The current section of the “Analysis” series covers Fineotex Chemical Ltd, an Indian company manufacturing specialty chemicals primarily for the textile industry.
“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.
Fineotex Chemical Ltd Research Report by Reader
I have learned a lot from the analysis and other articles on your website. In fact, it has prompted me to change the way I view companies and investments now.
Below is my analysis of Fineotex Chemicals Limited (FCL), a specialty chemical manufacturer. I have used numbers from Screener; however, I have also looked at annual reports for notes and a detailed breakdown of financial numbers.
I would like your inputs on my analysis.
Financial Analysis of Fineotex Chemicals Limited (FCL):
a) Sales Performance:
The consolidated sales of Fineotex Chemicals Limited (FCL) have increased from approx. ₹79.91 cr in 2012 to ₹182.33 cr in 2019, absolute growth of 128% or a CAGR of 12.5% over seven years. The company has registered double-digit growth in almost all the years under analysis, with 29.2% YoY growth for 2018-2019. The company has generated a cumulative income of ₹924.7 cr from 2012-2019.
FCL generates its revenues from the manufacture of chemical products or preparations of a kind used in the textiles, paper, and leather industries. The company produces at least 400 different products and sells to almost 60 countries.
b) Profit margins of FCL:
i) Operating profit margin:
FCL had an operating profit of ₹31.35 cr in 2019, a margin of 17.2% and a growth of 15% YoY.
There has been a healthy growth in its operating profit margins, increasing from 12.5% in 2012 to about 17.2% in 2019. While the operating margin increased from 2017 to about 22.2%, it has seen a consecutive decline in the past two years. As per the conference call for Q4 2019, the pressure on operating margins has been due to some disruptions in the supply of raw materials from China, and the margins are expected to recover once things settle in China.
ii) Net Profit Margin of Fineotex Chemical Ltd:
Net profit was ₹22.25 cr in 2019, a margin of 12.3% and slight degrowth from 2018. NPM took a jump in 2014, from 7.3% to 12.1% in 2015. It grew until 2017; however, it has declined in the past two years. The company generated a cumulative net profit of ₹121.4 cr during 2012-2019, with a CAGR of 20.8% over the seven years.
Operating Performance of Fineotex Chemical Ltd:
a) Net Fixed Asset Turnover Ratio (NFAT):
The trend of NFAT is worrying, as it has shown a consistent decline from 2012, declining from 19.24 in 2012 to 8.05 in 2019. It is notable however that the net fixed asset base has increased nearly 5.4 times from 2012.
As per the Q1 2019 concall, capacity utilization went from 54% to 60%, which is expected to fall to 58% in the future. The combined capacity of FCL and its subsidiaries in Malaysia has gone up from 26,000 tonnes per annum in 2018 to 43,000 tonnes per annum in 2019. The company may not be utilising its assets optimally. The low NFAT may also be due to the nature of their business, whereas per the management, different products have to be made by different production systems. Further, the requirement for products depends on the trends in the textile market, and different textiles need different products.
b) Receivable days:
Receivable days have been ranging between 70-80 days, being on the higher side in most years. The receivables have been increasing YoY, with a notable increase to ₹49.13 cr in 2019 from ₹27.92 cr in 2018. All receivables as per the 2019 annual report are unsecured. This could be indicative of a very lax credit system.
c) Inventory turnover ratio:
Inventory turnover ratio (ITR) has been fluctuating in the given period, with a declining trend in recent years. ITR has gone from 10.32 in 2017 to 7.89 in 2019.
Cash Flows Analysis of Fineotex Chemical Ltd:
a) Free Cash Flow:
FCL has generated positive free cash flows in all of the years except 2014. It has generated a cumulative free cash flow of ₹50.51 cr over the seven years. The company has been able to generate positive cash flows throughout its capacity expansions, with capital expenditure (capex) ramping up in the past two years.
All of its capacity additions and expansions have been funded through internal accruals, and the management believes that due to its strong cash position, it can continue to do so in the future without being dependent on debt.
b) Net Cash Flow:
FCL has generated a cumulative net cash flow of ₹17.99 cr over seven years. It should be noted however that there are some significant inflows and outflows of cash through the sale and purchase of securities and investments. There was an inflow of ₹10.67 cr through investments in 2019. This can be seen in the balance sheet as well, where the amount of current and non-current investments far exceed the amount of fixed assets. About one-third of the company’s assets are in current and non-current investments, and good portions of these are investments in mutual funds.
The company seems to have been growing its sales and net income at a very good rate and as per the management should continue to grow in the future. There are, however, concerns about declining NFAT and the increase in receivables. The company is relatively debt-free and funds most of its operations and expansions through internal accruals.
It should be noted that the company has a good portion of its assets in non-current investments such as equities and mutual funds and has been seeing considerable cash flows in the sale and purchase of these investments.
I would like your inputs on my analysis.
Dr Vijay Malik’s Response
Thanks for sharing the analysis of Fineotex Chemical Ltd with us! We appreciate the time & effort put in by you in the analysis.
While analyzing the past financial performance data of Fineotex Chemical Ltd, an investor would notice that until FY2011, the company used to report only standalone financials. This was because the company did not have any subsidiary. Since FY2012, the company has created many subsidiaries in India and abroad (Malaysia & UAE). As a result, FY2012 onwards, Fineotex Chemical Ltd provides both standalone financials as well as consolidated financials in its annual reports.
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 Fineotex Chemical Ltd, we have analysed standalone financials for FY2010-FY2011 and consolidated financials from FY2012 onwards.
Further advised reading: Standalone vs Consolidated Financials: A Complete Guide
Let us analyse the financial and business performance of the company over the last 10 years.
Financial and business analysis of Fineotex Chemical Ltd:
While analyzing the financials of Fineotex Chemical Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 25% year on year. Sales of the company increased from ₹21 cr. in FY2010 to ₹187 cr in FY2019.
The growth of the company has been almost a consistent journey except in FY2014 when it witnessed a decline in sales. In FY2014, the sales of Fineotex Chemical Ltd declined by 10% over the previous year. However, since FY2015, the sales of the company have increased every year. In the reported results of the last 12 months (Oct. 2018-Sept. 2019), the sales of Fineotex Chemical have increased to ₹197 cr, which is about 8% up from the FY2019 sales of ₹187 cr.
Whereas the sales growth of the company seems consistent; however, the profitability of the company has shown a different trend. The operating profit margin (OPM) of the company used to be 23% in FY2010, which declined over the next few years to reach a low of 9% in FY2012. Thereafter, the OPM increased to 26% in FY2016. Subsequently, the OPM has again declined consistently to 18% in the last 12 months (Oct. 2018-Sept 2019).
In order to have a better understanding of the business model and the factors affecting its performance, an investor needs to analyse the reasons for the fluctuations in its sales and profit performance over the years. Fineotex Chemical Ltd has provided annual reports from FY2011 onwards on its website, which offer some insights to the investor.
An investor would note that there have been sharp fluctuations in the operating profit margins of Fineotex Chemical Ltd from 23% to 9%, to 26%, and then to 18 over the years. Such fluctuations in the profit performance of a company indicate that the company has a low negotiating power over its customers. As a result, it finds it difficult to pass on the increase in the cost of raw material to its customers. Such situations usually force the company to absorb the raw material price increase on its own and in turn, reduce its profit margins.
The company has highlighted in its various annual reports that it is exposed to the risk of an increase in raw material prices and other inflationary factors. In FY2012, when the company witnessed a sharp decline in its OPM, then it explained it to the shareholders.
FY2012 annual report, page 6:
Due to rising costs of the oil, depreciating Indian Rupee and their inflationary impact on other items, the input costs continued to rise in the year under review. This also led to severe strain on the margins.
An investor would note that the profit margins of the company declined despite a significant increase in the sales of the company in FY2012. However, the sales growth did not result in an improvement in the profit margins.
FY2012 annual report, page 9:
The Company’s performance during the year shows a jump of 17.57 % over the last year. However, due to the rising raw material costs the profit before tax has remained almost at the same level in the year under review.
The company disclosed to the shareholders that the company is not able to pass on the full impact of the increase in prices of its raw materials to the customers.
FY2014 annual report, page 13:
There was a record fall in the Rupee value vis-a-vis the US dollar during the year resulting overall rise in input costs which could not be fully passed on to the customers.
Moreover, whenever, the company is able to pass on the increase in costs to the customer, then there is usually a time lag and the company is exposed to lower profitability margins in between.
FY2011 annual report, page 10:
The rising inflation puts the Company’s plans at a risk of underperformance. This also puts the margins at risk as the lag between rise in inputs and compensation received by us in the form of higher revenues.
After reading the analysis of multiple companies at our website, an investor would know that most of the time, the companies that face difficulties in passing on the impact of increased raw material costs are the ones that operate in highly competitive industries.
Many times such industries are fragmented in nature and the customers have the option of choosing from many suppliers. Therefore, the customers have a higher negotiating power. As a result, suppliers are not able to pass on the increase in raw material costs to the customers. In turn, whenever the raw material prices increase, the suppliers take a hit on their profit margins.
In the case of the textile chemicals segment, Fineotex Chemical Ltd highlighted to its shareholders that the industry is highly fragmented with many small suppliers providing intense competition.
FY2013 annual report, page 11:
Due to uncontrolled competition from unorganized sector, the Company has decided to follow a wait and watch policy before committing the balance funds. It has purchased land but is going slow on the nature of expansion to pursue.
In FY2014, the company highlighted to the shareholders that the company is facing competition from small scale and unorganized sector and as a result, the company is exploring diversification in other lines of businesses.
FY2014 annual report, page 16:
The industry is fragmented and has many players from tiny industries to large corporations.
The risk from the small scale and unorganized sector is real and the company is taking steps to diversify in other products as well as other fields.
Subsequently in FY2017, the company described the state of the industry in its annual report, which highlighted that the textile chemicals industry is fragmented with many small players who compete primarily on price to supply mostly commoditized chemicals. In addition, the cyclical nature of the customer industry (textile) affects the business & profit performance of the textile chemical manufacturers.
FY2017 annual report, page 22:
Fragmented industry structure with few scaled up Indian players: Most players operating in India are still small in scale. At the global level, however, there is significant level of concentration. Most segments in India witness a dominating presence of a few global leaders. This has implications on the competitiveness of Indian players..
Commoditisation: Several mature products in the sector have already been commoditised or are at risk of the same.
Regulations: Cost of compliance might make operations increasingly economically unviable for small players.
Similar products, little differentiation: A majority of the Indian players sell chemicals with little differentiation, thus competing largely on price.
Cyclicality of textile business: Another challenge for Indian players is to deal with the cyclicality in the textile manufacturing business.
In the past, the company tried to diversify into real estate sector to mitigate the threat of competition from small scale and unorganized players. In FY2013, the company incorporated a subsidiary to focus on the real estate business.
FY2013 annual report, page 8:
During the year, FCL Landmarc Private Limited was incorporated as a wholly-owned subsidiary to pursue Company’s activities in the realty sector as approved by the shareholders at the Ninth Annual General Meeting without affecting the activities of the chemical business. It will carry on the realty business as joint ventures in the initial stages. Realty business has better potential & profitability.
Further advised reading: Understanding the Annual Report of a Company
An investor would note that the business performance of Fineotex Chemical Ltd stayed subdued until FY2014. From FY2015-2016 onwards, the performance of the company improved significantly where both the sales and the profit margins of the company increased.
An investor would note that this period coincides with the crackdown by China on the polluting industries, which created many business opportunities for the manufacturers outside China including India.
FY2016 annual report, page 23:
Chinese exports have shrunk over the last few years, as there were strict penalties enforced by the Chinese Ministry of Environmental protection. This has opened up huge export opportunities for India due to its cost competiveness, scale, reliability, R&D capability, huge pool of technical human resource & ability to customise.
As a result, an investor would notice that the profit margin of Fineotex Chemical Ltd increased from 10% in FY2014 to 26% in FY2016. However, as the Chinese manufacturers adapt to the new regulations and the supply in China resumes, over time, the profit margin of the company has started to come down. The operating profit margin (OPM) of the company has declined to 18% in the last reported 12 months period (Oct. 2018-Sept 2019).
This situation may be similar to the position of other industries like graphite electrode manufacturers, which witnessed significant demand from China during this period as it focused on less polluting electric arc furnace for producing steel, which uses graphite electrodes. The sales and profit margins of all the graphite electrode manufacturers increased significantly. However, soon, the graphite electrode manufacturers in China increased supply and the business performance of Indian manufacturers slowed down.
An investor may read the analysis of one of the graphite electrode manufacturers of India, HEG Ltd to understand more about the impact of Chinese actions on Indian manufacturers.
Read more: Analysis: HEG Ltd
Therefore, going ahead, investors should keep a close watch on the profit margins of Fineotex Chemical Ltd.
Looking at these aspects of the business model of Fineotex Chemical Ltd, an investor would appreciate that the business performance of the company is dependent on many macroeconomic parameters, which are not in its control. For example, the cyclical nature of the textile industry, recent impact of the Chinese crackdown on polluting chemical manufacturers, intense competition from established European manufacturers as well as small scale & unorganized players of India etc.
As a result, an investor would appreciate that the business performance of the company is expected to witness periods of increase and decrease in its sales growth as well as profitability going ahead.
Therefore, when an investor notices that the profit margins of the company, have declined since FY2016 including the latest 12 months period (Oct. 2018-Sept 2019), then it does not surprise her. The investor realizes that such fluctuations are not an aberration in the company’s performance, but these reflect the nature of its business model.
The net profit margin (NPM) of Fineotex Chemical Ltd has largely followed the trend of its operating profit margin. NPM of the company was 17% in FY2010, and then it declined to 7% in FY2013. The NPM increased subsequently to 20% in FY2017 only to decline to 12% in FY2019.
While analysing the tax payout ratio, an investor would notice that the company has reported a stable tax payout ratio of 27%-33% over the years, which is close to the standard corporate tax rate prevalent in India. When an investor analyses the annual reports of the company for periods in which the tax payout ratio is low, then she notices that the impact is primarily due to a part of income being taxed at a special (low) rate. It might be the income due to short-term capital gains on financial instruments, which attract a lower rate of about 15%. Another factor affecting the tax payout ratio is the difference in the income tax rate between India and foreign countries.
FY2018 annual report, page 136:
An investor may contact the company directly for any further clarification about the differences in the tax payout ratio of the company.
Further advised reading: How to do Financial Analysis of Companies
Operating Efficiency Analysis of Fineotex Chemical Ltd:
a) Net fixed asset turnover (NFAT) of Fineotex Chemical Ltd:
When an investor analyses the net fixed asset turnover (NFAT) of Fineotex Chemical Ltd in the past years (FY2010-19), then she notices that the NFAT of the company has declined consistently over the years. NFAT used to be about 12 in FY2012, which declined to five in FY2018. The NFAT improved slightly to six in FY2019.
This trend of NFAT indicates that overtime; the efficiency of utilization of the manufacturing facilities of the company seems to have declined.
Moreover, an investor would notice that in the normal course of business, manufacturing companies usually have an NFAT in the range of 1-4. An NFAT of 6-11 like in the case of Fineotex Chemical Ltd indicates that the business of textile chemicals needs comparatively low investment in plant and machinery.
As a result, any person/entity with a small amount of effort can raise the capital and put up a competing manufacturing plant. An investor would appreciate that this may be one of the reasons for the intense competition faced by Fineotex Chemical Ltd from small scale & unorganized players. This is because many firms in the unorganized sector may be able to compete with it by investing a small amount of money in the textile chemical manufacturing set up.
The low capital requirement and the resultant intense competition from the unorganized sector seem to be one of the key parameters leading to the fluctuating profit performance of Fineotex Chemical Ltd over the years.
b) Inventory turnover ratio of Fineotex Chemical Ltd:
While analyzing the inventory turnover ratios (ITR) of Fineotex Chemical Ltd, an investor would note that during FY2010-2019, the ITR of the company has witnessed a significant decline. In FY2011, the ITR used to be 14, which declined to eight in FY2019.
It indicates that the efficiency of the company in managing its inventory has declined over the years. It remains to be seen whether the company is able to improve its inventory management going ahead.
c) Analysis of receivables days of Fineotex Chemical Ltd:
An investor would notice that over the years, the receivables days of Fineotex Chemical Ltd have been around 80 days. It witnessed some periods of improvement like in FY2012 when the receivables days improved to 55 days or in FY2018, when the receivables days were 74 days. However, after each such period of improvement in receivables days, the company witnessed its receivables/debtor days increase towards 80 days.
An investor would notice that receivables days of 80 represent a high credit period to the customers.
While analysing different aspects of the business model of Fineotex Chemical Ltd, an investor notices that its major clients are textile manufacturers, which are larger players than the company is. As a result, the company is usually in a weaker negotiating position over its customers. Therefore, the company seems to be facing challenges in collecting the money from its customers in time.
An investor would appreciate that if the receivables were outstanding for a long period after the due date, then there is a possibility of the company not able to collect it at all.
When Fineotex Chemical Ltd prepared its financials as per the new Indian Accounting Standards (IndAS) in FY2018, then it wrote down its receivables shown in FY2016 and FY2017, indicating that it may not be able to collect those receivables.
FY2018 annual report, page 145:
Further advised reading: Understanding the Annual Report of a Company
Over the years, the declining efficiency of inventory utilization and long receivables days have led to a significant amount of money being stuck in working capital. The inventory of the company increased from ₹2 cr in FY2010 to ₹25 cr in FY2019, indicating that an additional amount of ₹23 cr is stuck in the inventory over FY2010-2019. Similarly, the trade receivables of the company increased from ₹6 cr in FY2010 to ₹49 cr in FY2019, indicating that additional ₹43 cr are stuck in the due from customers.
As a result, when an investor compares the cumulative net profit after tax (cPAT) of the company with the cumulative cash flow from operations (cCFO) for FY2010-19, then she notices that Fineotex Chemical Ltd has not been able to convert its profits into cash flow from operations.
Over FY2010-19, Fineotex Chemical Ltd has reported a total cumulative net profit after tax (cPAT) of ₹129 cr. whereas during the same period, it reported cumulative cash flow from operations (cCFO) of ₹83 cr.
It is advised that investors should read the article on CFO calculation mentioned below, which would help them understand the situations in which companies tend to have the CFO lower than their PAT and the situations when the companies tend to have CFO higher than their PAT.
Further advised reading: Understanding Cash Flow from Operations (CFO)
Margin of Safety in the Business of Fineotex Chemical Ltd:
a) Self-Sustainable Growth Rate (SSGR):
Further advised reading: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company
Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.
Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.
While analysing the SSGR of Fineotex Chemical Ltd, an investor would notice that over the years, SSGR of the company has been high in the range of 60-80%. Investors would note that the primary reason for the high SSGR is the high NFAT of the company, which has ranged from 6-11 over the years.
While studying the formula for calculation of SSGR, an investor would understand that the SSGR directly depends on the NFAT of a company.
SSGR = NFAT * NPM * (1-DPR) – Dep
- SSGR = Self Sustainable Growth Rate in %
- Dep = Depreciation rate as a % of net fixed assets
- NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
- NPM = Net profit margin as % of sales
- DPR = Dividend paid as % of net profit after tax
(For systematic algebraic calculation of SSGR formula: Click Here)
An investor would appreciate that the company has been growing at a rate of 20%-25% over the years, which is lower than the SSGR. As a result, investors would note that Fineotex Chemical Ltd would be able to meet its growth requirements from its internal resources without the need for additional sources like debt or equity.
However, an investor notices that the company raised money from equity (IPO in FY2011). The company raised about ₹29.5 cr from the initial public offer (IPO) in FY2011, which led to the cash & investments balance of the company increasing from ₹4 cr in FY2010 to ₹32 cr in FY2011. However, an investor notices that later on, the cash & investment balance of the company never declined significantly. Instead, the cash & investment balance has increased from ₹32 cr in FY2011 to ₹63 cr in FY2019.
An investor would appreciate that such a position may indicate that the company did not need the money raised from IPO for its business purpose and the company could manage its growth easily from its internal business profits. As a result, the company has consistently reported high cash & investment balance over the years.
An investor is able to observe this aspect of the company’s business when she analyses the cumulative cash flow position including free cash flow for the company over the last 10 years (FY2009-18).
b) Free Cash Flow Analysis of Fineotex Chemical Ltd:
While looking at the cash flow performance of Fineotex Chemical Ltd, an investor notices that during FY2010-19, the company had a cumulative cash flow from operations of ₹83 cr. However, during this period it did a capital expenditure (capex) of ₹36 cr. As a result, it seems that the company had a free cash flow of ₹47 cr. (= 83 – 36).
Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF
An investor would notice that the company is able to report a free cash flow despite not being able to convert its profit after tax into cash flow from operations. From the above discussion on net fixed asset turnover (NFAT), an investor would remember the company has a high NFAT because the business of textile chemicals does not need a lot of capital. As a result, Fineotex Chemical Ltd is able to meet its growth requirements from the cash generated from operations even though, it has faced a significant amount of money being stuck in inventory and trade receivables over the years.
Free cash flow (FCF) is one of the main pillars of assessing the margin of safety in the business model of any company.
Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing
Additional aspects of Fineotex Chemical Ltd:
On analysing Fineotex Chemical Ltd and reading the annual reports since FY2011, an investor comes across certain other aspects of the company:
1) Management Succession of Fineotex Chemical Ltd:
Fineotex Chemical Ltd is run by the father & son, Mr. Surendra Tibrewala (aged 63 years) and Mr. Sanjay Tibrewala (aged 38 years).
FY2011 annual report, page 6:
Such transition of leadership indicates that the company has put in place a management succession plan in which the new generation of the promoter family is being groomed in business while the senior members of the promoter family are still playing an active part in the day-to-day activities.
The presence of a well thought out management succession plan is essential in the case of promoter run businesses as it provides for a smooth transition of leadership over the generations and provides continuity in the business operations of any company.
Further advised reading: Steps to Assess Management Quality before Buying Stocks
2) Capacity expansion by Fineotex Chemical Ltd:
While reading the past annual reports of the company, an investor notices that in FY2011, the company used to have a manufacturing capacity of about 5,000 MTPA.
FY2011 annual report, page 35:
By 2019, the company has increased its manufacturing capacity to 43,000 MTPA, which includes 36,500 MTPA in India and 6,500 MTPA in Malaysia.
Investors’ presentation, Nov. 2019, page 11:
INDIAN FACILITIES LOCATED AT MAHAPE, NAVI MUMBAI
- The Current production capacity is 36,500 MT p.a
MALAYSIAN FACILITY AT BANDER BARU BANGI, MALAYSIA
- Current production capacity of 6,500 MT p.a.
An investor would note that the company seems to have relied on both organic and inorganic routes to increase capacity. It acquired a stake in BT Biotex Malaysia to acquire manufacturing capacity. However, an increase in the manufacturing capacity by eight times over the last 10 years represents a significant increase in the scale of the operations of the company.
3) Transactions of Fineotex Chemical Ltd with the promoters’ family:
While reading the annual reports of the company, an investor notices that Fineotex Chemical Ltd has done many transactions with the promoters’ family members & their companies.
a) Transactions related to office premises:
While reading the FY2012 annual report, an investor notices that Fineotex Chemical Ltd has taken some property on rent from Ms. Kanaklata Tibrewala and in turn, the company is paying her a rent of ₹780,000 per annum. In addition, the company has paid a security deposit of ₹1.95 cr to Ms. Kanaklata Tibrewala for the property.
FY2012 annual report, page 51:
Moreover, in the annual report, the investor also notices that the security deposit paid to Ms. Kanaklata Tibrewala is interest-free in nature.
FY2012 annual report, page 27:
Interest Free deposit towards rented premises paid to relative of director Rs.19,500,000/-(Rs.19,500,000/-)
By looking at the above information, an investor notices that the amount of security deposit (₹1.95 cr) is very high when compared to the amount of yearly rent (₹7.80 lac).
- The security deposit amounts to an advance of about 25 years’ worth of rent of FY2012, whereas the usual term for security deposits in commercial rental transactions is about 6 months of rent.
Further advised reading: How Promoters benefit themselves using Related Party Transactions
In the FY2014 annual report, an investor gets to know additional details about the properties taken on rent by the company from Ms. Kanaklata Tibrewala.
FY2014 annual report, page 6:
An investor notices that Ms. Kanaklata Tibrewala is the wife of the promoter of the company, Mr. Surendra Tibrewala and that the security deposit of ₹1.95 cr has been paid for an office premise of 970 sq. ft. located at 42, Manorama Chambers, SV Road, Bandra (W) in Mumbai.
Investors may note that this office is the registered address of Fineotex Chemical Ltd.
FY2019 annual report, page 147:
The registered office also includes the adjoining premises: 43, Manorama Chambers, SV Road, Bandra (W), which is owned by the promoter of the company, Mr. Surendra Tibrewala.
FY2014 annual report, page 6:
An investor notices that in FY2014, the company paid ₹8.82 lac for the premises to Mr. Surendra Tibrewala and ₹8.28 lac for the premises to Ms. Kanaklata Tibrewala.
FY2014 annual report, page 47:
From the above table, an investor also notices that Fineotex Chemical Ltd has also taken a factory premise at MIDC, Navi Mumbai on rent from Ms. Kanaklata Tibrewala.
Moreover, in FY2014 annual report, an investor notices that the company has taken an office premise on rent from Mr. Sanjay Tibrewala in Andheri (E), Mumbai.
FY2014 annual report, page 6:
Therefore, it seems that the promoter family purchases office and factory premises in their personal capacity and then gives these premises on rent to the company.
Moreover, when an investor notices that the company has paid an interest-free security deposit for these premises, then it may look like the company has directly/indirectly partly contributed towards the cost of acquisition for these premises.
Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?
b) Transactions with Sanjay Exports, a proprietary firm of the promoters:
While analysing annual reports of the company, an investor notices that over the years, Fineotex Chemical Ltd has done multiple transactions with Sanjay Exports, which is a proprietary firm of promoters.
i) Sale/export of products via the firm:
While reading the past annual reports of the company, an investor notices that previously, the company used to sell goods to Sanjay Exports. It seems like a transaction where Sanjay Exports used to sell these goods onwards in foreign countries.
FY2013 annual report, page 38:
An investor notices that in FY2012 and FY2013 each, Fineotex Chemical Ltd sold about ₹6 cr worth of goods to Sanjay Export, which amounted to about 17.5% of standalone sales in FY2012 (operating revenue of ₹33.3 cr) and 14.5% of standalone sales in FY2013 (operating revenue of ₹40.6 cr).
FY2013 annual report, page 21:
It looks like a significant amount of revenue was from the sales done by the company to Sanjay Exports, which looks natural that would have sold these goods further in foreign countries at an additional profit.
Many times, investors would notice that the dealings of sale and purchase of goods between the company and promoters’ entities have the possibility of shifting of economic benefits from the company to the promoters. It is especially in the cases where either the sales are done at a lower price than the price at which the company could sell its goods in the market or the purchases are done at a price higher than the price at which the company could procure goods from the market.
An investor may appreciate that the company can export the goods to the customers directly. An investor may assume that Sanjay Exports may have access to certain customers who need these goods and in turn, Sanjay Exports is earning trading profits. However, the investors should note that in such a case, instead of dealing with these customers on a personal level, the promoters should share details of these customers with the company, as they are the management team of the company.
Therefore, in cases where an investor comes across instances of the company entering into sales of goods or purchase of goods from promoter entities, then she should be cautious in her analysis.
Further advised reading: How Promoters benefit themselves using Related Party Transactions
Investors may remember the case of Jet Airways (JA). In the case of JA, one of the company of the promoter Mr. Naresh Goyal, Jetair Pvt. Ltd (JPL) acted as a booking agent for Jet Airways. JPL earned a commission of crores of rupees from JA. When JA became bankrupt, then the promoter entity JPL was sitting on cash reserves of crores of rupees. (Source: Naresh Goyal’s firm had Rs 260 crore cash when financial crunch hit Jet Airways – Business Today)
An investor may find many other examples in India as well as the foreign corporate world where the promoters have entered into business transactions with their public listed companies and in turn, generated personal wealth out of such transactions.
ii) Purchase of motorcar from Sanjay Exports:
In FY2017, Fineotex Chemical Ltd purchased a car of about ₹41 lac from Sanjay Exports.
FY2017 annual report, page 72:
As mentioned above, investors should be cautious while analysing such transactions of sale/purchase of assets from promoters. This is because such transactions have the possibility of shifting the economic benefits from the company to the promoters.
c) Transactions with Proton Biochem Private Limited:
While reading the annual reports, an investor notices that almost every year, Fineotex Chemical Ltd (FCL) has business dealings with another promoters entity: Proton Biochem Private Limited (PBPL).
An investor notices that in FY2019, FCL received services worth ₹2.5 cr from PBPL and it collected rent of ₹4.55 lac from PBPL.
FY2019 annual report, page 143:
It might represent a case where promoters by way of PBPL, are using a premise owned by FCL to give services to FCL.
It might be a case where promoters by way of PBPL, have hired a few employees sitting in FCL premises, to provide these services to FCL and are earning money from FCL. In such a situation, the promoters being the managers of FCL may very well hire these same employees in FCL so that FCL can get these services from its own employees and save money.
As discussed above, an investor would appreciate that the business dealings of promoters with the public companies always have a risk of shifting economic benefits from the public shareholders to the promoters. Therefore, investors should be cautious while analysing such transactions.
Fineotex Chemical Ltd also realized it in the past. In FY2014, the company highlighted to the shareholders that PBPL is a promoters-owned entity, which does business only with FCL. Moreover, it contributed to about 50% of the turnover of FCL. The company acknowledged that such business transactions of the company with the promoters are not good corporate governance. As a result, the promoters want to sell PBPL to FCL.
FY2014 annual report, page 11:
Resolution No. 8
Proton Biochem Private Limited (Proton) (CIN-U74950MH1994PTC078288) is a related concern of the Company. It is one of the promoters. The shareholdings of Proton is held by the Tibrewala family. It almost exclusively does the processing for Fineotex and contributes around 50% of the Company’s turnover. Though the arrangement is approved by the Central Government and is extremely vital to Company’s business, the Company is advised that it would be a good governance practice to take over the business. One of the easier methods is to make it a wholly owned subsidiary.
However, even after acknowledging that these business dealings are not good from a corporate governance perspective, dealings of FCL and PBPL are continuing.
Further advised reading: How Promoters benefit themselves using Related Party Transactions
It is advised that investors should be cautious while analysing companies, which have business dealings with promoters. This is because, many times, these transactions have the possibility of transferring economic benefits from public shareholders to the promoters.
4) Raising money via initial public offer (IPO) at a high cost:
While reading the history of Fineotex Chemical Ltd, an investor notices that the company had come up with an IPO in FY2011. While analysing the details of IPO, an investor notices that the company paid almost 10% of the issue proceeds as expenses for the IPO.
FY2011 annual report, page 23:
An investor notices that the company raised about ₹29.5 cr from the IPO and out of this paid about ₹2.9 cr as issue expenses, which is about 10% of the IPO proceeds. An investor would appreciate that any source of funding, which has a 10% upfront cost of funds is generally considered as a very high-cost source of funds.
Moreover, from the above discussion on self-sustainable growth rate and free cash flow, an investor would note that the business model of the company is not capital intensive. High net fixed asset turnover (NFAT) of 5-11 for the company also directs to this conclusion. As a result, the company can fund its growth requirements (capital expenditure) from its business profits. In such a situation, an investor is not able to understand the urgent need to raise IPO funds at a high cost of 10% of the issue proceeds.
An investor would also note that since the IPO, the company has always maintained a high cash & investment balance of ₹30-60 cr. The continued presence of high cash & investment balance also indicates that the company may not have needed the IPO money in its business growth.
While reading the annual reports of the company, an investor would notice that soon after the IPO, the company started investing money in publicly listed equity shares of other companies like Sun Pharmaceuticals Industries Limited.
FY2013 annual report, page 31:
By FY2015, the number of companies where Fineotex Chemical Ltd has invested money has increased to 40 companies.
FY2015 annual report, page 88-89:
In the FY2018 annual report, an investor notices that over FY2016-2017-2018, the company has invested its money in & out of about 140 companies.
FY2018 annual report, page 86-87:
Further advised reading: Understanding the Annual Report of a Company
Moreover, an investor notices that at times, the company has frequently increased and decreased its shareholding in different companies, which indicates an intention to gain from short-term share price movements.
In FY2019, the company did not disclose the list of companies where it has invested its money.
An investor would appreciate that the attempt to gain from short-term movements of stock markets by deploying shareholders’ capital may not be the most desirable thing by minority shareholders. Minority shareholders may want the company to either utilize the surplus money as investments in the core business of the company or return it to the shareholders.
An investor may note that the company came with a buyback offer in FY2017; however, the amount used in the buyback about ₹2.9 cr was very small when compared to the cash & investment balance of ₹60 cr available with the company at March 31, 2017.
FY2017 annual report, page 17:
The buyback of 9,98,110 Equity Shares was completed on 31st January 2017 utilizing a total of Rs. 2,92,34,846 (excluding Transaction Costs) which represents 73.23% of the Maximum Buy-back Size with a balance of Rs. 1,06,89,554.
In light of the same, an investor is intrigued when she notices that in FY2019 annual report, the company has sought permission to raise an additional ₹100 cr by way of equity dilution.
FY2019 annual report, page 26:
Given the Company’s future growth plans, the Board of Directors of the Company, (“Board”) which term shall be deemed to include any committee constituted by the Board or any person(s) authorized by the Board in this regard), considers it necessary to augment the long term resources of the Company by way of issuing securities to eligible investors, subject to an aggregate maximum limit of up to an amount of Rs. 100 crores, and further subject to the prevailing market conditions and other relevant considerations
An investor should be cautious while analysing companies, which keep on raising money by diluting the equity frequently when they are not able to utilize the existing available resources like surplus cash & investments. It might represent a case where companies wish to raise as much money as possible while the going is good. Investors may appreciate that raising money by way of diluting equity should be the last option for any company after it has exhausted all other possible options if it wishes to protect the interest of existing minority shareholders.
5) Decision to diversify in unrelated business activity: Real Estate:
While reading the annual reports of Fineotex Chemical Ltd, an investor notices that in the past when the company got the surplus money with itself, then apart from investing in equity shares of other companies, it also invested money to venture into real estate stating that real estate business has better potential and profitability.
FY2013 annual report, page 8:
During the year, FCL Landmarc Private Limited was incorporated as a wholly owned subsidiary to pursue Company’s activities in the realty sector as approved by the shareholders at the Ninth Annual General Meeting without affecting the activities of the chemical business. It will carry on the realty business as joint ventures in the initial stages. Realty business has better potential & profitability.
However, in FY2017, the company realized that it may not make much headway in real estate and as a result, sold its subsidiary FCL Landmarc Private Limited at a loss to the company.
FY2017 annual report, page 87:
During the year under consideration, the Company has sold its 100% stake in erstwhile Indian subsidiary FCL Landmarc Private Limited at loss of Rs. 38,289/- which has been given effect to in Profit & Loss Account.
It may seem to an investor that when a company had surplus funds, which it keeps with itself without investing in the core business or returning it to shareholders, then there is a high probability that the company will invest it into unrelated areas. In many such cases, the companies may invest the money at suboptimal returns to the shareholders.
As a result, an investor should be cautious while analysing companies, which have surplus cash but are hesitant to give it back to the shareholders.
Further advised reading: How to Identify if Management is Misallocating Capital
6) Issuing shares of foreign subsidiaries to third parties at a loss to the company:
In FY2017 annual report, the company has intimated its shareholders that its step-down subsidiaries have issued shares to third parties at a loss to the company.
FY2017 annual report, page 87:
During the year under consideration, the step down subsidiaries of the company have issued shares to third parties resulting into loss to the Company amounting of Rs.1,67,010/- in aggregate, which has been given effect to in Profit & Loss Account
In other sections of the FY2017 annual report, the investor notices that the shareholding of the company in Malaysia subsidiaries has come down from 60% to 57.14%.
FY2017 annual report, page 83:
From the above disclosures, an investor may estimate that the step-down subsidiaries of the company in Malaysia have issued shares to third parties at terms, which are detrimental (loss-making) to Fineotex Chemical Ltd.
However, while reading the financial history of the company, an investor notices that the company has held its Malaysian subsidiaries in very high regard with respect to the value-added to the company in terms of business and brands. Malaysia subsidiaries have been one of the major factors leading to an increase in sales and profits of the company over the years. In light of the same, an investor is surprised to note that these subsidiaries have issued shares to the third parties at a loss to the company.
Investors may contact the company directly to understand more about the terms at which these shares were issued by the Malaysian subsidiaries to the third parties and why these are at a loss to the company.
Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?
7) Capital advances, which seem to be unutilized over long periods:
While analysing the past annual reports of Fineotex Chemical Ltd, an investor notices that the company has a capital advance of about ₹3.69 cr, which is present in almost every year’s financials since FY2013.
- FY2013 annual report, page 31: capital advance: ₹36,960,000
- FY2014 annual report, page 37: capital advance: ₹36,960,000
- FY2015 annual report, page 63: capital advance: ₹42,210,000
- FY2016 annual report, page 65: capital advance: ₹36,960,000
- FY2017 annual report, page 65: capital advance: ₹36,960,000
- FY2018 annual report, page 91: capital advance: ₹37,960,000
- FY2019 annual report, page 89: capital advance: ₹37,960,000
By looking at the above data, it seems to an investor that the capital advance of ₹3.69 cr, which was given in FY2013, has not been used until FY2019 by the company.
Investors may contact the company directly to understand whether the capital advance given in FY2013 is indeed outstanding in FY2019. If yes, and then what are the reasons for the same and who is the counterparty. This is because a long-standing advance may seem like interest-free money given to the supplier to use for her benefits without providing the required goods/benefits to Fineotex Chemical Ltd.
8) Very low power & fuel costs for Fineotex Chemical Ltd:
While analysing the financial performance of the company, an investor notices that over the years, the power & fuel costs of the company are very low at 0.2%-0.4% of the sales. This is in sharp contrast to the power & fuel costs for other specialty chemical companies, which have power & fuel costs in the range of 5%-15% of sales.
The below chart compares the power & fuel costs as a percentage of sales for Fineotex Chemical Ltd with other specialty chemical companies like Alkyl Amines Chemicals Ltd, Balaji Amines Ltd, and Navin Fluorine International Ltd.
An investor would notice that there is a stark difference in the power & fuel costs of Fineotex Chemical Ltd when compared to power & fuel costs of other specialty chemical companies.
Investors may contact the company to seek further clarifications about whether the power & fuel costs are the right parameters to compare these specialty chemical companies and what are the reasons for the very low power & fuel costs of Fineotex Chemical Ltd.
9) Non-compliances with the disclosure norms by Fineotex Chemical Ltd:
While reading the corporate announcements filed by the company at Bombay Stock Exchange (BSE) website, an investor notices that the company filed the annual secretarial compliance report for the period ending March 31, 2019, on the BSE website on May 30, 2019 (Source: click here). In this secretarial compliance report, the auditor highlighted that in FY2019, the company did not comply with the disclosure requirements at four instances. Some of the non-compliances are related to prior intimation to stock exchanges about the board meeting to raise funds and timely intimation of the outcome of such board meeting. For example:
- Requirement: Reg. 29(d) of LODR: The listed entity shall give prior intimation to the stock exchange about the meeting of the Board Of Directors in which the following proposal is due to be considered “fundraising by way of further public offer
- Company’s action: No prior intimation was given to the stock exchanges of the Board Meeting held on 14th August 2018…
- Requirement: The listed entity shall disclose to the exchange, within 30 minutes of the closure of the meeting Outcome of the Board Meeting where the decision with respect to fundraising was….
- Company’s action: No outcome of the meeting was given to the exchanges wherein the decision with respect to the raising of funds was considered in the Board Meeting held on 14th August 2018….
In addition, while reading the FY2014 annual report of the company, an investor notices that the company has missed providing the details of related party transactions in its consolidated financials. The company provided the table of related party transactions in the FY2014 annual report in the standalone financials on page 47. However, in the consolidated financials, there is no table containing details of related party transactions.
10) Errors in the annual reports of Fineotex Chemical Ltd:
While reading the annual reports of the company, an investor comes across many instances where the company has made mistakes in its annual reports.
In the FY2014 annual report, the company made a mistake while doing the sum-total of the fixed assets disposed of during the year.
FY2014 annual report, page 36:
In the FY2015 annual report, the table of indebtedness has errors in calculations of debt at the end of the year.
FY2015 annual report, page 46:
In the FY2015 annual report, the company disclosed that at the start of the year, it had a debt of ₹369 lac and during the year, there was a reduction of debt of about ₹19 lac. As a result, an investor would expect that the debt at the end of the year will be ₹350 lac (= 369 – 19). However, the total debt shown at the end of FY2015 is ₹178 lac.
In the FY2015 annual report, the company made another mistake while doing the sum-total of the fixed assets purchased during the year.
FY2015 annual report, page 87:
When an investor attempts to do the total of the assets purchased during FY2015, then she notices that the sum of the numbers is about ₹6 cr whereas the company has given a total of ₹4.6 cr in the table.
In the FY2017 annual report, there are multiple errors related to the shareholding of promoters in the annual report.
On page 41, despite an increase in percentage shareholding of the promoters after the buyback, the company mentioned that there has not been any change in promoters’ shareholding.
FY2017 annual report, page 41:
Moreover, in the above table, an investor would notice that the total number of shares held by each of the promoters is unchanged. The increase in the percentage shareholding is due to a decrease in the total number of shares of the company after the buyback.
However, on page 59, the company reports that the number of shares owned by Mr. Surendra Tibrewala has increased during the year from about 6.91 cr shares to 7.00 cr shares, which is in sharp contrast to the disclosure at page 41 of the annual report discussed above.
FY2017 annual report, page 59:
An investor may contact the company directly in the case; she wishes to seek clarifications about these errors.
Margin of Safety in the market price of Fineotex Chemical Ltd:
Currently (January 27, 2020), Fineotex Chemical Ltd is available at a price to earnings (PE) ratio of about 13.7 based on the last four quarters consolidated earnings from Oct. 2018 to Sept 2019. The PE ratio of 13.7 provides a small 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, even 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, Fineotex Chemical Ltd seems like a company, which has been able to grow its sales at a growth rate of about 25% per annum over the last 10 years (FY2010-19). The sales growth journey of the company has been almost consistent with only one year of sales decline in the last 10 years. However, the operating profit margin (OPM) of the company has seen high fluctuations during the period. OPM declined from an initial 23% in FY2010 to 9% in FY2012, then increased to an all-time high of 26% in FY2016 and since then has been consistently declining to 18% in Oct 2018-Sept 2019.
There seem to be multiple reasons for such fluctuations in the OPM. The company is finding it difficult to pass on the increase in raw material costs to its customers due to intense competition from large European manufacturers as well as from small scale & unorganized sector in India.
The company got a big boost in its sales as well as profitability in FY2016 when China imposed restrictions on polluting chemical manufacturers. As a result, the company got many opportunities to export at highly profitable prices. However, since then, gradually, the supply situations seem to be stabilizing and the high-profit margins of Fineotex Chemical Ltd are moderating.
Fineotex Chemical Ltd has not been able to maintain its working capital efficiency over the years. As a result, the company has witnessed a lot of money being stuck in working capital over the years. However, it seems that the business of textile chemical manufacturing requires low capital and as a result, despite comparatively low CFO, the company is able to manage its capital expenditure from its business cash flows.
An investor notices that the company’s business is not very capital consuming. Nevertheless, the company raised high-cost money by way of IPO in FY2011 by paying almost 10% of the proceeds as issue expenses. The company since then is maintaining high cash & investments on its books. The company seems to be using the high cash & investments in activities like buying & selling of stocks of other publicly listed companies as well as investing in real estate ventures. The company used a small amount of surplus money in a buyback in FY2017. However, the company is planning to raise still more money by diluting its equity further.
Fineotex Chemical Ltd is a family-owned and family-managed business where the son of the founder promoter is already playing an active role in the day-to-day management of the company. It indicates a smooth management succession planning by the company. However, investors notice that the promoters are engaging in many business transactions with the company on personal levels. Promoters buy properties and then give them on rent to the company. Promoters have formed an export house, which they seem to use to export the company’s goods in foreign markets. Promoters have formed a company, which provides services to the company by utilizing the premises of the company itself. At times, the company has realized that such practices are not good from a corporate governance perspective. However, the transactions are continuing.
While analysing the history of the company, an investor notices that there have been instances where the company has not met the compliance norms stipulated by the regulators about intimations to the stock exchanges. Moreover, the company seems to have done a few mistakes while preparing its annual reports. On one occasion, it missed out putting related party transaction details in the annual report.
There are some aspects, which need further clarification from the company like very low power & fuel costs when compared to its peers. Investors need to contact the company to understand the low power consumption in a manufacturing company. Moreover, the investors may also contact the company about the capital advances, which seem to be outstanding for a long period.
Going ahead, investors should keep a close watch on the profit margins of the company as well as transactions of the company with the promoters. Investors need to monitor the usage of surplus cash & investments available with the company. In addition, investors need to check whether the company uses the funds in non-core business activities.
Further advised reading: How to Monitor Stocks in your Portfolio
These are our views on Fineotex Chemical Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.
You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”
I hope it helps!
Dr Vijay Malik
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Registration Status with SEBI:
I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013
Details of Financial Interest in the Subject Company:
Currently, I do not own stocks of the companies mentioned above in my portfolio.