Is anyone else looking at the Vardhman Textile spinoff - Vardhman Special Steels

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So while researching the textile sector in general, i came across Vardhman Textiles and then its spinoff company which has just started trading (May 17th, 2012) called Vardhman Special Steels. And whenever i hear of a demerger/ spinoff, I stop and pay attention, especially after I read the book - You can be a stock market genius by Joel Greenblatt.

In this situation, i really have not looked at the business outlook of VSS in detail. The valuation is that attractive. And there are other factors too:

1). The stock is trading below its liquidating value as defined by Graham. The calculations are given below:

Figures in INR Cr.

Current assets

Current Investments 18 100% 18
Inventories 95 66% 62.7
Trade receivables 105 80% 84
Cash 87 100% 87
Loans & advances 16 80% 12.8

Fixed assets
Tangible assets 43 15% 6.45
CWIP 8.6 15% 1.3
Long term investments 81 100% 80
(debt mutual funds)
Loans and advances 12 15% 1.8
**
**
Total 353
Total current liabilities 188 100% 188
Total non current liabilities 93 100% 93

Liquidating value 72
Liquidating value per share 38.7

2). The promoters are the biggest shareholders holding approx 75% of the shares of VSS. So their interest are aligned with the shareholders.

3). If that is not enough to convince you of the intent of the promoters, here’s more good news. The promoters have lent the company INR 66 cr through their companies. From the latest balance sheet:

Short term borrowings

From related parties
)- Vardhman textiles limited 29.8 cr.
)- Vardhman acrylics limites 35.9 cr

So, the promoters do have a lot to lose if the company goes down. And the share price does suggest that it is going down.

4). Currently, around 11% of the shares are held by MFs. As generally happens, the institutional shareholders will exit the demerged company after the demerger. If that happens, as i assume it will in this case, the share price will go even lower.

5). If you insist, i will tell you a little about the earnings of the company. First it is not loss making. That should be enough. Maximum i will do is look at the ROE and cash flows.

Net profit margin: 4.9%
Net asset turnover: 1.87
Leverage: 1.48
ROE : 13.6%

Last year, on a net profit of 26 cr

CFO: 5 cr.

Operating cash flow was much below net profit, because of an increase in receivables and increase in “other current assets/ loans and advances.”

)- Increase in tradereceivablesis concern and one to look out for.
)- Other CA/ Loans and advances consists of advance to suppliers mostly (13 cr. out of 16 cr.) So no problems there.

6). Currently, the stock is trading around 34. I will wait till it does down further and then start buying.

Any feedback will be much appreciated.

Thanks.

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No information on institutions liquidating their holding. M-cap is too low for them to remain invested in this counter. Further volumes are too thin to allow them to offload. In fact Reliance Mutual fund brought some shares at the time of listing of demerged entity. One may have to wait for eventual selling, if it comes.

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Looked at this stock. If they have as much cash on their BS as say they have, why are they taking short term working capital loan from bank and that too on a secured basis by hypothecating entire present and future fungible assets?

Do you have a view on how the quality of the promoters here? While I am not passing any judgment here, I would say that in these type of situations unless you can trust the management there is very little likelihood that anything will come to you.

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Looked at this stock. If they have as much cash on their BS as say they have, why are they taking short term working capital loan from bank and that too on a secured basis by hypothecating entire present and future fungible assets?

Do you have a view on how the quality of the promoters here? While I am not passing any judgment here, I would say that in these type of situations unless you can trust the management there is very little likelihood that anything will come to you.

5

looks interesting at first glance, mcap of 58 cr, turnover of abt 500 cr, low PE. Debt of 230 cr is on higher side. Still checking.

As per Peter lynch, Promoters will demerge a company only when the demerged company is in good shape so as to avoid the embarrassment of rescuing it later. However, same cannot be taken for granted. Need to view the AR and also if anyone has any idea on the quality of promoter.

6

Though looks cheap on some parameters but I think its sort of another highly competitive business and hence not a interesting long term story.

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I agree that VSS is in highly competitive industry and not a long term story. But from medium term perspective, the negatives seem more or less priced in. However, I am not sure at what price one should make entry.

As per AR, The Company follows a LVCQSA strategy - Low Volume Critical Quality Special Application which gives it an advantage of less competition from mass players and increased loyalty from customers seeking stringent quality.

As per my calc - ROCE for FY 12 - 25 % , but if we take debt into account it will be higher. As the debt has been raised for expansion.

AR 2011-12

**
**

DEBT - 245 R

CASH - 87 CR

non current INVEST IN DEBT FUNDS - 83 CR

current invest in debt mfs - 18 cr

**inventory - 95 cr

**

POSITIVES ( in my opinion)

)- Company had reported an EPS of 14 for FY 12. As mentioned in AR due to plant upgradation / expansion work, revenue will be less in FY 13 due to plant shut down for some periods. After new capacity comes on stream and provided auto industry is not in trouble, the company should be able to improve earnings.

)- High promoter holding. Promoters of Vardhman Textiles hold 61%+ in the Vardhman textiles. They could have demerged the company VSS with every shareholder getting proportionate share in VSS. That way promoter stake in VSS would be 61%. Why would they care to increase stake to 75%.

-As per AR It is anticipated thatVehicle Production in India shall witness strong growth of 3.5 times till 2020 from 13.36Million units to 46.79 Million units. [Source: E&Y Report on âAssessment of CostCompetitiveness in Electric Arc Furnace v/s. Medium Blast Furnace Route for Steel Production.â] As regards, Indian Auto Components the demand is expected to reach INR 5.1-5.6 lakh Crores (USD 108 â 119 billion) by 2020 from INR 1.4 lakh Crores (USD 30 billion) in 2009.[Source: http://www.businessandeconomy.org/17032011/storyd.asp?sid=6008&pageno=1].

Hence, it is expected that the demand in the Auto Industry shall remain firm giving a

fillip to the Industry in general and Special Steels in particular.

-In view of the anticipated good demand, the unit of the Company is also planning expansion in its various operations in 2011-12 to increase its share in Low Volume, Critical Quality and Special Application segment besides increasing the capacity of its rolling products.

-Company has OEM approval from most of the auto companies.

)- As per AR thecompany has been the preferred supplier to leading companies like Telco, Ashok Leyland, Maruti, Hindustan Motors, Toyota, M&M and Escorts among others.

)- As per AR they need 130 cr for expansion. In my opinion the company will not need to raise further debt for present planned Capex. In six months upto Sept 12 qtr the total debt has reduced by 18 cr. Debt raised thru ECB route being cheaper option.

-Company is flwg conservative approach by recognizing forex loss on books but not the forex gain

NEGATIVES

)- Small cap, low liquidity

)- Cyclical business, commodity business, limited or no pricing power

)- Capacity utilization was almost 100% in Fy12, some part of production was outsourced. Expanded capacity needs to come on stream. After Capex , it is not clear that how much capacity will increase.

)- Unsecdured debt of 105 cr

OTHER observations

)- Vardhman textiles is profit making and dividend paying company

)- Non executive Chairman -Mr. Prafull Anubhai (73) is a Corporate Advisor. He is associated with Educational Institutions likeIIM(A) Ahmedabad and is the Chairman of Board of Management of Ahmedabad University

MD - Mr. Sachit Jain (44 ) is a B.E. (Electrical) from IIT (Delhi) & MBA from IIM (Ahmedabad). He has over 20 years of experience in the Textile and Steel Industry.

Could not find anything negative about promoters.

-The company has one plant in Ludhiana and is into manufacturing specialty steel and alloy products catering primarily to automobile applications (and, also for Industrial, Defence and Engineering Applications to a limited extent).
The Company has its presence in different states across the Country presentlywith 6 branches and 6 warehouses.

)- Majority of expenses is for Power and fuel and then for raw materials. (iron and steel scrap and ferro alloys)

)- The Company has started the implementation of its Rolling Mill upgradation project with an investment of around` 130 Crores. Almost all the equipments have been ordered and it is expected to be completed by March-April 2013.With this project, the Company will be able to increase production, improve quality, reduce costs and improve customer satisfaction by reducing changeover time as well as adding to the product range.

-As the Country is witnessing the slow down in growth, the automobile industry has slowed down. This is having a serious impact on business sentiments for alloy steels also.

As a result, this year the volume will be under stress as also margins. In addition, there will be plant shutdowns which has to be taken for the Project. This will have an impact

even on margins. The Company hopes to recover its performance from the year 2013-14 onwards.

-The biggest risk the Company sees is that there could be larger than planned disruptions

in the project which could hamper current operations. Also, the current slowdown could get much worse which may further affect volume. The rupee may continue its steep fall

adding to the Company’s costs as lot of scrap is being imported. Also, this would increase the cost of ECB. To mitigate the above risks, the Company has appointed M/s Realization as Project Consultants who are one of the top consultants in the world in implementation of Project by using Critical Chain method propounded by Dr. Eliyahu M. Goldratt of ‘Goal’ fame. The Company has found their inputs quite useful while implementing the Rolling Mill Project.

Disc : not yet invested. Waiting for a further dip / another qtr of results. (hopefully poor results)

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Further to above, i found this link about alloy steels.

-The process of making Alloy Steel is a highly specialized and complex process of manufacturing.

Each Alloy Steel grade is tailor-made as per customerâs specification and end application (it is not a commodity product)

Requirements of Alloy Steels are in small batches ranging from 500 kg to 40 metric tonne per grade. Due to the specialized nature of requirements, alloy steel manufacturers are not able to achieve economies of scale.

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  • Conference Call held on 11th Feb '13-Key highlightsby Capital Market.
    • Addressed by Mr. Neeraj Jain Executive Director
    • Management has indicated that based on latest SEBI rule, they would not disclose any quantitative details, unless the same is filed with the exchange.
    • During the quarter, Yarn business for the company and for the whole industry as a whole did very well. There was a strong realization growth both on y.o.y basis and on q.o.q basis.
    • Chinese government has imposed an MSP of cotton from their farmers at 120 cents. At that rate, many of the Chinese traders and yarn manufacturers are hesitant to go ahead when the international prices are hovering around 80 cents. Further a 40% import duty is imposed on cotton imports without the allocated quota. Chinese government are carrying more than 7 million tons of cotton as piled up stock, which they bought it from farmers.
    • Due to this there is hardly any exports of cotton yarn happening from China. Further demand for cotton imports on quota has increased. All these, together with favourable rupee are a win win situation for exporters of cotton yarn from India. Hence both India and Pakistan cotton yarn exporters stand to benefit at the costs of Chinese exporters
    • As per the management, it is difficult to visualise the stand of Chinese government in future, but near term, the trend is likely to continue.
    • The company will add another 120000 spindles, which will be operational from Oc-Dec’13 onwards, but the full impact will be visible only from FY’14 onwards. A total capex of about Rs 1000 crore is envisaged of which about Rs 500 crore will be spent before Mar’13.
    • Management has not disclosed the current derivative position, which is open and its rate, as the same is not disclosed so far to the exchanges.
    • Vardhman Textiles also got the benefit of the disruption in terms of power costs that is happening in the Southern markets. The conditions for operating the mill is much better in Northern India compared to Southern market due to either non-availability or very high costs of power in The South.
    • Fabric will continue to remain around 1/3rdof revenues going forward. Of the total Yarn manufacture, about 1/3rdgoes to manufacture fabrics and of the remaining 2/3rd, about 50% is exported.
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The company held its conference call on 11thNov’13 and was addressed by Mr Rajeev Thapur CFO and Mr Neeraj Jain Executive Director Yarn division

Key highlights by Capital Mkt:

During Q2 FY’14, the company sold about 40424 Metric Ton of Yarn, up by 10% YoY, about 377 lac meter of Grey Fabric, up by 12% YoY and about 246 Lac Meter of Processed Fabric, up by 18% YoY.Exports constitute about 35% of total turnover.

There has been a spurt in the margins on YoY basis largely due to favorable conditions in respect to the availability of raw material at reasonable cost and strong demand of yarn due to increase in export of yarn to China.

However, as per the management, with the increase in cotton prices on YoY basis and relative lull in demand as of now, the margins, may not continue at this elevated level.

China has played a huge role in increase in yarn prices. This is 3rdconsecutive year of cotton imports done by China and Chinese government continues to maintain high cotton inventory. The cotton prices for cotton yarn manufacturers in China are high, hence they are forced to import from countries like India, Pakistan etc. Chinese policy on cotton and exports will be revealed only by Jan’14 and by that time things will be clearer.

Also on YoY basis the cotton prices are higher by around 20%. Although the season has just started and one needs to see the availability and the quality, clearer picture will be evident only by Jan’14 on cotton prices.

Vardhman Textiles had booked cotton at lower levels last year and hence the inventory benefit was gained so far in FY’14. However the stocks of low costs cotton are getting consumed and Q3 FY’14 will be a mix of low cotton inventory and new cotton arrivals at higher price. Hence the margins of H2 FY’14 will be lower than H1 FY’14, but how much is difficult to quality as it all depends upon how the season of cotton ends and also the Chinese policy.

The company had suffered some MTM losses as it had booked some forward contracts on exports at around Rs 60 to $. But for Q3 FY’14, the booking has been made at higher rates, so some forex gain is coming.

On the expansion side, during Q2 FY’14, additional 62496 spindles, 960 rotors and 120 looms became operational at various manufacturing units. The full effect of the expansion will be visible from Jan’14 onwards. With this, the company has around 900 thousand spindles operating at around 90% of capacity by Jan’14.

Of the Rs 800 crore of capex planned for FY’14, about 75% is already spent in H1 FY’14 and the rest will be done by end of Mar’14. For FY’15 there are no major plan of capex except the normal maintenance one.

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