightened its assets and increased turnover. It is also debt-lite. Operating leverage will impact EPS much more directly here.

Earnings Quality

  • On Jan 9th, 2018, the CFO S. Visvanathan has resigned to pursue a career outside the Aditya Birla Group, or so the group said in a press release.
  • In 2016-2017, the Cash Flow from Operations went up from 310 to 418 crore.
  • The DSO and Inventory Days also went up in the period and so did the Days Payables Outstanding which very conveniently shows a decrease in cash conversion cycle.2018-01-21_17-54-37
  • These ratios may suggest favorable trade terms, vertical integration or may warrant a deeper dive to check for financial controls for ABFRL.

DISCLAIMER:

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion. I do not have any position in stocks mentioned in this post.

I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”. No BUY/SELL/HOLD advice is offered on this blog, in any form whatsoever. Views expressed are my own and not of my employer. Stock Markets are very risky and can cause a permanent loss of capital. You should seek professional advice.

Fineotex Chemicals: Stock Market Recursion

This post is not buy/sell/hold advice. Please see the disclaimer at the end before reading further

The Indian stock market has all types of companies. The deeper you look down the spectrum of market capitalization, the stranger things you will find, growing away from the analyst spot light. Fineotex Chemicals Limited (FCL) is one such micro-cap company. With only 72 employees on its rolls in India, FCL operates in the attractive space of speciality chemicals competing with foreign MNCs that dominate the space of textile finishing.

Textile speciality chemicals is a high margin business as textile finishing and processing is a key value chain activity for textile companies but forms only a small portion of their total costs – putting companies like FCL in a comfortable niche. Customer retention in this business is high, due to high switching costs and involvement and R&D is a key differentiator.

But what is really interesting about FCL is that it is a proxy play on the growth of the Indian stock markets. See below for the latest quarterly results.

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What’s unusual about the above schedule?

Out of the Non-current assets, Financial Assets (Investments) is more than Property Plant & Equipment!

Further, the company has 11 crores investment in land and property.

So what’s the real business here? Chemicals or investing?

See a partial snapshot (the full roll was too big and printed on the AR in landscape view!) of stock market investments made by the company from their annual report.

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See the names of other smallcaps – Vardhman Acrylics and Vidhi Dyestuffs, which are also speciality chemical companies and competing peers of FCL. The company also has a ton of mutual fund investments. A key risk with thise type of balance sheet is that a deep stock market correction will prove a doubly whammy for FCL investors. Perhaps this partly explains why FCL trades at a Beta of 1.8, which is a very high indicator of volatility.

Thoughts on September Quarter Results

While maintaining healthy margins, thanks to pricing power in textile finishings and low input costs from crude prices, the company has struggled to grow its topline. This quarter the company has shown improvement, albeit marginal, in the standalone revenues and a slightly more impressive growth in consolidated revenues (FCL has subsidiaries in Malaysia and the Middle-East).

The EPS has grown by 25% in the standalone September Quarter 2017 over September 2016 results. It is fair to take same calendar quarters for comparison to adjust for cyclicity in demand. Its standalone PE is currently trading at 27, which puts the PEG at slightly more than 1, which is cheap compared to peers in the speciality chemicals space, especially considering FCL’s sustained high margins over the years.

DISCLAIMER:

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion. I hold a position in FCL so my views are biased.

I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”. No BUY/SELL/HOLD advice is offered on this blog, in any form whatsoever. Views expressed are my own and not of my employer. Stock Markets are very risky and can cause a permanent loss of capital. You should seek professional advice.

Investing in Road Infrastructure stocks? Here’s one strategy.

This post is not buy/sell/hold advice. Please see the disclaimer at the end before reading further

While the goose of private capex has been cooked, the Government of India is taking every step to boost public spending on infrastructure.  The focus is currently on roads. In 2015-16, NHAI awarded about 50 projects to build 2,624 kilometres of roads. A budget of US$22.35 billion has been set out by the Indian Government for infrastructure projects, for which highway construction will play a major part.

As Bala writes in this brilliant piece infrastructure companies have many moving parts that make them unsuitable as buy and hold investments, not least of which are – cyclicity, incalculable extraneous and confounding factors such as commodity prices and the lumpy, often misleading nature of their earnings.

On the other hand Infrastructure is one of the handful of sectors in this market that shows earnings visibility and a clear growth highway ahead.

So how to negotiate this paradox?

Proposed strategy: PROTECT DOWNSIDE RISK (And the upside will take care of itself)

Since the opportunity size is so large, if we can find companies where the downside risk is protected, it should be profitable. Let me lay the downsides for you and the mitigating techniques while researching potential Infrastructure companies to invest in.

Risk 1: Uptick in Commodity Prices leading to Working Capital Problems

Commodity prices are cyclical and have been in their trough for the past two years. It is expected that the uptick in key commodity prices will begin from 2018. Steel, cement are some critical inputs for the construction sector.

Steel – In the recent years India has imposed anti-dumping duty on steel and China has rolled back on capacities. This suggests domestic steel may go up in price.

Cement – Cement is priced by a cartel of producers in India. Further the government has put it in the 28% GST category.

This is sure to increase burden of raw material costs on Infrastructure companies.

Mitigation: Find Companies with Low Leverage and low P/B

Like any sector emerging from a multi-year downturn, most infrastructure companies are currently saddled with debt. Take the following precautions:

  1. Consolidated earnings – When screening companies, check both the standalone and consolidated balance sheet. Construction/Infrastructure companies in India tend to be conglomerates with diversified interests in power, real-estate and (sometimes) loss making foreign subsidiaries. Always check the consolidated financials to get a real picture of financial health.
  2. Price to Book value – use this metric for relative valuation as P/E can be misleading, given that earnings are lumpy (more on this later) and P/E does not capture bloat in balance sheet
  3. Mix of project/order type with the company – While leverage is not a disqualifier in itself, too much debt on the books puts some companies out of the competition for BOT (Build-Operate-Transfer) projects. BOT projects have higher risk of exposure to commodity price related working capital problems. On the other hand BOT projects have higher entry barriers than hybrid and EPC (engineering, procurement and construction) models that require upfront commitment from the government to take on 40% of the burden of costs. It follows logically that EPC models (where the government takes on the full burden of working capital) will face more competitive bidding than BOT projects, which will enjoy higher margins. Companies with low leverage and healthy balance sheets will enjoy a huge advantage to bid and successfully execute BOT projects.

Risk 2: Lumpiness in Earnings

The public infrastructure sector has one key buyer: government. The project lifecycle is long with 100% buyer concentration. This impacts the nature of orders – sometimes you win the bid, sometimes you don’t.

Additionally, infrastructure companies can record “revenues” as time of the order or at time of complete transfer of ownership and risk. Accounting distortion is common in this sector.

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“Lies, damn lies and statistics”

Mitigation: Look at Cash EPS and Execution History

While the EPS of the company can be misleading. Cash EPS, which is a measure of Cash Flow from Operations / Dilute Equity outstanding would be a better measure of the health of the company. Again, due to the lumpy nature of infrastructure orders – do not look for consistency in Cash EPS but rather, its relative value compared to EPS.

Execution history is important. Companies that have suffered cost overruns in the past due to poor capital allocation or working capital management can be avoided. A leopard and management, rarely change their spots.

In Sum: The past is not the future

Road Infrastructure itself is a Rs 7-lakh crore opportunity. NHAI has 62000 crores worth of bids up in the next 6 months. Funding for Infrastructure is cheaper than it was in the past – interest rates are lower offering companies with debt significant relief in their existing interest payments while taking on new projects. Further, the Reserve Bank of India (RBI) has allowed companies in the infrastructure sector to raise External Commercial Borrowings (ECB) with a minimum maturity of five years and with an individual limit of US$ 750 million for borrowing under the automatic route.

Further, risk of input costs and overruns have been transferred from the building company, to the government under the Hybrid Annuity Model (HAM) and the EPC (engineering, procurement and construction) model. So the company executes and keeps the money, which is not trapped in working capital. We may be at the cusp of a unique wealth making opportunity in the stock markets. Stay vigilant.

DISCLAIMER:

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion. I hold road infrastructure stocks so my views are biased.

I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”. No BUY/SELL/HOLD advice is offered on this blog, in any form whatsoever. Views expressed are my own and not of my employer. Stock Markets are very risky and can cause a permanent loss of capital. You should seek professional advice.

Kriti Nutrients and Sanwaria Agro: Soya and Edible Oils back in focus

This post is not buy/sell/hold advice. Please see the disclaimer at the end before reading further

Soya products and the edible oils are areas I have been closely following. India imports  67% of its demand for edible oil. This is economically unsustainable due to several reasons. There are a few key factors about the industry:

  • The demand for edible oils is inelastic and insulated from macroeconomic conditions as cooking is a basic need for survival.
  • India has failed to be self-sufficient in edible oil production due to misaligned incentives for farmers and low agricultural efficiency, which causes Indian soya to be globally uncompetitive in prices.
  • Soya has applications beyond cooking oil in cattle feed (poultry), food proteins, value added products (like soy milk).
  • China is driving the global demand in soya and increase in prices of the raw material.

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The Indian government unfortunately has not recognized the importance of self-sufficiency in cooking oils and has not made it a policy priority. However with GST and the financial demise of large listed companies like Ruchi Soya, the space has opened up for smaller organized players with good balance sheets like Madhya Pradesh based Kriti Nutrients. I would prefer companies based in M.P and Maharashtra as they have the competitive advantage of sourcing Soya from local growth belts.

The financial health of Cooking Oil and Soya companies has been tenuous. Edible oil and Soya products is a low margin and commodity business. Bad macroeconomic and industry conditions have wiped out many companies big and small (e.g. Ruchi Soya). Only a few remain investment grade.

The cyclicity in the business is through the supply side – introduced by dependence on raw materials like Soya and Sunflower. The production of edible oils and soya products is subject to the vagaries of the monsoon and Indian agricultural conditions. The demand side itself is not cyclical as cooking oil is in demand around the year. This makes companies with good inventory management stand out.

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Kriti Nutrients : Improving on all parameters

Due to these factors discussed, it is also wise, when investing in the edible oil sector, to look for companies that are not pure play edible oil manufacturers but look to be mini-FMCG or food processing companies – thus diversifying their risk.

Kriti Nutrients: Offers products such as Soya flour, Sunflower oil and produces Soya liechestien for Nestle (probably for use in their baby food products). Kriti management though conservative has shown an intention to launch value added products albeit slowly. With access to M.P’s soya-belt, they are well positioned to capture new product categories like Soya milk and protein foods when the market is made. It also makes me believe they are a good acquisition or partnership candidate for large FMCGs like Britannia and Nestle. Fun fact: Inventory turnover of Kriti Nutrients is better than Nestle’s. All of this is not discounted in the price as Kriti trades at multiples that are normal to the edible oil industry.

Sanwaria Agro: The company is more of a food-processor than Kriti Nutrients, which leans more towards being an edible oil company. In addition to edible oil and soya chunks; Sanwaria offers flour and even basmati rice. The price has run up significantly in the past few months.

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Sanwaria Agro, Investor Presentation

In sum, a few reasons to be bullish about the edible oil/soya product businesses are listed below:

  • Unorganized to organized: GST pushes the unorganized market towards an organized market benefitting large and mid-sized listed players with low leverage and good inventory management
  • Push to pull: Domestic demand will see growth as the country moves towards self-reliance in edible oil and competitively priced soya products
  • The business has emerged out of a multi year down-trend, so valuations are reasonable
  • Reliance on monsoons is going to decrease and agricultural incomes are set to rise incentivizing farmers to grow soya and edible oil cash crops – securing supply side cyclicity
  • Protein intake increasing in a vegetarian country and the addition of value added products will see increased demand for soya chunks, tofu and other soya proteins as well as soya milk in the medium to long term
  • Health and quality consciousness: Soya oil is healthier than its counterpart – mustard oil, which is the dominant variety of cooking oil in India

DISCLAIMER:

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion. I hold Kriti Nutrients since lower levels so my views are biased.

I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”. No BUY/SELL/HOLD advice is offered on this blog, in any form whatsoever. Views expressed are my own and not of my employer. Stock Markets are very risky and can cause a permanent loss of capital. You should seek professional advice.

Taneja Aerospace: Speculation’s swift knife, whither will it turn?

This post is not buy/sell/hold advice. Please see the disclaimer at the end before reading further

  • Taneja Aerospace and Aviation Limited (TAAL) operates the Hosur Airstrip, 30 minutes from Electronic City Bengaluru
  • The airstrip is 2km long and can accomodate Boeing and Airbus class of narrow-body aircraft, with in-house hangar and repair facilities
  • The government under its low cost flying or UDAN (Uday Desh Ka Aam Nagrik) scheme recently airmarked TAAL’s Hosur Aerodome as a hub for low-cost domestic flights
  • Inspite of many triggers in place TAAL has historically failed to produce returns on assets making it a speculative grade stock

Continue reading “Taneja Aerospace: Speculation’s swift knife, whither will it turn?”

Grauer and Weil: Are the Risks worth the optionality of future growth?

This post is not buy/sell/hold advice. Please see the disclaimer at the end before reading further

  • Grauer and Weil is one of India’s largest companies in the Electroplating and Coatings chemicals business.
  • It is a diversified conglomerate of both commodity and speciality chemicals, with interests in paints and real estate.
  • The diversified businesses may be holding down growth in the core chemicals business
  • Management decisions need to be closely monitored

Continue reading “Grauer and Weil: Are the Risks worth the optionality of future growth?”

The New World: Karuturi Global and how (not) to invest in Ethiopia

The African nation of Ethiopia is famous for its cuisine, long distance runners and arabica coffee. Few however think of Ethiopia as a rising African power.

  • Since 1990, the rate of return on foreign direct investment in Africa has averaged 29%, nearly tripling FDI in Europe.
  • The Ethiopian economy has grown at a rate of 10% over the last 10 years.
  • Ethiopia has its own space program.

Continue reading “The New World: Karuturi Global and how (not) to invest in Ethiopia”