Kitex Garments Limited

Thanks Abhishek Sir. helpful to know

Mr. Sabu had claimed 600-650 cr topline for FY16 whereas it is 545 cr only. Letā€™s see what Mr Sabu has to say about it tomorrow. If Kitex has to rise to levels it had reached, visibility of growth is required. More clarity on own brand in US, lamaze sales, doubling of capacity in next 3 years, etc. would be useful.
Disc: Invested

Dear Ayush sir and senior boarders what do you make of the results and Please Elaborate the balance sheet condition.

Disc : Invested from higher levels

Can someone please share the conference call notes. Wondering why stock has corrected 9%+ post results conference call and is now at 18.9x FY16 trailing P/E.

Disclosure: Not invested

http://economictimes.indiatimes.com/opinion/interviews/expect-20-growth-in-fy17-sabu-jacob-kitex-garments/articleshow/51694799.cms

I saw this. The problem is I find the management commentary confusing. For example it took me sometime in the past to understand that when management talks of sales they mean net sales + other operating income + other income.

"Our plan was to clear all the debt and convert all the dollars but unfortunately the dollar crashed immediately after the budget. I think by next Q1 will be a clear zero debt on our books" This I have read so many times in the past many quarters I wonder if managementā€™s definition of debt is different from what we normally interpret.

Did management answer

  1. Why receivable days have gone from 48 days end FY15 to 70 days end FY16?
  2. Why has loans and advances gone up?
  3. Reason for increase in other expenses.
  4. Any guidance on margins for FY16?

Tried to summarize the conf call. Please add if i missed anything.

  • guidance given for 10% revenue growth at start of year which was revised to 6% at the end of Q3 and actual growth of 8% achieved.
  • guidance of 20% top line growth for Fy17, Fy18 and Fy19.
  • US office started operations in Oct 15. for lamaze and little star -developed designs for fall and holiday in a small way to start with. Shipments to start July or August. Expect goods to be in market in August or September.
  • 20% growth guidance includes lamaze business. expect 40 crores from lamaze.
  • Trying to add new clients. Working with target, kmart, sears. Also trying to add a wholesale business whose details cannot be disclosed at this point of time.
  • 80% of other operating income is drawback from excise and rest is from job work( fabric, printing )
  • Increase in receivables is due to delayed shipments in Q3. will go back to normal in q1 FY17.
  • Converting dollars held in SBI account will depend on dollar movement.
  • Interest cost decrease this year is due to interest subvention which was withdrawn in Q3,Q4 last year which was returned in Q1 this year.
  • Current Margin of 30% is sustainable. Margin is not going to come down. Will be maintained or increased but increasing is difficult.
  • Margin improvement over the last few years has been achieved by automation, reducing wastage in raw material consumption.
  • Auditor is changed this year as management wanted to move to a better auditor given the company has grown a lot.
  • 100 cr is working capex and company has 250 cr cash and 100 cr receivables.
  • plan is to double capacity without increasing labor by investing in machines.
  • plan to invest in spinning is still in pipeline. Exploring viability of technology where cotton can be used directly for knitting eliminating spinning.
  • if we invest in spinning capex will be 150 cr(will be invested over 3 years ). if the technology is found to be viable for mass production. it will cost less than 100 cr.
  • Capacity already added for FY17 growth. Going to invest for 20% capacity increase in FY17 to account for FY18 growth and again in FY18 for FY19 growth.
  • 10-15 cr to be invested for adding capacity to account FY18 growth. Considering 40-50 cr investments in green initiatives in FY17. Need to add further production facilities in FY18 which will require capex of 60 cr. FY19 will require 55 cr.
  • 12% revenue impact due to Jockey business this year. Jockey revenue is currently $ 9 mn. Will go down to $ 5 mn in Fy17 and subsequently go to zero. jockey is high margin product due to effeciencies (no change in design, continuous production line throughout the year).
  • US LLC will be treated as another customer. products will be sold at 30% margin to US LLC and US LLC will add 15% margin and sell. Profit will be shown in consolidated results at end of year.
  • trying to reduce customer concentration by capping sales at $13 mn for each customer. gerber is trying to double its orders but kitex is interested to allot additional capacity to new customers.
  • $18 mn of the 40 mn cash has already been sold in forward contracts ranging from rates of 68 to 71.
  • board will consider minority shareholders concern of increasing dividend payout.
  • KGL and KCL merger may happen in 2019 after KCL lists in 2018.
  • current capacity utilization is 99%. Capacity increase is not done in one shot. It is increased every day by adding additional components to the machinery.
  • KCL top line growth will be similar to KGL. Margins are in range of 25-26%.

Sabu passed some comments like dollar can never depreciate. euro will depreciate. When ayush asked why his model cannot be copied(and benefits passed to customers thereby killing the margins in the business) he mentioned that his model cannot be copied even if someone from other company come and sit in his factory and study. I was not convinced with the rationale that he has given. He said his folks have discipline and lot of brain power has gone into designing the factory. As lot of people will have discipline and brain power i could not get why his model cannot be copied.

Disc: Invested and bought more in last 45 days.

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Thanks Harsha for summarising the conf call in detail. Few concerns with Kitex which I also share with the market is that they keep on deferring on their commitment to clear debt. I think in last conf call they said that by q4 Fy16 they will be debt free. Now they push it to q1 FY17. They are playing the currency game which I donā€™t understand. Keeping the money in dollar accounts can help them save on tax but eventually they have to pay it whenever they convert. Converting that money and putting in FD in India can have a higher return or I am wrong here. Rupee may fall or rise so the currency game can hurt or benefit. Why they are not going for the sure thing which is FD in India ?

Regarding dividend policy, if they are able to retain it and invest at a higher return I am fine. But they should clear out a policy and do not keep on delaying on that front.

Last year they told that for next 3 years they would need just 100 cr capex to double capacity. Now 150 cr additional capex is required for spinning. Which means they are expecting huge demand and increasing capacity accordingly. Cotton to direct knitting and eliminitaing spinning is something to watch for. As per Mr. Sabu, They explore the latest technologies ahead of everyone ( read somewhere).

Mr. Sabu is always confident and sometimes overcommits which market has understood which will keep a check on PE In my view. But the business is good and his ability to grow the business so far has been brilliant. The base business is good and can keep on growing at moderate pace. Though it depends on their capability to add new clients which they have already started working on. This also requires addition of capacity which they already creating as per conf call. As jockey business reduction will also release capacity. Outbursting growth can come from Lamaze business and little star but it will take a year or two.

Over the next three years, things to watch for -

  1. How many news clients have been added.
  2. How is the Lamaze business doing.
  3. How is the little star brand doing.
  4. How is the spinning capex and technological advancements work out.

Disc. Holding from a higher level

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From what I understand there was nothing new that came out from the callā€¦ Yes there are a few concerns which we have known and extensively discussed lot of times but the business path looks good going forward with profits from Lamaze coming into play this yearā€¦ Overall seems a very decent bet at current valuations.

Updated report from Motilal

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If they wanted play the currency ā€¦ They can do it currency options ā€¦ No need to hold so much capital ā€¦ Giving very Low return for shareholdersā€¦

One of my friend who is in Forex department in one of the banks has said, as per RBI regulations the import/export companies cannot keep the cash in dollar terms if the period exceeds 3-5 days. They have to convert the same cash in Rupees if it is not used for the transaction

Correct me if I am wrong.

Disc: No holdings in Kitex Garments

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Hello Sethuraman, could you please elaborate on this? My understanding is that KGL is not earning any interest on the said dollar amount in bank. Even with a post tax return of 7% (assuming Rs. 250 cr is kept in a liquid fund) can generate Rs. 17.5 cr in interest income, per year. There is an opportunity cost to this and I donā€™t see how speculating on $ rate is going to make up for it in anyway.

Discl: Holding from higher levels

Hi Harsha,

Good effort. Just wanted to cross check if the mgmt guidance at the start of the year was just 10% for top line?

Hi Abhishek,

This is what i could find from a motilal oswal report. This is in the report they published after Q4FY15 results in April 2015

Management expects to double sales in 3 years, 20-25% sales growth for FY16,
30-35% sales growth in FY17, 35-40% sales growth in FY18.

So clearly they had bigger targets till last year. Have toned that down now.

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I am not a fan of forex speculation Mr. Jacob is currently engaging in (as many have already expressed). In fact it is good to question and be deeply skeptical of it as minority shareholders. However I have tried to understand EEFC acounts a bit. I am reproducing the below 2 Q&A from the RBI website ( https://rbi.org.in/Scripts/FAQView.aspx?Id=21 )

Q 4. How much of oneā€™s foreign exchange earnings can be credited into an EEFC account?
Ans. 100% foreign exchange earnings can be credited to the EEFC account subject to the condition that the sum total of the accruals in the account during a calendar month should be converted into Rupees on or before the last day of the succeeding calendar month after adjusting for utilization of the balances for approved purposes or forward commitments.

Q. 12. Whether the EEFC balances can be covered against exchange risk?
Ans. Yes, the EEFC account balances can be hedged. The balances in the account sold forward by the account holders has to remain earmarked for delivery. However, the contracts can be rolled over.

Mr Jacob mentioned in the conf call that they have booked forward contracts at rates ranging from 68 to 71. From the above Q&A, I understand that one can roll over forward contracts. So it looks like there is a way to keep your money in EEFC in US dollars by booking forward contracts and rolling over those contracts. Experts please correct me if I am wrong here. Also, I am looking to find answers to the following questions (specifically for EEFC accounts):

  1. What is the normal duration of a forward contract when it is booked for the first time(1 month/1 year/More than 1 year/Can be any duration at the discretion of the account holder)?
  2. Close to delivery if one rolls it over, what is the new duration of the contract(1 month/1 year/More than 1 year/Can be any duration at the discretion of the account holder)?
  3. Is there a restriction on how many times one can roll over a forward contract?

If anyone is aware of the answers to the above questions, please respond. I will try to find answers at my end too.

Disc: Invested. Views might be biased.

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I work in the treasury department of ICICI BANK, and I have previously also posted on this thread that one can keep USD or EURO, in the respective EEFC acccount. So there will be a diiferent EEFC account for Euro and USD.

Letā€™s say you receive USD 1 million on 14th April 2016. Co, pany can park these USD in its USD EEFC account.

You can also book a forward to hedge this USD.

In this case funds parked in EEFC account can either be hedged or just be kept.

Company have to convert this before 31st May 2016. If company fails to do this, bank will induce the conversion.

While booking a forward contract in normal duration, one has to provide an ā€œunderlyingā€.

Now this underlying can either be a contract company has entered or on the basis of ā€œPast Performanceā€ basis.

Under contract exposure, the duration of the contract and payment term and schedule will decide the duration for which a company can enter a contract. So letā€™s say, as the contract company will receive USD 3 million on 21st December 2016, so company can enter into a forward contract to hedge only USD 3 million and the duration of forward will be 21st December 2016 or before. Company has to provide this contract to the AD bank within 15 days onentering the forward contract.

On the ā€œPast Performanceā€ basis company can hedge export receivables upto a notional X.

This X is either the average of last 3 years export or last years export, whichever is higher.

There is no restrictions on how many times a company can rollover a contract, but each time there has to be an underlying.

Let me know, if I need to cover anything more.

Disclosure:completely exited few months back.

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Thanks - what does it cost do do a hedge like this and where does it reflect in the P & L. A few guess estimate numbers would be helpful.

Hedging cost is function of interest differential between two currencies broadly. I think on yearly basis that translates to 8-9% odd.
On shorter tenures this could vary much more due to market factors.

See, INR is a riskier currency than USD, hence future rate quoted currently will always be higher than current prevalent spot USDINR. This is called premium. Currently one year premium is around INR 4.25 per USD.

Letā€™s say current spot rate is 66.50. So one year future/forward rate will be 70.75

Hence an exporter will receive this premium, because by entering into a forward contract, he will sell USD on a future date, at a rate higher than the current rate.

Similarly, and importer will have to buy USD at a higher rate than the current rate.

There is no cost of entering into this contract.

But, the premium paid or received can be termed as profit or cost, but that will be a wrong way of catogorizing the same.

Yes, in option products, there is a fixed cost for both importer and exporter.

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