This article provides in-depth fundamental analysis of Nandan Denim Ltd, one of the world’s leading manufacturers of denim cloth with the largest manufacturing capacity in India.
In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.
Nandan Denim Ltd Research Report by Reader
I’ve come across a company called Nandan Denim Ltd and have done its financial and other analysis as suggested by you. I’m attaching the financials for the company for your reference. Also, giving my analysis of the company.
I would be grateful if you could spare some time to have a look at my analysis and let me know your thoughts on the same.
Financial Analysis of Nandan Denim Ltd:
1. P&L Statement:
Nandan Denim Ltd has seen a handsome sales growth in the last 10 years period. It has grown at a CAGR of 20% in the last 10 year period. There have been ups and downs, where the sales growth has declined, but it has never declined below 10% with an exception of FY 16 where the sales growth declined to 5%. However, this trend is likely to continue in 2017 as well, as the sales growth in the first 9 months stands at -3% (full year results are awaited as of 13th May when I’m writing this report). So we need to watch out if this trend is due to capacity issues, industry issues or company issues.
Nandan Denim Ltd has a healthy operating profit margins. The OPM showed a decline till FY’11, however, there has been a steady increase from FY‘12 till FY’16. One of the reasons for the increase in OPM is that company has invested in supplying their own raw material – from 50% of their need in FY 14 to 80-85% in FY 16, which would give them an advantage of 8-10% in the raw material cost. (There could be a minor drop in OPM in FY’17 looking at first 9 months results – yet to get the final results for FY 17)
- NPM of Nandan Denim Ltd declined from 5.1% in FY’ 07 to -0.4% in FY’09. However, post this there has been a steady increase in profitability of the company till FY’16. The current NPM stands at 5.5%, which is up from 3.3% in the FY’12.
- Need to note is that Nandan Denim Ltd has been under various capex investments in the past, and the NPM has fluctuated, but due to these (depreciation and interest changing). However, over the last few years, the organization has managed to keep a constant depreciation and interest expenses.
the organization has been paying their taxes diligently, indicating a good governance. The taxes have been within range, and not abnormally low over the years.
Interest coverage ratio:
Nandan Denim Ltd has maintained a high-interest coverage ratio over the last many years. Further, they have steadily increased their interest-coverage ratio over the last 5 years. This means they should be able to serve the debt very easily in times of difficulty.
2. Balance Sheet Analysis:
Debt – Equity ratio is higher than 1. Nandan Denim Ltd has gone in various capex investments from time to time, and this has led to high debt. However, there has been a constant effort to reduce the D/E ratio, and this has shown results as well. D/E ratio has come down from 2.2 to 1.7 over the last 4 years.
- The total debt for Nandan Denim Ltd stands at 530 cr, which looks reasonably high. The company has managed to reduce its cost of borrowing over last year. Further, they seem to be paying their interest regularly (also seen from their credit report).
Nandan Denim Ltd has been maintaining current assets more than current liabilities, with a ratio > 1.3. They will be able to take care of current liabilities very easily.
3. Analysis of cash flow statement:
Nandan Denim Ltd has shown a steady increase in its cash flow over the last 10 years.
Self-Sustainable Growth Rate of Nandan Denim Ltd:
- Nandan Denim Ltd hasn’t generated enough FCF (13% over the last 10 years). The bulk of the CFO has gone in capex, which has also been the cause of rising Debt over the last few years.
- SSGR of Nandan is negative, which is also the reason why their debt has increased over the year.
- This is a red flag as far as Nandan Denim Ltd is concerned and potentially a No-go for the stock.
- The only positive in this is that the additional capacity will start production in FY 17, which would increase cash flow for the company. Further, the management has reduced its D/E ratio over the last few years and wants to reduce it further (as mentioned in the Annual Report).
Inventory & Receivables of Nandan Denim Ltd:
- Both inventory turnover ratio and receivable days for Nandan Denim Ltd are increasing. While receivable days are still under control, the receivable days has gone up from less than 100 to 190 over the last few years. This is clearly a red flag for Nandan Denim Ltd as its taking much longer to collect its money from the customers
- Nandan Denim Ltd is increasing its sales, its receivables are increasing (nbr of dates), and this is coming along with rising Debt. This is not an ideal situation, as the company will find it difficult to pay off its debt. This is surprising as Nandan Denim Ltd has long-term tie-up with customers for 2/3rd of its orders with minimum yearly TO commitment.
- Further, there is a capacity increase taking place and they will need customers for that too.
- Trade payables have gone up too – from 68 cr to 75 cr in the FY16.
Further Reading: How to do Financial Analysis of a Company
Business Analysis of Nandan Denim Ltd:
- Nandan Denim Ltd has a higher profitability compared to the other main competition e.g. Arvind. Further, Arvind’s market cap/ sales ratio is 1.6, whereas Nandan’s is just 0.5. With a PE reasonable PE ratio of 10.5, we may look at a stock growth going forward.
- EPS of Nandan Denim Ltd is higher than Arvind as well.
- The stock could grow if the company pays its Debt in the coming year, and does not go in for any more capacity expansions in the coming years.
Further Reading: How to do Business Analysis of Companies
Industry Analysis of Nandan Denim Ltd:
- Nandan Denim Ltd has done backward integration, which should help increase its profitability over the long term. Source: Icra CR report FY 16
- Nandan Denim Ltd has an extensive industry experience, a wide distribution network, and led by promoters who have an extensive industry experience.
- This, however, comes with some industry risks – high capacity of the Indian players, cyclical demand, and raw material price fluctuations. The excess capacity could lead to a decline in profit margins. However, so far the company has managed to grow the margins despite this.
- Nandan Denim Ltd lacks in having premium offerings compared to its competitors like Arvind and Mafatlal. It focuses on the low-mid segment, where the realization is lower as compared to the premium segment. Not only does the lower segment offer lower realization, the offerings in that segment is commoditized.
- Nandan Denim Ltd’s investor presentation shows that their shirting revenue contribution has declined in FY16 vs. FY15.
Valuation Analysis of Nandan Denim Ltd:
the current P/E ratio is 10.5, which is quite low and within limits.
The PEG ratio should be 35 given that Nandan Denim Ltd is growing at 35% CAGR in the last 5 years. PEG ratio is 10/35 = 0.28, which is significantly lower than 1, and hence it can be said that the company is quite undervalued.
is 1/PE ratio, which would come to 1/10.5 = 9.5%. Today’s G-Sec rate is 6.9%, and this offers a MOS of 2.6% (9.5%-6.9%). This offers quite a good MOS for Nandan Denim Ltd.
P/B ratio for Nandan Denim Ltd is 1.91, which is less than the desired value of 2.0. This also means that PE*PB ratio for Nandan Denim Ltd comes to = 1.91*10.5 = 20.05, again lower than the desired value of 22.5. This again means that Nandan Denim Ltd is available at good valuations.
DY of Nandan Denim Ltd stands at 1.27%, which is lower than 2%. However, it can still be considered as a good yield as it is still above 1.
Further Reading: How to do Valuation Analysis of Stocks
Management Analysis of Nandan Denim Ltd:
The promoters have entered into a related party translations, where they have sold goods of 450 cr to other related companies, while it has paid 370 cr through goods purchased, expenses and capital asset sales. While I cannot determine the nature of these transactions. Crisil, in its FY14 credit report too, has pointed out about these transactions and has also suggested that going forward these transactions need to be reduced.
- Nandan Denim Ltd issued 50,00,000 convertible warrants to foreign portfolio investments on 9th Nov 15, for Rs. 200. The share price of Nandan Denim Ltd was Rs. 120 when the warrants were issued. Given today’s share price, these look quite reasonable.
- These warrants were converted into equity shares on 9th Nov 2015, at the price of Rs. 200.
- The share price of Rs. 200 looks fair in isolation, however, if we evaluate this closely evaluate this it comes to about 10% of the equity. If these FII’s had to buy 10% from the market, the stock price of the company would have gone up much beyond Rs. 200. Further, the promoters offloaded their share at Rs. 200, while the poor small investors will have to sell their shares at Rs. 134 (current price).
The promoter shareholding reduced a bit in FY14, however they brought it back to 61% in FY 16. In FY 17 however, the promoter share has reduced back to 58% in FY 17.
About 74% of the promoter shares were pledged in FY 12-13, which has come down to 4% in FY 17. This shows the interest of promoters in the business.
The salary of the MD is 67 Lacs, which looks quite reasonable. Remuneration of the other directors (non-family members) is also within range, which is 11 Lacs per annum.
However, Nandan Denim Ltd has paid 30crs in dividends with promoters holding 60% of the shares (18crs) despite having such a high debt!
Further Reading: How to do Management Analysis of Companies
- Please study this report, which states that SEBI held the MD of the company Mr. Ved Prakash Chiripal accountable way back in 2005-2006.
- They were accused of making misleading announcements, wherein there were differences between the audited and unaudited results. However, the issue was not established later.
In a separate case, they have also been charged for running an institute that gives out bogus BBA degrees.
“AHMEDABAD: Three members of Chiripal family has moved the Gujarat high court seeking legal protection against possible arrest in connection with the FIR lodged by a student alleging cheating and conspiracy by awarding them bogus BBA degrees by Shanti Business School run by Chiripal Charitable Trust. Brijmohan Chiripal, Ved Prakash Chiripal and Vineeta Chiripal and three others associated with the Institute have sought anticipatory bail.”
Source: The Times of India
- They have also being accused of a land scam in the past: https://www.youtube.com/watch?v=AMQr-f3vwbk
Final View about Nandan Denim Ltd:
- There are multiple positives going in for Nandan Denim Ltd – increasing sales, improving margins and PAT, strong customer base, backward integration (which will further increase margins), and reducing Debt. Further, if one compared Nandan Denim Ltd to other peers its market capitalization is much lower and there is a scope for this to increase. The stock is trading at a reasonable PE ratio of 10.5.
- However, this growth is largely funded by debt. While the D/E ratio has improved compared to FY13, it’s still quite high. The receivables and receivable days have increased substantially over the last few years – this will limit to pay their suppliers too.
- Promoters have offloaded their 10% share in terms of warrants to FII @Rs. 200, however small share price for small shareholders is still @Rs. 134, which is not favorable for the small shareholders. Further, the management, led by Mr. VP Chiripal has been accused of many frauds related to the Nandan Denim Ltd or other entities.
Given these, I would recommend NO-GO for Nandan Denim Ltd.
Dr Vijay Malik’s Response
Thanks for sharing the analysis of Nandan Denim Ltd with us! We appreciate the hard work put in by you in the analysis. The effort put in by you in the analysis is visible by way of references to different public documents and analysis of peers to bring our key aspects of Nandan Denim Ltd and its management. Your report of Nandan Denim Ltd would prove helpful to any investor trying to understand it as a business and an investment opportunity.
Let us analyse the performance of Nandan Denim Ltd over last 10 years (FY2007-16).
Financial Analysis of Nandan Denim Ltd:
Nandan Denim Ltd has been growing its sales since last 10 years (FY2007-16) at a brisk pace of about 18-20% year on year. It has witnessed its sales revenue grow from ₹222 cr. in FY2007 to ₹1,157 cr. in FY2016, which has further grown to ₹1,220 cr. in the FY2017.
As per the data shared by Nandan Denim Ltd, it has achieved this growth by both unit price increase as well as by selling a higher volume of denim cloth.
As per the May 2017 presentation of Nandan Denim Ltd, the realization of the company per meter of denim cloth has increased from ₹111.7 per meter in FY2013 to ₹131.6 per meter in FY2017.
Over last 10 years, the denim manufacturing capacity of Nandan Denim Ltd has increased from 32 million meters per annum (MMPA) in FY2007 to 110 MMPA in FY2017.
The management plans to achieve the future growth in its revenue by realizing higher realization per meter of denim cloth as well as selling a higher volume of denim cloth by optimally utilizing the newly installed capacity of denim manufacturing.
As per the management of Nandan Denim Ltd, it plans to increase the realization per meter of denim cloth by making denim, which is more aligned to latest fashion trends (value added products) and focusing more on exports business.
It remains to be seen whether the management of Nandan Denim Ltd is able to achieve these targets in future. An investor should keep a close watch on the realization levels of denim per meter achieved by Nandan Denim Ltd in future.
An investor would notice that the above-mentioned sales growth has been achieved by Nandan Denim Ltd by improving its profitability margins.
Further Reading: How to do Financial Analysis of a Company
The operating profitability margins (OPM) have improved from 13% in FY2011 to 17% in FY2016. Upon analysing the reasons for such improvement in the OPM, when an investor looks at the raw material costs of Nandan Denim Ltd, then she comes across a few facts, which seem to underlie the increase in OPM:
1. Declining cotton prices during this period:
The above chart shows that the cotton prices in globally have witnessed steep decline from the highs of FY2011 to current levels of FY2017.
The above chart despite representing global cotton prices seems to work well to indicate the input costs of Indian manufacturers as well because the Indian cotton market seems to be globally integrated without any import restriction put in by the Government of India.
The response from the management of Nandan Denim Ltd in the analyst conference call held on May 30, 2017 (page 6) clarifies this aspect of Indian cotton market:
Resha Haria: And in US, it is said that this time the cotton harvest is probably the best in the decades. So, there would be a good supply globally for cotton, so would that also bring down the prices of cotton in India or are the cotton prices in India insulated and is there some sort of an import restriction policy?
Ashok Bothra: There is no restriction as of now. Everything depends on the economics of the price. So, if we see that the landed prices of the imported cotton are cheaper, we will go for imports, otherwise if domestically cotton is available at a reasonable price, we will go for domestic supplies. So, if there is a bumper harvest globally, it will keep check on the Indian prices also. So, globally we are living in perfect market conditions.
There is no wonder that the raw material costs of Nandan Denim Ltd have declined from 78% of sales in FY2011, when the cotton prices were at the peak to 68% in FY2016 when the cotton prices have reduced substantially.
Moreover, apart from the reduced cotton prices, the efforts done by Nandan Denim Ltd to achieve backward integration by expanding the in-house manufacturing capacity of yarn to reduce the cost of yarn seem to have also contributed to reducing raw material costs and thereby improving operating profitability margins.
2. Backward integration:
Over last few year, Nandan Denim Ltd has been consistently increasing the in-house yarn manufacturing capacity. As per the presentation of the company for May 2017, it has increased the yarn manufacturing capacity in a step-wise manner from 54 tonnes per day (TPD) in FY2013 to 141 TPD in FY2017:
The increase in in-house production of yarn seems to have a dual benefit for the company:
- The cost of in-house yarn production is about 10% lower than the yarn sourced from the open market. The company has intimated this aspect of yarn sourcing in the May 2017 presentation:
▪ In-house production of cotton yarn would result in ~10% savings compared to purchase of yarn from the market.
▪ Better market response, efficient capacity utilisation and cost savings on captive yarn would result in EBITDA margin improvement from current 14% – 15% to around 19% – 20%.
- The in-house yarn manufacturing provides more control on the quality of the yarn production.
As a result, with increasing utilization of in-house produced yarn, the cost of yarn being used in denim production seems to have reduced over the years, which is another factor leading to improvement of operating profitability margins of Nandan Denim Ltd.
3. Passing on the cost of raw material increase to customers:
The company has been giving mixed messages about its ability to pass on the increase in cotton prices to its customers:
- In the conference call held on Feb 12, 2016, Nandan Denim Ltd conveyed that the cotton prices are a pass through for denim manufacturing:
Govind Sharda: Any spike or any rally in the prices of Cotton is the pass-through when it comes to the Denim manufacturing. So we normally do not keep huge inventory of Cotton with us, keep it a bare minimum level and our location becomes an advantageous proposition because we are so close to the market. So even if we place an order in the morning 8 O’clock by 2 O’clock we can get our cotton stock inside the plant.
- Again in the conference call on May 31, 2016, the company reiterated the same stance about the cotton prices being a pass through.
Govind Sharda: Historically when we talk about the cotton prices and linking it with the prices of the fabric, it is always a pass through whether it is a fall or it is a surge in the prices of the cotton, so we believe the trend will continue…………..yes temporarily there is a surge because of metrological department reports, so we do not expect any significant hit or support coming through the cotton prices because it is pass through.
- The company maintained the same stance in its FY2016 annual report (page 33) while discussing the mitigations of raw material risk:
Mitigation: Nandan Denim is located in Gujarat – the cotton hub of India. Further, cotton is a freely traded commodity across the globe to manage cost and quantity. Further, any spike in prices of cotton is a pass-through in Denim manufacturing. As a result, the Company does not keep huge inventory of cotton normally – optimising its working capital requirement and cost.
Further Reading: Understanding the Annual Report of aCompany
- When cotton prices started increasing from the start of FY2017, then in the conference call held on August 11, 2016, the company seemed concerned about the impact of increasing cotton prices on its margins:
Deepak Chiripal: Regarding the cotton prices, actually the cotton prices have drastically shot up only after I would say May or June, so really the impact of cotton rise has not been felt that much to that extent in the first quarter, it will be felt in the second quarter, because company also carries some stock, so really the cotton impact has not been that aggressive in the first quarter………As far as what company is doing is, company is trying to change the product mix, so as to get out of the situation of the input cost increasing, also company is trying to increase the prices and pass on some of the input cost to the final consumer.
Nandan Denim Ltd acknowledged that the cotton prices increase will hit its margins in next quarters. The cotton prices kept on increasing until May 2017 and we noticed that the operating margin of Nandan Denim Ltd declined to 15.6% in FY2017 despite continuous increase in the in-house yarn production.
Therefore, it seems that even though Nandan Denim Ltd might have the ability to pass on the increase in raw material costs to its customers, it might be able to do only for the products, which are high value-add (i.e. in line with latest/upcoming fashion trends) and not for the mass commodity denim products. A discussion from the May 2016 conference call gains significance in this aspect:
Deepak Chiripal: One more thing I would like to answer, you know the Denim business on one hand, deficnitely the market is growing but on the second hand there is a lot of capacity which is being added in the country so a lot of supply is also increasing. So I would say that it would be very difficult for any player to increase the prices for the same kind of product. So, it is very unreasonable to expect that given the demand and supply situation the company will continue to increase prices.
As per the management (Feb 2016 conference call), the composition of value added denim product in its overall denim revenue is about 10%, which means that most of the denim (about 90%) produced by Nandan Denim Ltd is the commodity product. Moreover, as communicated by the company, a denim product, which is value added today remain so only for a few months before the competing manufacturers replicate the same product and it becomes a commodity product.
Govind Sharda: The value addition is a very temporary phenomena and normally it is a fashion front runner. So a product which is a value added segment right now becomes a very normal type of products two months down the line and 6 months down the line it becomes a commoditized product. So definitely capturing a share of the value added product is a challenge in itself because it is the same product which is being sold. But, as of now, if I have to give a ball park number then I think we are able to get around 10% of our revenue pie from the value added products.
Therefore, it seems that for a denim manufacturer to promptly keep passing on the cotton price hikes to its customers, it needs to be very innovative and keep on introducing new denim variants in the market in quick succession so that the customer are willing to pay a premium pricing for its products and in turn the manufacturer can enjoy good margins.
Going ahead, an investor should keep a close watch on the operating profitability margins of Nandan Denim Ltd to assess the impact of increased in-house yarn manufacturing capacity commissioned in FY2017 and to assess whether the company is able to continuously produce value added products in the market.
Further Reading: How to Monitor Stocks in your Portfolio
The net profitability margins (NPM) of Nandan Denim Ltd have tracked the trend of operating profitability margins and as a result, NPM has improved from net losses in FY2009 to 5% in FY2016.
The tax payouts of Nandan Denim Ltd over the years are less than the standard corporate tax rate applicable to companies in India. It might be due to the tax incentives available to the company in light of textile being one of the focus areas of central and state governments. However, it is advised that the investor seek clarification from the company about the tax incentives available to the company or any other factors, which are leading to lower tax payout ratios.
Operating Efficiency Analysis of Nandan Denim Ltd:
An investor would notice that over the years the net fixed asset turnover (NFAT) of Nandan Denim Ltd has been improving. NFAT has improved from the low of 1.54 in FY2009 and has increased to 2.52 in FY2016. An investor would notice that the NFAT has been increasing during a period in which Nandan Denim Ltd has done substantial capital expenditure to increase the manufacturing capacity.
The rise in NFAT during periods of high capex is possible when the companies quickly make a new capacity functional and then reach optimal utilization levels in a very short time. Otherwise, we notice that companies usually take about 1-2 years to reach optimal capacity utilization once the new manufacturing capacities are commissioned. Therefore, most of the times, investors notice that the NFAT initially witnesses a decline when a company does the capex and then the NFAT gradually rises when the new capacities get commissioned and their utilization reaches optimal levels.
Further Reading: 5 Simple Steps to Analyse Operating Performance of Companies
While analysing the information presented by Nandan Denim Ltd in various communications to stakeholders, an investor comes across a few important aspects, which might have a bearing on the pattern of increasing NFAT achieved by Nandan Denim Ltd during the periods of high capital expenditure.
1) The capex seems to have been planned in phases:
A look at the year-wise capacity levels of Nandan Denim Ltd indicates that the company has increased its manufacturing capacity in phases, where it completed initial phases of expansion and started production in these phases and simultaneously worked on additional phases of capacity expansion.
Using the phase-wise expansion strategy seems to have led to better utilization of the incurred capital expenditure as compared to the situation where a company embarks upon a large capex and waits for starting production until the entire new planned capacity is complete and functional.
2) Cross-utilization of the new capacity:
As per the conference call in February 2016, Nandan Denim Ltd communicated to stakeholders that when it realized that the denim segment is witnessing better demand than the shirting segment, then it used part of the newly installed shirting facility to manufacture denim.
Demand for Denim in the Domestic market was in line with our expectation; however, the export market had a pinch and therefore offtakes in the segment were impact. During the 9 months period, exports comprised of 13% of the total revenue in order to cater to the domestic denim demand, a part of the Grey Shirting capacities were diverted to Denim manufacturing that led to reduced offtake of the Shirting product which comprised of 6% of the total revenues during the 9-months period.
This seems a good strategy by Nandan Denim Ltd to optimally utilize the available manufacturing capacity. It might also be one of the reasons, which has led to increasing net fixed asset turnover during the period when the company has been incurring large capital expenditure.
3) Capacity utilization levels:
Nandan Denim Ltd disclosed its capacity utilization data in its presentation of May 2017:
As per the information shared by Nandan Denim Ltd, it has achieved a capacity utilization of 84% in FY2017 on the total installed capacity of 110 MMPA of denim manufacturing.
As per the communication from the company to its stakeholders in May 2016 conference call, 84-85% is the maximum capacity utilization level, which can be achieved in a denim manufacturing plant and if a company has to grow beyond then it would need to install additional capacities.
Govind Sharda: No when we talk about 82% or 81%, there is not much scope of imporvement as far as the utilization is concerned., So you can do at max an incremental capacity utilization of 1, 2 or 3% if the company wants to become a star performer and I think that is the margin we are looking at, so incremental 2-3% is the number I would say the company is targeting as its own internal targets to improve upon but major growth or major topline is going to come from added capacities and new capacities becoming operational.
An investor would note that Nandan Denim Ltd had 99 MMPA of installed and functional capacity at the end of FY2016 and the additional capacity of 11 MMPA was commissioned in the December 2016 quarter. Therefore, the reported data achieving 84% capacity utilization level on the overall installed and functional capacity of 110 MMPA, seems to be a good performance by Nandan Denim Ltd as it indicates that manufacturing facility, which was commissioned in the Dec-2016 quarter also achieved the optimal capacity utilization at the end of FY2017.
The fact of quickly reaching the optimal capacity utilization levels (84%) within one-quarter leads to two conclusions for investors:
- Nandan Denim Ltd had a lot of latent demand for its products and as a result, it could optimally utilize the newly installed capacities within a short period and thereby could achieve improvement in the net fixed asset turnover (NFAT) during the periods in which it has incurred large capital expenditure.
- At the end of FY2017, the entire installed denim capacity is almost optimally utilized and therefore, Nandan Denim Ltd has achieved the near maximum volumes of denim production, which it could by commissioning the new denim manufacturing capacity at March 31, 2017. Therefore, any further revenue growth for Nandan Denim Ltd would be possible only after it immediately starts another capital expenditure program.
In light of the above analysis, we suggest that an investor takes the clarification from the company whether the data of capacity utilization of 84% level of the entire commissioned denim manufacturing capacity of 110 MMPA at the end of FY2017 is right?
- If the reported utilization level is for entire 110 MMPA, then whether by any means, Nandan Denim Ltd would be able to achieve higher capacity utilization levels than 84% in its plants to meet the volume growth requirement in coming future so that it can grow its sales?
- Increasing the capacity utilizations further to sell higher volumes becomes significant to achieve revenue growth in the light of the fact that Nandan Denim Ltd has witnessed decline in its realization per meter of denim in FY2017 and also that it has not been able to increase exports (high realization and margin segment) in line with its previous guidance of attaining almost one-third of revenue from exports
- However, if by any possibility, the data on capacity utilization shared in the presentation reflects only the utilization levels of previously commissioned capacity of 99 MMPA, then there seem to be a scope of additional denim volumes being produced from newly commissioned facilities of December 2016 quarter and in turn achieve revenue growth in future.
The above analysis seems to indicate that the recent large capacity expansion achieved by Nandan Denim Ltd by raising a significant amount of debt, does not seem to show visibility of volume growth for long-term future as the capacities are already nearing optimal capacity utilization.
In light of this observation, it does not look surprising to an investor that Nandan Denim Ltd has now resorted to equity dilution by way of issuing convertible warrants to foreign portfolio investors (FPIs) so that it may reduce its leverage and meet the cash requirements to fund another round of capacity expansion, which it might need to commence to achieve volumes growth in future.
The issuance of shares to Polus Global Fund by way of conversion of warrants in May 2016 and recent developments about the issuance of convertible warrants to 2 new FPIs: LTS Investment Fund Ltd and LGOF Global Opportunities Ltd seem to be part of such related developments. (Annual Report FY2016, page: 37):
Further Reading: Understanding the Annual Report of a Company
We would discuss more about high funds requirements to achieve revenue growth by Nandan Denim Ltd in more detail in later part of this article. Let us now look at the performance of Nandan Denim Ltd on other parameters of operating efficiency.
The company has managed to reduce its receivables days from the high of 113 days in FY2010 to 43 days in FY2016. This is a significant improvement in the credit terms being offered by the company to its customers and subsequent collection practices. The current receivables days seem to be in line with the usual practice of 45 days of credit period to domestic customers and further lower credit period for export orders backed by letters of credit (LC).
The inventory levels seem to be managed efficiently by Nandan Denim Ltd as the inventory turnover ratio (ITR) has improved from 5.2 in FY2012 to 6.9 in FY2016. Overall, the ITR has been mostly consistent within the range of 6-7.
It seems that as a result of efficient working capital management by the company, it has been able to reduce its working capital days (receivables days + inventory days) from 169 days in FY2010 to 96 days in FY2016.
Further Reading: 5 Simple Steps to Analyse Operating Performance of Companies
Margin of Safety in the Business of Nandan Denim Ltd:
i) Self-Sustainable Growth Rate (SSGR):
The investor would notice that Nandan Denim Ltd has a negative SSGR of about 3-4% over the years whereas it has been growing its sales revenue at a growth rate of 18-20% in over the 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 Nandan Denim Ltd.
As a result, Nandan Denim Ltd has witnessed its debt levels increase from ₹201 cr. in FY2007 to ₹530 cr. in FY2016. The debt has increased further in FY2017, however, we would get to know the exact level of debt at March 31, 2017, only when the annual report for FY2017 is published, which would provide the detailed notes to financial statements.
The detailed notes to financial statements are essential to know the complete debt levels of Nandan Denim Ltd as a part of debt known as current maturity of long-term debt (CMLTD) is shown as part of “other current liabilities” under the section “current liabilities”. The details of CMLTD are not provided by companies in the summary balance sheet, which is disclosed with September and March quarter results.
Further Reading: Understanding the Quarterly Results Filings of Companies
This assessment of SSGR gets substantiated when the investor analyses the cash flow position of Nandan Denim Ltd.
ii) Free Cash Flow Analysis:
Over FY2007-16, Nandan Denim Ltd has witnessed its sales increase from ₹222 cr. in FY2007 to ₹1,157 cr. in FY2016. For achieving this sales growth the company has done an additional capital expenditure (capex) of ₹746 cr. In addition, the company had an interest expense of ₹261 cr. over FY2007-16 to service the ever-present debt on its books. Therefore, Nandan Denim Ltd had to do meet a cash outflow of about ₹1,000 cr. to meet the capital requirements to expand its manufacturing capacities and achieve the 18-20% annual growth rate in last 10 years (FY2007-16).
However, the investor would notice that Nandan Denim Ltd has generated a cash flow from operations (CFO) of ₹637 cr. over FY2007-16 resulting in a shortfall of about ₹370 cr, which has been met by the company by raising incremental debt of about ₹330 cr. over FY2007-16 (₹530 cr. – ₹201 cr.).
SSGR and FCF are two of the main pillars of assessing the margin of safety in the business model of any company.
Apart from the above assessment of SSGR and FCF, there are two additional aspects, which deserve the attention of investors regarding the liquidity position of Nandan Denim Ltd and arrangement of funds to meet its cash requirements:
Additional aspects and annual report analysis of Nandan Denim Ltd:
1) Pledging of shares by promoters:
Amit, we appreciate the excellent work done by you in tabulating the year-wise pledging data. The pledging of shares by promoters should be a cause for concern as many times, it is an indicator of tight liquidity situation being faced by the company.
The example of another company, Omkar Speciality Chemicals Ltd is pertinent to assess the impact of pledging:
Further Reading: Analysis: Omkar Speciality Chemicals Ltd
In the case of pledging, it is advised that the investors take clarification from the company about the reasons for the pledging and the end use of the funds raised through pledging of promoter’s stake. It might be any one of the following scenarios:
- The shares might be pledged with lenders by promoters as part of additional security to lenders of Nandan Denim Ltd for the loans given by these lenders to the company. In such cases, the pledge gets released as the company repays the debt.
- The shares might be pledged by the promoters to raise funds in their personal capacity to meet their personal expenses or to fund their other capital commitments. In such cases, the minority investors carry the risk. This is because if the promoters are not able to repay their debt, then the lenders would sell the shares held by promoters in the market, which would lead to a decline in stock prices and the wealth of all the shareholders including retail minority shareholders will get eroded.
Currently, the pledge levels are significantly reduced at March 31, 2017, when compared to previous years. However, we believe that the investors should be aware of the reasons for which the promoters have pledged up to 75-80% of their shareholding in the past.
Further advised reading: How to know if Promoters are Losing Commitment to the Company
2) The increase in trade payables:
Trade payables represent the amount to be paid by a company to its suppliers/vendors. As per September 2016 quarterly results, Nandan Denim Ltd had trade payables of about ₹67 cr. at September 30, 2016, whereas at March 31, 2017, the trade payables increased to ₹135 cr., effectively indicating a shift of ₹70 cr. of cash from vendors to the company.
Even though at the face of it, it might seem that increasing trade payables means that the company is able to extract better credit period from its suppliers and thereby fund its working capital at the cost of its suppliers/vendors. This, in turn, leads to lower financing costs to the company. However, it is common finding that vendors/suppliers are the first counterparties to whom payments are delayed in times of liquidity stress. Therefore, many times, increasing payable days is the first indication of developing stress in any company.
Therefore, we believe that an investor should delve deeper into the assessment of trade payables.
Further reading: Understanding calculation of Cash Flow from Operations (CFO)
The continuous need of external capital (debt or additional equity) for sustaining the growth of Nandan Denim Ltd is evident from the fact that the newly added capacities for which the significantly debt funded capex has just been completed already seem to be running at optimal capacity. It indicates that there is low visibility of the newly installed capacities sufficing for the volume growth for long-term future as the data provided by the company shows that only marginal additional volumes can be generated in future from recently commissioned capacities.
As discussed earlier, the Nandan Denim Ltd has to face its own challenges in achieving higher realizations per meter of denim, which is witnessed by declining realizations in denim. An investor would note that the decline in denim realization in FY2017 has come during a period when the cotton prices have increased during FY2017. Therefore, it seems that the stated benefit of a pass through of increased cotton price to end customers is somehow not being realized by Nandan Denim Ltd.
As a result, the obvious choice for future growth in front of the company seems that:
- Nandan Denim Ltd should focus on achieving higher realizations per meter of denim by continuously innovating and making more value added products (which remain value added only for a short period of 2-6 months before the competing players copy them and the product becomes a commodity). The company has stated in its communications that it is in continuous efforts to achieve high share of value added products but the declining realization per meter of denim in FY2017 indicate that the efforts of the company are not yielding results now and it needs to continue its efforts so that the results in terms of better realizations are visible in future
- If Nandan Denim Ltd is not able to achieve higher volumes from currently available capacities (as these seem to have reached optimal utilization levels at March 31, 2017) and it finds it difficult to increase the realizations per meter of denim, then to grow in future, it would have to start another round of capacity expansion.
However, an investor would notice that Nandan Denim Ltd has already leveraged itself significantly by funding the recently completed capex primarily with debt. Therefore, the company might find it difficult to raise additional debt in quick succession for a new round of capex.
The company seems to realize that its leverage position is high and it might be one of the reasons for the company to raise additional equity from Polus Global Fund by way of convertible warrants, which got converted into equity shares in FY2017. This seems a step to reduce the leverage when measured in terms of debt to equity ratio.
In case, Nandan Denim Ltd finds it difficult to raise additional debt to fund new capex to grow volumes of denim sales, then it would either have to wait until it repays the existing debt by using the cash generated from existing manufacturing capacities and let go of volume growth in the interim. Only then the lenders would feel comfortable taking any higher exposure on the company. Or the company would have to raise further equity to reduce its leverage as well as to meet funds requirement for any additional capacity addition. The recent talks to issue convertible warrants to FPIs might be a result of such developments.
Running capital intensive businesses with low profitability margins is always tough. Many times, the growth in such businesses turns out to be cash guzzling, which such businesses are not able to meet from internal sources. Investors should be aware of the continuous need of additional capital by such businesses to achieve growth before making the final investment decision.
Examples of two companies with low NFAT and low profitability, which fell into debt trap while chasing the non-profitable debt-funded capital intensive growth are Amtek India Ltd (Castex Technologies Ltd) and Ahmednagar Forgings Ltd (Metalyst Forgings Ltd).
Investors should read these cases to understand the stress a capital intensive business with low NFAT can put on the balance sheet of the company if such a business is not associated with high profitability margins.
- Read: Analysis: Amtek India Ltd (Castex Technologies Ltd)
- Read: Analysis: Ahmednagar Forgings Ltd (Metalyst Forgings Ltd)
It is advised that going ahead an investor should continuously monitor the debt levels and additional equity infusion into the company.
While studying about Nandan Denim Ltd, an investor comes across certain other aspects, which are important for analysis and subsequent final investment decision by investors:
1) Project execution skills:
Nandan Denim Ltd was initially a trading company and it started denim manufacturing facilities in FY2004 with a capacity of 6 MMPA. The management has shown good project execution skills since then and within next 13 years, the company has a commissioned denim manufacturing capacity of 110 MMPA, which is apparently largest in India and fourth largest in the world.
2) Management succession planning:
Nandan Denim Ltd was incorporated by Mr. Vedprakash D. Chiripal and Mr. Brijmohan Chiripal in 1994. Currently, the next generation of the promoter family seems to be taking business responsibilities, which is evident by Mr. Deepak Chiripal taking over the responsibilities of CEO of the company.
It remains to be seen whether the new generation of the promoters is able to contribute and grow the company to next phase and more importantly, whether they are able to convert the company into a source of free cash flow to shareholders.
Further reading: Steps to Assess Management Quality before Buying Stocks (C)
3) Long term customer orders with minimum sales commitment:
As per the May 2017 presentation of the company (page 16), about two-third of its orders are under long-term agreements with customers, which have minimum yearly quantity commitments:
Around 2/3 rd of the orders are confirmed through long term agreements involving minimum yearly quantity commitment.
Such long terms agreements provide comfort to investors about the visibility of sales of the company.
4) Incentives of interest rate from central govt. and state govt.:
Nandan Denim Ltd has been receiving incentives from both central govt. as well as from the state govt. of Gujarat on the debt taken by it to funds its capex requirements. Such interest incentives are available for a Ltd number of years within which the debt needs to be repaid.
If any company is not able to produce sufficient cash from operations to repay these loans on time and therefore may have to resort to the refinancing of the loans, then the new loans would not have the subsidized lower interest rate. Such new loans would be at market rate, which increases the interest burden on companies, which are not able to generate sufficient cash to repay the loans taken.
Therefore, it is essential for an investor to keep a track of cash generation by Nandan Denim Ltd in future and monitor that the repayment of the loans is done within time and from internal resources.
5) Warrants issued at significantly higher price than prevalent market price:
In November 2015, Nandan Denim Ltd issued warrants to Polus Global Fund at ₹200/- per share. Previously, the share price of the company had been continuously at lower levels than the allotment price. The share price has touched the levels of ₹100 for the first time in June 2015 and had reached the highest levels of ₹158-160 during August 2015.
We believe that an investor should assess this aspect further as the allotment of warrants at a very high price is counter-intuitive for any investor, be it institutional or retail. As very high initial allotment price reduces the probability of future returns for the investors.
Moreover, the new FPIs, as per the FY2016 annual report, are also willing to subscribe to warrants at the same valuation of ₹200 per share arrived in FY2015 despite significant changes in the company and its capex execution in the interim.
6) Related party transactions:
As rightly mentioned by you, Nandan Denim Ltd has been entering into significant amounts of financial transactions with the promoter group companies. As per the annual report for FY2016, page 132, the company has entered into a significant transaction involving sales and purchases with related parties:
Many times, if the related party transactions are not at market prices, then they offer an instance of taking away the economic benefits of business activities from the shareholders of the company to members of the promoters group. Therefore, it is advised that an investor should study these transactions further to assess whether these transactions are at market prices.
Further advised reading: How Promoters benefit themselves using Related Party Transactions
7) Corporate guarantees are given on behalf of other companies:
As per the contingent liabilities section of the FY2016 annual report, page: 130, Nandan Denim Ltd has given guarantees to different banks (₹19.7 cr. and ₹16.3 cr.) on behalf of loans taken by Vraj Integrated Textile Park Ltd.
A guarantee to the banks on behalf of other companies means that if the other company, who is the actual borrower, is not able to repay the loan taken by it, then Nandan Denim Ltd will have to repay the loan to the lender.
This guarantee has the potential of increasing the debt obligations of Nandan Denim Ltd by about ₹36 cr. (amount of both corporate guarantees) over and above the loans taken by Nandan Denim Ltd of ₹530 cr. at March 31, 2016.
Moreover, the non-current investments section of the FY2016 annual report of the company, page 122, states that Nandan Denim Ltd has invested ₹5.8 cr. in equity shares of Vraj Integrated Textile Park Ltd.
We believe that an investor should study the relationship of Nandan Denim Ltd and Vraj Integrated Textile Park Ltd further.
Further advised reading: How Promoters benefit themselves using Related Party Transactions
8) Debtors/trade receivables are subject to confirmation:
The auditor in the FY2016 annual report of the company, page 128, has stated that the debtors are subject to confirmation.
33. Balances of Debtors, Creditors, Loans and Advances etc. are subject to confirmation and reconciliation.
Investors understand that it might not be possible for the auditor to take confirmation from each of the debtors. However, it is expected that the auditor would take confirmation from at least key debtors i.e., for example, largest 10 debtors/a sample of debtors on a random basis.
If the auditor has taken such confirmation on a sample of debtors, then it should be mentioned in the annual report.
Non-confirmation from debtors raises the risk of the said receivables being under dispute where the company might claim that the customer is liable to pay but the customer might say that the goods were faulty or never received and therefore, it is not going to pay.
9) Investigation and order by SEBI in the matter of group company Nova Petrochemicals Ltd:
Amit, thanks for bringing to our notice the SEBI order in the case of a promoter group company of Nandan Denim Ltd named Nova Petrochemicals Ltd. The order can be accessed at this link on SEBI website: Click Here
The case involved allegations that Nova Petrochemicals Ltd made a non-genuine announcement about its expansion plans and also gave misleading financial results to shareholders. It was alleged that these activities led to increase in share price of Nova Petrochemicals Ltd and the relatives of the promoters/management, then sold a significant stake in the company and got illegal benefit from it.
SEBI’s order finally exonerated the person accused of benefiting from such sales: Mr. Vishal Chiripal on the ground that he had sold a major portion of his shareholding before the said non-genuine announcement about the expansion plans was made.
However, the case highlights two important facts that:
- A non-genuine announcement about expansion plans by Nova Petrochemicals Ltd was made:
17. I note from the SCN that the announcement made by NPL on February 20, 2006, regarding expansion plan was non-genuine and misleading in nature as the Annual Reports of FY 2005-06 and 2006-07 did not reflect any information about the expansion plan being undertaken or executed by the company. I also note that the price of scrip after the above announcement went up from ₹102.50 on February 20, 2006 to ₹146.85 on March 8, 2006.
- And that misleading financial results were published by Nova Petrochemicals Ltd where the sum total of all the quarterly financial results of the company showed profits but the final audited results of the company showed a loss. As per SEBI, the company was not able to give a satisfactory explanation for it.
18. It is noted from the SCN that the NPL incurred a loss of ₹ 5.23 crore as on 31st March 2006 whereas the sum total of the unaudited figures for the quarter ending June to March 2006 showed a profit of ₹1.38 crores. Since there was a substantial difference in the unaudited and audited results, NPL was asked to clarify the same and the explanation of NPL was not accepted as it failed to substantiate the same. The NPL thus gave misleading results to the public.
These two findings become significant for the investors while analysing Nandan Denim Ltd because the chairman of Nova Petrochemicals Ltd during the period under which these allegations are made by SEBI was Mr. Ved Prakash Chiripal who is also the current chairman of Nandan Denim Ltd.
7. Investigtion revealed that NPL showed profit in three quarters of 2005-2006 while the yearly results of 2006 showed loss for which the company could not give any reasonable explanation. The Chairman, Ved Prakash Chiripal and MD, Shyam Gupta were aware of the negative results and the PACs, who were the family members and group companies of the Chairman and the MD, sold shares before the outcome of the negative results.
We believe that an investor should be aware of this event while analysing Nandan Denim Ltd and therefore, thank Amit for bringing it to the notice of the author and the readers of our website.
10) Group company guilty of violating rules for maintaining books of accounts:
In the letter of offer for the rights issue by Nandan Denim Ltd (then named Nandan Exim Ltd) in Dec 2007 (page 8), the company disclosed that one of its group company: Vishal Fabrics Private Ltd and its directors had been found guilty of violating rules of Companies Act related to maintaining books of accounts and have been fined by Additional Chief Metropolitan Magistrate, Ahmedabad in this regard.
B) Our group company Vishal Fabrics Pvt. Ltd. and its directors were held guilty of violating Sections 211 read with Section 209 of the Companies Act relating to maintenance of books of accounts of the company and have been imposed a penalty of Rs. 5000 each by the Addl Chief Metropolitan Magistrate, Ahmedabad.
11) Allegation about bogus degrees being issued by Shanti Business School run by Chiripal Charitable Trust:
As per a news item in The Times of India dated December 9, 2016, a student has filed an FIR against the Shanti Business School and in response, three members of Chiripal family: Ved Prakash Chiripal, Brijmohan Chiripal and Vineeta Chiripal have approached Gujarat High Court for anticipatory bail.
It is advised that an investor should follow up and find out the updates about the said case to know the truth behind the said allegations.
12) Media reports about irregularities in the property being developed by Chiripal group:
As per the link shared by Amit from YouTube (click here), which contains a coverage of a news item from Gujarati news channel: Sandesh News, certain irregularities are alleged in a property being developed by Chiripal group.
It is advised that an investor should look into this matter further to know the facts about the issue.
13) Error in the annual report:
In the FY2016 annual report of Nandan Denim Ltd, in the management discussion and analysis (MDA) section (page: 25), the company has mentioned that agriculture is the highest contributor to the Indian GDP:
Agriculture remains the highest contributor to the country’s GDP, and a forecast of normal monsoons after two consecutive years of low rainfall is expected to revive agricultural output, significantly strengthening the economy, as well as increasing rural demand. Urban consumption is also expected to rise, driven by the 7th pay commission.
Whereas, agriculture lost the status of highest contributor to Indian GDP in late 1970’s and since then it is services sector, which is the highest contributor to Indian GDP.
Margin of Safety in the market price of Nandan Denim Ltd:
Currently, Nandan Denim Ltd is available at a price to earnings (P/E) ratio of about 11, which offers some margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.
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, Nandan Denim Ltd seems to be a company, which has shown good sales growth over last decade, which is backed by demonstration of good project execution skills by the management as it has reached to the highest denim capacity in India and fourth highest capacity in the world of 110 MMPA within 13 years of starting denim manufacturing in 2007 with a capacity 6 MMPA.
The sales growth of Nandan Denim Ltd has been associated with improving profitability, which seems to be result of mixed impact of declining cotton prices over last 5-6 years and the backward integration of operations by the company. Nandan Denim Ltd primarily operates in the commodity section of denim cloth as the value added product constitutes only about 10% of overall sales. As a result, the company has found it difficult to pass on increases in the inputs cotton costs in FY2017 to customer, which seems to have led to decline in the denim realization per meter in FY2017. Nandan Denim Ltd has stated its strategy to focus more on value added products and exports to improve the denim realizations and the profitability, however, whether the company is able to successfully achieve the same, remains to be seen.
Nandan Denim Ltd operates in a capital intensive business and as a result, the growth of the company requires significant investments in the plant and machinery. The company has invested funds exceeding the cash generation from operations over past decade and as a result, it has witnessed its debt levels rise significantly along with equity dilution by way of issuance of shares to Polus Global Fund in 2016. The capital intensive nature of business operations of the company is evident from the assessment of Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) analysis of the company, both of which show negative values in their outcomes.
In light of the above analysis, it is advised that an investor should monitor the debt levels and the leverage position of the company closely.
Further Reading: How to Monitor Stocks in your Portfolio
Currently, Nandan Denim Ltd does not seem to have any operating leverage benefit left as according to the data presented by the company in May 2017 presentation, the company’s plants are running at 84% capacity utilization levels. As per the company management, denim manufacturing units operate at best at about 85% capacity utilization levels. Therefore, it seems that it the company plans to grow its sales volumes beyond FY2017 levels, then it might have to start a new phase of capacity expansion.
Looking at the current high leverage levels, the company seems to be looking at raising equity by way to convertible warrants to another set of Foreign Portfolio Investors (FPIs), which though would reduce the debt to equity ratio, but would dilute the stake of existing shareholders.
The management seems to have put in a succession plan in place. However, there are some instances about the management group’s actions in terms of related party transactions and other events of the past related to some of the group companies, which have come under the scanner of media and law enforcement agencies. It is advised that an investor analyse these issues in detail before they make final opinion about the company and its management.
These are our views about Nandan Denim Ltd. However, you should do your own analysis before taking any investment related decision about Nandan Denim 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.