Kitex Garments Limited

Key takeaways

  1. The management highlighted that Q1 is seasonally the smallest quarter (20% of annual revenues) as all shipments for ‘Spring’ are largely concluded by March while shipments for ‘Fall’ commence by August first week.
  2. legal hiccups have delayed brand tie-up with US brand. However, the company expects to conclude the agreement over the next quarter. The brand will be owned by Kitex LLC (KTG will own 50% stake and Kitex Children’s wear will own the remaining 50%). The management outlined that the JV structure will de-risk issues around capacity constraints and both companies will invest equally in building the licensed brand.
  3. On KTG/KCL merger, the company highlighted that E&Y has given three distinct options for the merger and the management will evaluate and take a call by the next quarter. The merger, once approved, would take approximately a year’s time to fructify.
  4. Management expects to double sales in 3 years, 15-20% sales growth for FY16, 30-35% sales growth in FY17, 35-40% sales growth in FY18.
  5. Management believes market demand is not a concern as far as growth is concerned; key constraint is managing higher production scale.
  6. Management highlights that it will look at importing fiber from US (since it is of high quality and is duty free) and will set up a plant in India. Quality of cotton imported from US is better and cost is cheaper, additionally clients would appreciate the products made from 100% US cotton, driving better margins.
  7. Lack of skilled labor, need for continuous training are key factors that limit quick scalability. Management has entered into an agreement with the government to recruit 400 people monthly to scale up manufacturing.
  8. On utilizing capacities better: With orders being of custom made items (distinct colors, design, styles, etc) – hence KTG can’t manufacture and stock up. Every season, buyers give separate designs, thus resulting in high customization.
  9. Order book and revenue visibility: Entire factory is fully booked for FY16; expect INR6b to INR6.5b revenues for FY16 translating into growth of 17-27%.
  10. No new clients added in 1Q and the company does not plan to add newer clients.
10 Likes

Looking at the recent price action and listening to the Q1’fy16 conf call, it seems market is jittery about the way the whole merger scene will play out. I could sense skepticism in the tone of the analysts in the con call. Market does not seem to take the following generously:

  • Unit in the US to be a JV with both KGL and KCL
  • Ambivalence around whether and when the merger will happen

In my opinion, this explains the recent price correction. Personally, I am sensing this as a great buying opportunity.

Disclosure : Took a position today at 800

I heard the call.

  • Sabu Jacob re-iterated guidance of Rs600-650crs for topline (sales + other operating income + other income). He said 1Q is when one season ends and new season begins. It is a short summer so his customers don’t pick up too much clothes as what they pick up will sell from September onwards only.
  • He remained confident of sales ramp in 2Q, 3Q and 4Q similar to last year.
  • PBT/ (sales + other operating income + other income) has improved from 20% to 22.45%. FY15 it was 27% and he expects this to move up in FY16
  • 180crs PBT looks a little tough in FY16 (Last year it was Rs141crs). So PBT could be lower than that. This is primarily because he hiring people every quarter and traing them for growth in FY17E and FY18E.
    -Re-iterated guidance to double sales in 3 years. Said demand is not the constraint but production capacity and people are the constraint.
  • On being asked about low interest income he admitted to the effect that they are betting on US dollar appreciating which is disconcerting but nothing new
  • Questions were asked on why Kitex LLC is a 50:50 JV and not wholly owned by KGL. About what will happen to KCL? Will it be merged with KGL or not. No direct answers here again. Sounded a little evasive. But well this not new and I guess everyone knows these issues.

As I see it there are 3 main issues
—Will FY16 600-650crs sales guidance be met?
—Will the sale doubling guidance in 3 years be met?
—Decision on KCL and if it will be fair or unfair to minorities?

Disclosure: Invested.

4 Likes

When we say merger, i assume we saying KGL is going to buy KCL. if KCL values increases it means KGL money will go out to buy KCL and KCL money will go to promoters.

JV venture profit will be divided 50:50 means later when KGL buy KCL, it has to pay all the money. That could be one of the reason market not happy with this JV and analyst asking again and again why can’t JV is part of KGL. 50% profit sharing with KCL means additional value creation will be divided but current business profit would be intact.
More information on this part will help to keep conviction.

Disclosure: Invested from lower level

  • KGL - KCL merger was there on their plate for many quarters and every time they said that report was not ready from E&Y. In this quarter, they have got the final report and they would decide on it next quarter. This just keeps dragging without any closure. Even US brand tie-up has this mix up of KGL-KCL and I don’t how the KGL stakeholders will be affected.

  • If they are talking about 15-25% percent growth, stock is overvalued even at this level.

  • Got jitters last quarter conf call when MD mentioned that "our stock has gone up like anything. thanks to everybody’. Have no idea what he meant by that.

  • No new clients added, no new capacity expansion and constraints on production scaling. Have started to suspect about their growth mentality. Think they would be too busy next few quarters to sort out the KCL-KGL merger and US setup.

Disc: Invested but exited 50% after listening to the conf call. Further decision on how this KGL-KCL pans out.

Went through the conf call notes and the AR

In the AR, the name of the bank in which Rs. 199 Cr. of cash is kept is
not given. I find it illogical that someone wold keep Rs. 199 Cr. of
cash in a zero interest regime whereas one can earn 9% here in India -
after all forex losses are only 2 % or so and in any case, most of
kitex’s costs are in India. Infact, even less than infosys which needs
to pay its sales guys in USD - I am not sure which are material expenses
that need to be paid in USD abroad.

  1. About the KCL/KGL
    merger, if they are serious I do not know why they would set up a JV
    between the two in USA. If the merger was going to happen, this is only
    going to complicate things

  2. If KCL and KGL are doing the
    same thing, why not shift more people to KGL and allow value to accrue
    there. After all, that’s what tata is doing between tata communication
    and ttsl

  3. Above all, I find it extraordinarily difficult
    to believe that kitex’s EBITDA and ROCE are higher than companies like
    google and apple which have an asset light, global brand and have
    humungous operating leverage, have no RM costs, have a short cash cycle

Also, if brand owners like mother care and gerber are earning 11-15%
margins, why would a supplier who has no brand pull, be allowed to get
away with 35 % margins.

  1. FY 15 audited financials were
    out on April 3rd which was a friday - the year ended on a wednesday. No
    other company in the world, not even google which does no " physical
    business" and all of its invoices are electronic and settlements done
    electronically, can release its audited results in two days flat.
    Infact, preparing a financial model on a company takes 2 days. How can
    trial balance, accounting policies/entries, schedules be done in two
    days.

  2. KGL results came out in two days flat but its
    quite ironical that KCL results have not been uploaded in MCA on time in
    yester years. - where one has typically 3-4 months’ time. A company
    that can give accounts to public shareholders can’t finish regulatory
    filing in 4 months’ time.

  3. I could not find if kitex’s statutory auditor is auditing someone else. It’s not a big 4. Not a big flag anyway.

Just my thoughts - I feel something does not add up here.

20 Likes

Was reading the mind map provided by contratarianvalueedge.com and found this analysis on Management guidance. If history is to be believed, we can see where it’s going…

Mind map link: https://drive.google.com/file/d/0B8Mr8IuAEwz7VEFjTFRnNG9KMG8/edit

Invested

3 Likes

To be fair some of the past delays in capex commissioning is due to prevalent political environment in Kerela. Mr Jacob has been on record threatening to shift to another state !

Disclosure: No holdings. Exited quite some time back. Figured out that I don’t understand the business :wink:

1 Like

Disclosure - no investment.

I was piqued enough by @varadharajanr observations to do a cursory look at AR 15. My own observations on top of his below.

  1. They hired EY LLP in FY 15 for internal audit for Rs 14,00,000. This was done by in-house personnel until FY 14. Consequently “Payment to auditors” has jumped 3 times to 24 lakhs.

  2. The statutory auditor mentioned last year (FY 14) that internal control systems were commensurate with the size of the company. Then why is it that with just a 15% top-line growth a big 4 internal auditor had to be sought, paying them nearly 3 times the statutory auditor?!

  3. This year’s annual report does not carry Annexure to the Independent Auditor’s Report. My friends in the audit profession will be shocked to know this. This is disquieting for me as an investor as one would have come to know the state of internal controls among others.

  4. I loudly second @varadharajanr 's point that it is well nigh impossible to sign off on audited accounts within 4 days of year closure for a firm of this size and the industry it is in. Maybe it is possible if March was a zero sales month giving enough time to reconcile everything. But that was not the case; JFM quarter had the highest sales for any quarter. Reconciling payables and receivables with creditors and debtors itself takes time. If the auditor managed to do it AND sign accounts in 3 days, it is highly unlikely that he sent out confirmation letters to debtors and creditors and got their satisfactory responses.

  5. The audit firm as @varadharajanr mentioned is auditing only this firm among all the listed firms and among all the 26,000 firms Prowess (a database of firms and their stats) has (KCL is not covered by Prowess). That to me is worrying. Without any prejudice to the auditors or audit practice, I know of one-person audit firms who just sign-off on document given to them without complying with audit procedures either in letter or in spirit.

  6. Their revenue recognition policy in my view is aggressive and does not allow for returns, although they do have sales returns. “Sales are recognized on inwarding of goods at customer’s end, where applicable as per terms of sale (for domestic) and on the date of bill of lading (for exports). Income arising on disposal of scrap/waste is recognized on receipt basis”

  7. I find it surprising that they are not fully funding their gratuity liability of about Rs 3.5 crores when they have about Rs 200 crores in the bank. It is the easiest of all employee liabilities to meet and usually handed over to LIC or such. Typically, a decently run firm would keep its “defined contributions” liability fulfilled, else they may be in violation of Payment of Gratuity Act. They have also not disclosed who’s managing their gratuity.

  8. One final observation is that they say they say they get short-term credit at 10.45% from SBI. But if it is a large export merchandise business, they can avail pre-shipment and post-shipment $ credit based on Letter of Credit - which should not be a problem given marquee clients. That would both hedge their currency risks and reduce their interest rates. So it seems quite un-businesslike to take loans at 10.45% (though their finance charges on average borrowings seemed to be 14%). Maybe I am missing something here?

All-in-all I should allow for the possibility that there are valid justifications or even errors for the above unfavorable observations. So comments welcome.

Warm regards,

14 Likes

Totally beats me, why people would believe the management claims / OR / what some investors claim

Management claims

  • Will start own brand in US
    Does anybody have any idea of how difficult, and expensive it is to build a new brand? Especially in a mature, competitive market like USA. The chances of success are less than 1% probably.

Investor claims

  • Scale advantage
    How can a company with merely 300 cr sales have scale advantage? 300 cr is clearly sub-scale. Anybody with some money in his hands can build a larger manufacturing facility, and find customers to absorb that much in an industry whose size is probably in billions of dollars

  • Switching costs
    In an industry worth billions of dollars, I can’t see why there must be switching costs to switch from a 300 cr player. There must be at least a 1000 players in this industry. If there were switching costs in the industry - the industry structure would have been completely different - there would have been maximum 10-15 players.

On the whole, it boggles my mind… This is purely a garments supplier, which is max valued at 15 PE… If it is fast growing - perhaps at 20 PE max.

Some brokers, and others have been pumping up the stock, I suspect…

Disc. Not invested

2 Likes

Some valid points made above by various boarders and several concerns are valid, however, some thoughts:

  • Because Gerber makes 11 to 15% it is not necessary that a supplier should make lesser margins. There are several global industry examples where supplier margins far exceed those of their customer.

  • They are the 3rd largest manufacturer focused on infantwear. Therefore they have scale. Switching costs are relevant and switching needs to be considered carefully because the infantwear segment is a niche segment. Health hazard issues related to dyes used - potential health issues to infants can result in expensive and damaging litigations in the US.

  • The key monitorable will be the KCL - KGL merger event. This will speak about Jacob’s integrity to the minority shareholders and ultimately impact the P/E multiple Kitex will be able to command.

Disc: Invested, currently holding 4% of portfolio.

2 Likes

How many infantwear suppliers do you think Mothercare has? I presume at least 25. I have gone to multiple mothercare shops in India - and found that they have infantwear manufactured in India, Bangladesh, Vietnam, Philipines, etc. I don’t think it will be very different for mothercare in US/UK.

Why can’t they switch their orders within their existing suppliers? There is no moat here, I am afraid.

Fair point ayush.

No apparently perceivable moat for an outsider.

the buyers would be in the best position to judge if they are able to get required quality at a beneficial price from kitex.

If kitex can indeed double their sales in 3 years while retaining profitability, it would suggest the buyers are sticky and like the value proposition kitex offers.

Time will tell…

1 Like

@GreyFool

I have been only focussed on this over the last two days and I am convinced that the Rs. 200 Cr. cash raises several questions.

  1. In AR FY 15, there is just a row called cash and cash equivalents for Rs 199. Where is this cash ? which branch /

  2. According to RBI regulations, an exporter has to repatriate the money back to India before 15 months. Surely, some part of this Rs. 200 Cr. consists of money earned in FY 14 and FY 13. Why is it not in a bank in India ? This is inexplicable. So, if they have the Rs. 200 cr. outside, it’s in violation of FEMA or more simply, the RS. 200 Cr. does not exist.

  3. The biggest dud in the logic is that most exporters convert USD into INR and park it in FD/liquid funds as interest rates in India are at least 6-8%. Even if someone makes 2-3 % losses in forex, it still makes a big difference, If in doubt, go look at all the IT serviecs companies and look at the staggering amount of cash they have in FD. Why would someone let go of a RS. 20 cr. interest income from a Rs. 200 Cr. money is beyond me. It can pay for the entire top management salaries for three years. This is a bummer to me - behavioural economics demands that not even reliance will let go of such an easy income -

  4. There is no statutory auditor certification on the cash and cahs equivalents. Who has seen it and wheres the bank certificate ?

  5. the management’s excuse for this Rs. 200 Cr. is that they can play forex/USD interest rate and make gains. If yes, they should be running an investment bank - not a textile company. In any case a 50 bps increase in USD only gives them 0.5 % increaes in yield - why forego 9 % interest here.

  6. they are borrowing here like greyfool said at 10.5 %. why pay 10.5 % here and get zero interest in the US bank - surely they are pleasing US banks like crazy.

My sense is that kitex is just like another textile company with 20-25% margins and the Rs. 200 Cr. cash is a “phantom” cookie jar. Seems like satyam redux - through a merger with KCL, (so like satyam maytas merger), wipe out the cash and keep the scheme going.

Several indicators like audited numbers in 2 days, an auditorwho audits only them, unfunded gratuity, singular relationship with the auditor and no one else, no clear schedules makes me very very nervous.

Discll: Not Invested - I always thought these numbers look too good to be true. I just dont; trust them.

I

16 Likes

Indeed very valid points.
Don’t know why VP core team is mum over this.

1 Like

Listened to the con call. other members have already posted the highlights. a couple of observation from my side.

  1. an analyst asked what would be the bottom line?. md’s response was bottom line on turnover or bottom line on profit?. i have no clue what he meant by that.
  2. for every question ( related to concerns,implications of external things ), his response was its not an issue. they will do better than previous quarter.
  3. in the last quarter con call, he was talking about technology, efficiency etc. now he says they are hiring aggressively.
    disc. no holdings. nor am i planning to buy at any valuation

We are discussing the same issue again and again. Similar discussion have happened one yr back also.
In Q3 or Q4 conference call Jacob has clarified the cash is not abroad, it is in India i think he said SBI. I dont know whether he was lying or sharing the truth. I dont know it is mandatory to mention ac no. in annual report.

All these questions are coming again mostly bec of a soft Q1 ( which was expected anyway). If Management is unethical they could have given a bumper Q1 as well ? like Q4.

I think finally it comes down to individuals, if one is comfortable with the story/promoter/VP/Prof Bakshi ( intelligent fanatics post) etc or not. It comes down to individual call after looking at all view points.
There are view points on both sides.

Some of the answers only time will tell who is right or wrong.
Individuals are advised to use their own judgement and not to borrow conviction from VP Core Team always. After all they are not promoter of Kitex :smile: and may not have all the answers immediately, end of the day everybody is an investor only.

At the same time all of us have all rights to further discuss and arrive at a logical conclusion if any.

Cheers
Santosh
disc : invested, views may be biased

8 Likes

@jatin/others
Please understand VP Core Team uses its discretion to “intervene” in debates, when its deemed necessary. When it is deemed unnecessary, we will choose to be silent - please allow and respect that space for us. Sometimes it’s prudent to avoid adding fuel to the fire - in both directions !

Seeing so much of hullabaloo over 1 quarter of results, we choose to point out a few things - if only to interject a dose of realism, prevent panic reactions, and cluttering of this thread with the same issues over & over again. These are our complete views at the moment - so we also reserve the right NOT to be drawn into further defending our individual/VP position.

  1. Most/All the issues that have been raised by folks recently (post the Q1 results) are “old” issues; nothing new has been brought out which has NOT been discussed and debated before the investment call by VP - which means in our collective wisdom we had taken the call on the Personality and assigned a suitable discount factor to the personality type, while assigning a Premium to his execution ability

  2. Merger issue existed before as well. We had made the call with the full knowledge that Merger may or may not happen. Even without the merger happening we saw the distinct visibility of a 25% CAGR over 2-3 years. Merger happening is a bonus - not factored in our Valuation case

  3. 200 Cr Cash Issue : If I am not mistaken it has been clarified by Management that the cash lies with a State Bank subsidiary (SB of Travancore?) Kochi branch many months back ??

  4. Once having made a Call we like to keep faith and give the business a reasonably long rope to show walking the talk. Just 1 Quarter of results/newsflow or some event trigger does not sway our FAITH. We question the FAITH only after 2-3 quarters of non-performance or deteriorating performance. Keeping FAITH is the most important trait you need once you have done solid homework, have slotted the Management Quality & Business Quality, and invested for the long term

  5. Having spent extensive time on the Business/Competitive space/Industry, we find this is a high quality sustainable business that is capable of investing capital towards earning high returns for a number of years, with a long runway in front. The business is led by an exceptional Jockey with exceptional focus on executional efficiency - with manic or as Prof Bakshi calls it fanatic focus & energy.

  6. Such exceptional, maniacal folks we don’t run into everyday. Yes there are personal quirks - that are sometimes not defendable as completely rational decisions, but these kind of folks believe they know best - it is their way and they believe this is the way to do it - they don’t care much to listen or explain their rationale. The key question to ask when faced with such a personality/business situation is what do you value more, and in the context of the overall possibilities, can you live with the idiosyncracies (unless you have reached the conclusion there is an intent to defraud - in which case the decision should be clear right, there is no debate). Do you think these are IGNORABLE? Are these interfering with actual business performance on the ground? (A good contrasting example to my mind is the Hawkins case - where business was getting hampered quarter, after quarter, after quarter)
    In our case we took a lot of time to take a considered decision - with all the anamolies right before us - and decided to keep faith in the business led by what we believe is otherwise an Excellent Management - but where “Managementspeak” probably needs to be adequately DISCOUNTED. We have an internal figure for that discount we cant reveal …ha ha…

  7. Normal growth in the business is a given for us, but there are a few “Optionalities” Kitex business throws up that most investors need to focus on. Execution on white label opportunities in the US market, and its own private label branding attempts. These will gradually unfold over next 1-2-3 years - and that is what we want to closely track. So far Kitex has been executing on home ground, Executing well in uncharted territory is the key monitorable for us - which will confirm or deny our main investment hypothesis.

  8. End of the day Investing is an ART form. There is no holy grail. Nothing really right or wrong. Take the decision based on your comfort level. If you are comfortable stay put and keep faith. If you are not comfortable, decide to exit. If you had invested based on the VP call at 300+ levels , there is no reason to complain anyways :smile: We absolutely reserve the right to be proved completely wrong and foolish in our call of keeping faith in the business and the management - for the moment.

  9. There are other things to focus on and investigate in the sustainability of the Kitex story. For example, there are more players (existing & emerging of some scale) in India of supplying infantwear to the same customers - can we list a few names, please… We will urge Members to shift focus to that and refrain from too much of what we call opinion-bazi - one way or the other.

  10. By all means keep track of the events/facts, bring out NEW (disturbing) facts by all means - that will be a skeptic’s job well done - that someone like Dheeraj continues to do - that’s his singular contribution to this community - we welcome more like him. And as promised whenever we are at Kochi next we will take up all these issues with Management - and revert with Management’s way of handing the objections and its responses.

32 Likes

Exactly @sinha124! I was not writing as I didn’t want to be seen defending the company but I’m surprised to see these issues being pushed on several places after the fall in stock price while most of these concerns have been out there well from before and most of the serious investors I know are aware of these and much more and have tried their best to find answers by attending the AGMs and doing homework. I’m not comfortable or 100% sure with all the responses yet continue to appreciate the remarkable work the company has done. One needs to attend the AGM of the company and see the huge and fantastic setup the company has created, the high quality work environment being provided, one of the best global names as customers and giving awards to the company. Plus if you go locally and speak to people, this guy has done substantial amount of CSR work in his local area and really helped people and spent money from his pocket. If one is interested then he should go through the entire thread once again and try to read the positive points also and try to check them. Anyways coming to my thoughts on the points raised (these are my thoughts and I reserve the right to be wrong or change my mind :slight_smile: ) :

  1. On cash balance - yes, its pretty concerning and the most important point. Infact I had raised it at a concall and AGM - the management told that the same is not lying in some foreign ac rather its very much in SBI Bank ac at Kochi. He even said he can give the ac no if needed :smile: So that was comforting however, the question still remains as to why he is not earning interest on the same and why is he speculating on making more gains from dollar appreciation (which I don’t like and concerns me).
    If you check the past balance sheet of the company, the company had a debt:equity ratio of 5:1 in 2007 and by 2013 there was consistent reduction in debt + cash generation and debt:equity ratio came down to 0.5:1. The cash balance has swelled up materially only in last 2-3 years. Earlier debt reduction wouldn’t had been possible if the business was not generating cash.
    Still, I continue to keep this as a key monitorable.

  2. On hiring of E&Y and paying lot of money - I see it as a good point. Earlier the issue could have been that the co has no professional auditors - atleast they took a move and got E&Y as internal auditor. From my CA experience I can tell that most of the cos have unknown auditors till they reach a point and are asked by investors to have known audit firm. And its not easy to change the old statutory auditors all of sudden.

  3. On signing of acs early - We had asked it at the AGM and were told that the company has a process of having acs finalization on a monthly or quarterly basis + they don’t have to deal with too many customers (total customers would be less than 10 I think) + the deliveries are not daily - there are fixed schedules. So its not that its impossible.
    We should ask the company why this excessive focus on being “first to report” - and provide them feedback - that this raises more questions and anyways do not get them any brownie points :smile:

  4. On KCL - KGL issue - Yes, we would prefer to have one entity but that’s not in our hands. If we are to pull out the numbers of KCL from MCA (which one can do by paying 100 Rs) the good thing to me is that KCL has also had good net profit margins over the last several years. There have been years when KCL has grown much faster than KGL and there have been years (like the latest one) where there has been a de-growth at KCL. But there is no clear trend.

Few more things we did to check about the company:

  1. Spoke to people in Kerala about the group - most of the time the feedback has been excellent. Even on our forum several people have given good feedback
  2. There are website like panjiva.com on which one can get shipment details - https://panjiva.com/shipment_search/results?q=kitex+garments
  3. Searched on EPF website - http://search.epfoservices.in/est_search.php
  4. Spoke to some professionals in the industry - and the feedback was good about the quality, infrastructure, technology etc.

Despite all this, given the points raised and short-comings in the company, this investment call can go wrong - so everyone please be careful and do your homework :smile:

I hope this helps.

Regards,
Ayush
Disc: I’m invested and my views might be biased.

34 Likes

Thanks Ayush and Donald for the excellent posts.
I am from Kochi,and one thing i can vouch for is the quality of products that Kitex makes.They are top notch. Also whatever feedback that i have heard about them from friends , relatives has always been good.

Disc: I am invested and my views might be biased.

3 Likes