Welspun India - most vertically integrated textile co

Looks Like Trident could be one of beneficiary of Welspun saga

Disc: Not invested

In this topic, disclaimers are very important.

Prima facie, there is an integrity issue with Welspun India.

Anyone supporting Welspun India needs to make a truthful disclaimer if they are holding the stock or not.

I really don’t think there is an integrity issue at the top level. Mainly because of the following:

  1. I am into manufacturing myself and on the off chance, it does happen that something other than the specification is supplied. Usually, the customer also has no problem as long as the product works (as was the case with Target for the past two years). The change may not be intentional. It may be just that the raw material specified is scarce/unavailable (as is the case of Egyptian ELS Cotton).

  2. Promoter is holding 73% of the equity. Do you really think they would do something like this on purpose? They have much more to lose than gain (maybe, corner more share at depressed prices).

  3. We can not rule out the fact that Target (or their minions) may have orchestrated this whole charade to corner some of the stock at low prices. Afterall, why did they remain quiet for two long years, when all of this was very evident. And why over-react by severing ALL business type and not just cancelling the order for that product. Afterall, they STILL DON’T have any problem quality-wise, only specification-wise.

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Can someone provide insight on what is the cost differential between using normal cotton vs. Egyptian cotton?

Thanks
VD75

Disc: No position. This is not a recommendation either to buy or sell.

  1. Was Welspun charging for Egyptian Cotton while using a lower/cheaper grade?

Imagine getting to know after 2 years that one was handed a 18k gold ring after having paid for a 24k ring. Will one rationalize it away saying that the ring looks equally good and performs its function. My guess is that most folks will feel scammed. If one sold it further as 24k gold ring, one would seriously be concerned about ones reputation with ones clients.

Welpsun conducted a conference call after Target announced an end its business relationship with Welspun. Here are the key takeaways:

  • The external audit will be completed by 6-8 weeks.
    
  • Egyptian cotton sheets accounted for only 10 percent of the business with Target.
    
  • **The company acknowledged that fault is likely to be with their own systems.**
    
  • There were no quality or safety issues with the finished product supplied; the problem was with the origin of the raw material.
    
  • The company supplied the same product to several other clients. Total sales of similar products constituted 3-6 percent of Welspun’s sales over the past few years.
    
  • The sales from U.S. account for two-thirds of Welspun’s sales.
    

The company on Thursday released a transcript of its conference call with investors earlier this week, during which managing director Rajesh Mandawewala said the company was taking responsibility for the mishap.

“There has been, let’s say, a failure on our part, so without any ambiguity the fault is on our side,” he said, pointing out several times that the problem was not about the quality of the sheets, but the “provenance” of the fiber.

When an investor asked what exactly had gone wrong, Mandawewala’s response was vague.

Either the company knowingly supplied a different(lower/cheaper) grade cotton and try to pull a fast one of Target or it itself was scammed by its suppliers or employees.

  1. Assuming Welspun too was scammed, who was in a better position to catch the fault? I would argue one nearer the raw material, Welspun in this case.

Why look for complex explanations when simpler explanation will do. Man is not a rational animal, he is a rationalizing animal.

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There is difference between Indian business culture and American business culture. We all know that business works on trustall over the world but there is a difference between how this trust is established in India vs US. Having lived in US for over a decade, I can seen some major difference between how trust is built in India vs US.

India - First verify then trust.
US - First trust then verify.

In India, we assume everyone is a crook and verify a person or a business a million times before establishing trust. Once that trust is established, a breach of trust (like this one with product quality) is ignored or brushed off as one-off incident.

In US, people and businesses are largely trusted initially and that trust is periodically verified. But as soon as trust is breached, it is automatically assumed that entire business was untrustworthy from the start and all relations are broken in a snap. This also acts as a deterrent for businesses to breach the trust. In US, it is generally assumed that a person’s character does not change over time. So if a person found to be a crook, he/she will remain crook for his/her entire life. (There’s no “take dip in Ganga to wash away your sins” concept in US). That’s the reason a breach of trust results in complete termination of business relationship and even results in legal action.

If Target continues to do business with an untrustworthy vendor, consumers will lose trust in Target and that will bring down Target. That’s true with other retailers as well so that are all verifying Welspun now.

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Disclosure - Not invested

In my view, the probability of the management not knowing is really low, especially since management owns 73% of the company. This is a widespread practice in India where companies mix low quality materials and pass it of as high quality (you cannot expect the promoters to accept that they knowingly did this, especially with a looming threat of lawsuits and loss of reputation).

The question is assessing how much does the company stand to lose in sales and whether the market has overreacted to this news.

Great insight brother, I did not know this! I assumed the basic psychology remained same all over the world.

DISC: Invested in the recent crash.

Well, pardon me, you are just giving clean chit to the management and shifting the blame to the lower level employees. The company, on its own, is just a name. It cannot operate itselft - it has to be some or the other employees. But even considering that your guess is right, why would someone look at a company whose employees are engaged in fraudulent activities? In simple words, the integrity has been compromised. Let the management do the clean up now. But I believe this is not going to die down soon.

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That’s a very good point.

However, for other value investors, is there a case for making an investment in such situations at a price? After all, markets do tend to overreact and if a great business can become a poor investment at some exorbitant price, should not a poorly run business become a bargain at a very low price?

If so, then what is that low price? How should one go about estimating it?

Well, let’s first think about what one must not do. The first thing to avoid here is to compare current market value with recent earnings. The PE multiple may have dropped but how sure are we that future earnings will not collapse because of loss of other customers? We already know that other large customers have started their own investigations. We also know that the company did not claim in the concall that it was not at fault. So, this isn’t a case of a trivial misunderstanding. One of the company’s largest customers has terminated its relationship.

The second thing what one must not do is to rush into buying just because the price is falling. That’s true even if the price could easily bounce back. Buying in response to a declining price without seeking an adequate margin of safety would be speculative at best. It would not classify as an investment operation using Graham’s definition:

“An investment operation is one, which upon proper analysis, promises safety of principal, and an adequate return. Operations not meeting these requirements are speculative.”

So, a Graham investor would not anchor to price. He or she would instead anchor to emerging fundamentals and it’s impossible, at this stage, to estimate what they would look like. As I mentioned in a previous post, this is an evolving situation and new information will come.

The third thing one must avoid is to make wrong analogies. Some members have compared this to American Expess and the Salad Oil Scandal. Other members have correctly pointed out that these two situations are not similar at all because in the case of Amex, the problem lied in a subsidiary which was involved in a totally different business. Another key difference was that Buffett had figured out carefully the worst case scenario and according to his careful research, the probability of the core business getting affected by the business was nil. He also ensured that Amex’s solvency was not going to be threatened due to loss of confidence in the “trust” behind the Amex brand causing people holding travelers cheques to encase them in a hurry.

One cannot, at least at this stage, get those comforts in the case of Welspun situation, In this particular case, the trust in the mind of one customer is already compromised and for other customers too it might get compromised so this situation is very different from the Amex situation.

Disclosure: No Position and won’t be having one either, at any price.

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Good Observation!

In my opinion perhaps if the price comes close to its book value(Rs.18) then one could enter.

We must watch out if the company takes this as an opportunity to cleanse the system or gets busy covering it up.

Disclosure:Not invested.Waiting to enter.

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I think one way to think about “management Integrity” issue is to go back in time (before this issue started) and ask yourself whether “Welspun” name comes to your mind when you start thinking about companies with promoters having high integrity and honesty. I guess not…

@abhishek2k has already given links of few news items about Welspun’s chequered past. If so, why does this news comes as surprise? I don’t want to sound negative but I feel like it is a “falling knife”. I am better off sitting on the sidelines and let go this so called " once in a lifetime money making opportunity" as it has potential to cause severe damage to my portfolio. I have tried something like this in the past and it still hurts…:cry:

Disc - Not invested and may think about entering if price goes to book value level

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Welspun has been a wealth creator for the past many years. I had entered Welspun at 342 and exited at 700 pre split.

The best way to play Target episode is to buy in SIP mode. Of course the risk is higher here but money is always made when the worst is going. Tracking Welspun India for the 10-15 years, I am sure they will tide through this though might take some time.

I recently entered again at 58 and have put only 40% of my desired amount in this company. Looking to put another 40% at 40-45 and more 20% at 30-35. I will then treat it as a fixed deposit and will forget it for 3-5 years.

Also I plan to limit my investment in Welspun India at 2-3% of my overall portfolio. One should invest only according to their risk taking capacity.

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Great discussion.

There are 3 potential scenarios:

1. Management did not know about it: While they can rationalise the event away in this case. To me it means that (para phrasing Fisher here) they are not execution focused and too far removed from day to day realities. If they don’t know what is going on w.r.t. one of their premiere customers in their largest market then what else do they don’t “know”. Score: Negative

2. Sabotage: This is a conspiracy theory. However, for arguments sake, using similar logic as above if their employee colluded with outside parties to do this for a top customer in a top market - then that speaks volumes of their management capabilities and culture. Score: Negative

3. Management knew about it: Enough said. Score: Double Negative

So for me this is 3 strikes. They should be treating this as a “meteorite level event” and be all over this. I cannot judge that from what is publicly known and hence have kept clear of this. How they are responding to this is not very positive. It reeks of a sarkari mentality where they setup a “committee” - in this case an “independent augit” :slight_smile:

Disclosure: Not invested, not interested. BUT, watching the saga unfold very closely to see how different mental models and public reactions/ perceptions vs. reality plays out.

Sincerely
VD75

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WELSPUN HAS BEEN ACCUSED OF PRICE MANIPULATIONS IN THE PAST -THINK TWICE BEFORE YOU BUY-READ THE ARTICLE BELOW

Home textile maker Welspun India has been in the news for supplying inferior bed sheet variant to one of its prestigious customers, Target. According to Target, Welspun had substituted Egyptian cotton with a cheaper type of cotton. Target has said that it was in the process of ending all business with Welspun. Welspun’s other clients which are big retailers Wal-Mart and JCPenny, have also ordered a review. The street, as expected, reacted very negatively to the development with the stock price slumping by more than 40% during the last three days post these allegations. The stock has been on the lower circuit for three days in a row with hardly anyone being able to sell and exit. Welspun was in damage-control mode. It announced that it would appoint external auditors, one of the top four firms, in order to carry out an audit of its supply systems and processes.
However, controversies are not new for the Welspun Group. It has been involved in a number of legal issues and allegations in the past. Welspun Group’s name surfaced in the Anjar land scam in 2004. In the scam, IAS officer Pradeep Sharma was accused of allotting land to Welspun near Anjar in Kutch at a price far lower than the market rate. Welspun had given a contract to a company named Value Packaging for corrugated printed board cartons. It was alleged that Value Packaging was given a contract at a much higher rate in lieu of allotting land at a lower price. The accused in the scam was a related party to Value Packaging.

On 2 December 2010, Securities and Exchange Board of India (SEBI) had banned promoter entities Welspun Corp from trading citing trade practices which were ‘fraudulent and unfair.’ The ban on promoter entities was lifted in an order dated 16 March 2012. The other companies that were accused on the same were Murli Industries, Ackruti City and Brushman India. SEBI had also prohibited businessman Sanjay Dangi and his group entities from dealing in any securities on account of charges of manipulation of share prices. According to SEBI, the four firms had raised funds through a qualified institutional placement or foreign currency convertible bonds during 2007-2009 and the Dangi group was observed to be trading churning the shares of these firms and manipulating the share prices.

According to a Securities and Exchange Board of India (SEBI) order, there was substantial increase in the price of scrip (Welspun Corp) from to around Rs275 from Rs75 during the period 9 March 2009 to 19 November 2009. This was accompanied by spurts in volume in the scrip. During to period 1 January 2009 to 25 March 2010, entities belonging to the Dangi group and Ashika group, along with Welspun Group itself were actively trading in the scrip, according to SEBI order. Majority of the activities of these clients in the derivatives segment was confined to this scrip.

SEBI found that there were linkages between the Dangi group entities with the promoters of these companies. Welspun Trading Ltd, which is one of the promoters of Welspun, had stake in Dangi group entities. Another promoter entity GRG Cosmetics Ltd had a stake in Amit Business Ltd, a Dangi Group entity.

In the second half of 2006, Welspun Corp into a contract for supplying pipes of specified certifications. The customer alleged that the pipes supplied did not meet the grade of steel specified. Many other customers of Welspun Corp had gone to the courts including Kinder Morgan Louisiana Pipeline LLC and T&R Pipeline Services on this score. Welspun Corp had then passed on the blame to Arcelor Mittal for supplying defective steel. Litigations like these have not only been very expensive for Welspun Corp, but have also damaged the brand of the company. Welspun India closed at Rs59.30 today, down nearly 10% on the Bombay Stock Exchange (BSE).

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Price manipulation can be alleged and understandable when price shoots up as in the case above. What is not similar is the sort of price decline and the allegations of price fixing when promoter holds 73%. IMHO There is not a single thing the promoter gains out of all of this.

The point here is that, How much of the promoters TOTAL wealth is invested in this co? I dont know the fact myself but could for a basic hypothesis from it.

@devansh_god

2 observations

  1. Mutual funds in the past 1 year have reduced their holding considerably in the company.
  2. After I know that the company has a tainted past, I won’t put my money in the stock. As good management is the most important criteria for value investing.

Nearly 85% in Welspun India!!
More abut the promoter :

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hey advait; i am not giving a clean chit to management. If management was involved, i expect them to be all over the place, not just cheating in a small segment (so far Egyptian cotton). Also after reading @hrfacebuk post on Egyptian cotton (and testing technology), i am not sure if the results could be conclusive.

Also, just think, the market and our reaction on supplying fake Egyptian cotton would have been same, if Target would have just penalized rather than cancel existing contracts?

That said, i live in this world, well aware of corruption in society and companies; and i won’t be surprised if management is found guilty for intentional misconduct.

Although, practically, here is what i think will happen (might not be true in terms of what actually happened). Auditor will complete the report, finding some issue with the Company’s supply chain. Wellspun will acknowledge that and share it with its key customers. Wellspun, might also agree to pay some one-time fine relating to its cotton business and stop supplying Egyptian cotton product.

In terms of fine, it should not be more than the revenues (c.500 cr, guess work) and due to it loosing Target and Egyptian cotton business, might report c.20% drop in revenues (10% of Target plus 10% from Egyptian cotton). Gradually it will find new customers and in two years time, it should be business as usual.

Also, other point to note; Wellspun’s key customers contract huge volumes and it would be difficult for them to find alternate source this easily. Also, there was no quality or safety issue; just with origin.

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