Q&A: Granules India, Divi’s Laboratories and Mirza International Limited

Modified on July 2, 2018

The current article in this series provides responses related to:

  • Granules India Limited
  • Divi’s Laboratories Limited
  • Mirza International Limited

 

Query

Sir,

Again a wonderful analysis done by you on Granules India. The issue of warrants, high promoter salary seriously hints at Promoter placing their interest much before the company. Obviously, we judge the promoter and the management based on the past only.

Read: Analysis: Granules India Limited

Still few doubts in general:

1. In a very fast growing company which has always been under expansion mode, change in turnover for the expansion it takes in the current year may be reflected after 2-3 years. And this overhang may continue if the company keeps on increasing its sales. Hence SSGR may not give the accurate picture? An exaggeration of this took place in Ahmednagar/ Metalyst Forgings but there the debt rose to 12X net profit and 4x Operating profit. In Granules India, it’s still 3x of Net profit and 1.5X operating profit.

Obviously, self-funded growth is remarkable, still, if a company feels that it can grow much more than that, obviously it will take debt. Please throw some light on this.

2. Now coming to the debt-funded dividend part. When the company is taking debt @ 10% and it is confident that it would generate a return at multiple of that. Why punish the shareholder temporarily and not give them dividends when their debts are manageable.

Both these points – insufficient SSGR & debt funded obviously puts the company in some grey zone. Without these, it would have been better. But still does it assures such grave red signals or just keeping the issues in check!!

Waiting for your reply sir.

Author’s Response:

Hi,

Thanks for writing to us. We are happy that you found the article useful.

1) We believe that whenever a company continuously keeps on doing debt funded capex for expansion, then it becomes very difficult to assess the efficiency of utilization of past capex as the current/new capex will always keep bringing the efficiency parameters down and the management will always have the plausible explanation for poor efficiency performance saying that the future after 2-3 years would be bright.

Such situation leads to the problems with capex utilization going undetected for long periods of time, which one fine day present negative surprises to shareholders.

You may read more about our thoughts on this issue in the following article:

Read: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

While analysing we focus on both the increasing debt levels as well as equity dilution as both result in the same outcome which is deteriorations of existing position of the equity shareholder.

2) We believe that paying out dividends from debt proceeds, which have interest cost attached, in the hope that the company would be able to generate excess returns in future is not a good practice. In personal finance parlance, it is using future income today by overspending by taking leverage. We are not comfortable with such approach when adopted by companies.

Read: Steps to Assess Management Quality before Buying Stocks (B)

However, as mentioned in the article, these are our views and we are only one of the participants in the vast market. Different market participants interpret same information differently and this essentially is the reason for the continuation of trading when participants take opposite sides of buy/sell trade while accessing the same information.

Therefore, we appreciate that investors question the logic provided in the article and come up with their own interpretation of the information.

Hope it answers your concerns.

All the best for your investing journey!

Regards

 

Query

Read: Analysis: Divi’s Laboratories Limited

Hi Dr. Vijay,

Thanks for this analysis. It is really helpful.

I was really curious about two things on Divi’s Laboratories Limited:-

1. Working Capital – You rightly analysed, the Working capital is high compared to its peers. However, if we look at the realisations and the operating margins (way higher than the Industry), that easily makes up for the high working capital (PS- there is no debt on the Balance sheet). In fact, isn’t it a moat for the company? I think it is leveraging its balance sheet strength to command industry-best margins (for more than 10 years).

2. Management’s commitment towards the business- Two important aspects as far as management’s commitment is concerned can be: – A) Managements execution capabilities; 2) Making competitive moats for the company.

As rightly indicated by you, management had a superb track record in project execution. Second, its capability to keep the competition at bay for more than 10 years makes a strong case for management’s active involvement in the company’s business.

Your concern about the unlisted company is something very interesting.

PS- Help me if I am missing something.

Author’s Response:

Hi,

Thanks for writing to us. We are happy that you found the article useful.

1) We believe that supplying APIs to branded generics manufacturers is a commodity business. We believe that in commodity businesses, profitability margins higher than peers should be looked with caution. Many corporate fraud cases had reported higher OPM than peers in businesses where no such significant competitive advantage existed.This is not to say that the presently analysed company is a fraud or on the contrary to say that it has a huge competitive advantage. This is to highlight that we believe that higher OPM than peers in a commodity business where your product is not much different than your peers, should be looked with caution and need to be analysed further.

We do not think that higher working capital is a moat. Let’s do a rough assessment:

  • Divi’s Lab has receivables days, which is about 20-25 days higher than its peers and it has OPM which is about 37-40% whereas peers have margins of 20-25%.
  • Looking solely at the above data, it can be inferred that the end customer is willing to pay about 15% extra for a higher credit period of 20-25 days.

We do not think that higher working capital in terms of higher credit period to customers is the moat here.

Read: How to Analyse Operating Performance of Companies

2) We would not be able to comment on the exact competitive positioning of Divi’s as it would require the understanding of the other vendors to their customers and Divi’s wallet share in those end customers.

However, we believe that API is not a very niche field and until some time back Chinese companies were the leading API manufacturers of the world. India is accustomed to importing the bulk of its API requirements from China.

We would need to wait for the outcome of the current USFDA issue to know whether the company resorted to cost savings by the way of bypassing prevailing/expected best practices.

Read: How to do Business Analysis of Companies

Hope we are able to address your concerns.

All the best for your investing journey!

Regards

Dr. Vijay Malik

 

Query

Read: Analysis: Mirza International Limited (Red Tape Shoes)

“The total P&L interest expense of Mirza International for 2007-16 is Rs. 237cr. which leaves little money for debt reduction. Instead, the FCF being Rs. 212 cr. is not sufficient to meet the interest expense and the company has to take additional debt (Rs. 93 cr.) in last 10 years to service the interest and pay dividends. “

In 2006, Interest Coverage was around 3.6 has gradually improved to 5.6 in 2017. Debt/PBIT have decreased drastically from around 5 to 1.5 recently. Hence, though debts have increased but when u consider the OPMs and improved profit levels, isn’t it at much more comfortable levels? So the company has to take additional debt not to service the interest and pay dividends but to increase its earning significantly. It can pay its debt in less than 2 years now!! Even the promoters have been raising stakes in the company.

Read: How to do Financial Analysis of Companies

From the time of analysis, P/E has decreased from 19 to 13.33 making its relatively attractive when compared to peers.

Author’s Response:

Hi,

Thanks for writing to us and sharing your valuable inputs!

We appreciate your assessment about the reasons for the increase in debt being the shortfall of FCF in meeting the requirements of interest outgo and dividend payments. It is a good analysis of the cash flow position of the company.

Regarding other parameters: Improvement in the interest coverage, reduction in the Debt/PBIT levels etc., if these parameters are seen on an exclusive basis, then the direction of change of these parameters is a positive sign for the company.

Similarly, reduction in P/E ratio also indicates that the margin of safety built in the purchase price is increasing with increasing earnings yield, which is the result of declining P/E ratio.

However, the above parameters only cover 2 of the important aspects of stock assessment namely, financial position and valuation levels. We believe that the investment decision should be based on the comprehensive assessment of the company after Financial, Valuation, Business, Management and Operating Efficiency analysis.

If after conducting the comprehensive analysis, the investor believes that the company fits her preferred criteria, then she may take the final investment decision.

The investor may use the following steps as guidelines to conduct her stock analysis:

Read: Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

All the best for your investing journey!

Regards

Dr. Vijay Malik

P.S.

 

DISCLAIMER

  • The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
  • I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
  • Currently, I do not own stocks of the companies mentioned above in my portfolio.

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