Analysis: ADF Foods Ltd

The current section of the “Analysis” series covers ADF Foods Ltd, an Indian manufacturer of packaged food products exporting branded food products to the Middle East (Camel, Aeroplane), USA (PJ’s Organics, Nate’s, Soul, Truly India) and around the world.

“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.

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.

ADF Foods Ltd Research Report by Reader

Dear Dr. Malik,

Hope you and your family are doing well and keeping safe in these difficult times.

I have attempted a brief analysis of ADF Foods Ltd based on your teachings and checklist. I request your inputs/feedback and comments for the same.

Regards,

Anirudh Mahanot

A)   Introduction of ADF Foods Ltd:

ADF Foods Ltd started its business in 1932 as ‘American Dry Fruits’ Store. Today they have a network of 182 distributors across 52 countries exporting ethnic Indian edible items like Pickles, chutneys, Sauces, ready-to-eat food, Frozen foods and canned foods. They have either developed or acquired the following brands:

• Truly Indian: Native Spices
• Ashoka – Indian flavours for Pickles, Ready to Eat, Chutneys, Pulps & pastes, Frozen snacks
• SOUL(catering to health-conscious segment in India) – Olive oil-based Pasta Sauces, Ready to cook Masala mixes, Pickles
• PJ’s Organic – Mexican flavoured organic Burritos (easy to eat category)
• Nate’s – catering to the Vegan segment; Meatless Meatballs, Chaats & Roti wraps, Mediterranean bites Falafel
• Aeroplane – A premium brand for Pickles, Pastes & Powders catering to Global markets primarily the Middle East
• CAMEL – Pickled, cooking pastes and curry powders specifically catering to the Middle East
• SOUL – UK: Catering to Indians in the UK, with ready to cook and ready to heat & eat

New Product Launches: Flavored Milk, Naan & Paratha, Baked Snacks (100% Veg, heat & Eat category), Frozen Chutneys & Dipping Sauce (Vegan, Ready to Eat, No Trans-fat, no cholesterol category)

B)   Financial Analysis of ADF Foods Ltd:

• Sales Growth: as we can see from the table, the company has been growing its sales at a modest pace of 10% CAGR for the last 10 yrs.
• Profitability: company has improved its profitability margins from its lows of OPM (8%) and NPM (3%) in 2014 to 15% OPM and 16% NPM (other income) and has been sustaining its operating margins above 10% for more than 5 yrs. The reason for the drop in 2014 profitability is mentioned in its Annual Report – FY(13-14) as below:

During the year under review, your Company has recorded revenue from operations (net) of Rs. 141.81 Crore as against Rs. 129.69 Crore in the previous year recording an increase of 9% over the previous year. The Net profit (after tax and extra ordinary items) for the financial year ended 31st March 2014 is Rs. 12.44 crore as against Rs. 15.58 Crore in the previous year. Since the Company had an extraordinary income of Rs. 7.20 crores in the previous financial year, the Profit after Tax for the current year is not comparable with that of the last year

• Tax Pay-out: Company has been paying its taxes consistently
• Interest Coverage: ADF Foods Ltd is a zero-debt company
• Debt to Equity Ratio: ADF Foods Ltd has reduced its debt to Nil
• Current Ratio: 3.02, much better than the minimum desired levels of 1.25
• Cash Flow: ADF Foods Ltd is a cash flow positive company and has been growing it for the last 5 years.
• Cumulative PAT vs Cumulative CFO: We can see from the earlier table, ADF Foods Ltd.’s cCFO 149cr > cPAT 127cr, implies that company has been able to collect its receivables and convert profits into cash over last 10 years.

C)   Valuation Analysis of ADF Foods Ltd:

• P/E: 13.6 (10 yr. average P/E of TEL is 17),
• PEG: 0.36,
• Earnings Yield: 7.3% (10 Yr. G-Sec yield is at 5.8%)
• Price to sales ratio: 2.1,
• Dividend Yield: 1.03%

As we can see due to the current Corona Virus pandemic, there is Global market meltdown, stocks across indices, market caps and geographies have corrected. In the process companies which have been trading at relatively higher valuations have also corrected, ADF Foods Ltd is one such case where historically (10 yr. average) it has been trading around P/E of 17 but currently available at 13. P/E to growth ratio (PEG) of 0.36 indicates that the company is available at a discount to its growth rate.

D)   Business & Industry Analysis of ADF Foods Ltd:

i) Comparison with Industry peers:

*Prataap snacks Sales and profit CAGR is of 9 yrs.

*MTR, Panchranga and lot of unlisted/unorganised players are peer competition for this business

ii) Sales Growth of ADF Foods Ltd as compared to peers:

From the above table, we can see that ADF Foods Ltd is growing its sales at a modest pace of 10% CAGR for the last 10 years. When compared with the peers, Tasty bites & Prataap snacks have been growing with 20% and 31% CAGR sales for 10 years respectively.

Now, let us look deeper into Tasty bite and Prataap snack’s growth, if we look at their profit margins (OPM & NPM) they are low as compared to ADF Foods Ltd. We can also see that Prataap Snacks Sales (31% CAGR, 9yrs) is much higher than Profit (20% CAGR), which indicates that Prataap Snacks has been growing its sales at the cost of profitability (NPM 3%).

I have also noticed that both ADF Foods Ltd and Tasty bites had better margins in 2010 which drastically dropped to low single digits (3%) in the year 2012-14 period and then started improving over years. ADF Foods Ltd has improved its margins much better in the last 3 yrs. as compared to both. Also considering at this point FCF/CFO which is highest for ADF Foods Ltd (45%) as compared to Tasty Bites (13%) and Prataap Snacks (-193%); implies that ADF Foods Ltd has better free cash flows and lower capex requirements.

iii) Return Ratios

SSGR (16%) for ADF Foods Ltd is higher than Sales growth (10%) for the company and can sustain its growth rate without raising debt.  SSGR for Tasty bites is at par with its Sales growth. However, Prataap snacks SSGR 3% is much lower than its Sales growth, which means it might need further debt to continue their growth at current levels.

The other return ratios for ADF Foods Ltd, ROE 15%, ROCE 19% and PBT/Average NFA of 51% implies that company has been able to generate good returns from the shareholder’s money and its assets.

iv) Creation of Value for Shareholders from the profits retained:

For every 1 INR of profits retained by ADF Foods Ltd it has created 3.58 INR for the shareholders over the last 10 years. Tasty Bites has created the maximum shareholder value in the same period among the peer set, which is also reflected in the P/E (68.8) and PEG (1.48) of the company.

E)   Operational Efficiency of ADF Foods Ltd:

• ADF Foods Ltd has improved its Net fixed asset turnover from 1.84 to 3.11 over the last 10 years, means it has been using its fixed assets efficiently.
• Inventory turnover ratio has improved from 7 times in Mar’15 to 8 times now.
• Receivable days need to be tracked as the best case was 56 days (Mar’15) while currently, it is at 68 days.

F)   Management Analysis of ADF Foods Ltd:

ADF Foods Ltd.’s business was started 1932 as a retail store – American Dry Fruits, it is in 1990-92 period that company was incorporated as a public limited company and went public. It was founded by Hariram Mewawala, Ramesh Thakkar and Kishore Thakkar.

After Ramesh Thakkar, Ashok Thakkar became the chairman and led the business until 2013 when Bimal Thakkar (age 45 now) took over from him as MD & CEO.

Mr. Bimal Thakkar was inducted into the business in 2003. He understands the nuts-bolts very well.

The next generation Mishal Thakkar (age 32, manager – operations) and Shivaan Thakkar (son of Bimal Thakkar, Manager -Business & Strategy Development) are already working with the company.

i) Insider trading in ADF Foods Ltd:

When I searched for SEBI Notices/ Frauds etc. for ADF Foods Ltd and their promoters, I found following news related to SEBI order issued to the company: (Source: Sebi orders impounding of Rs 1 crore from ADF Foods’ promoters, 4 others in insider trading case: Economic Times)

I have written to the company secretary asking for more details in this matter and whether the clarification was submitted to SEBI, if yes, what and how was this resolved?

To ascertain if the Promoters tried to manipulate or take advantage of the period between May’16 to July’16, I checked the Promoter shareholding End of Mar’16, June’16 and Sep’16 and there has been no change in the promoter holdings (No. of promoter shares # 11516650 remained constant) and therefore doesn’t look like a case of fraud or insider trading.

However, we will wait to get the clarification from the company secretary in this regard and then conclude either way.

ii) Salary vs Net Profit:

*Mr. Ashok Thakkar & Bhavesh Thakkar retired from their positions and the total remuneration includes the gratuity payout/settlement as well.

There are a few key observations from the above table; All 3 Promoter-Directors were being paid equally irrespective of the roles they played in the company. Maybe that is the understanding in the family and terms of agreement amongst them.

Until 2018, the remuneration for each of them was under 10% of Net profit, however, due to the equal remuneration being paid to all 3, the cumulative remuneration for three of them together was much higher than 10% of PAT.

In 2018-19 period, both Mr. Ashok Thakkar and Bhavesh Thakkar retired and hence their take-home remuneration was paid along with gratuity. In the same period, Mr. Bimal Thakkar who’s now the Chairman & CEO saw almost 3x jump in his remuneration as he’ll be now taking up bigger and multiple roles.

An important point to note is that in 2019, the fixed salary jump is in line with the past years but the Annual Performance-based incentive as a percentage of profit being paid is calculated and totalled up to the maximum limit to the last cent. Need to be carefully looked at going forward!

We can also see in Annual report where the board of directors have mentioned the Remuneration criteria for the MD & CEO, the commission over and above fixed salary is linked to the net profit of the company, which is a healthy practice and shareholder-friendly.

iii) Dividend Payment track record of ADF Foods Ltd:

ADF Foods Ltd had been consistently paying dividends until 2015. In 2016, they came up with the buyback offer. In the second half of 2019 and twice in 2020, the company has declared dividends. It is in 2018 when they did not pay the dividends, but they had reduced the Debt in the company to almost Nil by then.

iv) Promoter shareholding of ADF Foods Ltd:

From 2011 to 2017, the promoters have been steadily increasing their stake in ADF Foods Ltd; however, Promoter holding suddenly dropped from 54.3% to 35.2% between 2017 & 2019. The outgoing Chairman Ashok Thakkar, his son Mishal Ashok Thakkar and Priyanka Bhavesh Thakkar (Bhavesh Thakkar was the ED & CFO until 2018) sold their stakes in ADF Foods Ltd in the market transactions.

Post that the promoters (Bimal Thakkar & his Sons) have started increasing their stake in ADF Foods Ltd over the last couple of quarters, which is a good sign.

G)   Credit Rating history of ADF Foods Ltd:

ADF Foods Ltd has improved its LT credit rating from CRISIL BBB+ to A-(stable) and has sustained ST ratings of A2+ over 5years.

H)   Margin of Safety analysis of ADF Foods Ltd:

• Earnings Yield: P/E: 13.6 (10 yr. average P/E of ADF is 17.3), PEG: 0.36, Earnings Yield: 7.3% (10 Yr. G-Sec yield is at 5.8%)
• Free Cash flow (FCF/CFO): 45%
• SSGR (self-sustainable growth rate): 16%

With PEG of 0.36, FCF/CFO of 45% and SSGR of 16%, ADF Foods Ltd provides a good margin of safety at the current price. It should be able to sustain its growth without overly leveraging.

Summary:

• ADF Foods Ltd has experienced promoter management running the business for 5 decades with a smooth succession plan. Now the next generation (sons of Bimal Thakkar) have also been involved in the business (Operations & Business management + Strategy) at very reasonable salaries. However, the issues of Insider Trading as Highlighted by SEBI need to be delved further and ascertained what really transpired.
• ADF Foods Ltd has established a very good geographical reach and diversification (50+ countries) along with a strong distribution network (180+ distributors worldwide)
• ADF Foods Ltd has been able to broaden their brand & product portfolio (7 brands across Ready to eat, ready to cook, paste, pickles, frozen foods) and coming up with new product ranges almost every year. The focus has been to establish a higher-margin segment for the health-conscious and convenience food segment (Gluten-free, Vegan, Low cholesterol, easy to cook/heat & eat etc.) which will help in sustaining profit margins
• Intense Competition, since ADF Foods Ltd, earns significant part (95%) of their revenues from exports they compete with global players from India (MTR, ITC etc.), rest of Asia and the Middle East. Sustenance of Revenue growth while maintaining their profit margins needs to be monitored.
• Fluctuations in raw material prices: ADF Foods Ltd uses various kinds of vegetables, oils, spices and condiments in the preparation of its products. Rapid fluctuations in prices and inconsistency in availability throughout the year affect the Company’s ability to reach its consumers with the right value proposition. As raw material prices largely depend on inflation, monsoon, and government policies, the group remains exposed to any sharp fluctuations. Further, any hike in input cost cannot be entirely passed on to customers, given the competitive environment (Source Annual Reports & Credit Rating reports).
• Debt-free company
• Positive cash flow, FCF/CFO of 45%; ADF Foods Ltd has successfully converted its sales into profits and profits into cash over the years.
• For every 1 INR of profits retained by ADF Foods Ltd, it has created 3.58 INR for the shareholders over the last 10 yrs. => creation of shareholder value (ROE 15%, ROCE 19%)
• Credit Rating (ST-A2+, LT A- stable)
• The margin of safety, at current price ~292, we see a good margin of safety considering PEG (0.36), FCF/CFO (45%) and SSGR (16%)

Happy Investing,

Anirudh Mahanot

Dr Vijay Malik’s Response

Hi Anirudh,

Thanks for sharing the analysis of ADF Foods Ltd with us! We appreciate the time & effort put in by you in the analysis.

While analysing the past financial performance of the company, an investor notices that for the entire last 10 years period (FY2010-2020), ADF Foods Ltd has had a few subsidiaries to manage its overall business. As a result, the company has published both standalone as well as consolidated financials every year.

We believe that while analysing any company, an investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire group. Consolidated financials of any company, whenever they are present, provide such a picture.

Further advised reading: Standalone vs Consolidated Financials: A Complete Guide

Therefore, in the analysis of ADF Foods Ltd, we have used consolidated financials in the assessment.

Financial and Business Analysis of ADF Foods Ltd:

While analyzing the financials of ADF Foods Ltd, an investor would note that the sales growth of the company has witnessed three distinct phases during FY2010-2020.

First, during FY2010-2014, ADF Foods Ltd witnessed sharp growth when its sales increased from ₹97 cr in FY2010 to ₹208 cr in FY2014. However, thereafter, in the second phase of FY2015-2018, the company faced many challenges. During this period, the sales of the company declined from ₹208 cr in FY2014 to ₹201 cr in FY2018. Nevertheless, after FY2018, the sales of the company have increased consistently and ADF Foods Ltd reported sales of ₹273 cr in FY2020. Therefore, even though, it seems that the company reported a sales growth of 10% year on year in the last 10 years (FY2010-2020); however, upon closer inspection, an investor notices that the company has faced quite a few challenges in its business during this period.

While analysing the profitability performance of ADF Foods Ltd, an investor notices that during the first half of the last decade (FY2010-2014), when the company witnessed a sharp growth in its sales, the operating profit margin (OPM) of the company declined by almost 50%. The OPM of the company declined from 16% in FY2011 to 8% in FY2014.

After FY2014, when the company entered the phase of stagnant sales, then the OPM of the company started improving steadily year on year. The OPM increased from 8% in FY2014 to 15% in FY2020.

While an investor observes the net profit margin (NPM), then she notices that for most of the years, the NPM followed the pattern of OPM. The NPM of ADF Foods Ltd used to be 14% in FY2010, which declined to 3% in FY2014. Thereafter, the NPM has witnessed improvement and increased to 16% in FY2020.

Such kind of fluctuating performance of sales revenue and profitability indicates that the business performance of ADF Foods Ltd is exposed to strong headwinds (challenging) factors.

When an investor notices such kind of fluctuating performance in both the sales as well as profitability, then she acknowledges the need for a deeper understanding of the business of ADF Foods Ltd. She needs to understand the factors influencing the business performance of the company. This is because, once an investor has understood the key factors for ADF Foods Ltd, then she would be able to have a view about the expected future performance of the company.

From our previous analysis of multiple such companies that faced fluctuating/cyclical performance in the sales and profit margins, an investor would remember that most of these companies operate in businesses with intense competition and lower barriers to entry. Intense competition provides customers with many choices to buy. Therefore, such companies tend to face tough business phases and have to take a hit on their profit margins whenever the raw material costs increase.

With this background, let us attempt to understand the business characteristics of ADF Foods Ltd.

While reading about ADF Foods Ltd, an investor notices that the business of packaged food products has many organized and unorganized players competing for market share. The organized players include both domestic players as well as multinational companies selling their products in India. The unorganized players sell their unlabeled products in the market at a cheaper price and increase competition.

FY2019 annual report, page 61:

Increasing competition from existing players and entry of new players can impact the market share. The presence of unorganized sector offering products in loose unbranded form also intensifies competition.

An investor notices that the intense competition in the processed food segment is not a new development. The company has highlighted it to its shareholders continuously over the years.

FY2012 annual report, page 20:

The intense competition faced from established brands, from organized sector and numerous players in unorganized sector may pose as a challenge to the business.

FY2017 annual report, page 62:

Intense competition from unorganized sector: One of the characteristics of this industry is the presence of unorganized sector offering products in loose unbranded form which intensifies competition.

An investor notices that ADF Foods Ltd earns more than 95% of its sales from exports and about 5% from the domestic market.

FY2020-Q4 results presentation, page 6:

Exports contribute to more than 95% of revenues

Therefore, an investor would appreciate that ADF Foods Ltd faces competition from Indian and MNC players in the Indian market and in addition, in the overseas markets, it faces competition from MNC players, Indian players exporting overseas as well as manufacturers from countries with cheaper production like Malaysia and Pakistan.

The credit rating agency, CRISIL, highlighted the intense competition faced by ADF Foods Ltd in its report for the company in May 2020.

Exposure to intense competition: The ADF group is present in the processed and ethnic food segments. With bulk of revenue generated from exports, the group has to compete not only with packaged food manufactures in Pakistan and Malaysia, but also with established domestic players such as ITC, MTR and Pachranga.

In 2010, another credit rating agency, ICRA, highlighted the intense competition in the food processing industry in its report for ADF Foods Ltd.

However, ratings are constrained by the highly competitive nature of the food processing industry in the international and domestic market.

Advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

Therefore, an investor would appreciate that ADF Foods Ltd operates in a business segment, which faces intense competition from organized, unorganized, domestic as well as multinational packaged food manufacturers. In this business segment, a customer has the option to buy from many manufacturers.

An investor would appreciate that because of the intense competition, the packaged food manufacturers would face difficulty in increasing prices to the customers when their input costs increase. As a result, when input costs increase, then the packaged food manufacturers have to absorb the costs themselves and in turn, take a hit on their profit margins.

In May 2020, credit rating agency, CRISIL, highlighted the inability of ADF Foods Ltd to pass on the increase in input costs to its customers.

Vulnerability to volatility in raw material prices: Key raw materials include agro-based products such as mangoes, chillies, edible oil, and sugar. As raw material prices largely depend on inflation, monsoon, and government policies, the group remains exposed to any sharp fluctuations. Further, any hike in input cost cannot be entirely passed on to customers, given the competitive environment.

Therefore, when an investor analyses the business performance of ADF Foods Ltd during the period of FY2011-2015 when its operating profit margin (OPM) declined from 16% to 8%, then she notices that the company has repeatedly highlighted rising costs as one of the main challenges.

FY2013 annual report, page 14:

The continuing factors posing as hindrances for the Company are the complex supply chain configuration, the Labour intensive operations, and ever rising costs.

FY2015 annual report, page 52-53:

The Business risks or threats faced by the Company are mainly lack of adequate external infrastructure, increase in the prices of raw materials, packing material and fuel, non-availability of raw materials, exchange rate fluctuations, changes in fiscal benefits/laws.

Any increase in the prices of core raw materials, would adversely affect the Company’s operating results.

Therefore, an investor would appreciate that whenever the raw material prices for ADF Foods Ltd increase, then the company has to take a hit on its profit margins as due to intense competition, it is unable to pass on the increase in input costs to its customers.

In light of the competitive environment, one of the key measures left for companies to improve profit margin is to control operating costs.

In FY2017, when the operating profit margin (OPM) of ADF Foods Ltd improved significantly (in the consolidated financials), then the company intimated its shareholders that the improved profitability is due to cost control measures undertaken by it in USA operations.

FY2017 annual report, page 24:

The improvement in the profitability could be achieved on account of improvement in our US operations through cost control measures.

US Business: The Company has moved all its production to a contract packer located in Ohio. The contract manufacturing would help the Company to reduce considerably the cost of operation & improve financial position.

An investor would note that in the same year (FY2017), in the standalone financials, the company’s profitability has suffered and one of the reasons for the same was increase in raw material costs that could not be passed on to the customers.

FY2017 annual report, page 24:

The reduction in the net profit is mainly due to two factors. One of these is high input cost of major raw materials and the other is devaluation of sterling pound on account of Brexit which has impacted revenue and profits of our UK business.

Therefore, an investor would appreciate that the company faces serious challenges to increase product prices to its customers when its input costs increase and the main method to increase profitability for the company is to cut down operating costs.

Read: How to do Business & Industry Analysis of a Company

In light of the intensely competitive business environment and the inability of ADF Foods Ltd to pass on increases in input costs, an investor should be cautious when she extrapolates the current operating profit margins (OPM) of the company of 15% in the future. The raw materials used in its products are agricultural inputs whose prices and availability depend a lot on monsoon as well as government policies. As a result, there is continued uncertainty in the sourcing of the raw material by ADF Foods Ltd.

FY2017 annual report, page 60:

Procurement risk: …The major raw material being agro based, availability of same depends on the vagaries of nature. Therefore, any disruption in the supply due to a natural or other calamity or violent changes in the cost structure could adversely affect the Company’s ability to reach its consumers with the right value proposition.

The credit rating agency, ICRA, has also highlighted the challenges on the front of raw material for ADF Foods Ltd in its report for the company in September 2010.

Further, profitability of the company is susceptible to volatility in prices of its key raw materials (mango, oil, sugar and vegetables) which are dependent on climatic conditions in India and farm output besides the demand-supply scenario.

As a result, we believe that an investor should do deeper due diligence before she projects current profit margins of the company in future. While analysing the historical performance of ADF Foods Ltd, an investor notices that the company had operating profit margins at the levels of 15%-16% in FY2010-2011 and then the profitability witnessed a sharp decline. It took ADF Foods Ltd for almost 10 years to bring its profitability to the previous levels. Anyone who during FY2010-2011 would have projected the profitability margins of ADF Foods Ltd to stay at 15% or improve further would have faced a negative surprise.

Therefore, we believe that investors should be cautious in their assumptions about the company’s performance in the future.

While looking at the tax payout ratio of ADF Foods Ltd., an investor notices that for most of the last 10 years (FY2010-2020), the tax payout ratio of the company has been highly fluctuating. Over the years, the tax payout ratio has varied from 9% in FY2011 to 44% in FY2018.

An investor may appreciate that the major source of revenue for the company is export. As a result, the company would have some tax incentives from the government for its manufacturing operations focused on exports. These incentives would tend to decrease the tax payout ratio.

On the contrary, the company also had a manufacturing presence overseas in the past and as discussed above, it currently uses contract manufacturers. As a result, of these overseas manufacturing operations as well as the sales in different foreign countries, the company has to pay taxes in many foreign countries, which affects its tax payout ratio.

While reading the annual reports, an investor notices that in FY2018, when the company had the highest tax payout ratio of 44%, then it was primarily due to the difference in tax rates in foreign jurisdictions.

FY2018 annual report, page 156:

In addition, another factor that leads to deviation of the tax payout ratio of ADF Foods Ltd from the standard corporate tax rate of 30% is the tax exemptions granted to companies with a turnover of less than ₹250 cr, which is 25% excluding surcharges and cess.

FY2019 annual report, page 160:

Reduced rate of 29,12% is applicable for company’s which have reported a turnover of upto Rs.250 crores and the prospective rate has been used by the Company for calculating deferred tax as future tax rate is to be used.

An investor may contact the company directly for any further clarifications about its tax payout ratio and the incentives available to the company.

Further advised reading: How to do Financial Analysis of a Company

Operating Efficiency Analysis of ADF Foods Ltd:

a) Net fixed asset turnover (NFAT) of ADF Foods Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of ADF Foods Ltd in the past years (FY2010-19), then she notices that the NFAT of the company has improved from 1.84 in FY2011 to 3.11 in FY2019.

Increasing NFAT over the years indicates that the company has been able to improve the asset utilization efficiency of its plants.

One of the key reasons for the improvement of NFAT of ADF Foods Ltd over the years has been its improving capacity utilization of its plants.

During FY2010 and FY2011, the company had a low capacity utilization of 62% and 66% respectively.

FY2011 annual report, page 79:

The credit rating agency, ICRA, had also highlighted modest capacity utilization of its plants by ADF Foods Ltd as one of the concerns in its report for the company in September 2010.

Though ADF generates healthy operating margin, net margin of the company and profitability indicators remain moderate due to modest capacity utilization….

Whereas in recent years, the capacity utilization of the plants of ADF Foods Ltd has improved significantly. In May 2019, while upgrading the credit rating of the company, CRISIL highlighted the improved capacity utilization of its plants by ADF Foods Ltd as one of the strong points of the company.

Better capacity utilization, favorable raw material prices and increasing contribution from high margin frozen food segment has resulted in higher operating margin

As a result, an investor would notice that improving capacity utilization of its plants by ADF Foods Ltd has resulted in an increase in its NFAT over the years.

Moreover, an investor would appreciate that the recent capacity expansion plans announced by ADF Foods Ltd also indicate that the company has achieved the optimal capacity utilization levels for its existing plants.

FY2019 annual report, page 5:

……this year we have initiated capex of Rs. 20 crore for expansion of product capacities both at the Nadiad and Nasik facilities.

Going ahead, an investor should monitor the progress of the capacity expansion to check whether the company is able to complete the projects in expected time and cost budgets and if it can utilize them to optimal levels.

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

b) Inventory turnover ratio of ADF Foods Ltd:

While analysing the inventory turnover ratio (ITR) of the company, an investor notices that the ITR of ADF Foods Ltd had been stable in the range of 8.0 to 8.5 over the years.

Stable inventory turnover over the years indicates that the company has been able to manage its inventories efficiently without letting significant money being stuck in its inventory.

An investor would notice that some of the raw material used by the company like mangoes are season products. In such cases, companies need to purchase the requirement for the entire year during the mango season. As a result, many times, the companies dependent on agricultural inputs in their products carry a large inventory, which makes their operations working capital intensive.

The credit rating agency, CRISIL had highlighted the working capital intensive nature of business of ADF Foods Ltd in its report for the company in September 2014.

The rating strengths continue to be partially offset by the working capital intensive nature of operations and the near-term profitability pressure; and competition in the domestic ethnic food segment.

Advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of ADF Foods Ltd:

While analysing the receivables days of the company, an investor notices that over the years, the receivables days of ADF Foods Ltd have been continuously in the range of 60-70 days. Stable receivables days indicates that the company has been able to collect money from its customers without any deterioration in its working capital position.

Further Advised Reading: Receivable Days: A Complete Guide

Looking at the stable inventory turnover ratio as well as at receivables days of ADF Foods Ltd over the years, an investor would notice that the company has been able to keep its working capital position under control and not let it deteriorate over the last 10 years (FY2010-2019). As a result, it has not witnessed a lot of money being stuck in the working capital.

An investor observes the same while comparing the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of the company for FY2010-19.

Over FY2010-19, ADF Foods Ltd Limited reported a total cumulative net profit after tax (cPAT) of ₹127 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹149 cr.

It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than their PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

Therefore, an investor would appreciate that during FY2010-2019, ADF Foods Ltd has kept its working capital requirements under check. As a result, it has been able to convert its profits into cash flow from operations.

The Margin of Safety in the Business of ADF Foods Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Read: 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 ADF Foods Ltd, an investor would notice that just as the phases discussed above for sales growth, the SSGR of the company also depicts distinct phases.

The SSGR of ADF Foods Ltd used to be very low (negative) until a couple of years back whereas, in recent years, it has improved to 16%. One of the key reasons for a low SSGR for the company in the past had been its low profitability (NPM) during FY2012-2016.

While studying the formula for calculation of SSGR, an investor would understand that the SSGR directly depends on the NPM of a company.

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

• 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)

Please note that in our SSGR calculations, we use the 3-year average of each of the parameters. Therefore, both improvement and deterioration of the parameters affect the SSGR with a lag.

An investor would notice that during FY2012-2016, ADF Foods Ltd continuously had a low (negative) SSGR due to low profitability whereas, in this period, the company was growing its sales at a fast pace. As a result, the company had to raise capital by both debt as well as equity to fund its growth plan.

The company raised debt from HDFC Bank to acquire a company Elena’s Foods Specialties Inc. in the USA.

FY2011 annual report, page 48:

For the purpose of the acquisition of this new manufacturing unit in USA, the Company has pledged its fixed deposits worth Rs. 998 lacs and Mutual Funds’ Units of the face value of Rs. 875 lacs with HDFC Bank, Mumbai Branch. Pursuant to a Stand By Letter of Credit issued by HDFC Bank, Mumbai Branch in its favour, HDFC Bank, Bahrain Branch has sanction a term loan of US $ 4 million to ADF Foods Holdings (USA) Ltd.

Thereafter, the company raised additional debt to complete its expansion of Nadiad plant.

FY2014 annual report, page 21:

Your Company’s Greenfield project in Nadiad shall become operational during the current financial year.

An investor would notice that during this period, the company had a negative SSGR due to low profitability whereas it was making capital investments at a fast pace. As a result, the debt levels of the company increased from ₹1 cr in FY2010 to ₹43 cr in FY2013. In addition to debt, the company raised additional equity (₹13 cr) by way of warrants in FY2012-FY2013. The company issued 2,000,000 warrants at ₹65 each (2,000,000 * 65 = ₹13 cr) to the promoters in FY2012.

FY2012 annual report, page 13:

During the year, the Company allotted 20,00,000 (Twenty Lakh) warrants convertible into equivalent number of equity shares of Rs. 10/- each at an issue price of Rs. 65/- per warrant to certain members of the promoter group on preferential basis on receipt of the minimum subscription amount of 25% of issue price i.e. Rs. 16.25/- per warrant.

Out of the 2,000,000 warrants issued, 200,000 warrants were converted into equity shares in FY2012 and remaining 1,800,000 warrants were converted into equity shares in FY2013.

FY2013 annual report, page 24:

During the financial year 2011-12, the Company had issued 20,00,000 convertible warrants to certain members of the Promoter group on Preferential basis. Out of these, 2,00,000 warrants were converted into equivalent number of equity shares of face value Rs. 10/- each on 28th March, 2012. The remaining 18,00,000 warrants were converted into equivalent no. of equity shares on 23rd January, 2013.

Further reading: Stock Warrants to Promoters: How to Analyse

Therefore, an investor would appreciate that during the first half of the last decade, ADF Foods Ltd attempted to grow more than its inherent ability and as a result, it had to raise debt (₹42 cr) as well as equity (₹13 cr) to meet its growth aspirations.

After FY2014, the company went into a phase of stagnant sales. There was not sales growth from FY2014 (sales ₹208 cr) to FY2018 (sales ₹201 cr). Nevertheless, as discussed above, during this period, the company decreased its operating costs and as a result, improved its net profit margin significantly from 3% in FY2014 to 9% in FY2018. As a result, the SSGR of ADF Foods Ltd improved significantly.

As a result, the company could use its cash flow for retiring its debt as well as return the money to equity shareholders by way of the buyback.

By FY2018, the company has reduced its debt to ₹1 cr from ₹43 cr in FY2013. In addition, it did a buyback in FY2017 where it bought back shares worth ₹9.63 cr from its shareholders.

FY2017 annual report, page 25:

The Company bought back 798,539 equity shares at an average price of Rs.120.60 per share. The Company had thus spent Rs. 9,63,07,029/- (Rupees Nine Crore Sixty Three Lakhs Seven Thousand and Twenty Nine Only) excluding the transaction cost.

Thereafter, the company did another buyback in FY2019 where it bought back shares worth ₹29.99 cr from its shareholders.

FY2019 annual report, page 6:

…we successfully completed a buyback of 11,78,742 equity shares through the open market route at an average price of Rs. 254.43 per equity share utilizing a total of Rs. 29.99 crore

Further reading: Share Buyback: An Investor’s Guide

An investor notices that in the first half of the last decade, ADF Foods Ltd had low profitability; however, it chose to grow its sales at a fast pace. As a result, the company had to raise additional debt as well as equity to meet its growth requirements until FY2014. Thereafter, the situation changed. The company stopped chasing sales growth and instead focused on cutting down operating costs leading to improvement in profit margins. As a result, after FY2015, the company could repay almost its entire debt and could buy back shares from its shareholders.

b) Free Cash Flow (FCF) Analysis of ADF Foods Ltd:

While looking at the cash flow performance of ADF Foods Ltd, an investor notices that during FY2010-19, the company had a cumulative cash flow from operations of ₹149 cr. During this period it did a capital expenditure (capex) of ₹66 cr. Please note that while calculating the capital expenditure over last 10 years, we have removed the increase in fixed assets of ₹16 cr during FY2013, which in effect is due to the revaluation of one of its brands, which resulted in its intangible assets increasing from ₹29.5 cr in FY2012 to ₹45.5 cr in FY2013.

FY2013 annual report, page 86:

…the Company received Ashoka brand, which was valued at Rs. 2,935.99 lacs by an independent valuer…

Therefore, an investor would note that over FY2010-2019, ADF Foods Ltd reported a free cash flow (FCF) of ₹83 cr. ( = 149 – 66).

In addition to the capital expenditure, the company had to meet the interest expense of about ₹15 cr on the debt that it had for FY2010-2019. Please note that the amount of interest capitalized by ADF Foods Ltd is already reflected in the amount of capital expenditure.

As a result, the company had surplus cash of ₹68 cr (= 83 – 15).

The company use this surplus cash as under:

• Buyback of shares from shareholders of about ₹40 cr: FY2017 (9.63 cr) and FY2019 (29.99 cr)
• Dividend payments to shareholders of about ₹25 cr excluding dividend distribution tax.

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

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 ADF Foods Ltd:

On analysing ADF Foods Ltd and reading its publicly available past annual reports and reading other public documents an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.

1) Management Succession of ADF Foods Ltd:

While analysing the history of ADF Foods Ltd, an investor notices that the promoter family started business as a small shop selling dry fruits by the name “American Dry Fruits” in 1932. Over time, the family grew the business to a packaged food processor spread across many countries.

Mr. Ramesh H. Thakkar was the chairman of the company until his death in FY2014. Thereafter, his brother Mr. Ashok H. Thakkar became the chairman of the company.

FY2014 annual report, page 24:

Consequent to death of Mr. Ramesh H Thakkar, Mr. Ashok H. Thakkar, Vice Chairman has been designated as the Chairman of the Company in the Board meeting held on 11 th August, 2014.

Thereafter, Mr. Ashok H. Thakkar ran the company with his nephews Mr. Bimal R. Thakkar and Mr. Bhavesh R. Thakkar (sons of Mr. Ramesh H. Thakkar). The relationship is evident from the following disclosure in the FY2016 annual report.

FY2016 annual report, page 11:

Mr. Ashok H. Thakkar is related to Mr. Bimal R. Thakkar and Mr. Bhavesh R. Thakkar as their father’s brother.

The three senior members of the family ran the company together until FY2019. However, it seems that in FY2019, the family member decided to go different ways and Mr. Ashok H. Thakkar and Mr. Bhavesh R. Thakkar left the company in May 2018.

FY2019 annual report, page 27:

During the year under review, Mr. Ashok H. Thakkar, Chairman and Mr. Bhavesh R. Thakkar, Executive Director & CFO tendered their resignations from the closure of the business hours on 29th May, 2018.

At the same time, Mr. Mishal A. Thakkar, son of Mr. Ashok H. Thakkar also resigned from the company.

FY2019 annual report, page 16:

Mr. Mishal A. Thakkar is the son of Mr. Ashok H. Thakkar. He has resigned from the position of VP – Operations in the Company with effect from close of business hours of May 29, 2018.

After the resignation of Mr. Ashok H. Thakkar along with his son, Mr. Mishal A. Thakkar, and nephew, Mr. Bhavesh R. Thakkar, currently, Mr. Bimal R. Thakkar (aged 55 years) is in charge of the company’s affairs as chairman.

FY2018 annual report, page 10:

Mr. Bimal R. Thakkar has been appointed as an Executive Chairman w.e.f. 5th June, 2018 in place of the outgoing Chairman i.e. Mr. Ashok H. Thakkar

On February 15, 2019, Shivaan B. Thakkar joined the company as Manager – Business & Strategy Development.

FY2019 annual report, page 123:

Mr. Shivaan B. Thakkar – Manager Business & Strategy (w.e.f. February 15, 2019)

The company has disclosed that Mr. Shivaan B. Thakkar is son of Mr. Bimal R. Thakkar.

FY2019 annual report, page 37:

Mr. Shivaan Thakkar (3,000 equity shares representing 0.01% of total paid-up capital) and Mr. Sumer Thakkar (2,000 equity shares representing 0.01% of total paid-up capital), being sons of Mr. Bimal Thakkar, Promoter of the Company…..

The presence of family members of different generations in the company indicates the presence of succession planning in the family. This is because the leadership can be transitioned from the elder generation to the new generation smoothly. In ADF Foods Ltd, the presence of the elders, Mr. Ramesh H. Thakkar and his brother Mr. Ashok H. Thakkar along with the next generation, Mr. Bimal R. Thakkar and Mr. Bhavesh R. Thakkar ensured that there was no leadership vacuum in the company when Mr. Ashok H. Thakkar and Mr. Bhavesh H. Thakkar left the company.

The presence of family members of different generations in the company allows for grooming of the new generation of the promoter family 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) Recent shareholding changes of ADF Foods Ltd:

From the above discussion, an investor would remember that on May 29, 2019, Mr. Ashok H. Thakkar and Mr. Bhavesh R. Thakkar resigned from the company. However, while analysing the changes in the shareholding pattern of the company, an investor gets to know that Ashok and Bhavesh had started to sell the stake in ADF Foods Ltd, which they held directly as well as indirectly through their family members.

As per FY2018 annual report, page 41, Ashok and Bhavesh sections sold the following stakes:

• Ashok H. Thakkar sold 6.84% stake in the company out of 6.89% held by him at the start of the year.
• Mishal A. Thakkar, son of Mr. Ashok H. Thakkar, sold 8.49% stake in the company out of 8.59% held by him at the start of the year.
• Priyanka B. Thakkar, who is the wife of Mr. Bhavesh R. Thakkar, sold 3.77% stake in the company out of 5.19% held by her at the start of the year.

Further, as per FY2019 annual report, page 48, Bhavesh section sold the following stakes:

• Bhavesh R. Thakkar sold 2.12% stake in the company out of 5.55% held by him at the start of the year.
• Bhavesh Ramesh Thakkar HUF sold its entire 2.70% stake in the company at the start of the year.

Therefore, during FY2018 and FY2019, Ashok and Bhavesh sections sold 23.92% stake from the company (23.92 = 6.89 + 8.49 + 3.77 + 2.12 + 2.70).

As per the annual reports of FY2018 (page 41) and FY2019 (page 48), a major portion of this stake was bought by two entities

• Mentor Capital Ltd: 13.88% and
• Alpana S. Dangi: 5.30%

Both Alpana S. Dangi and Mentor Capital Ltd did not have any stake at the start of FY2018 in ADF Foods Ltd. Therefore, effectively, they bought 19.18% (= 13.88 + 5.30) stake out of 23.92% stake sold by the Ashok and Bhavesh sections.

Mentor Capital Ltd seems to be a part of the companies owned by an investor Mr. Sanjay Dangi. As per corporate database Zaubacorp, the following is the list of directors of Mentor Capital Ltd (click here):

• Abhishek Tejawat
• Amit K Dangi
• Sanjay Soumitra Dangi

Alpana S. Dangi also seems to be related to Mr. Sanjay Dangi (details below).

As per the shareholding pattern of ADF Foods Ltd for March 31, 2020 (BSE), the names of both Mentor Capital Ltd and Alpana S. Dangi are no longer a part of the shareholders. Instead, the name of Authum Investment and Infrastructure Limited appears with a 22.44% shareholding of ADF Foods Ltd.

As per corporate database Zaubacorp, the following is the list of directors of Authum Investment and Infrastructure Limited (click here):

• Vinit Kishorchandra Parikh
• Amit K Dangi
• Vimal Ajmera
• Tapan Sodani
• Alpana Sanjay Dangi
• Navin Kumar Jain

In the above list of directors of Authum Investment and Infrastructure Limited, an investor would notice that one of the directors is Alpana Sanjay Dangi. Therefore, it seems that the investor Mr. Sanjay Dangi has consolidated his holding in ADF Foods Ltd under Authum Investment and Infrastructure Limited and currently holds 22.44% stake in the company.

While doing a further search about Mr. Sanjay Dangi, an investor gets to know about certain instances where Mr. Sanjay Dangi has been penalized by Securities and Exchange Board of India (SEBI) in the past for allegations of market manipulation.

1) In 2010, Mr. Sanjay Dangi was barred by SEBI from dealing in equity markets (Source: Sanjay Dangi, another barred market manipulator, still pulling strings: Moneylife, Dec 9, 2010)

Last week, the market watchdog, Securities and Exchange Board of India (SEBI) had issued an order against Sanjay Dangi, a Mumbai-based high net-worth individual, barring him from dealing in the equity markets. Initial investigations by the Income Tax Department and further findings of SEBI confirmed that Mr Dangi had colluded with promoters of four companies, namely, Murli Industries, Ackruti City, Welspun Corp and Brushman India, to artificially jack up these scrips through dummy companies connected to the promoters or Mr Dangi himself.

2) In Jan 2013 (Source: Sebi confirms interim directions against Sanjay Dangi: Business Standard):

The Securities and Exchange Board of India (Sebi) on Tuesday confirmed its interim directions to bar Sanjay Dangi and his associates from dealing in the stock market for rigging share prices.

3) In Oct. 2013 (Source: Sebi slaps Rs 21 lakh fine on 6 entities in Sanjay Dangi case: Economic Times)

Sebi has slapped a total penalty of Rs 21 lakh on six entities for alleged failure to comply with market watchdog’s summons related to its probe on fraudulent trading activities by Sanjay Dangi and associated entities

The case of Mr. Sanjay Dangi was highlighted in a case study in the National Conference on “Capital Market Frauds and Malpractices – Genesis, Resolution and Prevention” on 10 October 2013 under Promoter-Broker-Operator nexus. The case study is available on the website of Institutional Investor Advisory Service (IIAS) (download here).

CASE STUDIES: Sanjay Dangi

One of the biggest crackdowns by SEBI on Insider Trading / Share Manipulation or Promoter-Broker-Operator nexus cases is the case of Sanjay Dangi, a Mumbai based High Networth Individual. Dangi’s cohorts were his wife Alpana Dangi and brother Sunil Dangi.

In light of the above information, when an investor notices that investor who has been accused of manipulating share prices of companies, own 22.44% stake of ADF Foods Ltd at March 31, 2020, then she should be extra cautious while putting her hard-earned money and do deeper due diligence before making an investment decision.

3) Promoters of ADF Foods Ltd fined by SEBI for insider trading:

While reading about the promoters of the company, an investor comes across an order by SEBI against some of the promoters of ADF Foods Ltd particularly Mr. Bhavesh R. Thakkar for insider trading in the shares of the company. In the order dated February 22, 2019, SEBI highlighted that in 2016, Mr. Bhavesh R. Thakkar bought shares of the company through his relatives (his mother in law and a cousin sister of his wife) before the buyback was announced by the company to stock exchanges. As per SEBI order, Mr. Bhavesh R. Thakkar sold these shares shortly after the announcement of buyback was made on the stock exchanges.

The SEBI order (available at SEBI website here) in this regard is an insightful reading to understand the ways in which promoters use accounts of the related parties to indulge in insider trading. The order depicts the relationship of the parties, the sequence of events, and the flow of money in a nice pictorial presentation to establish the case of insider trading.

The following section in the SEBI order, page 9 provides the relationship between the various entities involved in the case:

As per the SEBI order, the following people related to Mr. Bhavesh R. Thakkar played a key role in the insider trading case whose relationship is shown in the above chart:

• Priyanka Thakkar, wife of Mr. Bhavesh R. Thakkar
• Pallavi Mehta, mother in law of Mr. Bhavesh R. Thakkar
• Navin Mehta, father in law of Mr. Bhavesh R. Thakkar
• Shefali Mehta, a paternal cousin of Ms. Priyanka Thakkar and
• Abhishek Mehta, son of Ms. Shefali Mehta

SEBI noticed that the discussions about the buyback of shares started in the company on May 21, 2016, when the idea was first put up in a meeting. The buyback was finally approved and disclosed to stock exchanges on July 27, 2016.

During this period, Mr. Bhavesh R. Thakkar bought shares using the demat accounts of his mother in law, Ms. Pallavi Mehta and the cousin sister of his wife, Ms. Shefali Mehta on May 31, June 1, June 14, June 16 and June 28, 2016. On investigation, SEBI found out the chain of money transfers from the bank account of Mr. Bhavesh R. Thakkar to Ms. Pallavi Mehta and Ms. Shefali Mehta via the bank account of his wife, Ms. Priyanka Thakkar. For example, this illustration in the SEBI order, page 7, shows the way money was transferred from the account of Mr. Bhavesh R. Mehta:

As per the order:

• On June 14, 2016, Mr. Bhavesh R. Thakkar transferred ₹60 lac to the account of his wife, Ms. Priyanka Thakkar.
• On the same day, Ms Priyanka Thakkar transferred money to the account of her mother, Ms. Pallavi Mehta.
• On the same day, Ms. Pallavi Mehta transferred part of the money to the stockbroker, Lalkar Securities and transferred the remaining money to Ms. Shefali Mehta.
• Two days later, Ms. Shefali Mehta transferred the money received by her from Ms. Pallavi Mehta to the stockbroker Lalkar Securities.

In this manner, shares were bought in the accounts of Ms. Pallavi Mehta and Ms. Shefali Mehta using the money transferred by Mr. Bhavesh R. Thakkar before the buyback was announced to the stock exchanges.

ADF Foods Ltd announced the buyback to the stock exchanges on July 27, 2016.

After the buyback was announced, Ms. Pallavi Mehta and Ms. Shefali Mehta sold the shares bought by them from the money transferred by Mr. Bhavesh R. Thakkar. After the sale, the money was transferred back to Mr. Bhavesh R. Thakkar using the above account in a reverse manner. The chain of fund transfers is highlighted by SEBI in its order. For example, the following diagram shows the transfer of funds from the accounts of Ms. Pallavi Mehta and Ms. Shefali Mehta to the account of Mr. Bhavesh R. Thakkar on August 1 and August 2, 2016.

The above chart shows that

• On August 1, 2016, Ms. Shefali Mehta received money from stockbroker Lalkar Securities from sale of shares.
• The next day, on August 2, 2016, she transferred the money to the account of Ms. Pallavi Mehta, mother in law of Mr. Bhavesh R. Thakkar.
• The same day, on August 2, 2016, Ms. Pallavi Mehta transferred the money to the account of her daughter, Ms. Priyanka Thakkar, wife of Mr. Bhavesh R. Thakkar.
• The same day, on August 2, 2016, Ms. Priyanka Thakkar transferred the money to the account of Mr. Bhavesh R. Thakkar.

Looking at this evidence, SEBI concluded that Mr. Bhavesh R. Thakkar was in the possession of insider information about the buyback of shares of ADF Foods Ltd and bought shares of the company in the accounts of his relatives before the buyback was announced to the public. After the buyback announcement, when the share price of ADF Foods Ltd increased, then Mr. Bhavesh R. Thakkar sold the shares in the accounts of these relatives and thereby made illegal gains.

The stockbroker, Lalkar Securities disclosed to SEBI that the orders for buy/sell in the accounts of Ms. Pallavi Mehta and Ms. Shefali Mehta were received on phone from Mr. Bhavesh and others. SEBI order, page 6:

Lalkar Securities informed SEBI that orders used to be received on behalf of the suspected entities from Navin Mehta, Abhishek Mehta and Bhavesh Thakkar from mobile phone numbers…

As a result, SEBI found Mr. Bhavesh R. Thakkar and the other related persons guilty of insider trading in this case and put a penalty of ₹ 1.02 cr on Mr. Bhavesh R. Mehta and others. SEBI order, page 13:

….I prima facie find that Navin Mehta, Bhavesh Thakkar and Abhishek Mehta, being ‘Insiders’ have traded in the shares of ADF Foods through the trading accounts of Pallavi Mehta and Shefali Mehta when the price sensitive information remained undisclosed….

In view of the foregoing, I, in exercise of the powers conferred upon me……hereby impound the alleged unlawful gains of a sum of ₹1,02,63,169.81 (alleged gains of ₹77,23,637.73 + interest of ₹25,39,532.08 (from May 21, 2016 to February 15, 2019)…

From the above discussion, an investor would notice that Mr. Bhavesh R. Thakkar resigned from ADF Foods Ltd on May 29, 2018. In addition, he had sold some of his stake in the company as well.

Nevertheless, the above order should serve as a good illustrative example of the methods used by promoters of companies to profit by trading in the shares of their own company using the insider information.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

4) Back-to-back warrants issued by ADF Foods Ltd to promoters:

While analysing the FY2010 annual report of the company, an investor gets to know that in December 2007, ADF Foods Ltd had allotted 1,500,000 warrants to its promoters at ₹70 each, totalling to a value of ₹10.5 cr. The promoters had paid 10% of the money upfront i.e. ₹1.05 cr at the time of allotment of warrants.

An investor would remember that soon after December 2007, the global meltdown started in January 2008 and the prices of almost all the stocks across the world declined. At the same time, the stock price of ADF Foods Ltd also declined. As a result, the fact in warrant allotment that the promoters will only exercise warrants when they make money from them came true.

The promoters of the company refused to pay the balance 90% of the money and the warrants expired at the maturity.

FY2010 annual report of ADF Foods Ltd, page 6:

The Company had allotted 15,00,000 Convertible Warrants of Rs. 70/- each (Rs. 7.00 per warrant paid on allotment) on preferential basis to Promoters/Directors, their friends and relatives on 24th December 2007. None of the subscribers of the warrants had exercised their option and the same expired on 23rd June 2009. Rs. 1,05,00,000 received on allotment of warrants was credited to Capital Reserve Account.

This incidence proved the concerns of the minority investors about preferential allotment of warrants to promoters that promoters use warrants to benefit themselves ahead of minority shareholders.

An investor may read about other companies, where promoters refused to exercise warrants when the share prices declined in the following analysis articles:

• Analysis: IOL Chemicals and Pharmaceuticals Ltd

SEBI realized that 10% upfront payment of 10% for warrants was very low to generate commitment from promoters to infuse money in the company by compulsorily exercising to them. As a result, in February 2009, SEBI increased the upfront payment for warrants allotment from 10% to 25%.

The key reason that led SEBI to increase the upfront payment for warrants was that the promoters used warrants to enrich themselves when the stock markets rose while their loss was limited to only 10% if the markets fell. (Source)

There were complaints that promoters allotted warrants to themselves and select investors at a pre-determined price, but didn’t buy them when the due date came if the prevailing stock prices were lower than the decided price. If the prices were higher, they would convert those warrants and at least make a paper profit, and in some cases encash the gains.

It is to discourage promoters from trading profits. Warrants are seen as an instrument that gives an advantage to promoters above retail investors, who have all other rights equal to company founders.

When the markets melted during 2008 and early 2009, promoters of many companies such as Hindalco Industries, Tata Power, GE Shipping and Pantaloon Retail did not convert those warrants, regulatory filings show.

After similar complaints, in February 2009, the regulator had raised the up-front margin to be paid by warrant subscribers to 25% from 10% since the payment lost was insignificant compared with the losses one would have made if forced to buy.

This also goes with our belief that the warrants are if at all, 25% beneficial to the company and 75% beneficial to the promoters.

Common logic says that no one holding stock warrants would exercise them to get shares at a price, which is higher than the price at which he/she can get shares from the market.

More so, if the intention of the promoters is to infuse money into the company, then they should simply get all the shares at the current market price and give the entire money to the company upfront so that the company may use it for the purpose for which it needs money.

The entire gimmick of paying 25% at the time of allotment of stock warrants and then keeping the option to pay 75% at the time of exercise, which the promoters would decide based on whether at the date of exercise, the promoters are making money or not, seems like a facade to us.

If the promoters pay 25% now and let the stock warrants expire due to the market price being consistently lower than the exercise price in future, then it effectively means that the promoters did not have the true intention of infusing 100% of the money or that the company did not need 100% of the money.

It might be that the company needed only 25% of the money, which promoters put in by way of stock warrants allotment and the right to get shares in future at a discount is the payoff that promoters would enjoy as a consideration for giving 25% to the company. The company might not have needed the balance 75% at all.

Many times, like in the case of ADF Foods Ltd in FY2009, the markets crash after the allotment of warrants and the promoters refuse to exercise the warrants and pay the balance money, then the promoters lose the money, which they had paid upfront on the allotment of the warrants. However, in such situations, an investor should not think that the promoters have lost and the company got free money.

An investor should understand that the promoter is in charge of the company. He makes decisions on behalf of the company. He will not take the loss sitting down. Many times, investors would notice that when promoter lose money on a warrant issuance as the markets had crashed, then they make the company come up with a second warrant issuance, which is usually bigger in size and at a cheaper exercise price. This is primarily to recover their losses in the first warrant allotment.

In the case of ADF Foods Ltd, the promoters lost about ₹1.05 cr to the company in 2009 when the markets crashed after warrant allotment and they could not exercise the warrants. Immediately after the loss in the first warrant issue, the promoters came up with another bigger warrant issue at a much cheaper price where they could recover their losses.

FY2010 annual report of ADF Foods Ltd, page 6:

The Company had allotted 23,26,110 Convertible warrants of Rs. 32/- each (Rs. 8.00 per warrant paid on allotment) on preferential basis to Promoters/Directors, their friends and relatives on 29th July 2009. Of the above, 8,20,222 warrants were converted on 11th September 2009 and balance warrants 15,05,888 were converted on 27th October 2009. The balance amount of Rs. 24 per warrant was duly received before exercise of warrants.

Therefore, we believe that entire gimmick of a structured deal where the promoters get preferential treatment by allotment of warrants by paying 25% and then keeping the option to pay 75% at the time of exercise is not in the favour of minority shareholders.

Further reading: Stock Warrants to Promoters: How to Analyse

5) Strange case of giving out inter-corporate deposits by ADF Foods Ltd whenever the promoters had to exercise the warrants:

While reading the publicly available annual reports of ADF Foods Ltd from FY2010, an investor notices that the company has allotted warrants to its promoters at multiple occasions. However, upon deeper analysis, an investor also notices that whenever the promoters exercised their warrants to get shares from the company, invariably, during that time, ADF Foods Ltd had given out inter-corporate deposits of nearly the similar amount, which was due from the promoters for their obligation on the exercise of warrants.

Let us see some of these instances of allotment of warrants, which were associated with giving out of inter-corporate deposits of a similar amount.

In FY2010, ADF Foods Ltd had allotted 2,326,110 warrants to the promoters at a price of ₹32 per warrant on July 29, 2009.

FY2010 annual report of ADF Foods Ltd, page 6:

The Company had allotted 23,26,110 Convertible warrants of Rs. 32/- each (Rs. 8.00 per warrant paid on allotment) on preferential basis to Promoters/Directors, their friends and relatives on 29th July 2009. Of the above, 8,20,222 warrants were converted on 11th September 2009 and balance warrants 15,05,888 were converted on 27th October 2009. The balance amount of Rs. 24 per warrant was duly received before exercise of warrants.

The promoters exercised the warrants after 3 months on October 27, 2009. For this transaction, the promoters had to pay ₹7.44 cr to the company on the allotment of warrants and the exercise (2,326,110 * 32 = ₹7.44 cr).

However, when an investor analyses the FY2010 annual report, then on page 97, she notices that the company has given out inter-corporate deposits of ₹8.50 cr in FY2010.

Whoever received these inter-corporate deposits, repaid them next year (FY2011 annual report, page 41).

Later on, while reading the FY2012 and FY2013 annual reports of ADF Foods Ltd, an investor notices that the company had allotted 2,000,000 warrants to its promoters at ₹65 per share.

FY2012 annual report, page 13:

During the year, the Company allotted 20,00,000 (Twenty Lakh) warrants convertible into equivalent number of equity shares of Rs. 10/- each at an issue price of Rs. 65/- per warrant to certain members of the promoter group on preferential basis on receipt of the minimum subscription amount of 25% of issue price i.e. Rs. 16.25/- per warrant.

Out of the 2,000,000 warrants issued, 200,000 warrants were converted into equity shares in FY2012 and remaining 1,800,000 warrants were converted into equity shares in FY2013.

FY2013 annual report, page 24:

During the financial year 2011-12, the Company had issued 20,00,000 convertible warrants to certain members of the Promoter group on Preferential basis. Out of these, 2,00,000 warrants were converted into equivalent number of equity shares of face value Rs. 10/- each on 28th March, 2012. The remaining 18,00,000 warrants were converted into equivalent no. of equity shares on 23rd January, 2013.

An investor would notice that out of the total price of ₹65/- per share, the promoters had to pay 75% i.e. ₹48.75 per share at the time of exercise of warrants (65 * 75% = 48.75).

The promoters exercised 200,000 warrants in FY2012 resulting in the obligation of ₹0.98 cr at the time of exercise in FY2012 (200,000 * ₹48.75 = ₹0.975 cr) whereas the promoters exercised remaining 1,800,000 warrants in FY2013 leading to an obligation of ₹8.78 cr at the time of exercise of warrants in FY2013 (1,800,000 * ₹48.75 = ₹8.775 cr).

While reading the FY2012 annual report, page 76, an investor notices that in FY2012, ADF Foods Ltd gave out an inter-corporate deposit of ₹ 1cr. In addition, in the FY2013 annual report, page 74, an investor notices that the inter-corporate deposit given out by ADF Foods Ltd increased from ₹1 cr in FY2012 to now ₹10.25 cr in FY2013 indicating an outflow of ₹9.25 in the form of inter-corporate deposits.

These inter-corporate deposits were duly paid back by whoever had availed them over the next two years.

These inter-corporate deposits are not reflected in the related party transactions section of the annual report indicating that the parties to whom ADF Foods Ltd gave money are not classified as related parties directly.

If an investor wishes for further clarifications, then she may contact the company directly to seek further details like the names of the counterparties to whom these inter-corporate deposits were paid by the company and the reasons for payment of inter-corporate deposits to other counterparties when ADF Foods Ltd itself had a lot of debt on its books. In FY2012, ADF Foods Ltd had a total debt of ₹37.5 cr, which increased further to ₹42.9 cr in FY2013.

As the money is a fungible commodity, therefore, the above increase in debt of ADF Foods Ltd in FY2013 and the simultaneous increase in inter-corporate deposits given out by it to other counterparties may be interpreted as a situation where ADF Foods Ltd raised additional loans in FY2013 to give them out as inter-corporate deposits to other counterparties.

An investor may seek details of these transactions of inter-corporate deposits of amounts similar to the exercise value of the warrants every time when the promoters exercise their warrants into shares. Investors may ask the company details of the counterparties of these inter-corporate deposits.

This is because, an investor would appreciate that if it is the money given out by the company in the form of inter-corporate deposits that is coming back to it in the form of exercise of warrants, then effectively, the company is itself financing the money that it receives from the warrant holders.

Investors may do their own deeper due diligence in this regard.

Further advised reading: Understanding the Annual Report of a Company

6) Acquisition of Elena’s Food Specialties, Inc. USA by ADF Foods Ltd:

In FY2011, the company intimated its shareholders that it has acquired a US-based food manufacturer, Elena’s Food Specialties, Inc. FY2011 annual report, page 13:

During the year your Company has completed the acquisition of Elena’s Food Specialties, Inc., a US based manufacturer and marketer of organic and natural food products.

The total consideration paid by ADF Foods Ltd to buy 89% stake in Elena in FY2011 was about $4.9 million for which it had taken a loan of $4 million. The credit rating agency, ICRA had disclosed these monetary details in its credit rating report for ADF Foods Ltd in February 2011.

ADF, through its step down subsidiary, acquired certain brands, inventory and fixed assets and assumed lease liability of Elena’s for total purchase consideration of US$ 4.9 million. The transaction was funded through term loan from bank – US$ 4 million and balance through internal accruals of the company.

As per FY2011 annual report, page 65, the INR value of $ 4.0 million loans taken by ADF Foods Ltd is disclosed at ₹16.78 cr indicating an exchange rate of ₹41.95 per USD. As a result, an investor can estimate that in FY2011, ADF Foods Ltd paid a sum of ₹20.6 cr to acquire Elena ($4.9 million @ ₹41.95/USD = ₹20.6 cr)

ADF Foods Ltd had initially acquired 89% in Elena’s business via its 89% shareholding in ADF Holdings (USA) Limited (AHUL). The shareholding of ADF Foods Ltd in AHUL remained at 89% until FY2014. In FY2015, ADF Foods Ltd increased its holding in AHUL to 100% (FY2015 annual report, page 133).

As a result, it might be that ADF Foods Ltd had to pay some additional amount to acquire remaining 11% stake in Elena’s business in FY2015, over and above ₹20.6 cr, which it paid in FY2011.

Nevertheless, when an investor notices the business performance of Elena’s acquisition, then she notices that the ADF Foods Ltd has never made any profits in its USA subsidiary ever since it started reporting its results from FY2012.

An investor notices that since FY2012, ADF Foods Ltd has continuously reported losses in its USA subsidiary and until FY2019, it has had a total loss of ₹36.6 cr in USA subsidiary.

As a result, an investor realizes that the acquisition of Elena done by ADF Foods Ltd in FY2011 does not seem to be a great decision by the management. Moreover, this acquisition is proving to be a continuous burden on the other profitable segments of the company.

Moreover, in the recent times, an investor notices that the company has realized that the brands acquired by ADF Foods Ltd in the USA by the acquisition of Elena, i.e. PJ’s Organics and Nate’s are no longer worth the value represented in the books. Therefore, the company has started to recognise impairment on these brands.

In FY2019, the company recognized a loss of ₹10 cr due to impairment of its brands in the USA.

FY2019 annual report, page 60:

The consolidated profit of the Company for the Financial year 2018-19 would have been higher but for one time impairment losses to the tune of Rs. 10 crores on account of impairment of certain brands in our US subsidiary.

In FY2018, the company had reported impairment loss of about ₹2.4 cr on account of certain brands of the subsidiary company. FY2018 annual report, page 148:

The indefinite life of the intangible assets are tested for impairment as a result of which impairment of Rs. 243.30 lacs on certain brands held in the books of its subsidiary company is included in current years amortization charge.

Moreover, in FY2020, the company again recognized an impairment loss of ₹0.35 cr due to certain brands of the subsidiary company. Q4-result, May 2020, page 12:

Depreciation and Amortisation expense in consolidated financials for the quarter and year ended March 31, 2020, includes an amount or Rs. 35.53 Lakhs on account of impairment of certain brands held in books or its subsidiary company.

Further reading: How to identify if Management is Misallocating Capital

7) Case of Power Brands (Foods) Pvt. Ltd:

Power Brands (Foods) Pvt. Ltd (PBFPL) used to be a 99% subsidiary of ADF Foods Ltd.

FY2010 annual report, page 112:

Consolidated financial statement of the Company includes the Financial statement of it’s 100% Subsidary Company, ADF Foods UK Limited., 99% Subsidary Company, Power Brands (Foods) Pvt. Ltd., 100% Subsidary company, ADF Foods (Mauritius) Ltd and 100% Subsidary company, ADF Foods (India) Ltd.

As per the FY2010 annual report of ADF Foods Ltd, page 79, which incorporated the annual report of PBFPL, the company disclosed that the promoters of ADF Foods Ltd are the shareholders of the remaining stake.

FY2010 annual report, page 79, the section containing the annual report of PBFPL:

Name of the Related Party Relationship

• ADF Foods Ltd: Holding Company
• Ramesh H. Thakkar: Shareholder
• Ashok H. Thakkar” Shareholder
• Bimal R. Thakkar: Shareholder
• Bhavesh R. Thakkar: Shareholder
• Bimal R. Thakkar (HUF): Shareholder
• Bhavesh R. Thakkar (HUF): Shareholder
• Mishal A. Thakkar: Shareholder
• Miss Suchita A Thakkar Shareholder

Therefore, from the above disclosures, an investor notices that PBFPL was 99% owned by ADF Foods Ltd and the promoters were a part of the remaining stake of PBFPL.

As per FY2010 annual report, page 74, PBFPL reported a loss of ₹2 cr in FY2010.

As per FY2011 annual report, page 70, PBFPL reported another loss of ₹2 cr in FY2011.

As per FY2012 annual report, page 93, PBFPL reported a loss of ₹1.94 cr in FY2012.

As PBFPL was reporting continuous losses, therefore, it does not come as a surprise to the investor when she read in FY2013 annual report that shareholders of PBFPL have decided to dissolve the company.

FY2013 annual report, page 56:

Power Brands (Foods) Pvt. Ltd. (PBFPL), a 99.99% subsidiary of the Company, has gone for voluntary liquidation vide special resolution passed by its’ Members’ on 5th November, 2012

It seems intuitive to the investors when they learn that ADF Foods Ltd has decided to dissolve PBFPL as it was continuously making losses. However, an investor is confused when she reads that in this same year (FY2013), ADF Foods Ltd acquired more shares of PBFPL for ₹3.3 cr and increased its stake from 99% earlier to 99.99% now.

FY2013 annual report, page 56:

The Company held majority shareholding in Power Brands (Foods) Private Limited (‘PBFPL’). It presently holds 2,08,85,992 fully paid Equity Shares of Rs. 10/- each (including 20,75,992 Equity Shares for Rs. 330.08 lacs acquired in Financial Year 2012-13).

Therefore, an investor is not able to understand the reasons for acquiring additional shares by paying out ₹3.3 cr to other shareholders just before PBFPL’s liquidation. An investor may note that this acquisition of 0.99% stake by ADF Foods Ltd by paying ₹3.3008 cr valued PBFPL at ₹333.41 cr. (3.3008 / 0.0099 = 333.41).

An investor may note that at the date of liquidation of PBFPL (Nov. 5, 2012), the closing share price of ADF Foods Ltd on BSE was ₹62.55, which gives it a market capitalization of ₹126 cr considering 2.02 cr shares of the company existing at Nov. 5, 2012. (P.S. Promoters exercised 1,800,000 warrants on January 23, 2013, which increased the total number of shares to 2.2 cr at the end of FY2013).

Therefore, an investor notices that while acquiring 0.99% stake from the other shareholders of PBFPL at ₹3.3 cr, ADF Foods Ltd valued PBFPL at a valuation of ₹333.41 cr, which was more than 2.5 times the valuation of total ADF Foods Ltd. Please note that the market valuation of ADF Foods Ltd included the value of its 99% existing stake in PBFPL.

In addition, when an investor reads further about the liquidation proceedings of PBFPL, then she notices that over time, ADF Foods Ltd received only two major assets from PBFPL, which included the brand “Ashoka” and property at Sewree, Mumbai.

In FY2012, ADF Foods Ltd disclosed to the shareholders that it has received the brand Ashoka from PBFPL, which it said that is valued at ₹29.4 cr by an independent valuer.

FY2012 annual report, page 56:

By virtue of the above distribution, the Company received Ashoka brand, which was valued at Rs. 2,935.99 lacs by an independent valuer in lieu of its investment in PBFPL’s equity shares of Rs. 2,211.08 lacs. Accordingly, the Company has capitalised the said brand in its books at Rs. 2,935.99 lacs, after adjusting the same against the investment value of Rs. 2,211.08 lacs and carrying the balance of Rs. 724.91 lacs to the credit of the statement of profit and loss as an exceptional item.

The company mentioned that it has capitalized the brand at ₹29.35 cr in its books, which is visible in the FY2013 annual report of the company. In the FY2013 annual report, page 69, the company added ₹29.35 cr in the Gross Block under “Additions/adjustments during the period” in the intangible assets section.

The company also disclosed that it has recorded the excess value of ₹7.24 cr as a profit under the exceptional item in the profit and loss statement. An investor would appreciate that this recognition of profit by ADF Foods Ltd is tantamount to revaluing its own intangible asset and then recognizing it as a profit.

In FY2015 annual report, ADF Foods Ltd disclosed to the shareholders that it has received an immovable property from PBFPL as well as its 99.99% share of the cash present with PBFPL. ADF Foods Ltd also disclosed that the complete value from PBFPL is now realised; indicating that there is nothing more expected to be received from PBFPL.

During the current Financial Year, the voluntary liquidator, with the prior approval of the members vide their special resolution dated 10 th November 2014, distributed PBFPL’s immovable property situated at Sewree, Mumbai and part of cash and bank balance to its Shareholders in proportion to their respective shareholding in PBFPL while retaining certain other current assets to meet with it’s contingent and other liabilities. The excess value of assets so received over the investment value in Equity Shares of PBFPL has been accounted for in the Company’s Statement of Profit & Loss under the head exceptional item.

Consequently, the investment in Equity Shares of PBFPL stands fully realised.

To ascertain the value of the immovable property received by ADF Foods Ltd from PBFPL in FY2015, an investor needs to analyse the fixed assets schedule of the annual report on page 122. This is in anticipating a similar treatment for the immovable property received from PBFPL in line with the treatment of brand Ashoka received by ADF Foods Ltd in FY2013.

An investor notices that in FY2015 annual report, the fixed assets schedule indicates the addition of total gross tangible fixed assets of ₹21.23 cr (= 19.40 cr + 1.83 cr), which includes the addition in fixed assets due to operationalization of greenfield manufacturing capacity at Nadiad.

FY2015 annual report, page 122 (the figures are mentioned in ₹ lacs):

FY2015 annual report, page 24:

During the year the Company’s new manufacturing plant at Nadiad has become fully functional…..

In FY2013 annual report, on page 8, the company had intimated to the shareholders that the expansion project at Nadiad would cost about ₹20 cr.

Your Company’s Greenfield project in Nadiad which is spread over 45,000 square feet., would be operational by end of the financial year 2013-14 and the same would increase manufacturing capacity of the Company’s core products such as pickles, pastes and chutneys. The approximate project cost would be Rs 20 crores.

Therefore, an investor notices in the fixed assets section of the FY2015 annual report shared above, the addition for ₹19.40 cr seems on account of operationalization of the greenfield capacity expansion at Nadiad and the other addition of ₹1.83 cr seems to be the value of the immovable property received by ADF Foods Ltd from PBFPL.

Therefore, if an investor analyses the total value of assets, both tangible and intangible, received by ADF Foods Ltd from PBFPL, then she notices that it included brand Ashoka valued at ₹29.35 cr in FY2013 and immovable property valued at ₹1.83 cr in FY2015. This totals to ₹31.18 cr (=29.35 + 1.83).

As the company had stated that the realization of assets/value from PBFPL is now complete, therefore, an investor may consider ₹31.18 cr as the total value of 99.99% stake held by ADF Foods Ltd in PBFPL valuing total PBFPL at ₹31.183 cr (=31.18 / 0.9999). Moreover, an investor would notice that the value of ₹31.183 cr includes ₹29.35 cr assigned to the value of Ashoka brand by an “independent valuer”. The investor would appreciate that the valuations of brands are always subjective and their value differs from one person to another.

When an investor compares this value of ₹31.183 cr of PBFPL realised now with the value of ₹333.41 cr at which ADF Foods Ltd had purchased 0.99% stake from its other shareholders by paying them ₹3.30 cr in FY2013 just before its liquidation started.

Therefore, it looks like a case where ADF Foods Ltd gave an exit to the other shareholders of PBFPL at a higher valuation just before its liquidation than the value, which ADF Foods Ltd could recover from PBFPL.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

8) Important information missing from the annual reports of ADF Foods Ltd.

While searching about the ADF Foods Ltd on the internet, an investor finds a report prepared by Nirmal Bang in August 2016 after their meeting with the management of the company (Source: Nirmal Bang website, Click here). From reading this report, an investor notices that the management of the company highlighted some of the challenges faced by it in the USA business.

The report mentions that one of the issues faced by the company in the USA was in 2014 when one of the previous promoters of Elena Foods who still held 11% stake in the business, changed the recipe of one of the products without management’s approval and as a result, ADF Foods faced a big recall of its product from many stores. It resulted in a big hit on the US business.

Nirmal Bang report on ADF Foods Ltd, August 2016, page 2:

Year 4- In 2014, one of the previous partners materially modified the product recipe without appropriate management approval which led to product recall by most stores, delivering a big blow to the US business of ADF Foods.

An investor would appreciate that this is a major development related to the business of the company. Product recalls like this hit the image of the brand as well.

However, an investor notices that the company did not disclose this important development to the shareholders in any of its annual reports.

An investor would note that this incidence of a product recall that hampers the brand as well, was a very important development and this development should have been intimated to the shareholders in the annual report.

Investors may contact the company directly for any further details/clarifications in this regard.

9) Independent directors of ADF Foods Ltd:

While reading about the composition of the board of directors and the disclosures made by ADF Foods Ltd in this regard, an investor notices a few incidences that provide insights.

In FY2019 annual report, page 52, ADF Foods Ltd made the following disclosure about one of its independent directors, Mr. Jay Mehta:

Mr. Jay Mehta resigned as Independent Director on 27th September, 2018 and was again appointed as an Additional Director in the category of Non-Executive Non-Independent Director on 12 th February, 2019.

The company disclosed that in FY2019, the status of Mr. Jay M. Mehta changed from an independent director to non-independent director. The position is still non-executive director, which rules out that Mr. Jay Mehta has taken some active role in the company that might have necessitated a change of status from independent to the non-independent director.

As per FY2019, page 50, the number of shares of ADF Foods Ltd held by Mr. Jay Mehta during FY2019 are constant at 50,000 shares with no purchase or sale of shares during the year.

Therefore, without any change in shareholding or any change in the executive status of the director, the company disclosed that the person would now be classified as a non-independent director.

Such changes bring questions in the mind of an investor about whether the director was really an independent director all the while he was on the board of directors previously.

Further advised reading: Steps to Assess Management Quality before Buying Stocks

10) Signs of weak internal control processes at ADF Foods Ltd:

While reading the annual reports of the company, an investor comes across a few instances where ADF Foods Ltd did not fulfil its mandatory requirements like filing of disclosures with stock exchanges or paying off the dues of lenders on time. These instances though seem small but might indicate weaknesses in the internal control processes in the company.

The secretarial audit report of the FY2019 annual report highlighted some of the lapses on part of the company when it omitted out names of sons of the chairman, Mr. Bimal R. Thakkar from the list of promoters in the shareholding details.

FY2019 annual report, page 37:

Mr. Shivaan Thakkar (3,000 equity shares representing 0.01% of total paid-up capital) and Mr. Sumer Thakkar (2,000 equity shares representing 0.01% of total paid-up capital), being sons of Mr. Bimal Thakkar, Promoter of the Company was not disclosed under promoter and promoters group in shareholding pattern filed by the Company with the Stock Exchange(s).

In addition, after the buyback was complete, then there were delays in filing the changed shareholding pattern as well as returns of the buyback to the stock exchanges and SEBI.

There was delay in filing of revised shareholding pattern of the Company pursuant to capital restructuring by way of Buy-back of Equity Shares by the Company resulting in a change exceeding two per cent of the total paid-up share capital.

There was delay in filing of return of Buy-back by the Company with Securities and Exchange Board of India as per Section 68 of the Companies Act, 2013.

In FY2016, the company filed its returns but did not submit the accounts of some of its subsidiaries to the Registrar of Companies. FY2016 annual report, page 38:

The financial statements [Standalone and Consolidated] of the Company for the financial year ended March 31, 2015 were filed with the Registrar in Form AOC-4 as per the provisions of Section 137 of the Companies Act, 2013. However, accounts of the subsidiary companies of the Company which have been incorporated outside India were not attached inadvertently.

In FY2018, the secretarial auditor highlighted that the company did not comply with two statutory guidelines. First, it conducted the annual general meeting (AGM) without the presence of the chairman of the audit committee and second, it did not remit the dividend from its foreign subsidiary in stipulated time.

FY2018 annual report, page 32:

The Annual General Meeting of members of the Company duly convened on August 23, 2017. However, the Chairman of the Audit Committee was not present at the meeting.

There was a delay in receipt of dividend remittance from foreign subsidiary company of the Company.

Previously, on a few occasions, ADF Foods Ltd disclosed that at the year-end, the company had not repaid its interest due to the lenders on time.

• In FY2011, interest accrued and due was ₹3.45 lac (page 65 of FY2011 annual report),
• In FY2015, interest accrued and due was ₹0.22 lac (page 97 of FY2016 annual report),
• In FY2016, interest accrued and due was ₹0.16 lac (page 97 of FY2016 annual report)

In addition to the above instances where the failure was to meet the statutory and contractual obligation, at other times, an investor notices that there were instances of damages in the production plants due to fire.

• In FY2012, loss of stock due to the fire of ₹41 lac (page 80 of the FY2012 annual report)
• In FY2013, loss of stock due to the fire of ₹48 lac (page 76 of the FY2013 annual report)

In addition, in the FY2013 annual report, the company provided ₹4.1 cr for estimated losses on the “onerous contracts” (FY2013 annual report, page 87). An onerous contract means an order/contract where the company knows that the cost of fulfilment would exceed the money to be received indicating that it is a certain loss. Onerous contracts may indicate lapses in proper processes of verifying the economic worth of orders before committing to the customer.

An investor should be aware of the signs of weaknesses in the control processes of any company. This is because there have been instances in the corporate world where the companies with weak internal controls were hit by frauds later.

Many times, the lack of strong processes in the companies leads to significant issues being undetected for a long period. Investors may remember the case of National Peroxide Ltd where the lack of strong processes provided the opportunity to the senior management to siphon off the money by a continuing financial fraud for almost 10 years.

Read: Analysis: National Peroxide Ltd

11) A lawsuit against ADF Foods Ltd for violating health and safety code in the USA:

In FY2019 annual report, ADF Foods Ltd intimated its shareholders that in the USA a lawsuit was filed against the company for alleged violation of health and safety code in California. In addition, the company also mentioned that it is exploring a consent agreement in this case.

During the year the subsidiary received the notice of violation from Centre for Environmental Health (CEH), a non-profit California Corporation which has filed a law suit against ADF Foods (USA) Ltd. & certain others non-affiliate Companies as defendants (‘’Defendants’’) with the Superior Court of California, County of Alameda. The plaintiff in its complaint has alleged that the Defendant and distributors and Importers who have violated California’s Proposition 65, Health & Safety Code § 25249.5, et seq…..

The Subsidiary is currently consulting with its legal counsel & exploring filling a consent agreement with CEH. Approximate liability expected is US$ 130,000 (Including US$ 30,000 attorney fees) Amounting to Rs.89.89 lakhs.

When an investor finds out that the company is exploring the consent agreement in the case, then she doubts whether the company knew that it violating the health and safety code and as a result, instead of contesting the allegation, it is settling them.

As per Q4-FY2020 results, page 12, the company paid ₹67.88 lac to settle the lawsuit.

It also includes expense aggregating to USD 95,000 equivalent to Rs. 67,88 Lakhs. The same is towards litigation settlement amount and legal fees In respect of a lawsuit filed In US.

An investor may contact the company directly to understand the reasons for settlement in this case. She may ask whether the company knew beforehand that it was in violation of the health and safety code.

The Margin of Safety in the market price of ADF Foods Ltd:

Currently (July 7, 2020), ADF Foods Ltd is available at a price to earnings (PE) ratio of about 13.9 based on FY2020 consolidated earnings.

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

Analysis Summary

Overall, ADF Foods Ltd seems a company that has grown its business at a pace of 10% year on year for the last 10 years (FY2010-2019). However, upon closer analysis, an investor notices that the business of the company has gone through some very different phases during this period. During FY2010-2014, the company increased its sales very fast even when it suffered a significant drop in profit margins. As a result, most of the growth during this period was funded by debt and equity dilution instead of business profits.

Thereafter, since FY2015, the sales growth of the company stalled. The company started focusing on reducing its operating costs and as a result, the profit margins of the company started improving. In the absence of sales growth, the company used its profits to reduce debt and return money to shareholders by way of buybacks. Now, in recent years, the company has witnessed its sales and profitability increase.

ADF Foods Ltd operates in an intensely competitive business environment where many domestic and international players compete for market share. The competition becomes more intense because of many unorganized players selling unbranded packaged food products. As a result, the customer always has the option to buy from many suppliers. This results in very low pricing power in the hands of ADF Foods Ltd and other packaged food manufacturers.

As a result, whenever the cost of raw material and other input costs increase, then the manufacturers have to take a hit on their profit margins because they are not able to pass on the increase in costs to the customers. Over the years, ADF Foods Ltd witnessed its operating profit margins decline from 16% to 8% within a couple of years. In addition, the major raw material of the company is agricultural products where price as well availability depends on vagaries of nature like the monsoon, natural calamities etc. as well as government policies as well as political factors. As a result, the raw material costs of the company keep on fluctuating significantly and similarly, its profit margins see wide fluctuations year on year.

The business operations of ADF Foods Ltd are working capital intensive because it has to buy its seasonal raw materials in a short period to last it throughout the year, which increases the inventory requirements. Nevertheless, the company has kept its working capital position stable over the years without any significant deterioration.

ADF Foods Ltd witnessed significant changes at its promoter levels after the death of is chairman Mr. Ramesh Thakkar in FY2014. Over the years, his younger brother Mr. Ashok Thakkar and one of the sons, Mr. Bhavesh Thakkar quit the company along with selling the majority of their shareholding in the company. Currently, Mr. Bimal Thakkar, son of Mr. Ramesh Thakkar manages the company along with his son, Mr. Shivaan Thakkar. At all the times, an investor notices that members of different generations of the promoter family are a part of the company, which has ensured that there is no leadership vacuum in the company even at the times of apparent differences in the senior members.

An investor notices that when some of the promoters from Mr. Ashok Thakkar and Mr. Bhavesh Thakkar sections sold their shares in the company, then the majority of their shares were purchased by entities related to an investor, Sanjay Dangi. Analysis of news items from the past indicates that Mr. Sanjay Dangi had been involved in manipulations of stock prices of some companies by colluding with their promoters. At times, Mr. Dangi was fined by SEBI for these activities. An investor needs to be aware of this aspect and possible ramifications and risks that may arise due to it.

During FY2017, the promoters of the company, Mr. Bhavesh Thakkar section bought the shares of ADF Foods Ltd before the buyback was announced to the public and then sold the shares after the buyback announcement when the stock prices increased. SEBI held them guilty and in turn, fined them for insider trading. Nevertheless, Mr. Bhavesh Thakkar has resigned from the company in May 2018.

ADF Foods Ltd had issued warrants to its promoters at multiple occasions in the past. At times when the promoters decided not to exercise the warrants when the stock price of ADF Foods Ltd declined after allotment of warrants, then the company quickly issued another larger set of warrants to the promoters at a lower price. In addition, an investor notices that every time when the promoters of ADF Foods Ltd exercised their warrants and in turn, had a payment obligation towards the company, then at each of these occasions, the company paid out inter-corporate deposits of a similar amount to some counterparties. An investor may due deeper due diligence for these inter-corporate deposits.

At one occasion in FY2013, ADF Foods Ltd acquired a 0.99% additional stake in one of its subsidiaries, Power Brands (Foods) Pvt. Ltd (PBFPL), where it already had 99% stake. It paid ₹3.30 cr to acquire 0.99% additional stake from its promoters at a valuation of ₹331 cr, which was even higher than the total market value of ADF Foods Ltd, which already included the value of 99% stake of PBFPL. Moreover, an investor noticed that soon after the acquisition of shares in PBFPL, the subsidiary filed for liquidation. Upon liquidation, when the assets of the company were distributed to shareholders (ADF Foods Ltd is 99.99% shareholder), then the company got a total value of about ₹31.2 cr, which included ₹29.4 cr for brand Ashoka and ₹1.83 cr of immovable property. Therefore, it looks like a case where the actual value of PBFPL was about ₹31.2 cr where the company gave exit to the promoters from PBFPL by buying out their stake just before the liquidation at a valuation of ₹331 cr.

ADF Foods Ltd acquired a US-based food manufacturer in FY2011 for about ₹20 cr. However, over the years, the company has continued to lose money in its US business. Until FY2019, it has already lost more than ₹36 cr in its US business. In addition, it has realised that the brands acquired in the US are not as valuable as thought earlier and as a result; it has impaired the value of these brands in recent years. In addition, the company faced a lawsuit in the US for violating the health and safety code and as a result, it had to pay damages and legal costs.

Moreover, the US business suffered a major blow when in 2014, one of the partners of the company changed the recipe of a product and as a result, the product had to be recalled from the store. It hit the business and the brand of the company. However, the management of the company intimated about this incidence to the equity research analysts of Nirmal Bang and did not include its details in the annual report of the company.

Over time, an investor notices that at occasions, ADF Foods Ltd had failed to comply with statutory guidelines like disclosing names of promoter family members who held shares of the company in the details of promoter shareholding. At another occasion, it did not file details related to buyback at time. At times, it did not submit accounts of its subsidiaries to the Registrar of Companies. At other occasions, it did not repay its lenders on time and as a result, it had interest accrued and due at the year-end. An investor also notices multiple incidences of loss of goods due to fire at its plants. At times, it entered into contracts where fulfilling the contract involved sure shot loss (onerous contracts). When seen in conjunction, these incidences indicate that the company needs to strengthen its control process in its business & operations.

Going ahead, an investor should keep a close watch on the profitability of the company as well as the developments related to its US operations.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on ADF Foods 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!

Regards,

Dr Vijay Malik

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.