LUX INDUSTRIES - Can it Scale?

[diffsoft]

@gurjeev This is awesome digging up! The listed company gets slapped with debt of a private company that was otherwise held by promoters!

I just had a quick glance at the valuation report here, and the valuer uses EV/EBITDA multiple comparables for out of the 3 options considered. This method, once can argue, ignores debt carried by the company.

Here’s how it is:

But, as on March 31, 2018, the debt outstanding of JMH was only about Rs 112 crores as seen from here and pasted below

So was the additional debt added after March 31, 2018?

[gurjeev]

[diffsoft]

Great. What is the source? Looks like some source that pulls data from MCA.

The merger is not cleared by creditors yet, and I don’t see any NCLT dates listed, and I wonder what these banks have to say…this movie will be fun as it unfolds

[gurjeev]

List of Companies in India, Indian Companies, Companies Registered in India

[zygo23554]

For more details on the SEBI fine, please refer the document SEBI Order - Chitragupta Sales & Services Pvt Ltd.pdf (350.2 KB)

Source: Public media

Gist: Most likely looks like buy/sell orders executed with same counter parties driven by the operator in an attempt to show paper losses and reduce tax outgo

On a different note, JM Hosiery’s net worth after March 2019 results is < 120 Cr, no banker will lend 450+ Cr to a company since there are neither assets nor receivables to take as collateral. On the Q4 Conference call it was clarified that JMH and Ebell together will add 100 Cr debt to the company. The data on some of these websites are really dated and cannot be relied upon.

Coming to the related party transactions, I’d done some detailed work on this and had concluded that promoter entities effectively are lending to Lux Industries at an interest rate of around 8.5% as of date. This was a direct question I asked them on the Q4 conf call and this was the answer, this is documented in the transcript. As of March 2018, an amount of 52 Cr was outstanding to the promoter entities by Lux Industries. This is a case of promoter entity lending to the listed company at a fair interest rate and not a case of listed company money being lent out to privately owned companies.

Please come to your own conclusions.

Disclosure: Invested, I am a SEBI registered IA.

[diffsoft]

@gurjeev you may want to download charge documents from MCA and verify, would be about ₹ 105 or so.

@zygo23554 could you point me to the source of JMH net worth as March 2019?

[zygo23554]

As of March 2018 the net worth of JMH was 91.48 Cr - you can find this in the merger document on the company website.

In FY2019 JMH clocked revenue of 328 Cr, at a PAT of 5.5% accretion to net worth would have been 18 Cr, so net worth as of March 2019 likely to be in the range of 110 - 115 Cr

[diffsoft]

@gurjeev and @zygo23554

I just got to the bottom of it by downloading from MCA. While Instafinancials is correct about the amounts, the amount is fund based and non-fund based, and if it is fund based, it gives the maximum limit. That does not mean all of it is utilised or taken as loans.

I have attached the Rs 110 crores of Allahabad Bank cc limit of Certificate of Registration for that charge. CERTIFICATE-OF-REGISTRATION-FOR-MODIFICATION-OF-CHARGE-20180528.pdf (529.1 KB)

Similarly I also have for Rs261.5 cr for Canara Bank as lead consortium. It’s again total limits.

Ofcourse @gurjeev some of your other points do remain valid.

[Akhil_7306]

Fixed assets of just 8 cr. Does it mean Lux is contract manufacturing for JM Hosiery?

[ashwinidamani]

Typically how all Hosiery Cos work (except Page) is that they have some own plants and a lot of outsourced job workers. This was because they suddenly started experiencing huge volumes and did not want to loose out on demand by the time they setup factories.

So with all old Hosiery cos you will have a mix of Own + Outsourced work.

Tirupur is the largest belt where almost all hosiery manufacturers are placed.

In Hosiery industry, typically few things have to be managed

1. Brand
2. Distribution
3. Purchase of Yarn and Thread.

If these three are controlled you are more or less done.There is no special hidden technology

Also one small insight, Jockey never was a good competitor in Banyan Segment in terms of product quality. Internationally they are more known for Underwear and that’s where they are strong. Lux, Rupa and Parrot are the best in terms of quality if you take channel feedback of longevity of product

[ashwinidamani]

While all of may be focussing on Innerwear, the biggest growth I believe may be coming from Loungewear/Nightwear and Ladies leggings.

[diffsoft]

I don’t think you can conclude this straight away. If it is doing contract manufacturing then related party transactions should show purchases, however if it indeed does, that cannot be conclusive, just indicative.

I just had a passing interest because I find the Balance Sheet very unusual for this kind of business and that increases my skepticism, and look for reasons why.

[Akhil_7306]

There seems to be some kind of business relationship between JM, Ebell, and Lux based on related party transactions.

Lux has sold as well as purchased goods from these entities. Why would it purchase goods worth 30 cr from JM Hosiery, when JM seems to be outsourcing its own requirements?

[gurjeev]

Yes those are sanctioned limits. Utilization data is as under

1. Short Term Loans availed by JM are 112 Cr.
2. Long Term Loans availed are 10 Cr. Ther by 120-125 Cr debt utilized till march 18. The indebtedness could be more or less as of today we dont know.
3. JM has given 28 Cr as loans and advances to its connected firms. Here JM shows good skills to charge more interest behaving like a good NBFC firm.
4. JM has only 8 Cr of fixed assets and 2 Cr in cash. Major % of the money is in working capital. As on 2018 Inventory is 104 Cr and receivable are 120 Cr.
5. JM has been making losses in operating cash flows to the tune of 8-10 cr mainly because of its slow working capital.

Concern her could be seeing the operations of JM does it look suspicious that the value of shares to be alloted to the promoters by merging these entities could be much more than the actual value gained by the public company that’s lux after the merger. Promoters have a complex structure of business. Which loans are going for what is tough to understand. Say for example 14 cr advance given to Krishna Tissues Pvt. Ltd @ 12%. This firm is in another line of business where the promoters are different, business is different their area of operation is different.

If JM has debt 125-150 Cr utilization why it is behaving like an NBFC giving loans at 10-12% to other un related parties. ???

Point is why take loan like an NBFC and let it ahead for higher interest rate where the concerning party is down with whole lot of debts.

Some details of Krishna Tissue

The more deeper you go more complex structure opens up.

Looks like 2 NBFC’s are getting merged with LUX rather than 2 manufacturing business. Outstanding debt of JM at year end 2018

[diffsoft]

All very important questions for which management may have its own reasons. On loans the rates could be because the credit risk is high. The parties could be subcontractors to whom contractor financing is done…etc etc.

You may then well ask that these accrued income due to financing will bump up EBITDA for the swap ratio, and if someone has an incentive to do so, they may as well. So I would assume that it they may have done it (incentives far outweigh moral considerations imo) so that the swap ratio benefits JMH etc. But I could be wrong.

Since I am not invested I can say what I want and be unaffected by it! But for someone holding the stock it’s a different feeling.

[gurjeev]

JM has 8 Cr in fixed asset and 28 loans and advance given. May be the manager’s find more value in lending the money rather than investing in the business and growing it. And that too when the debt is above net worth of the business.

If the management knows that risk might be high so charging high interest rate of 12%. Point is why indulge in the high risk payoff when u are banking on loan funds.

The insiders know much more than anyone

[gurjeev]

As per 23rd April 2019 Concall.

The focus is on the core business or showing the numbers to the analysts ??. Reduced one expense to cope up for the other expenses to show stable numbers.

[zygo23554]

I have always believed that homegrown consumer businesses in India spend advert money in very inefficient ways - especially those who don’t have the experience of building brands over a period of time.

Lux advert spend is actually much more than it needs to be, they can probably cut down spends by 20% and still continue to grow the brand. On a scale of 1200 Cr revenue Lux ASP spend is pretty close to Page which does the same on a revenue scale of 2500 Cr.

For a brand like Lux where the brand pull at the economy segment does not do too much for them, I’d rather have them do trade discounts and clear inventory rather than spend money on advert. Advert spends need to be targeted clearly, that’s how one gets a better ROI rather than spend money on brand ambassadors who may not do too much over the long term for the brand.

I was a participant on the call and I saw this as a positive - for my own reasons. It tells me that the management is grounded and not getting carried away by the vision to build a brand and overspending in the process. I believe that Lux can grow sales at 12-15% without having to spend so much money on ASP, they can be as effective at 20 Cr lower spends which can impact bottom line significantly. This is anyway not a high end brand though they do have some products they are trying to position as semi premium. I think trade channel discounts can move the needle much more than brand spends in most of their product categories

[gurjeev]

Valid point for Advertising spends.

But spending approx close to same amount as it is compared to revenue of page and generating more or less half the revenue as compared to sales

Secondly in repeated instances the management has indicated that profits were little suppressed due to additional channel discounts.

Is this brand pull or brand push strategy. Little focus should be seen on this dimension also. And if the spends are not doing too much for them then they should genuinely cut it to get better, but with that the sales might not falter down.

As in the market everyone knkws about Lux brand because they see their loved super stars on tv with it. Their reducing could effect revenue

[lingalarahul7]

ONN vs. One8:

One confusion I have about Lux is ONN vs. One8. I have provided my thoughts on what could be the management rationale as well below, but thought I’ll put it down to share with other VPers.

If the company markets One8 to premium customers, won’t they be cannibalizing their ONN premium brand. And important to remember that One8 brand is not owned by the company but just manufactures and markets their products.

My guess for the management’s rationale is that One8’s products are super-premium (priced above Jockey) while ONN products are sub-premium (priced below Jockey). So they expect that it won’t cannibalise. Can others please provide their thoughts on the same?

Working Capital Management:

Working capital was my primary concern while initially going through the financials. However, very nice to see the management’s AR FY19 theme about improving their working capital. Improvement in working capital can improve cashflows of the company.

Penning down management’s thoughts on “Sales Quality” from AR FY19. Reading that annual report helped me deepen my understanding on why strong working capital is important for a company. I’m copying down some points from the annual report as it has been a pleasure going through those.

1. There is greater respect for the company whose profits are reflected in the cash and bank balance than for companies where the profit is hidden in debtors
2. A greater value is being attached to companies with a high cash flow accompanied with a slightly modest net profit when compared to companies with a high profit but with a low cash flow
3. There is a greater business appraisal clarity: that the strength of a brand reflects in not just the velocity of sale derived from a distinctive consumer pull but the ability in being able to extrapolate from that consumer pull to getting trade partners to pay cash down for purchases
4. There is a greater acceptance of the view that companies with smaller receivable cycles are less risked and more sustainable, generally inviting a superior credit rating that could, in turn, help mobilise debt at a lower cost and in doing so, moderate the Company’s break-even point
5. A company with a large part of its profits and cash flows sitting in the bank accounts of its trade partners is not representative of a company with a sustainable long-term competitiveness; rather, it is the sign of a company whose corporate policies are run for the benefit of trade partners instead of for the benefit all stakeholders
6. An increasing number of analysts are seeking companies that extend the power of their brands (corporate and product) to kick-start a virtuous cycle: stronger procurement muscle to be able to buy raw materials and resources at a lower cost in exchange for the ability to put cash down; utilizing this advantage to generate a margin higher than the sectoral advantage; creating a larger surplus when marrying this increased margin with growing offtake; utilizing larger suplus to enhance organizational value, visibility and respect.

Some other statements from management in the annual report include “During the last few years, companies like ours focused totally on maximising sales. We focused on sales maximization by increasing brand investments, working closely with trade partners and getting them to buy as much of our products as possible. Since the focus was on maximizing business quantity, the one reality that became secondary at our company was business quality.”

If one is openly coming up with such aggressive statements, any rational person should be willing to put lots of efforts to improve their working capital cycle.

Margin Improvement:

Also would like to pen down the factors driving the margin improvement over the past few years. Request others to add if they think I missed anything.

1. Large scale Dankuni plant which brought in lots of efficiencies - Operating leverage, efficient machines, solar plant…
2. Upgradation of Tech which helps them manage their inventory better - SAP HANA

Hopefully, the merger and their new focus on business quality would help improve it further.

Some things which are pinching me a bit are:

1. Allegations on the promoter about being behind his son-in-law’s death
2. Management boasting a bit too much in their annual reports. Have noticed that it is generally the case in my limited experience, but I feel it is a bit too much in case of Lux Industries
3. Related party transactions but good to see the merger announcement by the management and hopefully that will reduce the size of related party transactions, in both absolute and relative terms
4. Management repeatedly says Lux Venus seeing a lot of growth due to GST in conf calls, but is not visible in the numbers
5. The company also keeps saying that their Northern, Western and Eastern markets contribute 63% of revenues and they are weak in Southern market. Assuming exports at 10%, it implies Southern markets contribute 27% to topline and that only means they are stronger in Southern markets. Not sure why we have this inconsistency

Overall, I felt the management is looking for respect / recognition from Mumbai by improving their business quality. Many of their actions suggest it: Margin improvement, Implementation of SAP HANA, Merger, Efforts to improve working capital, Pride in Annual Reports…

Discl: Just started tracking. No holdings. Please do your own due diligence. Not a buy / sell recommendation.