Nandan Denim Limited - No. 1 position in denim play

Stock Opportunities
21

Thanks Abhishek for having done a detailed analysis and posting it on the forum. Also to other boarders for bringing out the positives/negatives and having a good discussion on the same.

I am invested in the business and following were the reasons for me to invest. The ongoing expansion, the expected OPM marigin improvement to 20-22% from existing 15%-17% after the completed backward integration, improving ROCE(ROE might not be a good measure for this company as it uses a lot of leverage), large addressable Indian market, favourable industry tailwinds(cheap debt/subsidies, low cotton prices and china not very competitive at the moment in this segment). Also, the stock looked cheap from P/E point of view with decent fundamentals. Also, the past record of management showed that they have ramped up the business well.

The negatives are that it is capital intensive business and don’t have much pricing power(my understanding).

I am a novice investor. So probably I don’t understand the risk in its entirety. What will happen if government stops subsidies or if China becomes competitive again or if Denim goes out of fashion in Indian market. I don’t really know. But I feel the probability of these events happening in the next 2 years is extremely low and hence I am personally comfortable ignoring these risks.

@abhishek90 - I saw your valuation excel sheet. Your FY16 EPS projection is 18.11. In the past 2 quarters the cumulative EPS is 6.83( 3.4 and 3.43). Would the business be able to make EPS of 11.28 in the remaining 2 quarters? Also, will it be able to grow the revenues 25% each year for the next 2 years with the new capacity(which is expected to be completed by 1st quarter FY17)? My understanding is that they are already operating at 99MMPA and the full capacity would be 110MMPA. The backward integration should give them marigin improvements but not more denim capacity. So can they increase revenues by 25% for next 2 years with the existing capacity? I am asking this because you have spoken to management and probably you understand these things better. Thanks in advance.

Disclosure - Invested from 75 levels. 20% of portfolio. Views might be biased.

22

Hi Janarthanan,

Thanks for appreciation. My answers to your queries -

1). EPS valuation of 18.11 made by me was before I met the mgmt. Till then I just had a talk with IR over phone. Once i met the mgmt - Govind Sharda - he told that there was some delay in the expansion plans which will reduce the projected EPS of 18.11 to some extent. But, again he told that the backward integration is going to help in a big way to increase the EPS. (Backward integration was planned to get finished by end of financial year - which we completed early). He did not tell exact figure. But, we might think to have EPS between 15-18 (18 has a high probability).
2). Sales will be 25% YOY for next 5 years atleast. They have plans to set up processing unit - hiring fashion designers, adding value added products in the portfolio, which will give them entry into global markets. Think when the domestic denim industry is expected to grow at 15-18% CAGR, Nandan is expected to grow at 25% CAGR - basis expansion done, backward integration done, export market entry, etc.
3). Capacity is 99MMPA - but the capacity utilization is 80% - that means 80MMPA. So company has 30 MMPA open capacity left.

Ignore the EPS for this year - it can be 15 or 18 - because still 4 months to go and we do not know how fast or slow the expansion plans will take place. But, if we look into long term - sales are there to grow at 25% CAGR, backward integration is there to help raise EBITDA margins, processing facilities to bring value addition and increased realization per metre.

Mr. Govind Sharda - with surety told that the CFO this year will be 200 cr (133 cr last year).

2 Likes
23

As per 2015 AR 87.3% of sales are domestic whereas the remaining 12.7 are exports. Exports registered a 75% YOY growth.
Nandan Denim will be the 5th largest
manufacturer of denim in the world by installed capacity yet currently only has 1% of global market share.

It has lot of headroom to grow its exports. If the numbers were inverted, then I would have worried about slowing denim sales in the USA etc
but as of now there is less to worry as the exports component is less.

Domestic denim market growing at 15 to 18% per annum so market is set to double in 4 to 5 years.

Some positive factors for domestic denim market:

Low per capita consumption of jeans at 0.3 to 0.4
More than 70% of population with age less than 30…thus a huge addressable market.
just 15% of denim consumption happens for females and kids category: lot of room to grow here as well
Almost 50% of denim gets consumed in top 10 towns of India that represent less than 10% of population. So there exists a huge runaway for potential growth.

Risks:

Increase in cotton prices affecting profitability
Dumping by China who is the largest manufacturer by current capacity
Long term trends for fashion including denim hard to predict at a global level
Withdrawal of subisdy/interest subvention for TUFS (Both state and centre subsidies)

Disclosure: Not invested but interested

1 Like
24

Hello all,

Would recommend you do a bit of research on the promoter group before investing (Chiripal Group). They are not known to be the most ethical people and noone can be sure about their businesses and fungibility of cash. At a time when a lot of denim players have posted losses (Check Aarvee), they have been posting profits, which rumours say, are to receive bank loan sanctions. There is a reason why no private sector bank has touched this company.

My two cents having lived in Ahmedabad and worked in the banking sector. Please do your own research before investing.

Cheers,
Karan

5 Likes
25

Some thing which caught my eyes.

Nandan Denim in 2015, had a Tax liability of around 19.6 Cr as shown under P&L statement where as only 11.9 Cr was actually paid (figure from Cash flow statement). Similarly in 2014 a Tax deduction of around 15.6 Cr is shown in P&L statement where as only 8.6 Cr was actually paid (figure from Cash flow statement).

In addition there is promoter pledging although now reducing. Plus as from their analyst meet they have no vision on what should be their ideal Debt/Equity ratio.

Is it safe bet ?

I am not yet sure & staying away for the time being…

26

Dear Karan,

Change is the essence of life and as things and environment changes, people also do change. Before investing my hard earned money in this company, the biggest issue I had was the promoter integrity. I did not go further into my research before checking this issue. Chiripals have really changed their image, the way of doing business and ethical conduct. I have confirmed this from a high post person at Arvind - its biggest competitor. The source is very genuine since my audit firm helped me have arrange the meeting with this fellow (I am a CA and I used to do articleship there).
Your question about its profitability - I would like to inform you that Aarvee denims are not doing their business properly. Their focus is needed, which will not come untill the family disputes in the promoter family are resolved. I have checked this / confirmed this news.
Look at all other players in the denim market - all are increasing their capacities and earning good enough.
What has happened to Dolly Khanna and other investors like ex CIO of Fidelity investors who have invested their money here.
Again with my knowledge about accounting I post here the same conclusion -

No company can do all the 5 things together -
1). Pay dividends
2). Pay taxes.
3). Generate positive operating cash flows
4). Generate decent ROE.
5). Make big frauds.

Small frauds are done by every company - which we should not be concerned about.
To your concern, E&Y has been appointed as the management audit firm - I have confirmed this with both IR and the president of the company. - Any one can call the IR and confirm this.
Also, IR had told me about changing of their statutory auditors. ( this is not yet released by company officially). It was just a casual talk and got slipped from his tongue - I think.

Even I am from Ahmedabad and have previously done audits for Arvind Limited, Asarwa Mills and have visited Arvind, Nandan and done some scuttlebut by meeting a big wholesaler of denim fabric.

About rumors on bank loan sanctions - We do not rely on rumors in investing I guess. Moreover, with debt to equity of 1.5 (post receipt of govt subsidy) - where the debt has been received at a mere 1-3% interest cost, where company is generating enough profits to service debt - where do we see threats.

SBI is the biggest lender for this company. I am not sure on this - Govt. might have a mandate of opening a loan account with public sector banks to avail the subsidy benefits - this is practice in grants and subsidy matters. Other than debt for expansion - they only have debt for vehicle and other old debts (whose proportion is very low).

If you have any concrete info - like you told you work in bank - have you/your bank encountered any serious issue about the company? Did Nandan approach your bank and your bank rejected it? Request you to give insights on this.

Your issues regarding profitability (comparing with Arvee), debt problems, promoter integrity and frauds have been answered hereupon and I dont see any issue on those fronts.

Best Regards,
Abhishek Shah.

1 Like
27

To me - promoter continuously buying shares from open market, company appointing Big 4 audit firm for management audit and changing statutory auditor (action not taken yet), aggressive expansion plans at cheapest debt + seeking one year for better integration/streamline/bring efficiency/process re-engineering makes me think that the promoters are not that aggressive and not very conservative also. Appointing independent directors such as SBI CEO i guess (refer AR FY 15), person with good experience in branding are true signs of people and corporate governance changing there. I do not need more signs to invest my money here.

Disc: My views may be biased. but, my views are based on my proper research and scuttlebut done.

1 Like
28

Dear Nabilmoideen,

Have you figured in Deferred tax assets and Deferred tax liabilities in your calculation?

Please take that in your calculations - you will find the exact figure.

29

Hello Abhishek,

I appreciate your efforts in doing a thorough research and scuttlebutt on Nandan Denim. Many times it is not possible for retail investors to travel far and take a call on business and management by observing things at ground level. One has to rely on secondary research only. Your efforts have given me more optimism about Deepak Chiripal who I felt was doing a good job in running the business and changing things which are not desirable by the investing community.
Thanks a lot for being generous as well as active in sharing your research.

Regards,
Saurav Jalan

Disclosure : Invested with significant margin of safety. Hence, my opinion could be biased. Please do your own due diligence before investing.

2 Likes
30

From what I have learned about this company, due to the growing market, it will need to continuously invest in capacity expansion and hence free cash flow may be hard to come by. As long as the interest subsidy stays for few years and the expansion is done through debt at a cost of 1% to 3%, then it will be a job well done.

As and when the interest subsidy comes to an end, one will have to look at whether the internal funds of the company are strong enough to fund expansion. So as a company it will need constant investments to grow top line. Yes the capacity utilization is not 100% so as it reaches closer to 100% operational leverage will start showing up. But with the planned capacity expansion to 110 mmpa and coupled with the fact that current utilization is not 100%, it would need significant marketing efforts to take it closer to 100%.

This is just my 2 cents on the co. Take it with a pinch of salt as I have recently made a small entry in to Nandan Denim as a tracking position.

31

Wanted to know from @abhishek90 as well as others who track Nandan whether it is safe to assume that the debt overhang of the company’s balance sheet is no longer a cause of concern as the subsidy is likely to continue and the only genuine risk to this story is that of promoters/management integrity and governance.

32

Dear Nelson,

Yes, its a good move. Consistent growth can be seen in textile sector.

1 Like
33

Dear Nelson,

TUFS being extended is good for Textiles in general. But please be wary that the new TUFS has no mention of interest subsidy on loans. It talks of only capital subsidy.My understanding is that all old loans will be cleared for interest subsidy and any new loans would not be eligible for interest subsidy. So Nandan might get the benefit for its loan from TUFS, Irrespective of TUFS, Nandan would continue to get the state subsidy from Gujarat government though. Other boarders who track Nandan, please correct me if I am wrong.
Disclosure - Invested. Views might be biased.

1 Like
34

Thanks for the reply Dear Abhishek and Dear Jana.

From this article:

Abudgetary provision of 17,822 crore has been approved, of which12,671 crore is for committed liabilities under the ongoing scheme, and
`5,151 crore is for new cases under A-TUFS. The scheme will come into
effect from the date of notification.

Does Nandan Denim fall under the head of committed liabilities is what I was curious to know. The debt part has largely been ignored due to the state and central government subsidies. I just wanted to have some clarity on whether things will remain same going forward as well. The state subsidy as you mentioned will continue so the only doubt is for central government subsidy under Amended TUFS. Wish the management had something about this to get some clarity on the issue.

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Religare - http://www.religareonline.com/research/research-reports/religare-investment-call-colon-nandan-denim-ltd/4176

1 Like
36

Dear All,

Has anyone calculated how much incremental return will they reap on this expansion of denim capacity from 99MMPA to 110MMPA ? They are spending 600crs on expansion and their FY15 Sales and PAT was 1100 crs and 51 crs respectively on 80MMPA capacity utilisation.
Also, what is the average capex which is required to expand the capacity by 1MMPA in the denim industry ?

Waiting for the opinion of fellow investors.

Thanks and Regards,
Saurav Jalan

Disc : Invested with significant margin of safety.

37

I understand the following from the past few conf calls and interviews

  1. With the entire 110MMPA for Denim commissioned and at 80-85% utilization levels (This is the norm in denim industry or weaving industry in general), the max top line expected is roughly 1400-1450 Crs at average realization between Rs 130 - Rs140 per metre. The above top line includes 10MMPA of shirting too. Not sure of the exact realization for shirting.

  2. Backward integration should add roughly 4% to existing EBITDA margins which will trickle to the NP margins. We need to watch how much depreciation(expected to be 100Cr per year) and interest(Nandan planning to payback 60Cr debt per year) impacts the NP margin.

  3. Value added products can enhance the top line further. But there are 2 methods - one by weaving where more number of picks are introduced. This method increases the realization per meter but this also reduces the number of meters produced per unit time. The other method is by processing(I am yet to understand this fully) whereby volumes are not impacted. Currently Nandan is doing value added products using the weaving method. Also, another thing to keep in mind is that value added products don’t remain in value added category for long. They get outdated within 1-2 quarters and become commodity products. So Nandan has to continuously be on the forefront of producing value added products and be on top of the latest trends. So we need to watch how they go about this. My personal take is that it is not going to be easy. Probably max 20% of their volumes might be value added products in next 2 years time.

Regarding average capex required to expand capacity by 1MMPA, I do not know the exact answer for the industry. For Nandan Denim, in the last conf call it was mentioned that roughly 250 crores(out of 610 crores) is for expanding Denim capacity from 70 to 110 MMPA. So Nandan has spent roughly 250Cr/40MMPA = 6.25Cr for 1MMPA.

Disc: Invested and views might be biased.

3 Likes
39

Dear sir,
I am planning to take a small position here.
Is the management clean? they have been totally un-responsive to my queries.

Also, need to figure out the long term outlook for this one~~ Ramu

40

@ramaxcoder

The investment thesis for me was the capacity increase, margin expansion(due to backward integration/ increase in % of value added products) and low valuation.

Net profits have increased by 30% and ~25% in last 2 years. The effect of full expansion will be in H2 of this FY going by the last conf call and I personally expect a 25+% profit increase this year too(assuming H2 brings in 40% increase in profits and H1 about 10%).

The full effect of expansion(capacity and backward integration) will be exhausted by FY18. What I mean here is that the full revenue potential of the current capex cycle which they underwent in the last 2-3 years will be fully reflected in their revenues in FY18. This is with the current realizations and do not include any higher margins they might earn in the value added category.

Further long term outlook depends on how the company positions itself in the value added category. Their processing division needs to deliver results in the next 2-3 years and this is a key moniterable going forward. I think they have some ideas of how to progress further - like become direct preferred supplier to big brands/customers(now it happens via agents), become a diversified player in textiles - like shirting and terry towel(currently terry towel is under the parent group and there was news that this might get moved under Nandan Denim. But the business is pretty new and they have just started capex for it). But all these are new domains for the company and we need to see how they execute their vision. All said and done, this is a capital intensive business and if they do not make headway via value added products then further increase in topline will come only with additional capex.

Rgd management quality, I found them to be okay so far. I haven’t found anything wrong with them expect that there were bullish statements made by Mr Govind Sharda when he was new and he has toned down and is more realistic in his projections in the recent conf calls/interviews. Could you post your queries sent to the management? - Folks following the company can probably help with answers to those questions.

Disc - Invested. Views could be positively biased. No transactions in the last 1 year.

1 Like
41

I am looking to exit or decrease my textile industry exposure.
True textile industry is cyclical in nature and has growth potential for 2-3 years more,
but I have some concerns on textile stocks, irrespective of what happens in the books of companies.
See Indo count is stuck in spite of market having a rall, there are small signs like this which indicates they may start consolidating soon. They may not look over priced but going by historical PE of most textile stocks even 10x-15x PE is on higher side.
Let me know if anyone have similar feeling.

Disc: Invested in multiple textile stocks including Nadan Denim