This article provides in-depth fundamental analysis of Omkar Speciality Chemicals Ltd, an Indian manufacturer dealing in specialty chemicals and pharma intermediates ranging from organic, inorganic and organo-inorganic intermediates products.
Its products include derivatives of Molybdenum, Selenium, Iodine, Cobalt, Bismuth, Tungsten, Tartaric acid etc. The products are used in various industries like pharmaceutical, chemicals, glass, cosmetics, ceramic pigments and cattle & poultry feeds and are exported to Europe, Canada, Asia, South America and Australia.
Omkar Speciality Chemicals Ltd Research Report by the Reader
I have tried to do a company analysis of Omkar Speciality Chemicals Ltd using the points shown by you.
Omkar Speciality Chemicals Ltd is a speciality chemical manufacturer making various chemicals, especially for pharma companies and veterinary industry.
- It has 200+ products and 800+ customers with the largest contributing to 6-7% of sales.
- It also holds 4 patents and has good R&D infrastructure.
- It has a demerger scheme currently.
Financial Analysis of Omkar Speciality Chemicals Ltd:
- Sales have almost quadrupled over the last 6 years.
- Profits have increased 3 times.
- EBITDA margins have remained constant over this time.
- Taxes have remained in 25-35% range.
- Positive cash flow from operations.
- Net profit margins may have been affected by taxes in the past
- Debt – Equity, current ratio, fixed ratio etc. have been decreasing over the last few years due to large debt pile.
- Debt to equity has been greater than 1 over last many years
- High debt expenses
Further Reading: How to do Financial Analysis of Companies
Operating Efficiency Analysis of Omkar Speciality Chemicals Ltd:
- Inventory turnover has increased
- Working capital constraints are visible from the fact that cCFO lower than cPAT by 1 cr. Management also admits WC problems.
- Working capital days have been reduced by efforts of management to control inventory levels and lower receivable days. This is understood from BS, concall, and AR.
Further Reading: How To Analyse Operating Performance of Companies
Business Analysis of Omkar Speciality Chemicals Ltd:
- Capex done in large quantity over last few years to take capacity from about 1,000MT to about 5,000MT. (Since this is volumetric capacity, it doesn’t mean that capacity actually is 5,000MT, it is slightly lesser)
- Another 5,000 MT plant has been constructed as UNIT 5. It is still to start operations, which are being delayed due to various factors. So total capacity is about 10,000MT.
- Capacity increase is being undertaken at other plants at smaller level to meet demand.
- Increase in depreciation for December quarter 2017 signifies some of the new capacities at original plants are operating now.
- Low fixed asset turnover shows capital intensive nature of business.
- Low ROCE which may be because of aggressive expansion and inefficient conversion of capital into profits.
- No FCF due to heavy capex
- Pharma companies may have problems due to Trump’s policies.
Further Reading: How to do Business Analysis of Companies
Management Analysis of Omkar Speciality Chemicals Ltd:
- Management seems to be technically competent enough as they have increased capacity and sales and have good understanding of product demands and business technical aspects.
- Promoters issued themselves warrants at Rs.150 to get working capital for company at a time when share price was in 130-140 range, so no immediate profit making tendency.
- Promoters have no other business except a brokerage, so they have good incentive to perform well.
- Salary and commissions have increased at a rate almost equal to growth of sales, however, it had a large increase in FY2016
- No fraud cases found against promoters
- Concalls are held if any clarity is required on an issue. It can be to stabilize share prices as large quantity was pledged for WC requirements.
- Lasa Laboratories was acquired at a turnover of 1 CR. It had turnover of about 136 cr within 4- 5 years.
- No related party transactions except salary.
- Pharma companies trust this company and chemical quality, also its facilities have GMP certification
- Dividends are funded by debt
- High debt undertake for expansion. Financial knowledge of promoters is quite low it seems.
- Promoter seem to have reduced their shareholding from 68% to 42 %. This is because they need to repay short term loans bearing high interest to reduce interest expense and also de-pledge shares kept with NBFC, so that demerger can proceed. As said earlier, promoters seem to have no other business to provide funds. Also some of the sale money has gone into the company as loan for WC requirement as public sector banks are not giving out loans easily after NPA crisis.
- Aggressive expansion dreams of promoters.
Further Reading: How to do Management Analysis of Companies
Please provide your valuable inputs for my analysis.
Thank You in advance.
Dr Vijay Malik’s Response
Thanks for sharing the analysis of Omkar Speciality Chemicals Ltd with us! We appreciate the hard work put in by you in the analysis.
Omkar Speciality Chemicals Ltd used to report only standalone financials until FY2010 when it made its first acquisition and purchased Rishichem Research Ltd. Therefore, from FY2011, the company started reporting both standalone and consolidated financials.
We believe that while analysing any company, the investor should always look at the company as a whole and focus on financials which represent the business picture of the entire group. Therefore, while analysing Omkar Speciality Chemicals Ltd, we have analysed standalone financials until FY2010 and consolidated financials from FY2011 until FY2016.
It might be noted that during FY2017, the company has undergone a merger and demerger scheme in which the speciality chemicals business of the company and its subsidiaries has been consolidated in Omkar Speciality Chemicals Ltd whereas the veterinary active pharmaceutical ingredients (API) business of the group has been transferred to Lasa Supergenerics Ltd. Therefore, from FY2017 onwards, the reported financial numbers would not be comparable with the reported financials of FY2016 and before. However, we will briefly analyse FY2017 results in the later part of this article.
Initially, we would focus on the financial performance of Omkar Speciality Chemicals Ltd for the last 10 years (FY2007-16) to understand the key business practices and the impact of management decisions on the business and their efficiency.
Financial Analysis of Omkar Speciality Chemicals Ltd:
Omkar Speciality Chemicals Ltd has been growing its sales since last 10 years (FY2007-16) at a brisk pace of about 30-35% year on year. It has witnessed its sales revenue grow from ₹37 cr. to ₹413 cr. in FY2016, which is a significant growth. The investor would also notice that this growth has been achieved by Omkar Speciality Chemicals Ltd while maintaining its profitability.
Over the years, the operating profitability margins of Omkar Speciality Chemicals Ltd have been constant at 19-20%. It is a good feature as the company has been facing fluctuations in the raw material prices during this whole period. Stable operating profitability margins over the years indicate that the company is able to pass on the changes in the raw material costs to its customers/end users and able to protect its margins. It is advised that an investor should always try to find out the reasons for stable profitability margins so that she might be comfortable with the level of sustainable profitability margins going ahead.
While analysing the publically available information about the company, an investor comes across the comments of the management (Mr. Pravin Herlekar) in the conference call held on April 12, 2016, where it has clarified the reasons for sustained profitability margins, which are spot orders and “cost plus basis” nature of contracts:
Baidik Sarkar: In Omkar, all your price contracts with your customers, are you able to pass through the material cost fluctuations and currency fluctuations also?
Pravin Herlekar: Orders are booked on spot basis. So there is nothing like any long-term contract.
Baidik Sarkar: So 16-18% margin reflects the steady state margins taking into account of all the raw material and currency volatility?
Pravin Herlekar: Based on the actual costing of raw material on cost plus basis, we are supplying to the customers. So the margins I do not see any reason why they should not be maintained.
The management clarifies that Omkar Speciality Chemicals Ltd does not have long-term contract with its customers and all the sale transactions are on spot sales basis where the company charges its customers on a formula (cost plus) basis and therefore, it is able to pass on any changes in the raw materials to its end customers and is able to maintain its profitability margins.
The lack of long-term contracts though has benefited the company in terms of maintained profitability. However, the lack of long-term contracts also exposes the company to the potential risk of its customers shifting to competitors at a very short notice.
Until now, Omkar Speciality Chemicals Ltd has maintained that it has a competitive advantage over its competitors in terms of its research and development ability of consistently producing newer chemicals to meet the need of customers as well being among the top producers in the world for its key products. However, it remains to be seen whether, in light of fiercely competitive business environment, the company is able to maintain its strong position going ahead.
Omkar Speciality Chemicals Ltd has been investing in expanding its operating capacity since last few years and as per the management has created a lot of spare capacity, which would help it maintain the business growth in the coming years.
An investor would notice that though Omkar Speciality Chemicals Ltd has been able to maintain a stable operating profitability margins, it has witnessed a decline in its net profitability margins (NPM) over the years. NPM has reduced from 10% in FY2013 to 7% in FY2016. The key reason for the decline in the NPM has been the consistent increase in the interest expense, which has increased from ₹8 cr. in FY2013 to ₹20 cr. in FY2016.
The interest expense has increased primarily on account of the debt taken by the company to fund the increase in the operating capacity discussed above. We would discuss more about the operating capacity and its funding in the later part of this article.
Further Reading: How to do Financial Analysis of a Company
Omkar Speciality Chemicals Ltd has been paying taxes, which have been in line with the standard corporate tax rate over the years except in the FY2015 and FY2016 where the company accounted for taxes at 14% and 42% respectively. The company has clarified about the difference in the tax rates in these two years, which is on account of the treatment of R&D expenses and creation of related deferred tax items, in its annual report for FY2016, page 47:
“Pursuant to the provisions of Section 35(2AB) of the Income Tax Act, 1961, the Company’s R&D facilities are duly approved by DSIR and the Company is entitled to claim additional deduction on account of expenses incurred on R&D. During the last year, while making the provision for tax, the said entitlement certificate was still awaited hence the provision was made without considering the said benefit and the same was adjusted while making provisions for tax for FY2014-15. However, the necessary benefit of the additional deduction was claimed by the Company while filing the Income tax return for FY 2014-15. Due to this, the provision entry for Deferred Tax was not made while finalizing the accounts for FY 2014-15. Impact of this was taken during the current year, resulting in the higher tax provision during the year.”
Further Reading: Understanding the Annual Report of a Company
Operating Efficiency Analysis of Omkar Speciality Chemicals Ltd:
An investor would notice that the net fixed asset turnover ratio (NFAT) of Omkar Speciality Chemicals Ltd, which has declined over the years. NFAT has reduced from 5.97 in FY2009 to 2.21 in FY2015. The key reason for such decline in NFAT over the years is primarily the investments in increasing manufacturing capacity, which has taken a few years to get completed.
The operating capacities have started to become operational in recent years and therefore, the NFAT has increased from 2.21 in FY2015 to 2.67 in FY2016.
As per the publically available data, Omkar Speciality Chemicals Ltd has faced a lot of delays in the commencement of its Unit 5 at Chiplun, Ratnagiri. Though nearly complete in structure, the unit was initially stuck for the lack of environment approval. As per the management, Omkar Speciality Chemicals Ltd has received the environment approval in January 2016 and is currently working on making additional effluent treatment facilities at Unit 5, which are suggested by the authorities as part of the environment approvals.
If Omkar Speciality Chemicals Ltd is able to complete the construction of additional facilities and start the operations at Unit 5 soon, then it might witness an improvement in the NFAT going ahead in near future.
When an investor analyses the inventory turnover ratio (ITR) of Omkar Speciality Chemicals Ltd, then she would observe that the ITR has been declining over the years from 5.1 in FY2008 to 3.1 in FY2015. At the same time, the receivables days of Omkar Speciality Chemicals Ltd have also witnessed sharp increase from 57 days in FY2008 to 122 days in FY2014.
The management has also realized that its working capital management has left a lot to be desired and as a result, it has communicated to the stakeholders that it has now made improving its working capital position is one of the key focus areas. Probably, as a result of management’s efforts, the inventory turnover ratio has improved to 4.4 and the receivables days have improved to 91 days in FY2016. As a result, the working capital days have reduced to 175 days in FY2016 from the high of 241 days in FY2014.
Further Reading: 5 Simple Steps to Analyse Operating Performance of Companies
An investor should notice that while calculating working capital (WC) days, we take into account only the inventory turnover and receivables days and do not factor in payable days i.e. (WC = Inventory days + Receivables days) instead of (WC = Inventory days + Receivables days – Payable days). This is because when a company is in liquidity stress, the first counterparty to which is delays payments is its vendors, which in turn leads to increase in payable days. An investor would appreciate that increase in payable days would lead to a decline in WC days if it is factored in the WC days formula and a parameter that is indicating the supposedly deteriorating position of the company might end up leading the investor to conclude that the WC days are improving.
An investor would notice that in FY2016, out of the total cash flow from operations of ₹67 cr. reported by Omkar Speciality Chemicals Ltd, about ₹37 cr. is only on account of increase in payables as witnessed from the annual report for FY2016, page 102:
Therefore, an investor should keep a close watch on the working capital position including the inventory turnover and receivables days to monitor the performance of the company going ahead.
Further Reading: How to Monitor Stocks in your Portfolio
The deterioration in the working capital position has been a significant development for Omkar Speciality Chemicals Ltd as it has led to a lot of funds/liquidity of the company being stuck in the working capital during a period, which has coincided with the period when it was doing significant capital expenditure to increase its operating capacity. As a result, the company has faced a liquidity crunch in the recent years and has to take some drastic steps to handle the liquidity issues. We will discuss more about these issues in the later part of this article.
Margin of Safety in the Business of Omkar Speciality Chemicals Ltd:
i) Self-Sustainable Growth Rate (SSGR):
The investor would notice that Omkar Speciality Chemicals Ltd has an SSGR of about 10-15% in the years whereas it has been growing its sales revenue at a growth rate of 25-30% in last 5-7 years.
Upon reading the SSGR article, an investor would appreciate that if a company attempts to grow at a sales growth rate, which is higher than the SSGR, which it can afford from its internal sources, then will have to rely on the funds infusion from outside in terms of debt or equity. The same has happened in the case of Omkar Speciality Chemicals Ltd.
This assessment of SSGR gets substantiated when the investor analyses the free cash flow (FCF) position of Omkar Speciality Chemicals Ltd.
ii) Free Cash Flow Analysis:
Over FY2007-16, Omkar Speciality Chemicals Ltd has witnessed its sales increase from ₹37 cr. in FY2007 to ₹413 cr. in FY2016. For achieving this sales growth the company has done an additional capital expenditure (capex) of ₹356 cr. However, the investor would notice that Omkar Speciality Chemicals Ltd has generated a cash flow from operations (CFO) of only ₹175 cr. over FY2007-16 resulting in a negative free cash flow (FCF) of ₹(181) cr.
SSGR and FCF are two of the main pillars of assessing the margin of safety in the business model of any company.
It is not surprising that to meet its funds requirement during FY2007-16, Omkar Speciality Chemicals Ltd has to rely on additional sources of funds like:
- Incremental debt of ₹217 cr. as the total debt level of the company has increased from ₹11 cr. in FY2007 to ₹228 cr. in FY2016,
- Net equity infusion of ₹68.51 cr. by way of the initial public offer (IPO) in 2011. An investor would notice that Omkar Speciality Chemicals Ltd has raised a total of about ₹79.38 cr (8.1 + 71.28) from the IPO as witnessed in the FY2011 annual report as ₹8.1 cr. increase in paid up share capital and ₹71.28 cr. increase in share premium account. However, the company paid a whopping ₹10.87 cr. as public issue expenses, which is a cost of about 14% (10.87/79.38) on the IPO proceeds. The investor would appreciate that paying an upfront fee of 14% to raise funds from any source is very high and many times shows desperation on part of the borrower/fund raiser to get access to such high-cost funds.
Further Reading: Understanding the Annual Report of a Company
- ₹14.25 cr. infused by promoters in the form of subscription to warrants
The urgency/desperation on part of the company to raise funds has been witnessed from a lot of other aspects, which an investor notices when she reads different publically available documents about Omkar Speciality Chemicals Ltd. An excerpt from the conference call held by the company on July 19, 2016 (page 4), is relevant:
Now we did try to infuse equity into the Company, couple of years ago we tried for QIP but the markets were not supportive at that time. Then we did discuss about some private equity and other things, but then again the things were not very much favorable to us at that time. So ultimately the target is to bring down the cost in the Company. So though it affects the promoters themselves, we did decide to sacrifice on our funds and liquidate part of our equity to raise funds to reduce the debts in the Company. So that is the rationale and reason for selling the shares
The above comment from the management indicates that in addition to raising high-cost IPO funds in FY2011 at a cost of about 14%, the company was not able to meet its entire funds requirement and tried to do additional equity dilution by qualified institutional placement (QIP) and attempted to source funding from private equity players, however, it could not find any institutional investor willing to put its money into the company.
It is not surprising that when the company has been attempting to do investments at a pace, which is not supported by its internal resources as indicated by SSGR being lower than achieved sales growth, the company will have to keep infusing funds from additional outside sources.
It seems that the inability of Omkar Speciality Chemicals Ltd to generate sufficient cash from operations to match its spending on capital expenditure, inability to keep the working capital under control, inability to raise funds from equity sources etc. and in turn reliance on more and more debt to meet the capex requirements was seen as a risky business strategy by the credit rating agencies.
As a result, its credit rating agency CRISIL downgraded the credit rating of Omkar Speciality Chemicals Ltd by 3 notches from BBB+ to BB+ in one step in December 2015. CRISIL highlighted the following reasons for its downgrade of credit ratings of Omkar Speciality Chemicals Ltd:
“The downgrade reflects deterioration in the Omkar group’s liquidity because of larger than expected, capital expenditure (capex) of over Rs.900 million undertaken in 201415 (refers to financial year, April 1 to March 31); the capex was largely funded through short term resources, leading to mismatch in cash flows and tightening of liquidity. Furthermore, commencement of operations of Unit 5 (organic manufacturing facility, with a total capital outlay of around Rs.750 million) has been delayed significantly on account of environmental clearance issues. Delays in expected accrual from this unit have further constrained the group’s liquidity. The bank limit utilisation levels were high, averaging over 95 per cent for the 12 months through September 2015. The current ratio also deteriorated to 0.84 time as of March 2015, from 1.08 times as on March 2014.” (emphasis mine)
An investor would note that BB+ is a rating, which classifies the debt of a company as non-investment grade or junk.
It seems that as a result, Omkar Speciality Chemicals Ltd has stopped getting itself rated from CRISIL and has changed its credit rating agency to Brickwork, which has assigned it a credit rating of BBB. It might be a case of credit rating shopping where a company when poorly rated by one credit rating agency finds another rating agency in the market, which can assign it a better credit rating.
CRISIL in its review has cited lack of information from the company as the reason for not being able to carry out a credit rating:
“CRISIL is yet to receive adequate information from Omkar Speciality Chemicals Ltd (OSCL) to enable it to undertake a rating review. CRISIL is taking all possible efforts to get to cooperate with its rating process for enabling it to carry out the rating review.”
No wonder that Omkar Speciality Chemicals Ltd found it difficult to raise additional debt from its bankers and has to resort to lending from various NBFCs against the shares held by promoters. These NBFCs extracted their share of benefits from the company by charging a high rate of 18-19% on the loan against shares taken by the company by pledging the shares held by the founder promoter, Pravin Herlekar.
When an investor reads through the transcript of the conference call held by the company in July 2016 (page 16), then the investor realizes the urgent/desperate stage the company had found itself for the lack of funds:
Jayesh Gandhi: Sir, my question is that if I am looking at your pledged shares in that last entire year, it has been above 50% of the promoters holding. So while we were requiring this much amount, could have we not gone to short-term funding from banks or maybe term loan from banks?
Pravin S. Herlekar: Yes, you are absolutely right and we have tried that exercise. But our major bankers are PSU banks and it takes a very-very long time, something more than six months at times to go through the entire procedure. So we did exercise that option but when we saw that the process is taking a lot of time and we had lot of compulsions on the capacities because we cannot leave it halfway through because that would lead to more troubles for the Company. And secondly, since last year also you must have seen our sales had grown and working capital pressure was also there. So we decided to bump in more funds by pledge of shares.
An investor can appreciate the urgency of the funds to avoid the liquidity crisis and the disinterest of the existing lenders to give any more funds quickly to the company in the above comment by the promoters of the company.
It is not difficult to understand for an investor that hardly any lender would wish to give more loans to a company, which:
- is consuming far more cash than it produces by way of operations
- already seems to have exhausted its key sources of equity infusion by way of high-cost IPO and other equity investors (institutional investors) are not willing to bet their money on the company
- has been rated non-investment grade (junk) by credit rating agency and
- whose hunger for cash is not yet satiated.
No wonder that initially, the promoters had to resort to loans against shares from NBFCs by pledging their own shares in the name of the company and now promoters are compelled to sell their shares in the company to repay those loans.
This is a typical case of someone (be it a company or an individual) taking much more on its plate than it can chew. Such situations lead entities to a debt trap.
An investor would appreciate from the above discussion that the companies, which have their Self-Sustainable Growth Rate (SSGR) higher than their sales growth meaning that they are able to fund their growth through internal resources and generate positive free cash flows depict greater strength in their business model (margin of safety) than the companies, which have lower SSGR and negative free cash flow.
Moreover, an investor would also appreciate from the above discussion that for the companies, which have negative free cash flows i.e. companies, which are investing more as capex than what they are producing by cash flow from operations, their dividends are primarily funded by debt. Omkar Speciality Chemicals Ltd has been facing a similar situation where the dividends of about ₹17 cr. declared by the company over the years are primarily funded from debt and therefore, she should not take any comfort of the dividend yield of such companies.
Further Reading: Steps to Assess Management Quality before Buying Stocks (B)
Until now, it seems apparent that the management of Omkar Speciality Chemicals Ltd has embarked upon a capacity expansion plan, which required resources much in excess of what it could generate comfortably. As a result, the company has landed up in a situation where the company has been running pillar to post to arrange funds be it high-cost IPO funds, exhausting the limits of comfortable exposure levels of existing lenders, infusing funds by warrants, reaching institutional investors for QIP, going to NBFCs for high-cost loan against shares and recently selling promoters’ stake in the company.
All these actions raise questions on the financial prudence of the management in commencing a large capacity expansion plan without proper financing plan being in place.
Additional aspects and annual report analysis of Omkar Speciality Chemicals Ltd:
Moreover, upon further analysis of Omkar Speciality Chemicals Ltd and reading other publically available documents, an investor notices multiple aspects, which deserve attention:
1) Management not able to meet its stated commitment to shareholders:
The promoters/management of the company has made numerous commitments to stakeholders about the timelines for getting the pledge on promoters’ stake released from the NBFCs:
- First, in July 2016, during a conference call (page 11), the management assured the stakeholders that they would be able to release entire pledge within 4-5 months.
Rushit Parekh: And as you mentioned that it will be repaid in the next four to five months‟ time frame?
Pravin S. Herlekar: Yes, it is.
Rushit Parekh: So if I understand it correctly, your entire shares which have been pledged will become unpledged?
Pravin S. Herlekar: It will.
Rushit Parekh: So after four to five months there will be no pledging left from the promoter side, correct?
Pravin S. Herlekar: Yes, absolutely right.
- Second time in August 2016, the management said that it will get the pledge on its shares released by October 2016 (page 16).
Mohit Bansal: I am actually sorry, I joined in late, I missed in the management commentary. My first question was regarding the de-pledging of shares in the last con-call which was a month back on this topic, you mentioned that in the next 15 days you would be reducing the stake, the pledge shares by some percentage sir. Where are we on that because we not seen any disclosure on that?
Pravin Herlekar: Yes, see what is happened is there are certain issues about prepayment of certain loans. So there will be penalties on that, etc. So we have deferred that and till such time, this money has been parked in the banks only and to that extent our utilization of CC limit will be going down. So we will be saving on the interest cost.
Mohit Bansal: So what is the timeline on the de-pledging?
Pravin Herlekar: I think it should happen somewhere partly in September partly in October.
- Third time in November 2016, during another conference call (page 8), when the management could not meet the earlier stated timeline, it stated that it would release entire pledge by end of FY2017:
Dimple Kotak: Okay sir as you commented in your initial commentary that you expect the banks to give you the working capital by the end of December at max, so can we expect by Q4 FY17 the entire de-pledging to come in?
Pravin Herlekar: I can say it is more than 100%.
However, the management could not meet even this deadline as at March 31, 2017, more than 21 lakh shares of promoters were still pledged with lenders.
When an investor reads through the reasons cited by the management for its inability to meet the stated deadlines for the release of the pledge, then she finds the explanation that the loans against shares have a prepayment penalty. Therefore, repaying these loans ahead of schedule would lead to additional cost for the company in the form of the prepayment penalty
Now, an investor is left confused about:
- whether the management had read the loan agreements that it had signed with the lenders before taking loans against shares
- if the management knew that these loans against shares had a prepayment penalty, then whether it took the concurrence of lenders about waiving the prepayment penalty before it started assuring the stakeholders that it would soon get the pledge on the shares released.
Whatever be the reason about the prepayment penalty being the road block for the pledged shares to be released, it shows that the management needs to do a bit more homework before it prepares its strategies and communicating it to stakeholders.
Further advised reading: Why We cannot always Trust What Management Claims
2) Management not able to meet its stated commitment to shareholders again:
As mentioned above, we believe that the management of Omkar Speciality Chemicals Ltd has led the company into a liquidity crunch situation by commencing a capital expenditure program, which needed funds far in excess of what the company could produce from operations. Moreover, the deteriorating working capital position further complicated the tight liquidity position of the company.
As a result, the promoters of the company had to resort to selling their personal stake in the company to raise funds to ease out the liquidity position of the company.
However, like in previous cases of assessing the funds requirement for the started capital expansion plan and assessing the feasibility of getting the pledge of shares released, the management has again erred while assessing the exact amount of stake that it might need to sell before the liquidity situation is brought under control.
- In July 2016, when promoters had a conference call about their stake sale, they communicated to stakeholders (page 9) that they would not sell any further stake. The promoter stake was at 58% at that time:
Siddharth Oberoi: Which you can easily repay.
Pravin S. Herlekar: Yes, which will be anyway generated.
Siddharth Oberoi: So one thing is clear that you are not selling any more stake, right?
Pravin S. Herlekar: We are not.
- The promoter reiterated their resolve of not needing to sell a further stake in the company during the conference all in August 2016 (page 4):
Dimple Kotak: Okay, but sir, your debt has increased from 207 crores in FY16 to 237 crores for the first quarter?
Pravin Herleker: Yes, now the part of it is by way of loan from the promoters itself. Loan in the books of the company has gone up, but then that has come from the promoters.
Dimple Kotak: Okay sir and sir going ahead, do we see further decline in the share percentage holding?
Pravin Herleker: No, now the holding stands at 58%, was earlier at 67%, though it stands at 58% and it will remain at that level. Now there is no more plan of selling of promoter stake.
- However, the promoters sold more shares later on and then during the conference call on November 8, 2016 (page 2), the promoters said that their stake will not go down below the majority mark:
Moreover, the EBITDA margins are also reasonably strong and sustainable, hence we decided to make every attempt to reduce the pressure of high pledge, especially with the de-merger process moving ahead. At the end of this exercise, there is some part of pledge left but the promoter’s holding will not go below the majority mark.
The promoters have resorted to further sale of shares and as per the shareholding pattern of Omkar Speciality Chemicals Ltd at March 31, 2017, available on BSE website, the promoter’s shareholding stands at 41.01%.
The company has been mentioning in its shareholding pattern disclosures that certain shares which are encumbered are not shown by depositories in the name of promoters and these shares though owned by promoters and pledged by the company to lenders, are reflected in the name of the financiers/lenders in the disclosed shareholding patterns.
Such a manner of disclosing shareholding patterns makes it difficult to assess the exact amount of shares, which the promoters own at any point in time, which is not a desirable practice to be followed. For ease of understanding by investors, the disclosures should state clearly about the total number of shares, which are owned by the promoters and out of which the stated number of shares are pledged with lenders so that the interpretations and conclusion are straightforward for the investors.
At March 31, 2017, the BSE website shows that promoters own 84.4 lakh shares out of total 205.8 lakh total shares of the company, which is 41.01% stake. It also mentions that 21 lakh shares of the promoters are pledged, which is 10.2% stake in the company. So if we assume that the disclosed 41.01% stake of the promoters does not include any pledged share, then the total promoter shareholding might get shored up to 51.21% (41.01+10.2).
It is to be noted that this is a mere guess given that the company is not providing the total number of shares actually owned by promoters in its shareholding filings. Therefore, if the stated promoter stake of 41.01% stake includes the pledged shares as well, then it might have happened that the promoter’s stake has already gone below majority mark.
Further advised reading: Why We cannot always Trust What Management Claims
3) Large established companies not paying up the sales consideration on time:
An investor would notice that the receivables days of Omkar Speciality Chemicals Ltd increased from 72 days in FY2012 to 122 days in FY2014. This has been cited as one of the key factors by the management as the reason for deteriorating working capital position.
However, if one notices the list of clients that Omkar Speciality Chemicals Ltd has displayed to investors as part of its April 11, 2016, presentation to investors, then the investor would find that they are all the names of large established companies in pharmaceuticals and chemicals industry in India and across the world.
The investor would appreciate that these companies are a few of the best credit rated companies across the world and we find it difficult to believe that such companies would have delayed payments to their vendors in recent years.
The investor might expect that the Eurozone crisis in last few years might have led the customers based out of Europe to delay the payments to some extent. However, Omkar Speciality Chemicals Ltd is primarily a domestic focused company with sales in India constituting more than 75-80% of its sales and more so Europe is only about 4-5% of its total sales revenue. Therefore, it seems difficult that the delay in payment that too from large well-known customers based out of Europe would have led to such deterioration of receivables.
Therefore, we believe that an investor should explore further the reasons for such significant deterioration of receivables days of the company before she commits her hard earned money to investment.
Moreover, we have always believed that the trinity of “Rising Sales, Rising Receivables and Rising Debt” when grows out of proportion, then it many times indicates cases of aggressive accounting practices.
- Further Reading: 7 Steps to Find out whether a Company is Cooking its Books
- Further Reading: Steps to Assess Management Quality before Buying Stocks (C)
In the case of Omkar Speciality Chemicals Ltd, the receivables and debt have definitely gone out of proportion of normally expected business levels.
The investor should also explore further about the sudden remarkable improvement of receivables days for the company.
4) Declining freight charges despite increasing sales in FY2016:
An investor would notice that the consolidated sales of Omkar Speciality Chemicals Ltd have increased from ₹265 cr. in FY2015 to ₹413 cr. in FY2016. However, surprisingly, the freight and transportation expenses at the consolidated level have declined from ₹1.71 cr. in FY2015 to ₹1.70 cr. in FY2016.
Annual report FY2016, page 116:
It is advised that the investor should get clarifications from the company in this matter before committing her hard earned money.
Further Reading: Understanding the Annual Report of a Company
5) Increased sales of Iodine and Selenium derivatives, but decreased consumption of Crude Iodine and Selenium metal in FY2016:
In FY2016, the consolidated level sales of Iodine and Selenium derivatives by Omkar Speciality Chemicals Ltd witnessed a significant increase in line with overall sales growth. As per the annual report for FY2016, page 118, the sales of Iodine compounds increased from ₹88 cr. in FY2015 to ₹118 cr. in FY2016. The sales of Selenium compounds increased from ₹16 cr. in FY2015 to ₹22 cr. in FY2016:
However, on the same page in the annual report, the investor finds that the consumption of crude Iodine and Selenium metal powder has declined in FY2016 against FY2015. The consumption of crude Iodine by Omkar Speciality Chemicals Ltd at consolidated level declined sharply from ₹82 cr. in FY2015 to ₹4 cr. in FY2016. The consumption of Selenium metal powder declined from ₹7 cr. in FY2015 to ₹5 cr. in FY2016
It is advised that the investors should take clarifications about it from the company before investing.
Further Reading: Understanding the Annual Report of a Company
6) Long delays in commissioning of the largest capex by the company: Unit 5:
As per Omkar Speciality Chemicals Ltd, the commissioning of its largest capacity addition at Unit 5 in Chiplun, Ratnagiri was delayed despite the construction being complete (as the company said that no major capex is pending) due to lack of environment approval.
As per the annual report for FY2016, page 45, the company received the environment approval for the unit in January 2016, in which the authorities asked the company to create some additional facilities of effluent treatment:
The Company’s had undertaken major expansion plans during previous years. Unit No. V could not be commissioned due to various reasons attributable mostly for getting statutory consents and clearances. During the FY 2015-16, the Company has been successful in getting the Environment Clearance from State Government. However, as per the conditions laid down by the sanctioning authority the Company has to put in additional equipments particularly for keeping the effluent treatment under control.
However, currently, despite the receipt of clear directions/steps to be taken by the company to meet the compliance requirements, the commencement of unit 5 seems to be getting further delayed with the assessed timeline of the management of starting the unit in phases in FY2017 seems to be getting missed.
Further Reading: Steps to Assess Management Quality before Buying Stocks (C)
7) The operating capacity data of the company:
Omkar Speciality Chemicals Ltd has disclosed its operating capacity data of different units under two different labels: Volumetric Capacity and Rated Capacity. The difference between the two figures in terms of currently operational capacity is significant.
As per the annual report of FY2016, page 49, the volumetric capacity at March 31, 2016, stands at 5,400 TPA whereas the rated capacity at the same date stands at 2,315 TPA.
The company has tried to explain the difference between the two capacity figures as below:
“The volumetric capacities indicate the aggregate volumes of all the reactors installed in the respective Unit. The rated capacity signifies the expected production in tonnage for a given product mix which is commonly being manufactured in the respective Unit.”
From the above, it seems that the volumetric capacity, which is the most highlighted number in all the communications by the company and in the discussions with the stakeholders, is more of a theoretical number and for all practical purposes, it is the rated capacity of the most commonly produced product mix is the actual capacity available.
8) The responsibilities of Mr. Omkar Herlekar:
On May 2, 2017, five directors of Omkar Speciality Chemicals Ltd including Mr. Omkar Herlekar, son of founder promoter Mr. Pravin Herlekar, resigned from their board positions.
As this event has happened post approval of the merger & demerger arrangement from National Company Law Tribunal (NCLT), therefore, we believe that it might be under the arrangement where Omkar would look after the API business of the group in Lasa Supergenerics Ltd.
Omkar has stated the same during the April 2016 presentation by Omkar Speciality Chemicals Ltd to the stakeholders:
“Both the Companies, Omkar Speciality and Lasa Supergenerics have different businesses and product lines. This de-merger will enable each Company’s Management to leverage upon their experience and expertise and take the businesses to greater heights. Post the De-merger, I will be responsible for the operations at Lasa Supergenerics Ltd.
It seems great that the said arrangement of focused responsibilities might help the management in creating better value for the shareholders.
However, as mentioned by you and also as per publically available information, Omkar also has interests in a brokerage firm, Amarnath Securities Ltd, which is a BSE listed entity.
As per the information available on the website of Indiainfoline.com, Omkar has made an open offer to buy 26% shares of Amarnath Securities Ltd (7,80,052 shares) at ₹16/-, payable in cash. This would entail a cash outflow of about ₹1.25 cr.
All Market Participants are hereby informed that Mr. Omkar Pravin Herlekar (“Acquirer”) have made an open offer to acquire up to 7,80,052 Equity Shares of Rs. 10/- each at an Offer Price per equity share of Rs 16/- each payable in cash, representing 26% of the total paid up equity share capital/ voting share capital of Amarnath Securities Limited (“Target Company”) pursuant to Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and subsequent amendments thereof from the public shareholders of the Company from 15th September, 2016 to 28th September, 2016.
When the founder promoter of Omkar Speciality Chemicals Ltd, Mr. Pravin Herlekar, was asked about this business interest of Omkar, then Pravin avoided the questions saying that it is an independent business interest of Omkar and has nothing to do with Omkar Speciality Chemicals Ltd. (July 2016 conference call, page 19):
Pratik Bora: Sir only one question, why open offer to Amarnath Securities?
Pravin S. Herlekar: Well, it is a different matter not related to Omkar Speciality Chemicals Limited. And Company has by no way invested anything in any of the business like this. Company Omkar Speciality is fully focused on its own business. Amarnath Securities is acquired by Omkar Herlekar, my son, and he is looking for some, exploring some opportunities in that company. So that is an absolutely independent business and the Company has nothing to do with it.
Pratik Bora: But sir, not Company but sir promoter level also, so when we are reducing our stake in the Company which is doing good and both its promoters are also bullish about the Company’s prospects, about the long-term prospects and contracts and they are reducing the stake in this company at the same time they are increasing the stake in a broking company. So how these are related?
Pravin S. Herlekar: I think let us not mix up the issues, the proceeds received out of sales of Omkar Speciality are fully brought in back through the Company, nothing is invested outside. It is an independent activity which Omkar is trying to pursue which has nothing to do with its commitment with the company, it continues to be a whole time director into the company and fully committed to Omkar Speciality’s business. Like in many cases many of the promoters have divergent businesses and they manage the things independently, there is no mix up of any activity.
There are a few things, which come to an investor’s mind upon analsing these developments:
- An interest in an entirely different business line when the company has just completed the major capex after suffering a lot of liquidity stress/tough time. One line of prudent thinking would expect that the management should now focus completely on realizing the full capacity utilization of the capacity that has been created by getting additional sales orders, expand the business to new customers, geographies, create new teams etc. Such activities would need heightened focus from the management especially the people responsible for Lasa Supergenerics Ltd, where the maximum capacity has been added.
- A cash outflow in terms of the open offer for a brokerage firm at a time when the founder promoter is selling his personal stake in the business to get the pledged shares released from high cost lenders indicates that this might not be the most opportune time to go for such diversifications.
- Omkar has not attended any of the conference calls in last 12 months after the conference call in April 2016. Even the announced panel of the conference call to be held by the company on May 24, 2017, to discuss the Q4-FY2017 results does not include the name of Omkar.
It is advised that the investor should be comfortable with the above issues and explore them further if she wants before she decides to make her final investment decision.
Further advised reading: How to know if Promoters are Losing Commitment to the Company
9) Q4-FY2017 results: the fair value of transfer of assets from Omkar Speciality Chemicals Ltd to Lasa Supergenerics Ltd:
Omkar Speciality Chemicals Ltd declared its Q4-FY2017 results on May 20, 2017. The company has reported a loss of ₹44 cr. in the quarter primarily on account of an exceptional loss item of ₹63 cr.
As per the company results filing, the loss is on account of the difference between the fair value and the book value of the assets transferred from Omkar Speciality Chemicals Ltd to Lasa Supergenerics Ltd.
Exceptional item consists of the difference between the fair value and book value of Assets transferred to resulting company amounting to Rs. 6321.38 lacs. The same has been charged to the Profit & Loss Account…
It effectively means that the assets, which were represented on the balance sheet of Omkar Speciality Chemicals Ltd at a certain value (book value) have now been transferred to Lasa Supergenerics Ltd at a lesser value (fair value). And as the fair value/the value realized by Omkar Speciality Chemicals Ltd shareholders is lower than book value by about ₹63 cr., therefore, it is recognized as a loss in the P&L statement of Omkar Speciality Chemicals Ltd.
A few things should come to the investor’s mind on this transaction:
- If the fair/realizable value of these assets was less than the book value, then the company (Omkar Speciality Chemicals Ltd) should not have waited for the demerger to revalue these assets at a lower value. It should have been done at the time the management came to know that the fair value of the assets is lower than the book value. Equivalent loss as exceptional item should have been realized at that point instead of waiting until demerger.
- However, if the assets are fully functional in terms of operability, then the new company Lasa Supergenerics Ltd, which has got these assets at a lower value would be able to show very good asset turnover ratios, lower depreciation and thereby higher accounting profits (PAT) and might be a higher valuation when the company gets listed on exchanges.
In the light of the current merger-demerger scheme of arrangement, which is under process and the annual reports with the restated positions yet being awaited, we are not able to put forward any view on the valuation of the shares of Omkar Speciality Chemicals Ltd.
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.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
Overall, Omkar Speciality Chemicals Ltd seems to be a company, which has been growing at a fast pace of 30-35% year on year for last 10 years (FY2007-16). The company has been able to achieve this fast paced growth with sustainable operating margins, which as per the company, it is able to achieve as it enters into only short term contracts with customers and therefore, is able to pass on the changes in the raw material costs to them.
The company has embarked upon a significantly large capacity expansion program, which has involved large capital expenditure. As a result, the company has to rely on equity funding (IPO) at very high costs, high debt burden, promoters funds infusion by way of warrants etc. As the company has attempted to take on expansion, which is far in excess of what can be supported by internal resources (SSGR), these sources of funds have not turned out sufficient to meet the overall funds requirement and the company has approached institutional investors for QIP, private equity for stake dilution. However, the institutional investors seem to have decided against putting in their money in the company.
Moreover, the company has not been able to manage its working capital well with funds getting stuck in receivables despite having customers of high repute. As a result, the company has faced a liquidity crunch with even some delays in depositing the undisputed statutory dues like income tax with the authorities beyond 6 months from which they became payable in FY2016.
No wonder that the credit rating agency, CRISIL, took note of this deteriorating liquidity position of Omkar Speciality Chemicals Ltd and downgraded it by 3 notches to non-investment grade in December 2015. As a result, the existing lenders of the company have shown a lack of interest in quickly providing the additional funds needed by the company. As a result, Omkar Speciality Chemicals Ltd has to rely on highly costly debt (18-19% per annum) in the form of loan against shares from different NBFCs.
Now, the promoters have realized the high cost of debt of the loan against shares and have finally resorted to selling their personal stake in the company to raise funds to get the pledge of the shares released, which is a desperate situation.
It seems that the company has found itself in such stressed situation as a result of much larger capex plan being started by the management without proper visibility of the associated costs and the sources of required funds. The financial prudence of the management leaves a lot to be desired.
Similarly, the assessment done by the management of the company before making different commitments to stakeholders needs improvement be it about the conditions of prepayment penalty on the pledge or the assessment of quantum of the sale of promoter’s stake.
The management is expected to perform better on its project execution skills and liaising skills so as to complete the projects in time as the continued delays in commissioning of Unit 5 is one of the key factors leading to the financial stress in the company.
There are certain aspects about the reported financials, which demand further analysis by the investor like declining freight & transportation cost while increasing overall sales and declining consumption of crude Iodine and Selenium metal powder while increasing sales of Iodine and Selenium compounds.
In light of the recent completion of significant capacity addition, it is expected that the management would be fully focused on achieving the full capacity utilization as soon as possible and reduce the liquidity stress along with the debt burden. However, we notice that Mr. Omkar Herlekar, part of the promoters, is focusing on the unrelated business of financial services.
Such unrelated diversification along with the stated management assumption in the conference call of July 19, 2016 (page 19), that they would keep getting business on their own from the customers without much effort might not be the best approach to the business in a very competitive world.
Pravin S. Herlekar:… I would only like to say as a concluding remark that Company has come a long way for over 30 years and what has happened during these 30 years is a excellent goodwill which is generated among all our reputed customers who are our real assets for the Company, apart from my fixed assets this is one of the most important asset which I feel is very important for us and which is driving the business. Because we get business from the customers on their own, we don’t have to pursue much for the marketing as such, this is number one. We have built a very good team of personnel across all our manufacturing units which is another asset for me.
We do not focus on macro-economic factors while analysing stocks, therefore, we do not have any views on the impact of election of Mr. Donald Trump as the president of USA on the investing rationale for Omkar Speciality Chemicals Ltd.
We believe that the investors should keep a close watch on the movement of promoter’s stake in the company along with the pledging level, overall debt level, receivables days and commencement of Unit 5 as part of their monitoring exercise.
Further Reading: How to Monitor Stocks in Your Portfolio
These are our views about Omkar Speciality Chemicals Ltd. However, you should do your own analysis before taking any investment related decision about Omkar Speciality Chemicals Ltd.
You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks“
Hope it helps!
Dr Vijay Malik
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- 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.