Kitex Garments Limited

Stock Opportunities Not-so-Hidden Gems
41

Guys,

Kitex seems a promising opportunity no doubt.

Valuations seem rich at the moment - good growth over FY15 can make valuations look reasonable.

However let me make the observations no one seems to be making - so that it doesn’t become a one-sided look at the business.

Business Quality

1). The industry structure seems favourable - Large Buyers have to come to Large Manufacturers like Kitex (and there are only a handful able to scale up or so is claimed)

2). There is huge customer concentration in KGL. Over 80% of business comes from top 3-4 customers - Gerber, Babies R Us, Carter and Mothercare?

3). Only one of the top 3 Customers - Carter is financially sound. Gerber was up for sale a year before and Babies R Us is a (profitable?) subsidiary of loss making Toys R Us (request Kiran to share details/links to the listed entities)

4). So there exists a risk to continued business. It can be argued that the deficit can be quickly filled by the next customer - but usually that may mean 3-4 quarters of lost opportunities before things stabilise

5). There is also geographic concentration risk with over 80% of business coming from the US.

6). Textiles (labour intensive) is a tough business no matter that they seem to be in a sweet spot today. They are doing business in a location that is tough for business.Scaling up will be difficult.

Management Quality

1). The scale and technolodgy edge Kitex has achieved is truly remarkable. Those who visited the factory vouch for the highest standards. Especially to Social and Environmental Compliance norms (Ayush’s blog has details of the clean Airconditioned environment for workers) - they have not been cutting corners here and seem to have been investing in these form the start - which is a big plus point today to large buyers.

That speaks of a visionary, progressive Management.

2, Management is given to making aggressive plans. If you look at the history of past 10-12 years, Management has repeatedly failed up to execute on announced plans. (request T Anil Kumar to supply the details). So all plans announced in Media of doubling capacity etc should be taken with a little pinch of salt.

3). There is that muddle about business allocation between KGL (the listed entity) and KCL the unlisted MD owned entity - leading to doubts over Corporate Governance. To be fair to Management - these kind of situations are pretty common in India - where the parent feels magnanimous to both the children. Those who visited AGM tell that the MD went to great lengths to assure investors that he is doing the right think for KGL. All the biggies - the big scale up oppotrtunties go to KGL; the starting orders small batches go to KCL - and this is how it will be - he will be preferential to KGL since it is the listed entity. Once KCL scales up to 400 Cr - he may look to merge it with KCL - he things he will get the right valuation then. There is that Management discretion you have to learn to live with - stay with the business for a couple of years before you can get comfortable on that count.

Transparency required

1). What is not that easily explained the inconsistency in details/break-ups of capacity between KGL & KCL provided to investors on one hand and Rating Agencies on the other. An ICRA Ratings report quotes the KCL capacity at90 million pieces per annum and KGL’s at 65 million pieces per annum. Investors at the AGM heard exactly the opposite.

http://www.icra.in/Files/Reports/Rationale/Kitex%20Childrenswear_r_26122013.pdf

2). Company intends to double capacities by FY15-16. There are some grand plans announced on using Robotics for expanded capacities that will lessen the dependence on Labour. Exactly how much is the Robotics spend - how much lesser Labour will be required - 30%, 50% ? what?

Even a 50% labour increase over 2 years is going to be very difficulty to achieve.

3). The company always talks about KCL+KGL combined capacities - 5.5 L pieces/day is not KGL capacity. At best that is 3.5 L/day balance with KCL or it might actually be the reverse case.

4). So any projections of 30%- 50% growthin FY15 or 100% by FY16 needs to be corroborated with exactly what is KGL capacity today and what are going to be the investments in KGL?

No one has an answer to that?

Risks

1). Labour/Scaling up

2). Ambitions of brands/wholesaale operations in US - This is a very tough business - which is completely a scale game - at US Cost structures. Won’t be easy for the company who has manufacturing experience - will have to re-invent itself?

Will request Vinod MS to create the Stock Story on Kitex - on as is basis, while we try to get more info/clarifications from Management

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42

Got this extremely informative link from multibaggersindia site.

http://www.indiantextilemagazine.in/cover-story/kitex-modernisation-new-markets-exploration-in-full-swing/

Firstly , it makes me more bullish on page industries looking at indian market size for children apparel.

This interview claims that the workforce of Kizhakambalam textiles :slight_smile: as 14000.

I was doing some basic calculations. Employee cost for FY14 is 56cr. Employee cost per month works out around 3300rs. I’am not sure how they get access to such cheap labour in such large pools. As Donald mentions scaling up this labour will be a big risk. Isn’t there any risks of labour unions etc here ?

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43

Past guidance miss: Yes in the past there were material miss in guidance provided by the company between 1998 and 2005. Miss in revenue guidance was as large as 20-30%. Post 2005 company avoided giving revenue guidance, atleast in ARs.

Regarding inconsistency in data, missing data points agree with majority of the risks raised. Now try to think what risks really MATTERS FOR INVESTMENT TIME FRAME OF 5-7 YRS.

Anyone who want exposure to Kitex story have to leave with the risk that 1) mgt enjoys discretion in allocating more order to unlisted company 2) Key-Man risk, What happens if MD gets hit by truck 3) inevitable delays in capacity expansion, labour issues and currency fluctuations. Simple way to avoid this risk is to avoid this story, which is perfectly a rational decision. First two risks will KILL THE IDEA, third one will result in lumpy returns.

What I can say is based on past analysis of ARs, mgt has not done anything blatantly wrong. No preference was given to unlisted company. Mgt has its own justification for having similar line of business in unlisted, but they say merger is possible in next three years.

Another way to think about Kitex would be to ASSUME THAT 1) Mgt is crook 2) There is no competitive advantage. Then try to find evidence to prove or disprove the same. Information on international competition & other stuff not available…

Lastly anyone who is investing might be disappointed by relying too much on mgt guidance on FY 15 or capacity expansion. They have missed past guidance by huge margin and anyhow I am not too good in assessing near term earnings.

Growth is going to be LUMPY, IT WILL NOT BE CONSISTENT GROWTH ON YEAR ON YEAR BASIS

I am reasonable confident that over next 5-7 years, mgt can repeat its past CAGR of 20-25% in revenue growth. Look at the US market size of USD 10bn, Europe is not yet explored by Kitex [which might be a market of equal size]. Again Japan & Canada are big markets.

For me most important aspect of Kitex is 1) Difficult to Kill the company 2) Competition will find it difficult to match the scale of Kitex, so not much competition 3) Huge growth opportunity. Future returns will be mostly in line with revenue growth and not much possibility of sustainable margin expansion & PE re-rating, IMHO. Lastly risk of permanent loss of capital is less but opportunity cost isdefinitelythere, with a time frame of 3-5 years.

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44

Counter-thesis to above arguments

1). We have many businesses which are capable of growing 20-25% CAGR for next 3-5 years - where we do not have these issues -transparency, consistency and strong visibility for next 2-3 years.

Just how can anyone say what will happen over next 5-7 years with any certainty - when no one can establish what the actual capacities are, how much they are going to invest in Robotics, how much additional labour they will need, how they will address the labour scalability issues at a region like Kerala!!

2). With competitive position and industry structure being (very?) favourable - Kitex should not be ignored - the near term growth is most possibly there - especially as some big time expansions have been completed. But to deliver a verdict on scalability 5 -7 years down the line - without diligence but based on inconsistent and contradictory figures quoted by Management - is a big big leap of faith. All these may/should prohibit you from making big allocations, which we are usually able to do - in amny other high-conviction ideas.

3). As most would have realised seeing VP Portfolio Performance - the real opportunity cost lies - in not chasing every promising stock idea - but in not allocating enough to your high conviction ideas!! Just look back in all 4 of our 10-15 baggers, and see how much conviction was there in Mayur, Astral, Ajanta and Atul Auto.

4). There is no excuse for not persisting and establishing through our consistent efforts with Management - what does or does not add up - either way. And making allocations accordingly

Its a lazy response to accept things the way they are - to live with the consequences. Everything here may be positive, but let’s not ignore due process in firmly establishing that.

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45

Till the facts come out, there is more merit in taking an opportunistic bet in Kitex for next 6-9 months to a year. With due care on allocations.

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46

Thanks Donald

Any comparision between Arvind & Kitex Garments would be helpful before taking a bet in Kitex for next 6-9 months to a year

47

Hi Arvind,

The business model of Arvind and Kitex is totally different. Kitex is into infant wear while Arvind is a diversified textile player with segments like denim, ladies wear and men’s wear. Also, Arvind is a much larger player compared to Kitex. Request you to read Kitex’s annual reports and Ayush’s blog for understanding more about Kitex.

Regards,

Ankit

48

Chief

Big picture question

Does it makes sense to buy a textiles processing company at 14x earnings 2 years forward

Even if it has exceptional return ratios, doing operationally well and looking good on technicals ?

Textiles at the end is textiles

49

Hi Anant, Arvind, Excel and Others,

Because of our Guru’s strictures against “textiles” as an industry, it might be difficult to appreciate - there are hidden segments - that seem to defy the generalisations. The constant technology change’cliche"is not much of an issue here seems like - prior to last years big capex on bleaching/fabric processing, the last major capex done by the company if I remember correctly, was in 2006.

[We do need more answers on the infantwear technology requirements/frequency of updates/scale-up challenges on what can be automated and what cant - means more labour -etc]

if you examine Debtor Trends trends at Kitex, another textiles “cliche” perhaps - Bargaining power of customers - doesnt seem coercive, infact there has been improvement from levels 2 years before.

[However Creditor days are showing the reverse - trend - reducing by half to just 20 days - as the company scales up. This is the other way round usual trends! Is this evidence of Supplier bargaining power? We need further explainations - as working capital needs seem to have gone up from levels 3-5 years back?]

Like Ankit suggests - do read the AR and try to familiarise yourself with the business, its customers and the global “infantwear” industry. This looks like a nice niche, where Kitex has today established itself - and might go on to a dominant position. The industry structure does seem favourable - in the sense that - Large Buyers have to come to Large Manufacturers.

Do continue the digging to understand more of the business and infantwear industry structure - especially about the large customers and large manufacturers.

We are trying to seek the help of Textile Industry friends to understand/validate more:

1). Validate Management claims of industry status and global competitiveness of other large Asian manufacturers in China/Singapore. Are they really scaling down as being reported?

2). How easy or difficult will it be to consistently scale for the next 3-5 years? How much of a role Labor scale up will play? How much of a role Robotics can play in infant garments making? With no alternate manufacturing sites/plans is Kitex making things more difficult for itself and concentrating risks to continued business operations? This is very different from strategies employed by other large players or the next biggest competitor in India at half the capacity - Jay Jay Mills?

3). If this segment is this lucrative and really scalable - why aren’t the Arvind Mills or the Bombay Dyeing or other large Textile players interested? Why can’t an Arvind mIlls enter/what was so difficult that they tried and failed at (as claimed by Management), or why would they leave it alone?

Will encourage everyone to help us get connected with domain experts/consultants/professionals in textile industry to understand the ground situation better.

As mentioned before, I see it as promising in the near-term but can’t take long term scalability as a given. we need to ask and get answers to many more aspects - some of which I have tried to highlight.

50

Im from textile field so let me help here with what ever I can.

Infant wear is basically or rather majorly 100% cotton. When it comes to cotton India has a huge advantage over china. In Polyester/Mam-Made fibres China has a upper hand. Now somebody would argue Pakistan is much better than India in China, the difference is because Pakistan produces high quality cotton it is majorly used in high end fabrics like shirtings… Infant wear doesnt require very high quality cotton moderate quality is good enough…

Players like Arvind, Alok, Mandhana are looking at India… The Indian market has bigger opportunities presently than export market… These players also make very fine fabrics (shirtings)… Now to change to infant wear would lead to change at very core levels, starting right from spinning… They might also be uneasy about buyers being from US and as someone pointed out not being healthy financially… The business in itself is not so difficult…

As I am from TamilNadu and from the same trade will try to dig in and see what else can I come up with…

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51

Super, Balkrishna!

Thanks. I am sure you can ask the right questions (with your textile background) and get us some answers faster. help validate claims and/or help spot gaps in the story.

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Some children clothing history and process… i guess most of it already known…

http://www.madehow.com/Volume-4/Children-s-Clothing.html

Disc: Not invested

53

Very good insights Balkrishna, thanks!!

54

Here’s a recent report (published on Jun 30, 2014) on pollution from Kitex Garments plant. Although the incident citing was in 2012 and company got a clean chit on Oct, 2013, want to understand how big a problem this might pose, specially considering US exports

55

Hi Balkrishna,

Can you try and get access to Jay Jay Mills, Coimbatore, which is only com in India catering to same clients as Kitex?

Thank you for your inputs.

Cheers

Vinod

56

Some info.

May be not relevant.Happened to visit a Anna aluminum show room in Kottayam town for buying thermal cooker.Surprised to see other products from the group including kitex infant clothes.Spoke with shop owner,as per him these kidswares are rejected during their in process quality check for very minor problems,they are selling these rejected clothes thru Anna show rooms across kerala.Clothes were selling for 100/200 rs each seems not selling for profit.all the Anna show rooms in Kerala are directly under taken by Anna group not under any franchise model.

My wife found all kidswares very cheap and same time with good quality…):

Disclosure : long on kitex,average buy price around 170,size 10 % portfolio.

Shanid VH

57

The businesses targeting kids have some inherent strengths like it’s easier to influence their minds, ROI for a longer period of time, loyalty etc. (i.e. I still enjoy BournVita :)). Whatever habits we form as a kid stays with us for a long time so businesses with good brands in kids products stand to gain for a long long time. In a country like India, Parents might not spend on their own, but for their little ones, who are their best future investments, they will go to any extremes to make sure that their kids are happy. Apart from these, Kids influence their parent’s buying decisions. That’s the reason why we see lots of advertisements on TV, targeting kids like, “Two Two times brush kiya?”, “Sanju Cake!!, Dant Sad Jayenge!!” :). Read below a very informative article on the subject.

http://mediasmarts.ca/marketing-consumerism/how-marketers-target-kids

Sometime back when I bought clothes for my 3 years old nephew, I was shocked to see the prices of kids clothes. when I made inquiry with the shop owner that when you need lesser cloth and lesser number of stitches on kids clothes, why do you charge so much, as much as that of adult one’s or even higher? To which he very calmly and assuredly replied that he charges higher because parents do pay higher as they have to when their dear ones likes something and demands it. So KGL has some inherent strengths with some pricing power. It would be interesting to see how KGL brand develops in US.

As far as concerns regarding business being in textiles, I think for guru Buffet being in US it might not make much sense, but for low cost producers Asian countries like India, China, Bangladesh etc., with abundant labour supply, KGL should do well in this labour intensive business especially when it’s a market leader. For a shorter term, outlook seems to be positive. For a longer term, let’s wait and watch, how the story unfolds.

58

Kitex is trading at 22x trailing PE which looks quite expensive to me.

When we have better business available at similar valuation (Ajanta, Shilpa etc), why should one invest in Kitex given there are still lot of unanswered questions??

PS- The time to buy Kitex was when it was selling at 60-70 Rs after Q2 results. But there was hardly any interest in it then!

59

I agree with Jatin. At the current valuation Kitex seems a very expensive buy.

There is big competition looming from China, Vietnam, Camobia and Bangladesh. Vietnam and Cambodia are growing their exports to US at a higher rate than Indiahttp://otexa.ita.doc.gov/msr/catV239.htm

So for Kitex to sustain these margins seems very difficult. The kids garment industry has a lot of players from India itself(Mumbai mainly and then Tirupur) who possibly can outplay them in the near future.

The company plans to take its performance to the next level by further modernizing its plants, by creating new markets in Europe and the US. If that seems like happening then it can command a higher PE like at the moment.

60

Its seems the results were terrible, stock tanked today, any update on q1 numbers, thanks