Indo Count Industries ~ Global Home Textiles Bedding Segment Leader

Stock Opportunities Untested - but worth a good look
67

Couple of reasons can be:

  1. Probable impact of cotton price rise on its margins and bottomline going ahead
  2. Stock was trading at peak multiples at the same time when its main RM Cotton was bottoming out. Maybe a case of mean reversion (mean reversion in stock price and a possibility of mean reversion in cotton prices). Mean reversion on both fronts at the same time can be a deadly combination for somebody who enters at peak multiples [not saying that this has happened in the case of Indo Count (as cotton prices haven’t gone up too much yet) and this is just a thought].

Talking about mean reversion and valuations - I am still learning on this front.

Cotton Prices - Globally prices seem to be stable but look like bottoming out at 7-9 year lows. China is the major driver of demand and Chinese have a policy of building up inventory but they have been buying locally and I think (can’t recollect properly) that they had put in some minimum support price too, to support the local cotton farmers. Seems like if no supply side constraints then global cotton prices should remain stable (if not venturing lower). Indian cotton prices I think had rebounded from lows of last few years (can’t find the chart now) and again look like have bottomed out. But from what I had gathered few days back prices should remain stable to go down mildly after going up in the recent past. I think fears around supply side constraints have waned down in the last few days and therefore should act as a cap on further price rise. However, I had read earlier that some companies are importing cotton as it has become cheaper to import because domestic prices were higher than global prices. In short doesn’t look like in future there would be much of a margin expansion due to cotton prices falling much.

Most important thing to figure out seems to be the composition of cotton and yarn cost as a part of their total RM and Component Costs and then assessing the impact of cotton price rise on their margins. They would also be utilising yarn as their RM but yarn prices usually (I think) rise with a lag and trail the cotton price rise in %age terms. I think (but I can’t recollect) that they had mentioned that Cotton cost forms 40% of their total RM costs (that would make it 20% of sales last FY16). Don’t know about Yarn cost though.

Another thing to understand would be the impact of cotton to polyster price ratio, as when this is higher then it has the potential to impact the sales of the company. I think this is driven by the crude price factor which we all know is down. I think cotton to polyster price ratio factor was already discussed somewhere at VP (can’t recollect if it was on this thread or some other thread). I think impact due to this would be more difficult to assess or quantify as compared to calculating the impact of RM price rise once composition is known.

Mgmt. has said earlier that it can pass on the price rise to customers but I am not sure as to how easy it is to do it in case of a steep RM cost increase and hence would like to discount this.

Just some thoughts that I had in mind.

Cheers.

Discl: No holding as of today. Few things stated above are interpretations on the basis of what I have read etc. and hence the same can be wrong. Please do your own due diligence and form your own views.

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68

Hi Guys,

Had exchanged few mails with Indo Count Mgmt. and their IR advisors Strategic Growth. Had a chat with their IR advisors today. Just summarising the points (some points already known but still putting it here).

  1. RM testing - As expected no way to do this (globally too at present I think only PIMA products can be tested). But supplier certifications etc. are given by suppliers and the most a company can do is to maintain these records properly (which they are doing). [As far as I know maintaining records of certifications and other documents, etc. are the only way at present for end customers to check the origin and source of RM (PIMA being an exception)].

  2. RM Cost Composition - On actual %ages, they will come back to me again. Will update once I receive. Other related Info.: 20% yarn sourced from in-house spinning division (so here all RM will be cotton). 30-35% yarn sourced from market. Rest is ready cloth sourced from market. Egyptian and Supima sheet sales are 10%-12% of sales.

  3. Imported & Domestice RM sourcing composition - Mostly RM sourced locally and less than 5% RM imported (This might actually be less than 5% as I think sometime back I had read in the AR that RM imported is less than 1% as a part of overall RM cost).

  4. Impact of a 10% rise in cotton prices on margins - Normally a rise till 10% can be absorbed internally by making some changes in the product mix or making changes to the blending ratio of RM etc,. (As far as I know other players also do this for e.g. had heard SP apparels mgmt. saying a similar thing in their Q1 earnings concall). We all know that they do maintain an inventory of 6-8 months and they had inventory till October- November. I have already shared info & view on cotton prices in my previous post above. However, they were of the view that they are not seeing cotton prices hardening much and has come down in recent months. According to them 10% rise in cotton prices would impact margins by 100 bps (1%) - I had thought this to be around 2.15% on the basis of assumption that cotton cost being 20% of sales, but as they said that they make adjustments etc, therefore impact of 100 bps maybe believable. They said they pass on the price rise (if above 10% rise or a steep rise) to customers when new contracts come up. Although this has some lag due to difference between actual price rise and new contract coming up later. In case of a major price rise they also take some hit and share the burden and don’t pass on entire price rise to customer.

  5. Capacity Expaansion & Utilisation and Growth -
    *** This year 62 mm capacity utilisation out of 68mm. New capacity of 90 mm - internal target is to utilise fully by FY19 but can spillover to FY20 as they see some slowdown as compared to their previous expectations.
    *** This year is a year of consolidation because of: 1) Higher base as growth in the past was fast. 2) In the sheets segment already a lot of market share gain has happened, therefore growth in this segment would be around 4%-5%. 3) Customers for new products (this include new customers and existing customers for new products) take around 1.5-2 years to crack. New products still being delivered as test quantity. 4) Better growth was expected in non-US markets but they have seen some slowdown in consumption in markets like UK (due to Brexit) and Middle East (crude impact maybe). They are present in mid to high segment in these markets.5) Duty disadvantage in UK when compared with a country like Pakistan. All in all might take sometime for demand to pick up in these markets. BUT please remember that mgmt. guidance of growth for current year and maintenance of current margins is after factoring in above factors.
    *** At present 80% weaving capacity outsourced. Phase 2 expansion would triple in house weaving capacity from 9mm to 27 mm. This should add 100-150 bps in margins.
    *** Full capacity utilisation of new processing and weaving capacity should add around 1000 Crs of revenue.

  6. Other points-
    *** Mgmt. invests in a project only when payback period less than 3 years.
    *** 60%-70% forex hedge at any point of time.
    *** Indian retail venture only through MBOs and no individual stores and in future also through e-commerce sites. Don’t expect much for first 2 years as takes time to build a brand.
    *** Present revenue composition - 65% US and 35% non-US. UK = 10%, Europe = 8%, Australia 5% and rest Middle East, etc,. Target for next 2 years is to bring US and non-US to 50-50 but taking more time than expected due to non-US markets slowdown.
    *** US fashion bedding would take atleast an year to show nunbers.

Discl: No holding as of today. Few things stated above are interpretations and hence the same can be wrong. Please do your own due diligence and form your own views.

Cheers.

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69

Hi,
Watching the indo count- counter for a while, and am surprised at the punishment heeded out by market to this company. I have been invested from 800 levels and found it attractive due to the following reasons:

  1. Company still expects to grow at 15-20% YOY. At a P/E of <12, this implies a PEG ratio of less than 1 .
  2. Negligible long term debt
  3. No forseeable threat to existing revenue stream.
  4. Good amount of capex in place to ensure that no more debt may be required.
  5. Good vision to expand into domestic and export markets. Branding efforts have been pretty good but will take time to fructify.
  6. Asset light model

It appears as a deeply mispriced bet.

70

Compare PEG with other textile companies. This is very high. Cyclical can not get this much. Growth will not be like past. No growth in last one year

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71

Rajesh,
I usually do not consider industry average to draw the base for a company. (I may be wrong here but offering my stance)
As long as the company continues to grow at the nominal rate expected here, the price is going to follow. So as long as the company grows at greater than 11% (current P/E), future growth will bring down the P/E thereby drifting the price to the mean.

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72

There is something called sector tailwind required for accelerated gains. IMO textile is facing sector headwind and even top quality stocks will under-perform. This is Mr. Market and there is no easy explanation. may be market wants to see the difference between boys and men. Investors have to worry and think what will make new investors to come and buy this stock. IT is facing similar situation and even good stocks are underperforming. Good to accumulate and wait or sell and get into a faster lane.

No holding here

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73

I mean to say not to forget that it is cyclical. Having many positives like asset light, support by big retails have given high valuation already. It is creating illusion of consistency of growth. Remember what Bakshi Sahib told in Goa. Cyclical can not have consistency in growth so no meaning of calculating PEG >1 (11/11). Cyclical are always sold in good times. These are opportunistic bets for limited period. I don’t see opportunity here at this price.
Disclosure - I was lucky to sell all holding at 900 recently after keeping more than one year. I sold immediately after I realised my illusion of consistency in growth. I have full right to be wrong. I am a learner.

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74

ok. Got your viewpoint. I would differ in ICIL being a cyclical bet.

75

Ok a theory of mine I have found to work, would llike to share with you not sure how many of you would agree, in cyclicals and commodities you enter when you see PE is expanding from very low value to doble digit or so and you exit when PE is contacting from high to low.
Unlike evergreen ones you don’t buy more when PE starts contracting and you dont start selling either when it’s at a high PE because you can never tell what’s the top, you have to wait for PE to start contracting and then make an exit.
If any of you agree let me know.

76

Ishan,
There are 2 parts to measuring the price of a company. 1) Valuation 2) Pricing.
For folks following the Pricing model, your theory certainly would explain the slow down in growth and transition to a gradual steady state (PE Contracting).
For the valuation folks, there is a discrepancy between the future value of the company and the current price. So to say Inefficient Market Hypothesis. :slight_smile:

Either ways, each one has their own conviction levels and that’s why we all constitute a “Market” with multiple behaviors.

77

I am confused why boarders are referring to ICL as a cyclical business. In a sense everything is cyclical, so you can’t really argue with that beyond a point. Like even FMCG staple companies are witnessing a low volume growth currently. Fundamentally ICL sells bed linen, and it customises it according to the buyer’s requirements. To me, this customization is the key to its high ROE. Cause its tough for everybody offer this service at the price and quality assurance when you talk small quantities and large varieties. For this it receives advance payments. Customer’s should be sticky, as long as you don’t Welspun your way out. I don’t think the growth rates should be anywhere near the past (given the low base). But I dont think it should be valued like other textile companies too. I mean, which other textile company generates this ROE

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78

Perfect Akshay. Nice to hear almost exactly the words i wanted to convey, from your mouth.

79

I am not calling the cotton spinning business has ended its cycle, it has it’s growth potential for atleast 2-3 years more but I am predicting the stock to behave like a cyclical, there is a difference beteen the two, people who have got a 80-90 bagger of indo count would definitely like to exit even tough it’s growing fast but maybe at a rate lower than before, when such a high beta stock even if it grows at a slightly lower rate than before it’s bound to see heavy correction, decreasing PEG can be dangerous for high beta stocks like this.

80

I dont think calling this a cyclical is right… Below are some points on this company which i think show this to be a growth company…with a robust business model to execute and grow over the next few years…

  • Asset Light Business Model ( giving it asset turnover of 3X compared to 1.2X for a fully integrated unit)

  • Bed Sheet market size is USD 4 billion. Has entered into new segments like fashion bedding, institutuional linens and utility bedding which expands its opportunity size 3X to USD 13 billion. ---- This shows the huge opportunity size for this niche segment it is in. Enormous room to grow for many years if management executes well.

  • Has been consistently reducing debt. Latest D/E of 0.52.

  • Free cash flow generating company for last 3 years. Has generated 307 cr free cash flow in last 3 financial years. Very few such companies in textile space.

  • It had entered CDR in Aug-08. Exited it in FY15 and has learnt a lot of lessons.

  • With focus on value added products, Indo Count has improved its contribution from higher count yarn products (800-1000 count yarn products); this has taken average cotton yarn count to 400 levels currently as against 200 two years ago.

  • Indo Count has also increased its contribution from niche and high-margin patented products like performance-based linen, thermal-based linen, and temperature-based linen.

  • Recent launch of its three brands mark its foray into B2C market.

Disc : Invested from lower levels. Please do your own reasearch as views might be biased.

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81

Company’s cost of debt capital (Interest expenses / average debt) is 16% and is highest in the industry. This is a reflation of company’s bad history with lenders. A 10 to 12% is a more reasonable rate given the over all interest rate levels in the economy. If you factor this into the valuation of the company you get a valuation of Rs 2400 Cr against market cap of 3000 Cr. Stock is overvalued by at least 20%. On top of that, it has planned expansion of 475 Cr over next 2-3 years against a operating cash flow of Rs 150 Cr per year. They have to borrow money to fund this expansion. At such a high borrowing rate, only way the stock can perform well if they can get a ratings upgrade and reduce their cost of debt capital.
No wonder their stock started the recent decline after they announced their expansion plans in Jan-Feb 2016.

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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?

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83

A very detailed analysis on Indocount by Dr. Vijay Malik. He has highlighted some serious management issues.
http://www.drvijaymalik.com/2016/11/analysis-indo-count-industries-limited-research-report.html

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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.

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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.

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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

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