Analysis: AksharChem (India) Limited

Modified: 04-Jul-20

This article provides in-depth fundamental analysis of AksharChem (India) Ltd, an Indian manufacturer of dye intermediates (Vinyl Sulphone) and pigments (CPC Green and CPC Violet) based out of Gujarat.

 

AksharChem (India) Ltd Research Report by Reader

 

Dear Dr Vijay,

Please find attached my detailed analysis of AksharChem (India) Ltd as per your articles and guidance, Kindly share your opinion with me and readers of site www.drvijaymalik.com

 

About the Company:

AksharChem (India) Ltd is engaged in manufacturing of Vinyl Sulphone (VS, a dye intermediate), a raw material used for manufacturing of reactive dyes which find application in the textile industry, CPC green pigment, violet pigment (new product).

 

Financial Analysis Checklist of AksharChem (India) Ltd:

  • Sales growth: 20.46%, Profit growth 128% (10Yr)
  • Profitability: 9%
  • Tax payout: Tax pay out of appx 30% since last 3 years
  • Interest coverage: 11
  • Debt to Equity ratio: 0.19
  • Current ratio: 1.80
  • Cash flow (CFO > 0): Yes – after meeting capex it has FCF
  • Cumulative PAT vs. CFO (cPAT ~ cCFO): 10Yr CFO= 71 is >> 10 yr PAT= 56 cr
  • AksharChem (India) Ltd is growing at a decent sales growth of 20.46% over last 10 years with a very good net profit margin that justifies that co. has good financial strength.
  • AksharChem (India) Ltd has an excellent profit growth of 128 over last 10 years.
  • From the year 2014, Aksharchem Ltd is regularly paying out tax with more than 30% that glimpse about last three years.
  • AksharChem (India) Ltd has a good interest coverage 9 times in recent years that also means that company has sufficient interest coverage to paying out its interest.
  • AksharChem (India) Ltd has current liquid assets more than the liabilities to take care of its current liabilities. That suggests AksharChem (India) Ltd’s strong position.

 

Operating Performance Analysis of AksharChem (India) Ltd:

  • NPM is 4-9% since last 4 years, it is improved in the current year due to high-profit margin after china ban related product due to environment factors.
  • Inventory turnover ratio is improving from 8.8 to 11.7(2011-2016)
  • Debtors days improving from 63- 44 (2007-2016).
  • Net fixed assets turnover (NFAT) ratio is increasing since 2008- 2016 from 4.5-7.0 and decrease to 3.3 in 2016 due high fix asset in 2015 and 2016.
  • Debt is increased from 8 to 31 in 2007-2016 but Debt to equity is 0.19 and it’s almost debt free as per the current fix and liquid assets.

 

Business & Industry Analysis Checklist of AksharChem (India) Ltd:

  • Increase in production capacity and sales volume: Yes
  • Conversion of sales growth into profits: Profit CAGR of 127% with sales growth of 20%
  • Conversion of profits into cash: 10Yr CFO= 71 is >> 10 yr PAT= 56 cr
  • Creation of value for shareholders from the profits retained: By retained earnings of 48, the market cap increase is 520 thus creating value created for share holders 10.76

 

Peer Comparison of AksharChem (India) Ltd:

Aksharchem India Ltd Peer Comparison Competitors

  • We can see below that AksharChem (India) Ltd is growing at higher sales and profit growth rate than other peer companies.
  • The increase in production capacity and sales volume: 2009 (6292 MT) – 2016 (9240MT): – currently board have approved the CAPEX of 175cr for coming 12-18 months for capacity and product portfolio expansion.
  • Conversion of profits into cash: 10Yr CFO= 71 is >> 10 yr. PAT= 56 cr
  • Creation of value for shareholders from the profits retained:  By retained earnings of 48, the market cap increase is 520 thus creating value created for shareholders 10.76

 

Management Analysis Checklist of AksharChem (India) Ltd:

  • Background check of promoters & directors: Not any kind of fraud was found during web search about promoters
  • Management succession plans: Not understood
  • Project execution skills: Not understood
  • Consistent increase in dividend payments: Last 4 years the divided was increasing with the profit of the company
  • Promoter shareholding: >70%
  • FII shareholding: NIL, Mutual fund- 0.06%
  • Salary: salary of promoters in 2015-16 is approx. 75 L against net profit of 16cr which is 4.69% of net profit, higher than the average of 2% of net profit.
  • Promoter buying the shares: shareholding of promoters has changed from 60 -70 % over 2011-1016.
  • Concern: Issue of Equity Shares on Preferential Basis
    • The Company has allotted 1,550,000 Equity Shares of Rs. 10/- each at a premium of Rs. 8.50 per share to Promoters on preferential basis on 25th May 2011 after getting consent from the Shareholders at the Extra Ordinary General Meeting held on 10th May 2011. Page 5 AR 2011-12
    • By issue of equity share promoters may have increased the shareholding from 60-72%, please clarify.
    • I don’t understand the impact of this on minor shareholders.

 

Other Business Parameters of AksharChem (India) Ltd:

  • Product diversification: Pure play: AksharChem (India) Ltd is pure play in chemical sector
  • Govt. Influence: no interference from government

 

Margin of Safety (MoS) Analysis of AksharChem (India) Ltd:

  • MoS in Purchase Price (Earnings Yield (EY) EY > 10 Yr G-Sec Yield): YES- EY 10 is > G sec yield
  • MoS in Business Model:
  • We can see that the self-sustainable growth rate (SSGR) of AksharChem (India) Ltd is about 11-35% over last two years. However, AksharChem (India) Ltd has been growing at about 21% over last 10 years. Comparison of past sales growth with SSGR would indicate that it could fund its entire growth by its profits.
  • FCF is one of the key parameters to determine the margin of safety present in the business of any company. After meeting its entire capex it has free cash flow which shows margin of safety.

 

Credit Rating Analysis of AksharChem (India) Ltd:

  • Continuous improving- Last rating was revised on 09 jan 2017 (A+ from A).
  • Credit Rating Report: The revision in the ratings assigned to the bank facilities of AksharChem (India) Ltd takes into account the significant improvement in its operating profit during H1FY17 on back of increase in sales realizations of its key product, Vinyl Sulphone (VS), due to global short supply and resultant improvement in its leverage and liquidity indicators marked by AIL’s zero net debt position with unencumbered liquid investments exceeding its total debt as on Sept. 30, 2016.
  • Currently, ban of competitor chemical product from china and approved CAPEX will give high-profit margin and sales growth.

 

Valuation Analysis Checklist of AksharChem (India) Ltd:

  • P/E ratio: 10.03 (TTM)
  • P/E to Growth ratio: 0.22
  • Earnings Yield (EY): Yes – EY 9.97 > government bond yields
  • P/B ratio: 4.45 – irrelevant
  • Price to Sales ratio (P/S ratio): 2.11
  • Dividend Yield (DY): 0.57%
  • The P/E ratio is 10.03 which give somewhat margin of safety at the current price.
  • Dividend yield is 0.57%
  • (P/S ratio) is 2.11 but high-profit margin, as well as current approved CAPEX of 175 cr over 12-18 month, give better sales in coming quarters.

 

Overall:

AksharChem (India) Ltd seems to be a company growing at a decent pace of 20%, which has been witnessing steady improvement in the profitability margins due to improvement in the sales mix by focusing more on the high profitability.

AksharChem (India) Ltd has been able to significantly improve its working capital management over the years, which has led it to keep its debt levels under check despite doing significant capex to support the sales growth.

 

Concern:

please focus on some doubts.

  • Promoters’ shareholding increase by the issue of more shares, the salary of promoters is approx. 4.69%.
  • High CAPEX approved by the board of directors about 175 cr over next 12-18 Months and its financial impact on business.

Regards,

Krimal Patel

 

Dr Vijay Malik’s Response

Hi Krimal,

We appreciate the hard work you have put to prepare this report on AksharChem (India) Ltd. The report is useful for any investor who wishes to analyse AksharChem (India) Ltd. I thank you on behalf of all the readers of www.drvijaymalik.com for the time & effort put by you.

An investor needs to keep an important event in the life of AksharChem (India) Ltd while analysing the company for investment. The event relates to the rearrangement of business assets between the group companies: AksharChem (India) Ltd and Asahi Songwon Colours Ltd in FY2015.

Before FY2015, the business of the two companies constituted primarily Vinyl Sulphone in AksharChem (India) Ltd and CPC Blue and CPC Green pigments in Asahi Songwon Colours Ltd. However, in FY2015, the promoter family rearranged the business in a manner that the CPC Green business division of Asahi Songwon Colours Ltd was shifted to AksharChem (India) Ltd.

As a result, from FY2015 onwards, AksharChem (India) Ltd contains Vinyl Sulphone and CPC Green pigment divisions and Asahi Songwon Colours Ltd contains CPC Blue pigment divisions.

We will discuss more about the business rearrangement among the promoter family later in the article, however, it is of importance currently that the financial performance of AksharChem (India) Ltd before and after FY2015 might not be comparable on a sequential basis. This is because of up to FY2014, the financial numbers represent the performance of Vinyl Sulphone alone and from FY2015 onwards, a mix of Vinyl Sulphone and CPC Green pigment.

Moreover, it also presents a good opportunity for the investor to understand the business dynamics of Vinyl Sulphone business division as the financial numbers up to FY2014 are exclusive to Vinyl Sulphone.

In light of this background, let us analyse the past financial performance of AksharChem (India) Ltd:

 

Financial Analysis of AksharChem:

AksharChem (India) Ltd Financials

Until FY2014, AksharChem (India) Ltd has been growing at an average rate of about 20% per annum, however, the growth was interrupted by a period of sudden decline in sales as well as very poor profitability. In fact, AksharChem (India) Ltd hardly made any profits until FY2012. It was making operating losses almost every alternate year. Primarily it is from FY2015 onwards that the company seems to have seen stabilization in its profitability margin.

Based on the above observation, an investor would notice that Vinyl Sulphone previous to FY2012 has been a very gruesome business, which despite year-round efforts of the management was resulting in losses.

The FY2012, directors’ report from the annual report of AksharChem (India) Ltd (page3) represents the business situation being faced by the company during this period:

The year 2011-12 was a testing period for the Company. The operations were severely impacted by the global recession and economic slow down. Sudden Crash in demand, unexpected volatility in the raw material prices and foreign exchange affected our bottom line.

Further Reading: Understanding the Annual Report of a Company

The fact of highly cyclical nature of margins of Vinyl Sulphone business has been highlighted by the credit rating agency CARE in its rating rationale for AksharChem (India) Ltd in March 2015:

The revision in the ratings of AIL takes into account the resultant benefits from merger of ‘Pigment Green’ division i.e. diversification of AIL’s product offering, addition of reputed clientele to its portfolio and higher degree of stability envisaged in its profitability margins which was otherwise exposed to highly cyclical dye intermediate (Vinyl Sulphone) business.

Further Reading: 7 Important Reasons Why Every Stock Investor Should Read Credit Rating Reports

The above disclosures coupled with operating losses from past years make is clear to the investor that in the past Vinyl Sulphone has not been a great business to be in. The management of the company has agreed to the same in the conference call held by it in January 2017 (page 13):

Management: I would say 10 or 15 years back, the Chinese Government as we all know was following a very expansionary policy producing at any cost, even environment, so they had all those Chinese plants located at all parts of the country, some on the rivers, some in the middle of the cities, so these plants were not sustainable in a long-term. So, some of these plants had to undergo a lot of environment kind of acts and safety acts. Recently the Chinese government has tightened because of which Indian products were not competitive because India was some of our companies were already environment conscious from the beginning. So we were under constant cost pressure which led to very low margins for around a decade for this product, I am not talking about this product, I am talking of the whole chemical industry.

The above section clearly states that in the past Chinese players enjoyed cost advantages on account of lower costs related to following environmental friendly production processes and it was very difficult for Vinyl Sulphone players to make any profit.

However, since last few quarters, the Chinese govt. has changed its stance towards its chemical industry and it has now tightened the environmental regulations around it. As a result, the Chinese players have currently, lost the cost competitive edge. As per the conference call of AksharChem (India) Ltd for February 2017 (page 3):

On the Industry in China, Indian production of Dyes and Pigments is expected to grow at 11.4% CAGR till 2019.There has also been reduction in support by Chinese government for our Chinese competitors in terms of tighter pollution control norms, increased penalty for non-compliance including higher fine and imprisonment, increased disclosure, reduction in subsidies, appreciation of Chinese Yuan. There has been a structural change in the industry where the Chinese players are not able to pull down the margins as they used to anymore and as a result the outlook for this industry has become very positive for the foreseeable future.

As a result, AksharChem (India) Ltd has been able to witness very high operating margins since last few quarters on its Vinyl Sulphone segment resulting in overall high margins for the company. It is the major reason for the sudden increase in profitability margins of the company.

An investor would appreciate that the major risk to such profitability of the company would the resurgence of Chinese manufacturing in future, which might again tilt the scale against AksharChem (India) Ltd.

The management seems very optimistic that it would take at least 10 years for Chinese companies to put their house in order and to again become competitive in the international market, as disclosed in the February 2017 conference call (page 8):

As far as second question goes about the Chinese people coming back, the Chinese enjoyed this pricing power and dumping and low cost manufacturing for 10 years, so my view on a macro level is that 10 years, I am not talking of Vinyl sulphone here, on a macro level, 10 years’ Indian Chemical company should enjoy the pricing power and 10 years our margins should fundamentally change and this industry should do well for 10 years in India that is my personal view.

However, we believe that instead of taking the management’s view on the face value, an investor should notice that the primary factor leading to previous advantages of the Chinese players and their current disadvantages is the stance of the Chinese government.

An investor should be aware that political dispensations in the countries, as well as their policy stances towards industries, keep on changing continuously. If the future leader of the state in China changes the approach of current government, then the industry situation might go back to the previously prevailing scenario and the supposedly high operating margins of Vinyl Sulphone division might again end up becoming operating losses.

Therefore, we suggest that the investors avoid believing the management without doing their own homework and always take the calculated risk while making investment decisions where the success is dependent upon the changing stance of governments.

Further Reading: How to do Business Analysis of a Company

The other business division of AksharChem (India) Ltd: CPC Green, does not seem to be facing the Chinese competition. As per the management, there is no “Chinese Story” in the pigments business as India is in a very strong position. February 2017 conference call (page 6):

Indian manufacturers among other chemicals to be able to get more margins, as far as pigments is concerned we do not face any competition from China, there is no Chinese story, almost 90% of the pigment green produced is from India, due to the Chlorination technology because India is very strong.

As the operating margins of the company have witnessed a marked improvement in the recent quarters, the management is of the view that it would be able to maintain operating profit margins in the range of 27-30% going ahead.

To assess the feasibility of such margins, an investor needs to assess the profitability margins of each of the business segments of AksharChem (India) Ltd: Vinyl Sulphone and CPC Green pigments.

We have analysed above that the profitability margins in the Vinyl Sulphone business seem only due to the changed stance of Chinese Govt towards its chemical industry. Otherwise, the Vinyl Sulphone business would hardly make any profits, as has been the case in the past.

To assess the sustainable margins of the pigment business, an investor should analyse past performance of Asahi Songwon Colours Ltd, which has been a pure play in the pigments segment.

Asahi Songwon Colours Ltd Financials

The past performance of Asahi Songwon Colours Ltd indicates that the OPM though cyclical in nature over the years has been around 15-16%. The same OPM levels might be expected to continue ahead for the pigments division of AksharChem (India) Ltd, which forms about 40% of the sales of the company.

To achieve and sustain the operating profitability margins of 25-30% as communicated by the management, AksharChem (India) Ltd needs to earn OPM of 30% on Vinyl Sulphone (60% of sales of company) to achieve OPM of 25% for entire company and needs to earn an OPM of 40% on Vinyl Sulphone to achieve OPM of 30% for entire company.

An investor would recall that the profitability margins of Vinyl Sulphone division had been dismal and erratic in the past bordering on losses and its profitability margins have improved recently only due to the interference of Chinese Govt. Therefore, the profitability margins expected by the management going ahead would depend a lot upon the actions/non-actions of Chinese Govt on its policies towards chemical industry going ahead.

As a result, even though the management seems confident that they would be able to command better margins for next 10 years, we advise that investors should take it with a pinch of salt and keep monitoring the profitability margins closely going ahead.

Further advised reading: Why We cannot always Trust What Management Claims

As far as the visibility of future growth is concerned, the management has mentioned in the February 2017 conference call (page 10) that AksharChem (India) Ltd is currently using about 73% of the installed capacity of Vinyl Sulphone and about 98% of the installed capacity of pigment division.

Currently our capacity utilization over in the last two quarters for Vinyl Sulphone has been roughly 73%, we hope to increase this capacity utilization by at least 10% to 15% in the coming time, so there can be volume growth in that. For pigment business, we are currently operating at 98%; however, very soon our capacity is increasing from 1920 to 2400, so we should see a substantial volume growth for the pigment business.

To continue supporting the sales growth further, AksharChem (India) Ltd plans to expand its manufacturing capacity further by taking a capital expenditure of ₹175 cr, which should provide the ability to increase revenue going ahead.

An investor would appreciate that the manufacturing processes of chemical industry have a lot of impact on the environment, therefore, obtaining environmental clearance for the planned capacity becomes crucial for any company. As mentioned by the management in the results presentation of February 2017, it takes about 3 years to get environmental clearance.

AksharChem (India) Ltd 3 Years For Environmental Clearance

Moreover, as per the credit rating report for AksharChem (India) Ltd released by CARE Ltd in January 2017, the company is in an advantageous position as it already has got environmental approval for its future planned capacity (page 2):

Furthermore, AIL already has environmental clearance from the Central Government in place for 2,880 MTPA of green pigment (as against current operational capacity of 1,920 MTPA) and for 600 MTPA of violet pigment (new product).

Further Reading: 7 Important Reasons Why Every Stock Investor Should Read Credit Rating Reports

The tax payout ratio of AksharChem (India) Ltd has been fluctuating in the past until FY2013, till the time it had been reporting dismal financial performance with intermittent losses. However, since FY2014 onwards, the company has been reporting tax payout ratio at the levels of standard corporate tax rate prevailing in India.

 

Operating Efficiency Analysis of AksharChem (India) Ltd:

While assessing the operating efficiency parameters as well, we need to keep ourselves aware of the addition of CPC Green pigment in its business a few years back as the Vinyl Sulphone and CPC Green pigment have different manufacturing characteristics and they need to be assessed in this light.

The investor may analyse the asset utilization parameters of AksharChem (India) Ltd until FY2014 to understand the characteristics of Vinyl Sulphone business and the asset utilization levels of Asahi Songwon Colors Ltd (in the screenshot shared above) to understand the characteristics of Pigment business.

An investor would notice that the net fixed asset turnover (NFAT) of AksharChem (India) Ltd has been averaging about 5-6 until FY2014, whereas the NFAT of Asahi Songwon Colors Ltd has been around 2-3 over the years. It indicates that the Vinyl Sulphone business has been less capital intensive than the pigment business.

As a result, it is expected that going ahead, the capital intensiveness of AksharChem (India) Ltd would increase. It seems to be the reason that the NFAT of the company has witnessed a decline in last 2 years since when the CPC Green pigment division has been merged with it.

The management has also accepted it in the conference call in February 2017 (page 10) and stated that going ahead, the company might witness an NFAT of about 2, which would entail much more capital expenditure to fund future growth than what it has been incurring in the past.

Management: Typically, if you see our past it has been quite good asset turnover, maybe we are one of the highest in industry if I am not wrong. However, going forward seeing the different product mixes approximately our asset turn can be around 2, but that would depend on different products having different asset turns.

When an investor analyses the inventory turnover ratio (ITR) of AksharChem (India) Ltd, then she would observe the similar factors that the ITR of Vinyl Sulphone division has been very high 18-20 in the past (ITR of AksharChem (India) Ltd until FY2014), whereas the ITR of pigment division has been comparatively lower at levels of 8-9 (ITR of Asahi Songwon Colors Ltd).

Therefore, upon merger, the ITR of AksharChem (India) Ltd has witnessed decline to 11 in FY2016. Going ahead as well, the ITR of AksharChem (India) Ltd is expected to remain lower than what it used to achieve until FY2014 and become more working capital intensive than the past.

The same observations stand out when the investor analyses the receivables days of the two different business divisions of AksharChem (India) Ltd. The customers of Vinyl Sulphone used to pay AksharChem (India) Ltd in about 45-50 days in the past, which it has brought down to 27 days in FY2014. However, the customers of the pigment division seem to clear payments in 70-85 days (receivables days of Asahi Songwon Colors Ltd).

As a result of merging of Vinyl Sulphone and pigment division, we notice that the receivables days of AksharChem (India) Ltd have increased from 27 days in FY2014 to 43 days in FY2016 leading to more money getting stuck in the receivables.

Therefore, the assessment of all the operating efficiency parameters: NFAT, ITR and receivables days indicate that going ahead, the business of AksharChem (India) Ltd is expected to witness higher capital intensiveness as well as higher working capital requirements, which would put a stress on the funds requirement and liquidity position of the company going ahead.

Further Reading: 5 Simple Steps to Analyse Operating Performance of Companies

 

Free Cash Flow Analysis of AksharChem (India) Ltd:

The analysis of free cash flow generation indicates that AksharChem (India) Ltd has been barely able to meet its capital expenditure requirements through internal accruals. The acquisition of CPC Green pigment division was funded by equity dilution as new shares of AksharChem (India) Ltd were given to shareholders of Asahi Songwon Colors Ltd in FY2015 in lieu of the demerger of CPC Green division from it. The payment of this consideration in cash would have stretched the balance sheet of AksharChem (India) Ltd.

In light of the same, it becomes essential that the company maintains the recent trend of improved profitability and moreover also convert the profits into cash. If the assumptions by the management of sustained pricing power to Indian chemical suppliers for next multiple years does not prove good, then we might see the company failing to meet the above described increased funds requirement from internal accrual. This, in turn, might put a stress on the balance sheet strength going ahead.

Therefore, it is essential for the investors to continuously monitor the profitability and working capital management efficiency of the company going ahead.

Further Reading:  How to Monitor Stocks in your Portfolio

Investors should be cautious of investing in companies, which might have to fund their expansion plans by raising debt and more so when the companies might not maintain high profitability margins. This is because, in such situations, high debt has the potential of increasing the risk and further reduced profitability under tough business conditions.

You should read the analysis of two other companies: Ahmednagar Forgings Ltd and Amtek India Ltd, to understand the impact low fixed asset turnover can have on the debt levels of companies. You may read their analysis here:

 

Additional aspects and annual report analysis of AksharChem (India) Ltd:

Upon analysis of AksharChem (India) Ltd, the investor notices multiple other aspects, which deserve attention:

 

1) Succession planning:

The rearrangement of the business divisions between AksharChem and Asahi seems a way of assets allocation by the mother Ms Paru M. Jaykrishna among her two sons: Mr. Munjal M. Jaykrishna and Mr. Gokul M. Jaykrishna.

Prior to rearrangement, AksharChem had a smaller business of Vinyl Sulphone and Asahi had a larger business of CPC Blue and CPC Green pigments. As a result of the rearrangement effective from FY2015, AksharChem is now vested with Vinyl Sulphone and CPC Green pigment businesses and Asahi is left with CPC Blue business, which seems more or less comparable now.

As a subsequent event, brothers Munjal and Gokul have resigned from the executive positions of each other’s companies on October 9, 2015:

Mr. Munjal M. Jaykrishna resigns from Asahi Songwon Colors Ltd (Corporate Announcement on BSE, Oct. 9, 2015):

Asahi Songwon Colors Ltd has informed BSE that the Board has accepted the resignation of Mr. Munjal M. Jaykrishna as Joint Managing Director of the Company with effect from October 09, 2015. However, Mr. Munjal M. Jaykrishna will continue to remain on the Board as a Non Executive Director of the Company.

Mr. Gokul M. Jaykrishna resigns from AksharChem (India) Ltd (Corporate Announcement on BSE, Oct. 9, 2015)

AksharChem India Ltd has informed BSE that the Board has accepted the resignation of Mr. Gokul M. Jaykrishna as Joint Managing Director of the Company with effect from October 09, 2015. However, Mr. Gokul M. Jaykrishna will continue to remain on the Board as a Non Executive Director of the Company.

The fact that two brothers are now handling the two companies independently has been re-affirmed by Munjal in the February 2017 conference call as well (page 13):

Secondly, that Asahi Songwon Colors is our sister company and that is being managed by my brother. I am managing AksharChem (India) Limited.

Things look good until this point as it seems that the independent business interests have been handed over to each of the brothers by Ms. Paru Jaykrishna and the brother seems to be keen to grow their businesses. This is evident from the recent expansions done by AksharChem (India) Ltd in its capacity of CPC Green and addition of new pigment CPC Violet.

However, if the investor reads the results presentation released by AksharChem (India) Ltd in February 2017, then she notices that it has plans of starting production of CPC Blue pigment:

AksharChem (India) Ltd Starting CPC Blue Pigment

The investor would appreciate that CPC Blue is the key business remaining in Asahi Songwon Colors Ltd. Therefore, it remains to be seen whether the start of manufacturing of CPC Blue pigment by AksharChem (India) Ltd would pose a competitive threat to Asahi Songwon Colors Ltd and thereby pose the probability of start of business/sibling rivalry among the family or it is a business collaborative decision where the family is still tightly knit.

Therefore, we believe that the investors should be cautious and keep a close watch on the developments related to the management actions of both the companies AksharChem and Asahi to understand whether the brother is moving in confrontational position. This is essential because there have been evidence in the past where the minority shareholders have lost while the majority shareholders/promoters have been busy settling their personal business rivalries using public companies as their means.

Further Reading: How to do Management Analysis of Companies

2) Investment decisions in quoted shares of other companies:

As per FY2016 annual report, AksharChem (India) Ltd has invested about ₹13.2 cr. in shares, which it has classified as quoted shares. There are multiple points which an investor would notice in these investments:

  • The list even contains minuscule investments of a few thousand rupees in some of the companies, which questions the seriousness of these investment decisions as being significant value adding to the shareholders of AksharChem (India) Ltd. Eight companies out of the total list of more than 30 companies have investments less than ₹1 lac.
  • Multiple companies out of the list have since delisted from the stock exchanges e.g. DCL Finance Ltd, Raymond Synthetic Ltd etc. However, AksharChem (India) Ltd has not got rid of these investments and moreover, is still showing them under quoted investments section. It is uncertain whether AksharChem (India) Ltd is still assuming that it would be able to recover the investments done in such delisted companies out of the total list of investments
  • Various companies have undergone name changes e.g. Raymond Synthetic Ltd to Recron Synthetics Ltd, Ipitata Sponge Iron Ltd to Tata Sponge Iron Ltd etc. However, the new names of these companies are yet to be updated in the annual report of AksharChem (India) Ltd. It makes the independent assessment of the current worth of the said quoted investments a bit challenging.

It would have been better that the company would either use these funds in the company operations, to do capital expenditure or distribute it to shareholders.

Further advised reading: How to Identify if Management is Misallocating Capital

 

3) Investment decisions of AksharChem (India) Ltd in its Subsidiaries:

Upon analysis of AksharChem (India) Ltd, an investor would notice that the company in recent past has bought and sold subsidiary companies in quick succession. It pertains to its investments in Akshar Pigments Private Ltd and Chhatral Environment System Private Ltd.

In the case of both these companies, the management has mentioned that these companies were yet to start operations and therefore, it has sold its stake in these companies. However, there does not seem to be any change in the status of these companies since the time AksharChem (India) Ltd invested in these companies some time back.

Therefore, it might be the case that the management might not have put enough thought while making these investment decisions and might have acted in an impulsive manner both at the time of initial investment and then divestment a short time later.

 

4) High remuneration payments and subsequent recovery of the same from the promoter managers:

The remuneration of promoter management witnessed a steep increase of about 17 times in FY2014 from ₹0.12 cr. in FY2013 to ₹2.12 cr. in FY2014:

AksharChem (India) Ltd Huge Increase In Remuneration FY2014

However, it seems that AksharChem (India) Ltd had paid the remuneration in excess of the statutory limits and therefore, the company had to recover the excess remuneration in the subsequent year FY2015:

The Prior Period Adjustments of Rs.11,565,000/- shown in Statement of Profit and Loss represents the recovery of excess payment of Remuneration paid to the Managing Directors of the Company during the Financial Year 2013-2014.

One of the reasons leading to the recovery of excess remuneration might be that AksharChem (India) Ltd might have failed to get the central govt. approval for payment of remuneration to management, which is higher than the statutory limits.

Further advised reading: How to identify Promoters extracting Money via High Salaries

 

5) Some issues in the consolidation of the company accounts:

Usually, while consolidating the accounts, a company is expected to merge its subsidiary companies (>50% shareholding) in itself and show the interest of the third parties in such subsidiary companies as minority interest. Usually, in such cases, the investment in the subsidiary company is not shown as a non-current investment as it forms part of the shareholder’s equity and reserves of the consolidated entity.

However, while analysing the consolidated financials for AksharChem (India) Ltd on page 114, the investor would notice that it has disclosed its investments in its 99.9% subsidiary Akshar Pigments Pvt. Ltd as a separate non-current investment:

AksharChem (India) Ltd Akshar Pigment Investment

We believe that an investor should spend more time analysing the basis/assumptions in the consolidation of accounts, which are followed by the company and if necessary, then take clarification from the company.

Further Reading: Understanding the Annual Report of a Company

 

Now let us address some of the specific queries asked by you:

1) Project execution skills:

We believe that while assessing the project execution skills of the management, investors should focus more on the organic greenfield/brownfield capacity addition. In the case of AksharChem (India) Ltd as well as the Jaykrishna group, it seems that the companies have been able to successfully execute the expansion projects in the past.

Further Reading: Steps to Assess Management Quality before Buying Stocks (C)

 

2) Allotment of shares to the management on the preferential basis:

In FY2012, AksharChem (India) Ltd allotted shares to the promoters on preferential basis at ₹18.50:

AksharChem (India) Ltd Preferential Allotment

The share price at the date of allotment was ₹25.55/-.

AksharChem (India) Ltd May 2011 Stock Price

There are a few points, which the investor needs to think over while making the final opinion about this preferential issue:

  • The preferential issuance of equity shares to promoters is a better event for the company and minority shareholders than the preferential issuance of warrants to promoters. This is because, in the case of preferential issuance of equity shares, all the money is received from promoters upfront, which can be used by the company for its purposes. Whereas in case of warrants, only 25% is available to the company for usage and balance 75% is contingent on the promoter finding the warrants in the money at the time of exercise (meaning that the market price of shares is higher than the warrants’ price and promoters make a profit by converting warrants into shares). So the 75% is received only when promoter benefits by warrants conversion otherwise the company will have only 25% of the funds for its usage. It leads us to believe that warrants are only 25% beneficial to the company & minority shareholders and 75% beneficial to promoters.
  • Until FY2011, AksharChem (India) Ltd was going through very tough business phase due to Chinese completion. It had hardly made any operating profit over last 5 years. In such a situation, companies find it difficult to raise funds from external sources like banks etc.
  • The share price of AksharChem (India) Ltd since November 2010 to mid of May 2011 had been hovering around or below the allotment price of ₹18.50. However, whether the stock price in this duration, which saw very low volumes, was the actual market price or the promoters had deliberately kept it depressed so as to get the preferential allotment at a low price is something we are not able to comment on. An investor should make her own inference in this regard.

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

Further Reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

 

Margin of Safety in the market price of AksharChem (India) Ltd:

AksharChem (India) Ltd is currently available at a P/E ratio of about 10 based on last 12 months EPS, which offers a margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

However, it remains to be seen, whether the company would be able to show any margin of safety in the business model by generating sustained free cash flow going ahead.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

 

Analysis Summary

Overall, AksharChem (India) Ltd seems to be a company which was undergoing through very difficult business situation until recently when it got a better performing CPC Green pigment division as part of the promoter family arrangement. The company has been lucky that the better profitability of CPC Green division has been supported by the surprising improved profitability of Vinyl Sulphone division due to change policies of Chinese govt. As a result, the credit rating of AksharChem (India) Ltd has witnessed good upgrades in recent time.

However, the CPC Green division has brought in a business, which is more capex and working capital intensive when compared to existing Vinyl Sulphone business. As a result, going ahead, the growth of AksharChem (India) Ltd is expected to consume more funds than what it was doing in the past.

The promoters seem to have settled for independent business responsibilities in the group with both the brother looking after separate businesses. However, the plans of AksharChem (India) Ltd to start production of CPC Blue pigment, which is the key product of Asahi Songwon Colors Ltd, is raising the probability of sibling rivalry being at play. An investor needs to be cautious in such a situation.

The investment decisions of AksharChem (India) Ltd leaves a lot to be desired whether it is related to investing in subsidiaries or into quoted equity shares of other listed entities. It is desired that the company would improve its investing process so as to generate more value for the shareholders from its investments.

Going ahead, we believe that investors should keep a close watch on the developments in the Chinese policies related to the chemical industry, consumption of capital by the company for its growth and the management decision with respect to new products and investments.

Further Reading: How to Monitor Stocks in Your Portfolio

These are our views about AksharChem (India) Ltd. However, you should do your own analysis before taking any investment related decision about AksharChem (India) Ltd.

You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company

Hope it helps!

Regards,

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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