Indocount - Textile Stock

(dotaddict) #82

I have a few queries regarding the recent results. Request to the ones attending the concall on Monday to get some clarity.

  1. Company’s interest cost in this year’s results has remained high despite it coming out of CDR last year. How has the debt been funded? What are the cost of short term and long term debt respectively? (Most of the debt is short term in nature). For Welspun and trident, the cost of debt seems to be c.10% against c.18% for ICIL.

  2. How important are the export incentives for the profitability of the company? What is the visibility and risk regarding the same going forward?

  3. Why is company upgrading the spinning capacity? Wasn’t the idea to maintain a asset light company engaged in value added products?

  4. How much is the Capacity Utilization of the processing and weaving capacity respectively? (68mn meter of Total processing capacity, 68/4=17mn), Meter is Sq meter or does it mean something else?

  5. What is the reason behind the drastic fall in the other expenses in H1FY17 (194.80 Cr.) vis-a-vis H1FY16 (223.21 Cr)?

  6. What is the reason behind the sluggishness in sales, (US retail data has been good in last 3-4 months)? Is it price driven or volume driven?

  7. What has been the status of new client acquisition or new orders against satisfying the expanding processing capacity? Has company lost any client in last 4 quarters? Is/can welspun fiasco having/have a fallout on the Indian Bed sheet exports?

  8. Does Indo count see Trident as a direct competitor? Trident has seen drastic pickup in its bedsheet sales post commissioning of its new plant, has Indo count seen an increase in competitive intensity in last few quarters?

  9. How much of company’s success can be attributed to being at the right place at right time in 2005? How much of it is sustainable and what are the key threats that managements sees to the same?

  10. Export and domestic mix in cotton? How much is Egyptian? What are the other premium varieties we procure? What is the procurement policy? (In last year’s AR, Imports are <1% of total raw material used by value) How much faith can be reposed in the suppliers? How robust are the quality processes?

(avneesh) #83

A very detailed analysis on Indocount by Dr. Vijay Malik. He has highlighted some serious management issues.

(Varun) #84

Very good analysis by the author. However, I have a query:

Regarding the adjustment of depreciation against revaluation reserve. The author states that the company inflated its profit by about Rs 23 cr in past 2 years, but I do not agree. See, when the asset is revalued the entry is adjusted by debiting assets account and crediting revaluation reserve account. Thus any increase in value of assets is accounted in revaluation reserve account only. Thus, while depreciating the asset, the depreciation amount is charged from both P&L account and revaluation account. It means basically reversing the revaluation entry and charging actual dep. in p&l account. So net net, there will be no difference in P&L account on due to revaluation of assets.

Eg. A machine worth Rs 100, dep. rate of 10% p.a. is revalued at rs Rs 150 while maintaining dep rate of 10%.

Case 1: No revaluation - Rs 10 will be charged to p&l account
Case 2: Revaluation - Rs 50 will be credited to revaluation reserve and machinery account will be debited and it will become Rs 150. Now at 10%, depreciation charge will be Rs 15. Now Rs 10 will go to P&L account and Rs 5 will be set off in revaluation reserve account.

Net Net, in both cases only Rs 10 will be charged to P&L account.

Revaluation reserve is just a tactic to increase shareholder fund, without actually earning them. May be, banks wanted the company to revalue assets on current value to show a better position as they were under CDR. Good companies must stay away from such shady stuff.

Regarding revenue recognition policy also, I have a different view. Such transactions do not inflate the sales of the company on regular basis. Now say, I have recognized Rs 100 in sales ex-factory. Next year, they are sent back, the sale will deflate by Rs 100. Since this is a continuous practice, it does not matter much. Look at a scenario where Rs 100 sale is not sent back.

Year 2014 = Sales Rs 2000 - 100 (unapproved) = Total Rs 1900
Year 2015 = Sales Rs 2000 + 100 (PY sale which got approved) - 100 (unapproved) = Rs 2000
Year 2016 = Sales Rs 2000 + 100 (PY sale which got approved) - 100 (unapproved) = Rs 2000
Year 2017 = Sales Rs 2000 + 100 (PY sale which got approved) - 100 (unapproved) = Rs 2000
and the process continues.

So, it is a management choice and I think the process of continuation makes the point of inflating sales invalid.

Regarding other two points, purchase of share warrants and fat salary are genuine and shows some profiteering from the management.

(Billu) #85

Thanks for the clarity, god knows how much time I spent trying to understand the accounting.

(shikhar mundra) #86

the point regarding share warrants is fine , but as investors cant we take it as a positive the next time promoters are issuing warrants to themselves? It might show the faith the promoters have in the companys near future.

(Varun) #87

The issue of share warrants is a legal process by which a promoter can bet on the company’s future without involving commitments.

Share warrant are like call options for the promoter. Promoter can allot the shares to themselves for 25% amount and rest to be paid after a few years. The amount is already decided and does not change with regards to the performance of the company.

If the company does not perform as per the promoter expectations, the promoter will not pay rest of the allotment money, the 25% will be forfeited and will become the capital profit of the company and promoter gets nothing. The cost of the promoter, in this case, is 25%. Assuming the stock available in F&O and minority shareholder buys the call options regularly, the cost will be very much higher. Also, in case the promoter is very sure about the company’s future why not invest 100% amount by taking preferential allotment? My view in such cases is that, the promoter is not very sure about the company’s future performance but needs to increase equity to improve ratios etc or under bank’s pressure. In case something goes bad, he being an influential person, can withdraw money by means of higher salaries or inflating expenses etc. So basically he risks nothing at all.

Now, if the company performs good or as per the expectation of the promoter, like this was the case, the promoter converted the shares and gained by just risking 25%. There is no lock in period of the shares allotted and are salable from the first day of issue. In such a case, the promoter does not even pay the cost of hedge as he has to pay only 75% money for allotment.

(Edit: I think SEBI has introduced lock-in period of 3 years for such allotments now.)

Considering, other options available, like rights issue, preferential allotment etc this is a bad way as it is kind of giving an undue advantage to the promoter which is not available to any minority share holder and thus, shows the attitude of the management towards minority.

Disc: Invested

(shunz) #88

Agreed. But the revaluation of machinery to higher value does not make sense and should not be done IMHO. Revaluation of freehold land is ok but machinery is not. In this case the revaluation leads to undue increase in book value.

(Varun) #89

Revaluation increases the book value only and that is what the impact is. What I feel is that this was done with the view to get better terms from bank. But, since I do not value stocks based on book value, I ignore such adjustments.

However, if such a thing is done by a company in apparently good financial position, it can be a red flag.

(hrfacebuk) #90

Just taking this ahead from an understanding point of view.

Isn’t that precisely the point that the author is trying to make that the additional Rs.5 would have been charged to the P&L account if the asset was valued fairly at the beginning itself. Or in other words this Rs.5 of addtional depreciation is being set off against the revaluation account (whereas it should be charged in the P&L account) and hence the Profit is being inflated to that effect.

Therefore, by revaluing the asset and setting of the resultant additional depreciation against revaluation reserve, one is inflating profits by not charging this depreciation in the P&L account.

Please let me know if I am missing something.


(Varun) #91

If that would be the case, the asset would have been valued at say Rs. 150 from the beginning. For that one needs to pay Rs 150 but they paid Rs 100. Eg. A land was bought for Rs 1000 in year 2000. In books of account, the land remains there at Rs 1000 forever. In case you want to revalue it to say Rs 2000, you make it by increasing the value of land by 1000 and crediting to revaluation reserve (not p&l account). It is a cashless entry i.e. to say just a book entry. It does not affect the P&L at all. No question of inflating or deflating the P&L.

This is done generally to increase the book value of the company. Eg. When one apply for a home loan, bank does not look at the book value of the house, but sends an approved valuer to value the home. Then it gives the loan after looking in repayment capability and the haircut on the value of home. Now, since this is a company property, company used this valuation parameter to change or increase the book value, may be to gather confidence of the bank or shareholders by showing that they have assets worth x.

(hrfacebuk) #93

So for Cash Profit, yes no impact on P&L as it is a cashless entry but reported profit does get inflated to the extent of Rs.5, right? So its more of a case of following better accounting practice rather than actual impact.

(Varun) #94

I think you should read the first example again. With Reval & without reval. I showed in both case Rs 10 will be debited from P&L. Others are just book entries and have no impact on cash profit or accounting profit. Now in case the asset was originally bought for Rs 150, there would be no question of reval and P&L would have been charged Rs 15, but the asset was bought for Rs 100 and depreciation will be charged to P&L as per the original invoice.

In case the asset was valued at Rs 150 against invoice value of Rs 100, the profit of Rs 50 would have been credited to P&L account also, but that profit is not credited to p&l account but to another reserve named revaluation reserve. Revaluation reserve cannot be used to distribute profits or issue bonus shares etc but only to write off the revalued asset.

(shikhar mundra) #95

why have the margins improved so drastically from 4 percent in 2012 to more thna 20 percent in 2016? The company says it has been due to backward integration and going into more value added products. But the share of value added products as of 2016 was only 10 percent to the topline, and also majority of yarn production is outsourced…so how does backward integration help significantly in improving margins.? can anyone share the data of how much percent yarn is outsourced , how much yarn is produced internally…how much yarn in kgs is used to translate into correspdoning one metre of finshed product…

Disc - Not Invested

(shikhar mundra) #96

my write up on indocount

(Mridul) #97

Anyone got link to Concall transcript held in last week of Nov 2016?

(jaitoshniwal1) #98

Nope…but audio is available on Research bytes.

(Tarun) #99

Q4 and full year FY’17 results are scheduled for tomorrow. Since 2014 IndoCount is reporting significant better ROE as compared to other textile export companies. Some broad ranging discussion has already taken place on the stock thread, with some wide conclusions.

Whats better than a DuPont analysis to understand what is differentiator - variable that is moving the needle in favor of IndoCount. Below is a comparison between Welspun, Trident and IncoCount. Understandably this is not an entirely like to like comparison. Trident being 50-50 between Export and Domestic with added twist of paper business. Welspun has found the range between bedding and bath both. Indocount on the other hand is still predominantly in beddings.

What DuPont analysis of ROE re-affirms in this case is that this claimed asset light model is helping them report better than peers ROE numbers.

In the mid to long term, my assessment is that with the planned and under progress CapEx of 175 + 300 Cr. proposed for mid-future will reduce the assets turnover metric (due to addition of new assets to books). However, at the same time Financial leverage metric will go up by an even bigger extent due to exponential effect of lower denominator (net-worth /equity). (current networth of 551.39 Cr against total assets of 1317.29 Crs.). Provided that they go for partially/fully debt funding for CapEx, and this is very likely since FY’16 Operational FCF was 167 Cr only)

Note: Have used the reported numbers on the face value for calculating the Operational efficiency, assets efficiency, equity multipliers and eventually the DuPont calc, without digressing into establishing veracity (triangulation etc.) of the reported numbers, for the time being.

Hope we will have few new pointers to ponder upon from the results tomorrow. Or at least we will be equipped to put a pointed finger for correct reason code, just in case drop on ROE.


Disc: Not invested as of date.

(rvetri) #100

Good analysis Tarun…


Results Out:

Direct PDF:

Profit - Down 28%
Revenue - No change


Sumarised Investor Presentation:

(Tarun) #102

Time for some super Saturday learning. Whats better than to pick up from where I left last week on IndoCount…

Firstly, due thanks to @amitayu for sharing with us how to drill down the Dupont analysis further in this thread (link). Highly recommend to all for good refresher and condensed learning. Coming back to the work in hand, my evolved Dupont analysis looks somewhat this now:

  • So now, with the new approach I am able to see the convergence of pricing power, Interest efficiency and tax prudence (not to imply any deceitful manner) playing collective role in NPM.

  • Trident got a NPM of 6% for FY’16 as against Welspun and IndoCount who has 12% each. Observation is that tax outgo and Intrest impact being more or less same for all three. The differentiation is in the form of PBIT/Sales. Trident at PBIT/Sales ratio of 11% whereas the other two at 21% each. What does that implies. Is it any ways suggesting lack of pricing power for Trident?

  • For past 2 years Indo Count has a slightly low PBT/PBIT ratio as compared to Welspun suggesting comparative higher tax out-go. Does that gives some confidence that there is not much issue related to tax evasion/ accounting creativity.

  • For past three years IndoCount has better PBT/PBIT ratio than Welspun and Trident. Implying lesser interest burden. I am inclined to think that this is again attributed to the asset light model that IndoCount claims to have. Even balance sheet suggests the same. Net Block, capital WIP, and other assets are all much lower in proportion to revenue for Indocount as compared to Welspun and Trident.

  • Now, for me, the two questions needs to be understood well much beyond the numbers.

1.whats the edge/moat that IndoCount has over its competitors to allow better pricing power and growth rate. whats the differentiation? AR does not explicitly suggest about any distinguished technical superiority, patent power, unique input/process/output dimension. If not about product proposition is it about innovation, market agility etc.?
2. Asset light model - Traditionally most of the textile companies has been with upfront CapEx heavy nature. whats different and how sustainable it is/will be for IndoCount?

Disc: Not invested as of date.