Analysis: Chaman Lal Setia Exports Limited

This article provides an in-depth fundamental analysis of Chaman Lal Setia Exports Ltd, an Indian basmati rice producer and exporter company owning the Maharani Basmati rice brand.

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.

Chaman Lal Setia Exports Ltd Research Report by Reader

Reader’s Query:

Hi Dr Vijay,

I would like to thank you a lot for the great service that you are doing to small retail investors who want to do value investing. I have been reading value investing-related articles from Prof. Sanjay Bakshi, Vishal (Safal Niveshak) and several other blogs and books for a couple of months now. But I must admit that the simplicity with which you have explained the basics of value investing is amazing. Your example-based approach to analysing companies based on principles of value investing helped me to learn a lot. I am grateful to you.

Based on your checklist I was trying to analyze a small company Chaman Lal Setia Exports Ltd:

• with market Cap < ₹300 cr
• profits < ₹35 cr with
• sales growth of 22%
• profit growth of 31% with
• good cash flow in the medium-term and
• price to earnings ratio (PE) under 10.

The company looks attractive to me. But there are certain questions.

I have read your article on KRBL Ltd and understand that rice milling is a cash-intensive industry. Chaman Lal Setia Exports Ltd has shown some good traits as well as some challenges. I would like to share my analysis with you and want to know your views.

Also, I have some confusion for which I have raised questions.

Please find attached the excel sheet downloaded from the screener website. I have added a sheet “DrVijayMalikChecklist” in which column ‘F’ and ‘G’ is my analysis on the checklist. Also, there is a sheet SSGR in which I have tried to calculate Self-Sustainable Growth Rate (SSGR). I considered Net Block as net fixed assets (NFA) (which I doubt is incorrect). Please point out where I can get NFA and also look at my calculation of SSGR.

I was not able to find 10 years’ annual reports of the company so for capital expenditure (Capex) and free cash flow (FCF), I have relied on data available on morningstar. Though it provided data from FY2010 onwards.

Summary:

• Chaman Lal Setia Exports Ltd is a small player in basmati rice milling:
• Compared to KRBL Ltd, which has a processing capacity of 195 MT/hr. this company has a capacity of only 14 MT/hr.
• As of the 2015 annual report, 80% of the revenue comes from exporting basmati rice and 20% from the domestic market.
• The company is able to increase its operating margin from 2.5% to 7.5% in the last 10 years.
• Trailing twelve months (TTM) operating profit margin (OPM) has even increased to 12.76%.
• The company is focusing on new clients and branding and packaging.
• It has some in-house technologies to reduce cost and water wastage which seems to boost the OPM.

The company has increased its sales at a compounded annual growth rate (CAGR) of 22% and profit after tax (PAT) at 31% in the last 10 years. But to my surprise, the production capacity remains at 14 MT/hr. since 2011 till date. I was not able to find annual reports beyond that. The actual production in 2011 was 32000 MT which is approx. same as in 2015. So is it possible that all growth in sales is coming from an increase in price?

It claims of producing rice for diabetics which is selling at a premium. An online search shows the Maharani Brand rice selling per kg for $4.95. The revenue from export in 2011 was ₹112 cr while in 2015 was ₹393 cr. Is all growth in sales coming from branding and an increase in price?

Also, the company has been awarded a star trading house by the government. Does that mean they also export other smaller players’ rice and record the revenues on its books?

The industry is capital intensive. Most of the money is stuck in working capital.

Though we can see that receivable days are stable at 34. Inventory turnover has increased to 7.5 from 2.5. While cumulative cash flow from operations (cCFO) in the last 10 years is just ₹20cr compared to ₹88cr cumulative profit after tax (cPAT). Chaman Lal Setia Exports Ltd is not able to convert profits into cash. The company is constantly using debt in the last 10 years, though the debt to equity ratio has come down from 1.32 in 2011 to 0.63 in 2015. As per the CRISIL credit rating report, the cash flow in 2016 and 2017 will be ₹22 cr each. That may give some cushion in the medium term.

CFO and FCF are alternating as positive and negative every year. Not sure if the ratio makes any sense.

• 6 year cCFO = ₹11.11 cr
• 6 year cumulative free cash flow (cFCF) = ₹ (-11.19) cr
• 6 year Capex = ₹22.30 cr
• 6-year Dividend Paid= ₹9.56 cr
• Capex + Dividend = ₹31.86 cr while cCFO = ₹11.11 cr

₹20.75 cr has to be supplied using debt which is not a good thing. It means that Chaman Lal Setia Exports Ltd is paying the dividends out of debt and also funding capex from debt.

As of FY2015, ₹17 cr of long-term borrowing comes from the directors’ deposit while ₹33 cr of short-term borrowing is in the form of cash/packaging credit from Punjab National Bank (PNB). The interest outgo for 2015 is ₹6.32 cr as per the income statement while in the cash flow (CF) statement, it is ₹11 cr. Which means it may be pre-paying the loan?

Financial Analysis of Chaman Lal Setia Exports Ltd:

• Sales growth: 10 years of sales growth is 22%. Though it saw a sudden increase in sales from 2013 to 2014 by 52%.
• Profitability: 10-year average OPM is 7.38%. It has been mostly stable and increasing from 4.88% in 2006 to 7.25% in 2015. Though rice is a commodity and price fluctuates company is able to increase OPM driven by its practice of maintaining low inventory, which helped it to mitigate the impact of falling paddy prices during the year. The trailing OPM stands at 12.76% due to an increase in sales and managing costs and branding and marketing efforts. Despite Iran sanctions, there is no impact on OPM as the company policy of 10% exposure to Iran. With sanctions removed, this could further increase.
• Tax payout: Since 2009 company is maintaining tax rate of > 30% Minimum tax rate is 18% in 2008, 23% in 2007 and 28% in 2006.
• Interest coverage: 5.68 for 2015 and has been more than 3 in last 5 years Rating upgraded to BBB+/Stable/CRISIL A2′ from ‘CRISIL BBB/Stable/CRISIL A3+’. marked by low gearing and a strong interest coverage ratio
• Debt to Equity ratio: 0.63 for 2015, reduced from 1.32 in 2011. It is close to reaching the range of < 0.5 this year based on good earnings. According to CRISIL “The rating upgrade also factors in CLSE’s healthy liquidity, with expected cash accruals of Rs.230 million to Rs.250 million per annum, against nil debt repayment obligations, in 2015-16 and 2016-17. Moreover, the company has efficiently managed its working capital requirements as reflected in its gross current assets of 99 days, with receivables at 40 days and inventory at 50 days, as of March 31, 2015. Also, the average utilization of its working capital facility has been low at 30 per cent over the past 12 months through March 2015. CRISIL believes that CLSE will maintain its business risk profile and liquidity over the medium term, supported by its increasing scale of operations and efficient working capital management”.
• Current ratio: 2.08
• Cash flow: 10-year cCFO is 20.2 cr. It has been positive and negative in alternate years. Seems it is stuck in working capital.
• Cumulative PAT vs. CFO: 10-year cPAT is 82.77 cr. 10-year cCFO is 20.2 cr. The company is not able to convert profits into cash. Need to check further. Inventory turnover has increased from 2.51 to 7.46. Receivable days see no improvement and remain at 34 days for the last 10 years with some cyclical ranging from 33 to 53.

Valuation Analysis of Chaman Lal Setia Exports Ltd:

• P/E ratio: 7.6
• P/E to Growth ratio (PEG ratio): 0.35
• Earnings Yield (EY): 13.16%
• P/B ratio: 2.9
• Price to Sales ratio (P/S ratio): 0.6
• Dividend Yield (DY): 0.66%

Business and Industry Analysis of Chaman Lal Setia Exports Ltd:

• Comparison with industry peers: KRBL which sells India gate basmati rice is the biggest player with sales of 3113 cr and PAT of 280 cr has a sales growth of 17% in the last 10 years compared to 22.73% of Chaman Lal. LT Foods with Daawat basmati rice has 2015 sales of 2734 cr with PAT of 76 cr has 10 years sales growth of 22.4% Kohinoor foods with sales of 1158 cr in 2015 and PAT of -72.55 cr has sales growth of 8.86% in 10 years. So Chaman Lal is growing at a better rate than its peers and matches the growth rate of LT Foods.
• Increase in production capacity and sales volume: The capacity of 14 MT/hr. in 2011 as per Crisil report. The same capacity till 2015. Actual Production 2015 = 31325.2 MT Actual Production 2010 = 32499.5 MT. It is surprising to see the sales coming from export in 2015 as 393cr compared to 112cr in 2010 with the same production.
• Conversion of sales growth into profits: Profit growth at 31% compared to sales growth of 22%.
• Conversion of profits into cash: 10-year cPAT is 82.77 cr. 10-year cCFO is 20.2 cr. The company is not able to convert profits into cash. Need to check further. Inventory turnover has increased from 2.51 to 7.46. Receivable days see no improvement and remain at 34 days for the last 10 years with some cyclical ranging from 33 to 53. Crisil expects healthy liquidity, with expected cash accruals of Rs.230 million to Rs.250 million per annum, against nil debt repayment obligations, in 2015-16 and 2016-17.
• Creation of value for shareholders from the profits retained: 67.72 cr is retained earnings in 10 years. 268 cr is increased in market cap in 10 years. For Re 1 retained Rs 3.95 market cap value created.

Management Analysis of Chaman Lal Setia Exports Ltd:

• Background check of promoters & directors: Chaman Lal is headed by experienced management who brings along more than 25 years of experience in the rice production and processing industry. It is led by Mr Chaman Lal Setia (chairman and managing director) who looks after the overall management of the company. His one son Mr Vijay Setia (executive director) looks after the procurement, processing and production of rice, while another son, Mr Rajeev Setia (executive director) looks after marketing and finance activities. Vijay Setia having experience of more than 35 years in the Rice Milling Industry. About 20 research papers, two technologies under patent. President All India Rice Exporters Association (Regd.). He is also engaged by Gerson Lehrman Group as a consultant in the field of food technology.
• Management succession plans: The second-generation promoters have also joined the operations and are actively involved in business activities. Mr Vijay Setia’s son Ankit Setia is a qualified food technologist and supports the company in R&D activities. Mr Sukarn Setia is driving the company’s marketing initiative and is looking after strengthening Chaman Lal’s position in the domestic as well as the export market. As per our interaction with the management, the company is expected to remain a family-run business.
• Salary of promoters vs. net profits: Each of the senior MDs is getting 50 lacs/year. While second-generation Sukarn and Sankesh Setia get 6 lacs/year. While Ankit gets 62 lacs/year which includes the commission of 50 lac. Overall the remuneration seems to be on the higher side to a tune of 2.32 cr which is 12% of the profit of 19.5 cr.
• Project execution skills: The Company has developed a Novel and innovative process which involves the recycling of most of the hot water used for soaking paddy during the parboiling of rice, thereby generating little wastewater and still having a high-quality product. The company’s novel and innovative products viz; Bhatti Sella, Pesticide Residue-free rice and quick-cooking rice and Rice for Diabetic People having moderate G.I Sale is picking up in various directions of the World markets particularly the Maharani Rice suitable for Diabetic people.
• Consistent increase in dividend payments: The company is reducing dividend % from 112% to 11% in the last 10 years. It is retaining earnings in the company for growth which it seems to achieve
• Promoter shareholding: 74.37%
• Promoter buying the shares: Promoters stake remains constant
• FII shareholding: 0%

Other Business Parameters of Chaman Lal Setia Exports Ltd:

• Product diversification: It’s a pure basmati rice processing company. Branding, packaging and exporting of rice. 80% of revenue from exports.
• Govt. influence: Govt. can influence but has less impact on basmati rice export as most of the basmati rice in India falls in the premium segment and is used for export.

Margin of Safety Analysis of Chaman Lal Setia Exports Ltd:

• Earnings Yield (EY): 13.3% > 7.5% so that provides a MoS of 5.8%
• Self-Sustainable Growth Rate (SSGR): SSGR came to 64% in 2015. 10 yr. the average comes at 28%. I am a bit unsure of my calculation.
• Free Cash Flow (FCF): CFO and FCF alternating as positive and negative every year. Not sure if the ratio makes any sense. 6 year cCFO = 11.11 cr 6 year cFCF = -11.19 cr 6 year Capex = 22.30 cr 6 year Div Paid= 9.56 cr Capex + Div = 31.86 cr while CFO = 11.11 cr 20.75 cr has to be supplied using debt.

Credit Rating Analysis of Chaman Lal Setia Exports Ltd:

• Credit Rating History: Credit rating improved from CRISIL CRISIL BBB/Stable/CRISIL A3+ to BBB+/Stable/CRISIL A2

Conclusion:

Since Chaman Lal Setia Exports Ltd is not increasing capacity, it is doing capex to improve efficiency, which is reflected in OPM. While the medium-term cash outlook seems good but long-term cash requirements can be challenging based on the nature of the industry. The management is experienced and in-house technologies have allowed the company to gain efficiency.  Though management is a family hierarchy with father, son and grandsons on the board of directors and playing all-important roles. The succession plan seems comfortable but management compensation is on the higher side at 12% of net profits.

If we consider 8 hr. * 300 days milling in a year at 14 MT/hr. then capacity comes out to be 33600 MT per annum.  If we consider 12 hr. * 300 days milling in a year at 14 MT/hr. then capacity comes out to be 50400 MT per annum. With actual production in 2015 at 32000 MT, the utilization is at 95% and 63% respectively. This gives me the notion that the company is well placed to meet more demand at the same capacity by working extra hours. Industry falls in the premium rice category so less impacted by regulations but not fully insulated. Recently Iran sanctions impacted the industry and low rainfall increased the price of paddy but the company was able to mitigate both these risks which were reflected in an increase in sales and OPM.

With PE of 7.5 and 10 years’ SSGR of 35% and actual growth of 22%, Chaman Lal Setia Exports Ltd provides a margin of safety (MoS), but the only challenging part is the cash flow from operations (CFO), which is challenged. It is yet to see how a company can increase sales, OPM and decrease debt to improve its CFO.

Out of all criteria mentioned in your checklist, 10 are not matching, which are mostly related to cash flow. Having said that other 22 criteria match. If the company continues to increase sales and OPM and improves its CFO it could be good in the long term.

Regards,

Faisal

Dr Vijay Malik’s Response

Hi Faisal,

First, I appreciate the time and effort put by you in analyzing Chaman Lal Setia Exports Ltd in detail. The compiling of data like production capacity, utilization levels, promoter’s salaries etc. requires a lot of diligent effort in scanning through past annual reports, which tests the patience of the investor.

I thank you for sharing your analysis with the author and readers of this website as your analysis is very helpful for all readers to get a good grasp on all the key aspects of Chaman Lal Setia Exports Ltd. Your analysis is helpful for investors to make a quick assessment of the company.

I congratulate you on the good work done by you.

Let us analyse the past financial performance of Chaman Lal Setia Exports Ltd:

Financial Analysis of Chaman Lal Setia Exports Ltd:

Chaman Lal Setia Exports Ltd, as mentioned by you, has been growing its sales at a good pace of 23% year on year for the last 10 years (FY2006-15). It is important to notice that the operating profit margins (OPM) of Chaman Lal Setia Exports Ltd have been stable in the range of 7-9% over the years. This is a very good sign considering that the main product of the company “Rice” is an agricultural commodity where wide fluctuations in the raw material prices are very common.

Stable operating margins speak about the strength of its rice brand “Maharani” where Chaman Lal Setia Exports Ltd is able to pass on the input cost escalations to the end consumers and protect its profitability margins.

The brand Maharani, though an established brand, however, does not come close to the brand India Gate rice of KRBL Ltd, which commands a premium over its peers and sells at a significantly higher price than other brands. A cursory analysis of the operating profitability margins of KRBL Ltd and its quick comparison with the OPM of Chaman Lal Setia Exports Ltd would tell the reader that KRBL Ltd has almost double the OPM of Chaman Lal Setia Exports Ltd, commands better brand recognition and pricing power.

Chaman Lal Setia Exports Ltd has been paying its taxes in the range of 30-34%, which is in line with the standard corporate tax rate applicable in India, which is a good sign for investors.

Read: How to do Financial Analysis of a Company

Operating Efficiency Analysis of Chaman Lal Setia Exports Ltd:

The operating efficiency parameters of Chaman Lal Setia Exports Ltd reflect that the efficiency has improved over the years. Net fixed assets turnover has increased from 16 to 24 over the last 10 years (FY2006-15). Similarly, the inventory turnover ratio (ITR) has improved from 3 in FY2007 to 7 in FY2015. This efficiency is evident for the reasons highlighted by you that Chaman Lal Setia Exports Ltd has been able to earn higher revenue from its existing plants without a lot of increase in operating capacity in recent years.

As highlighted by the company in its annual report, the primary reason for the increase in revenue with a similar level of operating capacity is on account of an increase in the prices of the products and the strengthening of the US Dollar against the Indian Rupee.

This is also corroborated by the fact that most of the growth in the revenue of the company has come from its export operations. Domestic sales are almost flat.

Read: Understanding the Annual Report for a Company

The analysis of the receivable position of the company presents an interesting picture. The receivables position of Chaman Lal Setia Exports Ltd is following a cyclical pattern with movement between 38-45-38-49-32-34 days over the years. However, if noticed from a 10-year perspective, the receivables days have improved from 38 days to 34 days, which is an improvement overall.

Read: 5 Simple Steps to Analyse Operating Performance of Companies

So, overall it seems that Chaman Lal Setia Exports Ltd has been improving its net fixed assets turnover, inventory turnover as well as receivables days.

Yet, when we analyse the key test of a collection of receivables and working capital efficiency, which is the conversion of profits into cash flow from operations by comparing cumulative profit after tax (cPAT) over the last 10 years with the cumulative cash flow from operations (cCFO), then the company fails miserably.

We realize that during these years (FY2006-15), Chaman Lal Setia Exports Ltd had a profit after tax (PAT) of ₹83 cr. whereas the CFO over a similar period has been ₹20 cr. To resolve the mystery, we need to see the absolute levels of inventory and receivables over the years, instead of relative parameters of inventory turnover and receivables days, to assess whether the funds are getting blocked in working capital. Upon analysis of absolute levels of inventory and receivables, we get the following picture:

Looking at the above data, it becomes clear that working capital has consumed at least ₹76 cr. from the profits with receivables and inventory amounting to ₹40 cr. and ₹36 cr. respectively. This roughly explains the difference between cPAT of ₹83 cr. and cCFO of ₹20 cr. (An investor may do further reconciliation of figures by analysing cumulative depreciation and incremental trade payables over the years).

Margin of Safety in the Business of Chaman Lal Setia Exports Ltd:

i) Self-Sustainable Growth Rate (SSGR):

The case of Chaman Lal Setia Exports Ltd is a good example of a case where the limitation of SSGR that it does not factor in working capital changes, gets highlighted.

Chaman Lal Setia Exports Ltd has stable profit margins and has improved net fixed asset turnover, which are key parameters in the assessment of the self-sustainable growth rate. As a result, an investor would notice that Chaman Lal Setia Exports Ltd has an SSGR of 30% -60% over the years, which is much higher than the sales growth rate of 23% being achieved by the company. As a result, if the investor ignores the working capital position of the company, it might be concluded that the company can keep growing at a rate of 20%-25% without needing to raise debt/additional equity.

However, such a conclusion would be erroneous. As mentioned in the article on SSGR, the investors must look at the working capital position before making a final opinion about the company from SSGR.

Read: Self-Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

In such cases, FCF would reveal a composite picture after factoring in the working capital and capex parameters.

ii) Free Cash Flow Analysis of Chaman Lal Setia Exports Ltd:

Faisal, you have done an excellent analysis of the free cash flow position of the company and the conclusion that the dividends declared by the company have been primarily funded by debt. As it is obvious from the above analysis that Chaman Lal Setia Exports Ltd has generated only ₹20 cr. from CFO during FY2006-15, whereas it has used ₹34 cr. in capital expenditure and declared dividends of ₹15 cr. over the same period (FY2006-15). Thus the inflow of cash is only ₹20 cr. whereas the utilization is ₹49 cr.

This cash flow gap of ₹29 cr. (49-20) has been bridged by the company by raising additional debt of ₹27 cr. An investor would notice that the total debt of Chaman Lal Setia Exports Ltd has increased from ₹23 cr. in FY2006 to ₹50 cr. in FY2015.

I advise investors to put a lot of focus on the free cash flow (FCF) generating ability of the company as it is only the free cash flow, which is the real value-generating ability of the company for its shareholders. FCF is like the net savings of a salaried person after deducting all the expenses and constitutes the disposable income. If a company does not have positive FCF, then the company might turn out to be a permanent cash flow drain for the shareholders, which are continuously asking for more and more funds to be deployed in either working capital or plant & machinery.

FCF is one of the key parameters to determine the margin of safety present in the business of any company. You may read the following article to understand more about the margin of safety in the purchase price and business.

Read 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of StockInvesting

Increasing debt levels with growing businesses are the features of companies operating in capital-intensive businesses.

Investors should be cautious of investing in companies, which have continuously increasing debt levels, as high debt has the potential of increasing the risk of bankruptcy and reduced profitability under tough business conditions.

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

• Analysis: Metalyst Forgings Ltd (erstwhile Ahmednagar Forgings Ltd)
• Analysis: Castex Technologies Ltd (erstwhile Amtek India Ltd)

Faisal, you have done a good assessment of the capacity utilization of the company and have led us to a useful conclusion that Chaman Lal Setia Exports Ltd might not lead to huge capex in near future to sustain its growth. And you have rightly pointed out that the key aspect of cash flow management by the companies remains better handling of working capital, primarily inventories and receivables. Therefore, any investor should continuously have the working capital position of Chaman Lal Setia Exports Ltd as one of the key monitoring parameters.

Read: How to Monitor Stocks in your Portfolio

Specific queries: 

1) Status of Star Export House:

You have raised a concern about the company being awarded a Star Export House by the government and whether Chaman Lal Setia Exports Ltd is exporting rice to other small players as well. In order to promote exports, the government has initiated many schemes out of which Star Export House is one. The exports labelled as Star Export House get many benefits like preferential clearance of consignments, the sufficiency of self-declaration for many documentary requirements etc. and many other benefits. Chaman Lal Setia Exports Ltd has more than 80% of its income from exports and it would have made sense for them to apply for Star Export House recognition.

The annual report of the company for FY2015 does not disclose any meaningful income from trading/other activities, which would have been the income from exporting the rice to other players. Also, the notes to accounts do not contain any provision and accounting treatment of such income. Therefore, I believe that trading rice with other players might not be a key activity for Chaman Lal Setia Exports Ltd. However, you may check on the ground with different rice traders to know more about whether Chaman Lal Setia Exports Ltd is involved in the trading of rice.

2) Negative figure in cash flow from financing:

The proceeds from borrowings of ₹ (-11) cr in cash flow from financing in FY2015, which is highlighted by you is the cash outflow for repayment of the debt by Chaman Lal Setia Exports Ltd. The repayment of the debt is also visible in the reduction of the total debt from ₹61 cr. in FY2014 to ₹50 cr. in FY2015.

3) Self-Sustainable Growth Rate and data assumptions:

In my assessment of SSGR, I take the netblock as NFA. You are right in that perspective. However, the only difference I see between my calculation and yours is that I take 3 years’ average data for each of the SSGR constituent parameters, which smoothens the abrupt year-on-year changes.

For FCF and capex calculation, all the requisite data is available in screen excel output. An investor does not need to take data from other sources like Morningstar. An investor may see the calculation of capex and FCF in the following article:

Read 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of StockInvesting

4) Loan from promoters/directors’:

You have rightly identified that the company has taken loans from its promoters. As per the FY2015 annual report, page 67, about ₹16.7 cr. of loans were outstanding on March 31, 2015.

An investor would notice that, in the FY2015 annual report on page 51, the company has disclosed that it has paid interest of about ₹2.6 cr. to directors for the loans.

If an investor calculates the effective interest rate, which is being paid by the company to the promoters’/directors’ for their deposits/loans, then it would be 15.6% (₹2.6 cr./₹16.7 cr.).

An interest rate of 15.6% seems high considering that the company can get cheaper financing from banks than the interest rate being paid to promoters.

5) Management compensation is high at 12% of profits:

I appreciate you for pointing out the high level of management compensation in comparison to the profits. While reading the annual report, an investor would notice that the company seems to be paying a high salary to its directors.

As per the FY2015 annual report, page 39, the company has paid a total of ₹2.3 cr. of remuneration to the directors. The net profit of the company for FY2015 is ₹19.5 cr. Therefore, the total remuneration of all the directors should not exceed ₹1.95 cr. (10% of ₹19.5 cr.) from an industry benchmark perspective.

There is another section of the FY2015 annual report of Chaman Lal Setia Exports Ltd, where I would want to draw the attention of the investor:

Change in Promoter’s Shareholding:

On page 36 of the FY2015 annual report, the company declares that there is no change in the shareholding of promoters in FY2015:

Whereas in another section of the annual report, on page 33, where the calculation of the promoter’s shareholding is detailed, it is disclosed that the promoter’s shareholding has reduced by 0.2% during the year:

It seems that the error has skipped the eyes of those responsible for making and verifying the annual report before publishing.

Margin of Safety in the market price of Chaman Lal Setia Exports Ltd:

Chaman Lal Setia Exports Ltd is currently available at a P/E ratio of about 8, which does offer a margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor. However, the analysis of FCF indicates that the company does not have a margin of safety in its business.

It might be that due to the lack of an effective margin of safety in the business, the market might be pricing the company at a lower price-to-earnings ratio (P/E ratio). In such a situation, the attractiveness of a low P/E ratio many times might be proved erroneous and the investor may end up getting into a value trap.

One should read the analysis of NOIDA Toll Bridge Company Ltd to understand the situation of a typical value trap.

Read: Analysis: Noida Toll Bridge Company Ltd (DND Flyway)

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

In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be sign 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, Chaman Lal Setia Exports Ltd seems to be a company growing at a decent pace of 20-23%, which enjoys value for its brand Maharani Basmati rice and thereby maintaining its operating profitability margins. However, the working capital-intensive nature of its operations has resulted in most of its reported profits getting stuck in its inventory. Therefore, Chaman Lal Setia Exports Ltd has to borrow funds from lenders to meet the gap for its capex and pay a dividend to its shareholders.

An investor should keep a track of working capital management by Chaman Lal Setia Exports Ltd to assess whether it is able to turn itself into a free cash flow positive company. The investor should also keep in mind issues related to management like the higher interest rate on deposits by promoters, high remuneration when compared to profits etc. while making her final opinion about Chaman Lal Setia Exports Ltd.

These are my views about Chaman Lal Setia Exports Ltd. However, you should do your own analysis before making any investment-related decision about Chaman Lal Setia Exports Ltd.

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

Hope it helps!

Regards,

Dr Vijay Malik

Investors’ Query

Dear Dr Vijay,

Great discussion, comprehensive analysis and lots of food for thought. Here are my observations and questions.

1. This is a very cheap stock given the growth it has shown. Companies with such growth are seen quoting at even 5-10 times their PE. How do I understand if I am being too choosy or not for this PE? Does the Cash Flow track record indicate long-term growth rate would reduce to 8% kind? (Ref. PEG=1)
2. The efficiency of Debt is increasing over the years (Sales/Debt, Net-Profit/Debt, D/E, Interest Cover) but the weakness in Cash Flow still is leading to increasing the absolute Debt. The 20-25% CAGR in Sales is aggravating because it needs more stocking of rice. From the stock market’s point of view, instead, should a company target to get a less aggressive Sales CAGR that Free Cash Flow can self-sustain? Where’s the trade-off in Market Capitalization terms?
   • (A) With 15 crore Dividends, and 20 crore Cash Flow, one way to look at the Plant CAPEX could be that the company managed 5 crores from internal accruals. For the rest, it took on Debt. (ROCE >> CoC).
   • (b) Loans by Promoters states “no risk of default on Principal as well as Interest”. With 15% returns in FY’14-15 and non-payment in FY’15-16 it may effectively feel like cumulative Preference Shares with a lazy arrangement – but kind of fair.
   • (c) with 23-31000 T of production per year, the average usage of 14 TPH plant capacity is still between 4.5-7.5 hours a day. Or is that already a bottleneck for Sales growth?

Thanks and regards.

Author’s Response:

Dear,

Thanks for your feedback & appreciation! I am happy that you found the articles useful! Thanks for sharing your valuable input.

Let’s now address the queries raised by you:

1 &2) It is essential for any company to make free cash flows to survive and create value for shareholders in the long term. Otherwise, the company is a continuous cash drain, which consumes the entire cash that it generates from operations as well as additional cash from debt/equity. There have been many cases where companies perished as a result of debt-funded growth:

E.g. Analysis: Ahmednagar Forgings Limited

Therefore, I always prefer to invest in companies which generate free cash flow. At some stage in future, the additional cash from debt &/or equity starts becoming unavailable and the whole business crumbles. In an extreme sense, it looks like a Ponzi scheme.

3A) Loan by promoters should ideally be equity. I believe that promoters should earn by way of dividends and if working as an executive, then as a way of salary. Any other format of taking cash from the company should be looked at with caution. Here also the interest rate being paid to promoters is much higher than the market rate, which further deepens my belief that any form of promoter’s money in the company, other than equity should usually be seen with caution.

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

3b) Faisal has shared a very good calculation of capacity utilization and future potential in the above article on Chaman Lal Setia Exports Limited. You may take guidance from his calculations.

Hope it answers your queries. If you have any other concerns, then feel free to write in comments. I will be happy to provide my input.

All the best for your investing journey!

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.