Analysis: Paushak Ltd

The current section of the “Analysis” series covers Paushak Ltd, India’s largest phosgene based speciality chemicals manufacturer. Paushak Ltd is a part of the Alembic Pharmaceuticals group.

“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.

Paushak Ltd Research Report by Reader

Good day Sir,

I hope you are doing well in these hard times. I wish for good health for you and your family.

I have been following your blog since March 2016 after I was first introduced to investing by reading the book ‘Rich Dad Poor Dad’. I have learned a lot from your articles, lectures and company analysis reports.

I have attached my analysis done on Paushak Ltd. As I am not from a finance background, there were a few aspects in annual reports, which I may have missed and wrongly understood. I would be highly obliged if you can take time out to go through the analysis done on Paushak Ltd and give your comments.

Thanks and regards,

Vinay Malik

Financial analysis of Paushak Ltd:

i) Sales and profit growth:

The company has been growing its sales at a moderate pace @ 19% for the last 11 years (2010 -2020) from Rs. 25.2 Cr in FY 2010 to Rs. 137.9 Cr in FY 2020.

CRISIL rating agency in the report dated Dec 2018 highlighted that Paushak Ltd has been able to grow in the last one and half years through diversification of customer base into sectors other than pharmaceutical.

Further, Paushak Ltd is also actively exploring various opportunities, including contract manufacturing, with global customers, who are a leader in their markets and sees a good opportunity for itself while offering an “India alternative” to them.

During the same period, Paushak Ltd saw net profit growth @ 32% from Rs. 2.1 Cr in FY 2008 to Rs. 34.9 Cr in FY 2020. Operating profit margins have been fluctuating over the last decade between 15% and 31%. The average OPM for the last 5 years is around 26%.

Strong operating efficiency aided by its backward integrated operations has led to a strong operating margin in recent years. Crisil Rating agency in the report dated Dec 2018, highlighted volatility in raw material prices causing margins to fluctuate. However, they further expected the margins to be over 25% over the medium term.

ii) Tax payout:

When an investor analyses the tax payout ratio of Paushak Ltd, then he notices that the company has been paying taxes lower than the standard corporate tax rate in India. In the last 11 years, the company has paid a total income tax of Rs. 49.7 Cr on total PBT of Rs. 207.3 Cr i.e. approx. 24%. However, as per details of computation of tax provided in AR FY 2018 and FY 2019, it is noticed that the company enjoys lower Tax rate benefits as the company falls under the provision of MAT u/s 115JB.

In addition, the applicable Indian statutory tax rate for the year ended 31 March 2018 and 31 March 2017 was 21.3416%.

iii) Cash flow analysis:

Over the period from 2010 to 2020, its cumulative PAT is Rs. 157.6 Cr and the cumulative CFO is Rs. 127.2 Cr. On comparing cPAT and cCFO, it is noticed that cCFO is approximately 80% of cPAT. However, when the investor notices cumulative other income for the past 11 years i.e. 2010-20, it is around Rs. 41.2 Cr. Therefore, cCFO is less than cPAT because of Paushak Ltd.’s high amount of other income (Income from investments, sale of land). Other income is not considered in CFO calculation although it will be added in PAT numbers. From 2010-20, FCF generated is approximately Rs. 56 Cr. FCF is the excess cash company has from its operations after fulfilling its Capex requirement.

At the end of FY 2020, Paushak Ltd has cash and cash investments of Rs. 164.6 Cr. Cash and Cash investments have increased exponentially from Rs. 53.7 Cr in FY 2018 to Rs. 116.9 Cr. in FY2019. As per AR FY 2019, investments made in Nirayu Pvt Ltd and Shreno Ltd are valued at fair value through other comprehensive income resulting in appreciation of fair value from 5.6 Cr to Rs. 66.7 Cr.

iv) Operating efficiency analysis of Paushak Ltd:

When an investor analyses the Net fixed Asset Turnover (NFAT) of Paushak Ltd, then he notices that the NFAT of the company initially improved from 2.66 in FY2011 to 5.49 in FY2014. Later on, the NFAT decreased to 2.63 in FY2017. Investors may relate the decline in NFAT with the capex done by the company on capacity expansion during the same period. Once again, the NFAT improved to 3.75 in FY2019. However, it again declined to 3.52 as the company has started capex of Rs. 120 Cr. for capacity expansion for period FY 2020-22.

On analysing trade receivables over the years, it is noticed that trade receivables of Paushak Ltd increased from 72 days in 2011 to 96 in FY2014. From FY 2014 to FY 2019, trade receivables were in the range of 93-99 days. In FY 2020, it improved to 78 days. Trade receivables as a percentage of sales have also improved in the last three years from 37% to 19%. During FY2019, the Company has made changes in its Policy for receivables, payables and working capital, which resulted in lower Receivable days and higher current ratio.

Paushak Ltd has maintained a healthy return on capital employed over the last 7 years except in FY 2017. Crisil expects ROCE of around 18% through the capex cycle.

Paushak Ltd has been able to maintain a high ROCE during the last capex, which started in FY 2014

v) Research & development efforts of Paushak Ltd:

The company has been able to improve its profit margins because of investments done by the company in research and development to improve its operational efficiency and add high margin products. Paushak Ltd has a strong R&D focus with R&D investment of the order of 2-3% of net sales for the last 12 years.

Steps that were taken by the management (as mentioned in Annual reports)–

• Focus on the development of continuous processes instead of batch processes. Converted more products into continuous processes and thereby improved capacities without inordinate investments.
• Focusing on a more profitable product mix.
• Focus on R&D for cost reduction.
• Backward integration of operations, which helps it to cushion the impact of raw material prices.
• In FY 2015, management conducted a detailed study of their entire operations process through a reputed professional engineering consulting firm.
• Automation process to ensure that the Company maintains the highest levels of good EHS (environment, health and safety) practices.
• The company invested in a windmill for captive use. A significant part of energy requirement is met from such non-conventional source of energy.
• Developed indigenous technology for its one of the key product portfolio

Over the period of time, it is seen that expenses towards power and fuel have been brought down from 14% to 4% which shows that steps taken by management in R&D have improved operating efficiency and profit margins.

vi) Equity and debt Analysis:

No equity dilution happened in the last 12 years. Promoters have maintained their holdings around 66% for the last 10 years. Paushak Ltd did a buyback of shares worth Rs. 21.25 Cr (@1700/share) in April 2018. Promoter i.e. Nirayu Pvt Ltd participated in the buyback of shares wherein they surrendered 2.83% shares. This reduced their holding from 66.68% to 66.44%. However, over the FY 2019, they bought shares from the market, which increased their promoter holding to 66.71%.

Paushak Ltd has no debt on its balance sheet. Paushak Ltd has grown business with only internal accruals and it has maintained its debt-free status for the past many years. This shows that the balance sheet of the company is strong.

Paushak Ltd has been a consistent dividend payer for the last 12 years. The current dividend yield is less @ 0.24%. However, the company has been utilising the retained earnings to improve earnings for all shareholders by investing the same in their core business.

vii) Expansion of Phosgene capacity:

Paushak Ltd has kept its focus on core competency i.e. phosgene based speciality chemicals and intermediates.

• The company expanded its manufacturing capacity of Phosgene from 120 MT/month in FY 2009 to 400 MT/Month in FY 2019. Paushak Ltd started the capex in FY 2014 for an investment of Rs. 15 Cr.
• Currently, Paushak Ltd is in the process of expanding its capacity by 3 times i.e. from 400 MT/month to 1200 MT/month. As per Crisil Credit Rating report dated 17.02.2020, required capex of Rs. 120 Crores is expected to be largely funded with internal accrual and surplus cash equivalents of around Rs 50 crore as on September 30, 2019. Till 17.02.2020, Rs 25 crore of capex has been carried out, and Rs 75-80 crore is likely to be incurred in fiscal 2021, and the balance in the following year.

Expansion approval was granted for the following products as per information available here.

As per the Environmental Impact & Risk Assessment Report prepared by Aqua-Air Environmental Engineers Pvt Ltd, Surat, the average production of phosgene was 212.64 MT/Month of the total capacity of 400 MT/Month. Capacity utilization of phosgene is around 53.16% in FY 2016-17. As sales have increased from Rs. 72.3 Cr in FY2017 to Rs. 137.9 Cr in FY2020, it may be assumed that current capacity utilisation would be more than 80%.

Competition analysis for Paushak Ltd:

Apart from Chinese competitors, other competitors of Paushak Ltd are Atul Ltd and BASF. Atul is the only other Indian company licensed to produce phosgene. Atul has also expanded its phosgene capacity five times (I could not find Atul Ltd.’s capacity).

i) Entry barriers for other companies:

Phosgene being a hazardous gas is heavily regulated by the government. Getting approval for a manufacturing unit or expansion of the existing unit is not easy and is a time-consuming process, which may take 3-4 years. The company is one of the few players licensed to manufacture phosgene gas.

Management of Paushak Ltd and their remunerations:

Paushak Ltd belongs to Alembic Group. Paushak Ltd is led by Mr Chirayu Amin and his family members, the promoters of Alembic Pharmaceuticals Ltd.

Mr. Abhijit Joshi is the MD & CEO of the company. He has drawn a gross salary of Rs. 56.43 lacs in FY2019 (Rs. 23.5 lacs in FY 2014) which is well below the ceiling as per the Act. Mr. Abhijit Joshi joined the company as Whole-time Director of the Company effective from 1 May 2013.

In FY 2018, the Board proposed payment of commission to Mr. Udit Amin, Non-Executive Director of up to 3% of the net profits of the Company, which was approved at the 45th AGM, held on 6 Aug 2018. In FY 2019, he received Rs. 76.75 lacs as commission. Total remunerations do not appear to be very high.

From FY 2015 to FY2019, permanent employee strength has increased from 172 to 265. Crisil Rating agency also highlighted the hiring of personnel at senior and mid-management levels in the strengths of the company.

Further, in Feb 2020 they have published an advertisement for the hiring of 56 personnel. This seems to be in line with the expansion plan.

i) Related party transactions of Paushak Ltd:

The company has significant investments in related/promoter companies.

a) Purchase of Options Right of Immovable property of Shreno Ltd. Can it be called the wrong allocation of funds?

In FY2014, Paushak Ltd entered into an Option Purchase Agreement for a parcel of land at Bangalore with a real estate developer. The Company has given deposits of Rs 8,50,00,000/- towards acquiring option rights having a total value of Rs 18,94,86,000/-. Paushak Ltd can exercise its Option Rights at any time before the expiry of 48 months from the date of execution i.e. 21-06-2013 of the Agreement.

Later these Rights were cancelled at the option of Shreno Ltd.

Also read: How to do Business Analysis of Real Estate Companies

b) In FY 2019, Paushak Ltd sold the land for a sum of Rs. 10.17 Cr to related party M/s Alembic Ltd. (pg. 77 of AR FY2019). Earlier, the company used to receive the rent of approximately Rs. 17 lacs/annum from this land.

c) Current investments in related parties are approximately Rs. 79.81 Cr.

Risks (as mentioned in annual reports) and steps to mitigate them:

• Paushak Ltd identifies safety aspect of phosgene & downstream products production as a key risk.
• With increasing utilization of its manufacturing capacities, Paushak Ltd needs to increase its investments and efforts on Environment, Health & Safety requirements considering the hazardous nature of its operations. At the same time, the Company needs to ensure that despite an increase in investments for EHS, it manufactures quality products at competitive prices.
• Cost competition and pricing pressure experienced in various products.
• Cost competition and pricing pressure from Chinese manufacturers have been a threat to the industry in general.

The margin of safety for Paushak Ltd:

i) Self-Sustainable Growth Rate (SSGR):

SSGR of Paushak Ltd has been between 40%-69% for the last 5 years. Because of high SSGR, the company has been able to grow @ 19% for the last 11 years without the need for external capital.

ii) Free Cash Flow (FCF)

FCF is the excess cash company has from its operations after fulfilling its Capex requirement. Over the last 11 years, FCF generated is approximately Rs. 56 Cr. In 11 years, Paushak Ltd has done a total capex of Rs. 71.2 Cr including capex done for the expansion of capacity from 120 MT/month in FY 2009 to 400 MT/Month in FY 2019 and current capex undertaken in FY2020. It appears that the company has been able to grow and expand without taking any debt.

iii) Price to Earnings Growth Ratio – PEG Ratio is 0.7 i.e. less than 1 which means that the stock price is currently undervalued.

iv) P/E Ratio is 19.8 at CMP 2125 on June 04, 2020, which provides a very less margin of safety.

Future growth:

Future growth outlook depends on:

• Timely execution of capex without deteriorating the balance sheet.
• Ability to get contract manufacturing for global customers.
• Maintaining the return on capital above 20%.
• 3 times capacity will give ample room to growth the top line.
• Maintaining the current profit margins in future.
• Proper allocation of capital by the Management and rewarding the minority shareholders.

Please provide your input.

Regards,

Vinay Malik

Dr Vijay Malik’s Response

Hi Vinay,

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

Let us analyse the financial performance of the company since FY2011.

Financial and Business Analysis of Paushak Ltd:

While analyzing the financials of Paushak Ltd, an investor notices that the sales of the company had grown at a pace of about 20% year on year from ₹30 cr in FY2011 to ₹138 cr in FY2020. The sales growth of the company had been almost consistent year on year except for two instances. First, in FY2017, the sales of the company declined to ₹72 cr from ₹78 cr in FY2016. Thereafter, in FY2020, the sales of the company declined to ₹138 cr from ₹140 cr in FY2019.

However, when an investor notices the operating profit margin (OPM) of the company, then she notices that the OPM of Paushak Ltd witnessed fluctuations in the past.

From the above chart, an investor would notice that the OPM of the company declined sharply almost every alternate year. The OPM declined from 20% in FY2011 to 15% in FY2012. The OPM again declined from 23% in FY2013 to 20% in FY2014. Thereafter, the OPM declined significantly from 25% in FY2015 to 17% in FY2017. In the recent past, the OPM has improved to 31% in FY2020.

The fluctuating profit margins of the company indicate that the company faces some challenges in passing on the increase in the cost of raw materials to its customers. As a result, when the input prices increase, then the company has to take a hit on its profit margins. Most of the time, such fluctuating margins with low pricing power are found in the industries where manufacturers face heavy competition.

In the case of Paushak Ltd, the company is the largest producer of phosgene based speciality chemicals in India.

FY2019 annual report, page 13:

Paushak is India’s largest phosgene based specialty chemicals manufacturer serving pharmaceutical, agrochemical and performance industries. The Company is domestic market leader in most of its product portfolio.

However, despite being the market leader, Paushak Ltd faces a lot of competition as well as pricing pressure from cheaper imports from China as well as other Indian producers of phosgene products.

In FY2012, when the company faced a decline in its operating profit margin (OPM) to 15% from 20% in FY2011, then the company highlighted the competition from low-cost products from China as well as Indian manufacturers.

FY2012 annual report, page 3:

The threat to our business is the competition of low cost phosgene intermediates from China and other countries and competition within India.

The pricing pressure from the competition was one of the reasons when the company witnessed a decline in sales as well as a significant decline in profit margins in FY2017.

FY2017 annual report, page 10:

Cost competition and pricing pressure experienced across various products is a significant concern…

FY2018 annual report, page 16:

Cost competition and pricing pressure from Chinese manufacturers has been threat to the industry..

In FY2019, when the company increased its sales to ₹140 cr from ₹105 cr in the previous year, then the company highlighted that it has benefited from the reduced competition from Chinese manufacturers due to strict environmental norms implemented by the Chinese govt.

FY2019 annual report, page 13:

The Company has benefited from the constrained supplies and shortage of intermediates and chemicals from China due to stricter environmental compliance. However, supplies from China is expected to improve in near future, which will result in more cost competition and pricing pressure.

Once again, in FY2020 when the company witnessed a decline in its sales, then the key reason was the competition at low prices from China. The company expects these challenges to increase going ahead.

We have experienced competition and pricing pressure from Chinese suppliers and expect the same to increase. It is also expected that competition will increase both, locally and internationally.

During the current times, when many countries have put trade restrictions on imports from China, an investor may think that the threat from the low-cost imports from China may be over. However, an investor needs to keep in mind a few aspects. First, when large markets like the USA stop accepting Chinese products, then the remaining countries face an increase in competition from Chinese suppliers as the Chinese manufacturers start exporting more products to the remaining countries that accept their products.

Second, if a country does not accept Chinese products directly, then the Chinese manufacturers use the multistep supply global chains to export products to any market. For example, when India imposed duties on Chinese imports, then China started exporting duty-free fabric into Bangladesh where the fabric was converted into garments and then those garments were imported duty-free from Bangladesh into India.

Source: FY2019 annual report of Century Textiles & Industries Ltd, page 18:

The duty free import of fabrics from China into Bangladesh and in return the Garments are being imported duty free into India from Bangladesh is hitting hard the Indian Textile Industry.

A reading of our analysis of Century Textiles & Industries Ltd would help an investor understand these dynamics related to trade and global supply chains in any industry: Analysis: Century Textiles & Industries Ltd

Therefore, an investor may appreciate that if any country is able to manufacture goods at a cheaper price, then the competition will hit the business of the manufacturers in the target country (e.g. India) whether by way of direct imports or by way of indirect imports using global supply chains.

In addition, the company stated that the fluctuating price of crude oil is one of the parameters that affect its business.

FY2018 annual report, page 16:

..rising crude cost along with fluctuation in foreign currency pose significant risks for the business.

From the above disclosure by Paushak Ltd, an investor would appreciate that the crude oil prices have an impact on the profit margins of the company. As a result, an investor may infer that the recent sharp increase in the profit margins of the company during FY2018-2020 might be due to a decline in crude oil prices. The crude oil prices declined from $75 per barrel in FY2018 to $11 per barrel in FY2020. (Source: Macrotrends)

The credit rating agency, CRISIL has also highlighted in its report for Paushak Ltd in Dec. 2018 that the key reason for fluctuating profit margins of the company is volatile raw material prices.

Due to volatile raw material prices and moderate scale, the margin has fluctuated between 19-25% during fiscals 2013 and 2017

Moreover, on multiple occasions, the company has highlighted that it is dependent on the pharmaceutical industry for its business. At times, when the pharmaceutical products where their products are used, reach the end of their life, then the sales of Paushak Ltd are hampered.

FY2011 annual report, page 5:

A number of our existing products going into Pharma industry are coming under pressure due to maturity of their end-applications. At the same time, other Pharma products have to await the respective patent expiry.

In FY2017, when the sales of the company declined from the previous year, the company once again highlighted the dependence on the pharmaceutical industry and the intense competition it faces that has led to pricing pressure.

FY2017 annual report, page 10:

The pharma intermediates segment is under pressure due to end product stagnation and cost pressures.

From the above discussion on the competition from low priced Chinese products limiting the pricing power of the company, continuously fluctuating crude oil prices as well as the maturity of pharmaceutical end products, an investor may appreciate that the OPM of Paushak Ltd is expected to remain volatile going ahead. As a result, an investor should keep a close watch on the profit margins of the company going ahead.

Further advised reading: How to do Business Analysis of Chemical Companies

In addition, an investor may appreciate that one of the strengths of the business model of Paushak Ltd is the restrictions imposed by govt on phosgene.

Credit rating report of Paushak Ltd by CRISIL, Dec. 2018:

The company is backward integrated and is one of the few companies licensed to manufacture phosgene gas as there are government restrictions on it.

It usually takes 4-5 years to get all the required approvals for any expansion of phosgene manufacturing capacity. In the past, Paushak Ltd started the process of taking approvals for capacity expansion for phosgene products in FY2010.

FY2010 annual report, page 5:

Company has filed an application with the Government for permission to significantly increase its licensed capacity for Phosgene and downstream products.

However, the company could start construction of the plant only in FY2014 as it took the company almost 4 years to get all the requisite approvals from the Ministry of Environment and Forests, the Ministry of Industries and the Gujarat Pollution Control Board.

FY2014 annual report, page 12:

The Company have initiated the new project installation in 2 phases with an investment plan of ₹15 Crores. This would enhance the capacity of phosgene from existing 120 MT per month to the permitted 400 MT per month.

Therefore, an investor may appreciate that one of the reasons for the high OPM of Paushak Ltd in the range of 20-30% is linked to the restrictions imposed by the govt. on the processing of phosgene. In case, to boost the economic activity, improve the ease of doing business or as a part of the structural reforms, then an investor may notice that the company may face significantly enhanced competition and low-profit margins.

Therefore, going ahead, an investor may keep a close watch on the govt. regulations related to phosgene. This is because; any relaxation by the govt. in the current restrictions on handling phosgene would be a significant change in the industry dynamics affecting Paushak Ltd.

While looking at the tax payout ratio of Paushak Ltd., an investor notices that for most of the last 10 years (FY2011-2020), the tax payout ratio of the company has been lower than the standard corporate tax rate in India.

One of the key reasons for the lower tax payout ratio has been that until FY2019, Paushak Ltd was under the minimum alternate tax (MAT) regime.

FY2019 annual report, page 83:

The company falls under the provisions of MAT u/s 115JB and the applicable Indian statutory tax rate for year ended March 31, 2019 is 21.55%

However, from FY2020, the company has come under the new standard corporate tax rate applicable in India.

FY2020 annual report, page 90:

The company falls under the normal provisions of Income Tax Act, 1961 and the applicable Indian statutory tax rate for year ended March 31, 2020 is 29.12%.

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

Operating Efficiency Analysis of Paushak Ltd:

a) Net fixed asset turnover (NFAT) of Paushak Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Paushak Ltd in the past years (FY2011-20) then she notices that the NFAT of the company has witnessed a fluctuating pattern. Nevertheless, each of the periods of decline in NFAT corresponds to the capacity expansion projects undertaken by the company.

The NFAT of the company increased from 2.98 in FY2012 to 5.49 in FY2014 with the increase in sales during the period. However, from FY2015 to FY2017, the NFAT of the company declined to 2.63. The key reason for this decline was the increase in net fixed assets because of the capacity expansion project executed by Paushak Ltd during FY2014-FY2016.

Thereafter, the NFAT of the company increased to 3.75 in FY2019. In FY2020, the NFAT of the company has declined to 3.51, which again seems to be due to the initiation of another capacity expansion project by Paushak Ltd in FY2020.

The credit rating agency, CRISIL, in its report for Paushak Ltd in Feb. 2020, has provided details of the capacity expansion project along with the expenses incurred by the company on it.

Capex of Rs 120 crore, to increase capacities, has commenced in fiscal 2020, with about Rs 25 crore expended till date.

Going ahead, the investor should keep a close watch on the execution progress of the project to assess whether the project is going as per the budgeted cost & timelines.

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

b) Inventory turnover ratio of Paushak Ltd:

While analysing the inventory turnover ratio (ITR) of the company, an investor notices that the ITR of Paushak Ltd has improved over the last 10 years. The ITR of the company has increased from 5.4 in FY2012 to 8.1 in FY2020.

Such a pattern of ITR indicates that Paushak Ltd has been able to manage its inventory efficiently without any deterioration in the efficiency over the last 10 years (FY2011-2020).

Advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of Paushak Ltd:

While analysing the receivables days of the company, an investor notices that over the years (FY2011-2019), the receivables days of Paushak Ltd have deteriorated. The receivables days increased from 72 days in FY2011 to 93 days in FY2019.

Due to the long receivables period, the company had to take steps to control the situation. The company intimated its shareholders in the FY2020 annual report that it has changed its policies for receivables. As a result, its receivables days improved from 93 days in FY2019 to 78 days in FY2020.

Further Advised Reading: Receivable Days: A Complete Guide

FY2020 annual report, page 16:

During the year, the Company has made changes in its Policy for receivables, payables and other components of working capital, which resulted in change in working capital ratios.

Nevertheless, increasing receivables days over the years affected the working capital position of Paushak Ltd.

When an investor notices the change in trade receivables of Paushak over FY2011-2020, then she notices that over this period, the trade receivables of the company increased from ₹6 cr to ₹26 cr. It indicates that during FY2011-2020, about ₹20 cr of funds were stuck in receivables.

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 FY2011-20.

Over FY2011-20, Paushak Ltd Limited reported a total cumulative net profit after tax (cPAT) of ₹155 cr. However, during the same period, it reported cumulative cash flow from operations (cCFO) of ₹125 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 the PAT.

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

Learning from the article on CFO will indicate to an investor that the cCFO of Paushak Ltd is lower than the cPAT due to the following factors:

• Increase in trade receivables (₹20 cr) and inventory (₹11 cr) over FY2011-2020, which is deducted from profits while calculating the CFO.
• Other income of ₹40 cr over FY2011-2020, which is deducted from profits while calculating the CFO.

The Margin of Safety in the Business of Paushak 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 Paushak Ltd, an investor would notice that the company has consistently had a high SSGR (40-60%) over the years. The key reasons for high SSGR for the company have been its high profitability, decent asset turnover and low dividend payout ratio.

Over the years, Paushak Ltd has reported a net profit margin (NPM) of 25-30%, net fixed asset turnover exceeding 3.5 and low dividend payout ratios of 5-7% of earnings.

While studying the formula for calculation of SSGR, an investor would understand that the SSGR directly depends on net profit margin (NPM) and net fixed asset turnover (NFAT) of the company. In addition, SSGR is inversely dependent on the dividend payout ratio 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)

Therefore, an investor would notice that Paushak Ltd has continuously had a high SSGR (40-60%) over the last 10 years (FY2011-FY2020). Whereas the company had been growing at a rate of 20% over the same period. SSGR indicates that the business model of Paushak Ltd has the inherent to support growth rates of 20%.

As a result, Paushak Ltd has been able to grow its sales from ₹30 cr in FY2011 to ₹138 cr in FY2020 only from its business cash flows. The company has always kept minimal debt on its books. Paushak Ltd is debt-free in FY2020.

In addition, the company returned excess cash to its shareholders by way of a buyback in FY2019.

FY2019 annual report, page 18:

the company has bought back and extinguished 1,25,000 (One Lakh Twenty Five Thousand ) fully paid up equity shares of the company having face value of ₹ 10/- each at a price of ₹ 1700/- per Equity Share aggregating to ₹ 21,25,00,000/-…

Further advised reading: Share Buyback: An Investor’s Guide

The investor arrives at the same conclusions when she assesses the free cash flow (FCF) position of Paushak Ltd.

b) Free Cash Flow (FCF) Analysis of Paushak Ltd:

While looking at the cash flow performance of Paushak Ltd, an investor notices that during the last 10 years (FY2011-2020), the company reported cash flow from operating activities (CFO) of ₹125 cr. During this period, the company spent ₹70 cr on capital expenditure. As a result, the company had a free cash flow (FCF) of ₹55 cr (=125 – 70).

In addition, the company also had other non-operating income of ₹40 cr over FY2011-2020. As a result, Paushak Ltd had a total surplus fund of about ₹95 cr (=55 + 40) over FY2011-2020.

Upon reading the annual reports of Paushak Ltd, an investor notices that the company has utilised the surplus cash in the following manner:

• Buyback of equity shares worth ₹21.25 cr in FY2019
• Dividends (excluding distribution tax) of about ₹10 cr during FY2011-2020.
• Reduction of debt from ₹2 cr in FY2011 to debt-free in FY2020.

The remaining funds have been kept by the company with itself, which it has invested in financial instruments as well as in the promoter group entities. On March 31, 2020, Paushak Ltd had cash & investments of ₹165 cr at market/fair value.

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

Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) are 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 Paushak Ltd:

On analysing Paushak Ltd and after reading its publicly available past annual reports from FY2009 and 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 Paushak Ltd:

While analysing the history of Paushak Ltd, an investor notices that the company was promoted in 1972 by the promoters of the Alembic Pharmaceutical group.

Currently, the promoters, Mr. Chirayu Amin (age 73 years), chairman, and his son Mr. Udit Amin (age 40 years) are a part of the board as non-executive directors.

FY2020 annual report, page 33:

Mr. Chirayu Amin, Chairman: Promoter Non-Executive

Mr. Udit Amin, Promoter Non-Executive

FY2020 annual report, page 8:

Mr. Udit Amin is the son of Mr. Chirayu Amin.

In addition, the day-to-day executive leadership is provided by a professional director, Mr. Abhijit Joshi (age 63 years), a whole-time director & CEO. Mr. Joshi joined the company in May 2013.

FY2013 annual report, page 3:

The Board of Directors at its meeting held on 24th April, 2013 appointed Mr. Abhijit Joshi as Additional Director of the Company with effect from 1st May, 2013. Mr. Abhijit Joshi has done his Masters in Organic Chemistry and Production Management. He has vast experience of 32 years in the fields of Basic Research, Tech-transfer, Production and Manufacturing site administration, etc. He has worked with various well known Indian as well as Multinational Companies in pharmaceutical space.

From the leadership structure of Paushak Ltd, it seems that the promoters provide the overall strategic leadership by being in the non-executive roles on the board of directors whereas the day-to-day executive leadership is provided by professional managers.

Further advised reading: Are professionally managed companies safer for shareholders?

In addition, the presence of the father-son duo of Mr. Chirayu Amin and Mr. Udit Amin on the board of directors indicates the presence of a well thought out management succession plan. The presence of members of different generations of the promoter family at the same time in the board allows the opportunity for the younger generation to learn the finer nuances of the business while the older generation is still around.

It 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) Related party transactions of Paushak Ltd:

While reading the annual reports of the company, an investor notices that since FY2008, the first data in the publicly available annual reports, Paushak Ltd has given a large amount of funds to the promoter owned entities.

The money has been put in the promoter group companies under different forms like equity shares, preferential shares, option right of immovable property or optionally convertible preference shares (OCPS). In addition to the investment transactions, Paushak Ltd also entered into property buy/selling transactions with the promoter group entities.

Many times, these investments were of a significant amount when compared to the net profits of the company. At times, when the repayment of the preferred shares came due, then the company and the promoters extended the repayment date of the instruments so that the promoter group entities can use the funds for extended periods.

Most of these investment transactions of Paushak Ltd were with the following entities of the promoter group, which were present in the list of shareholding companies by which promoters owned a stake in Paushak Ltd. (FY2015 annual report, page 18)

• Whitefield Chemtech Private Limited (2.42% stake in Paushak Ltd in FY2015)
• Sierra Investments Limited (25.42% stake in Paushak Ltd in FY2015)
• Shreno Limited (7.40% stake in Paushak Ltd in FY2015)
• Nirayu Private Limited (5.35% stake in Paushak Ltd in FY2015)

i) Investment in the debt of promoter group entities of Paushak Ltd:

While analysing the annual reports of the company, an investor notices that right from FY2008 until FY2020, Paushak Ltd has continuously funded promoter group entities via preference shares or other exotic instruments like “Option Right of Immovable Property”.

From the above table, an investor would notice that the investment by Paushak Ltd in the debt of promoter group entities was about ₹13 cr from FY2008 to FY2013. It increased to ₹17 cr in FY2014. It came down to ₹1.1 cr briefly in FY2017. However, it increased again and in FY2020, the exposure of Paushak Ltd in the preference shares of promoter group companies was ₹54.2 cr.

The promoters of the company have continuously kept these debt investments with themselves by extending the tenure of the preference shares when they reached their maturity date. Alternatively, the promoters found out new exotic instruments like “Option Right of Immovable Property” to make Paushak Ltd give loans to their entities.

For example, the existing preference shares of ₹8 cr issued by Whitefield Chemtech Private Limited were due for redemption on March 29, 2012. However, in FY2012, the company extended the maturity date of remaining preference shares to March 29, 2015.

FY2012 annual report, page 19:

The shares were due for redemption on 29.3.2012. However, at the request of the issuer, the Company has agreed the extension of redemption date as 29.3.2015.

On March 29, 2015, when the preference shares became due for redemption, then the promoter group entity, Whitefield Chemtech Private Limited could not repay Paushak Ltd in full. On March 31, 2015, the company still had dues of ₹2.7 cr to Paushak Ltd, which was finally repaid in FY2016.

Similarly, the existing preference shares issued by Sierra Investments were due for redemption on March 01, 2015. However, as per the FY2015 annual report, page 43, the company redeemed only 60% of the preference shares and extended the maturity date of the remaining preference shares to March 31, 2017.

From the above table, an investor would notice that when one promoter group entity, Whitefield Chemtech Private Limited, redeemed ₹3.3 cr of the preference shares in FY2014, then in the same year, the promoters made Paushak Ltd invest ₹8.5 cr in the “Option Right of Immovable Property” of another promoter group entity, Shreno Limited. As a result, despite redemption of a part of the preference shares by one promoter entity, the overall exposure of Paushak Ltd to the promoter group entities in FY2014 increased from ₹12.1 cr to ₹17.1 cr.

Therefore, an investor would notice that throughout FY2008-FY2020, the promoters of the company have made Paushak Ltd give money to the promoter owned entities by way of different instruments. At times, the amount of the money given by Paushak Ltd to the promoters entities (₹13 cr – ₹17 cr) was multiple times the net profit of the company of ₹3-4 cr until FY2012.

In addition, on multiple occasions, Paushak Ltd gave loans to its related party companies where it gave a loan during the year and received it back before the end of the year.

In FY2013, it gave a loan of ₹1 cr to related companies, which was repaid before the end of the year.

FY2013 annual report, page 15:

The Company has granted unsecured loan to company listed in register maintained under section 301 of the Companies Act, 1956. Total number of party is 1 (One) and total amount outstanding as at 31.03.2013 is Nil. The maximum amount involved was ₹ 1,00,81,370/-.

In FY2014, it gave a loan of ₹2 cr to related companies, which was repaid before the end of the year.

FY2014 annual report, page 21:

The Company has granted unsecured loan to company listed in register maintained under section 301 of the Companies Act, 1956. Total number of party is 1 (One) and total amount outstanding as at 31.03.2014 is Nil. The maximum amount involved was Rs.2,05,27,123/-.

It might seem like a case where the promoters shifted the economic benefit worth many years of profits of Paushak Ltd to themselves by making the company invest in the preference shares or “Option Right of Immovable Property” of promoter owned entities.

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

ii) Investment in the equity shares of promoter owned entities by Paushak Ltd:

While analysing the utilization of funds by Paushak Ltd over the years, an investor notices that the company has continuously invested in the equity shares of the four promoter owned entities mentioned earlier.

Paushak Ltd invested in the equity shares of Whitefield Chemtech Private Ltd and Sierra Investments Limited at least since FY2008, the earliest publicly available data. In FY2018, both Whitefield Chemtech Private Ltd and Sierra Investments Limited were merged into Nirayu Pvt. Ltd. As a result, the investment done by Paushak in these two companies was transferred into preference shares of Nirayu Pvt. Ltd.

FY2018 annual report, page 64:

During the year, upon the amalgamation of Whitefield Chemtech Pvt. Ltd. (WCPL) and Sierra Investments Pvt. Ltd. (SIPL), with Nirayu Private Limited (NPL), 9,919 and 1,27,134 Preference Shares of Rs. 100/- each at a premium of Rs. 900/- each, have been allotted by NPL in exchange of 1,150 equity shares of Rs. 10/- each held in WCPL and 28,252 equity shares of Rs. 10/- each held in SIPL,

Further advised reading: Understanding the Annual Report of a Company

In addition, apart from the investment in the equity shares of Whitefield Chemtech Private Ltd and Sierra Investments Limited, from FY2016, Paushak Ltd had invested in the equity shares of Nirayu as well as Shreno Limited.

On March 31, 2020, Paushak Ltd had an exposure of about ₹44 cr in the equity shares of promoter group entities including minor equity shareholding in Alembic Ltd and Alembic Pharmaceuticals Ltd. (valued at about ₹0.05 cr).

iii) Sale of properties by Paushak Ltd to promoter group entities:

As per the related party transactions disclosures of Paushak Ltd, it sold a land parcel to Alembic Ltd for ₹10.17 cr in FY2019 (Source: FY2019 annual report, page 77).

Next year, in FY2020, the company sold another land parcel to Alembic Pharmaceuticals Ltd for ₹2.43 cr.

Both these transactions are within the promoter group entities. In addition, the annual reports do not contain any details of an independent bidding process to sell the land parcels to independent third parties. Therefore, an investor needs to do her own due diligence in order to estimate whether these transactions are at fair value or not.

An investor may directly contact the company to know further details about these land parcels like their size, location etc. She may also seek details on whether any bidding for the land parcels was done by the company. These details would help the investor in doing an independent check for the valuation.

3) Promoters using funds of Paushak Ltd for holding their stake in the company:

An investor would notice from the above discussion that Paushak Ltd has given a significant amount of money to the promoter owned entities, which in turn hold a stake in Paushak Ltd.

An investor would appreciate that money is a fungible commodity. As a result, an investor may interpret these transactions like initially, the promoters invested money in Paushak Ltd in the form of equity shares. Later on, the promoters withdrew the money from Paushak Ltd in the form of investment by Paushak Ltd in the preference shares, equity shares or “Option Right of Immovable Property” in the promoter owned entities.

Moreover, an investor would notice that the investment by Paushak Ltd in the preference shares of promoter group entities is a continuous exercise. This may look like a case where the company has loaned out money to the promoters, which they had invested in the equity shares of Paushak Ltd in the form of promoter shareholding.

To understand more about the manner in which promoters use the funds of the public companies to increase their stake in these companies and to read many live examples of such instances, an investor may read the following article:

How Promoters use Loopholes to inflate their Shareholding

4) Remuneration to Mr. Udit Amin, son of Mr. Chirayu Amin:

From the above discussion on management succession, an investor would notice that both the promoters, the father and son, Mr. Chirayu Amin and his son, Mr. Udit Amin are in a non-executive position in the board of directors. A non-executive position means that the directors are not involved in the day-to-day activities of the company. Instead, the directors are involved in some other commitments full-time and are available to the company only on a limited basis, mainly around the board meetings.

However, when an investor notices that Mr. Udit Amin, the son of the chairman is taking more remuneration than his father Mr. Chirayu Amin as well as more money than the remuneration of the whole-time director and CEO, Mr. Abhijit Joshi, then the investor feels that the remuneration of Mr. Udit Amin might be higher than justified.

In FY2020, Mr. Udit Amin had the following remuneration when compared to the chairman and the CEO of the company (FY2020 annual report, page 82):

• Udit Amin, non-executive director: ₹1.25 cr
• Chirayu Amin, chairman: ₹0.007 cr
• Abhijit Joshi, WTD & CEO: ₹0.61 cr

In FY2019, Mr. Udit Amin had the following remuneration (FY2020 annual report, page 82):

• Udit Amin, non-executive director: ₹0.77 cr
• Chirayu Amin, chairman: ₹0.007 cr
• Abhijit Joshi, WTD & CEO: ₹0.56 cr

Therefore, an investor notices that the remuneration of Mr. Udit Amin who is associated as a non-executive director with the company is higher than his father who is the non-executive chairman as well as the whole-time director & CEO who is associated full-time with the company.

Moreover, the remuneration of Mr. Udit Amin increased by 62% in FY2020 to ₹1.25 cr from ₹0.77 cr in FY2019 where the net profit (PAT) of the company had declined by more than 10% in FY2020 to ₹35 cr from ₹39 cr in FY2019.

In light of the above factors, an investor may make her own judgment related to the remuneration of Mr. Udit Amin.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

5) Escalation in the cost of the capacity expansion project of Paushak Ltd:

While reading the credit rating report of the company by CRISIL in December 2018, an investor notices that the estimated cost of the capacity expansion project proposed by the company is about ₹120 cr.

Paushak is embarking on large capex of about Rs 120 crore to be executed over fiscals 2019-2021. The capex is largely towards expansion of existing capacities, including increasing phosgene capacity by upto three times.

However, when the investor reads the approval letter for the project from the Ministry of Environment, Forest and Climate Change in August 2018, then she notices that the company intimated to the ministry a project cost of ₹75.5 cr.

Approval letter (download here), page 3:

The estimated project cost is Rs.75.5 crores including existing investment of Rs.5.5 crores. Total estimated project cost is Rs.70 crores for expansion Project.

In light of the same, an investor notices that the company increased the cost of the project by about 60% from ₹75.5 cr in August 2018 to ₹120 cr in December 2018, within a duration of 3 months.

An investor may contact the company directly to seek clarifications about the reasons for the significant increase in the project cost over a period of 3 months.

6) Mismatch in the information in the annual report of Paushak Ltd:

While reading the annual reports of the company, an investor notices that at times, the company has given different data for the remuneration of its whole-time director (WTD) & CEO, Mr. Abhijit Joshi at different places in the annual report.

The FY2019 annual report mentions the following about the remuneration of WTD & CEO:

• Page 33: ₹56.33 lac
• Page 28: ₹48.70 lac

The FY2018 annual report mentions the following about the remuneration of WTD & CEO:

• Page 35: ₹52.48 lac
• Page 30: ₹47.33 lac

An investor may contact the company directly to understand the reasons for disclosing different remuneration of the WTD & CEO at different places of the annual reports.

In the FY2020 annual report, this error did not appear and the company disclosed the same remuneration data at different places in the annual report.

7) Sharp decline in the power & fuel costs of Paushak Ltd in FY2017:

While analysing the financial performance of the company for FY2017, an investor notices that during the year, the sales of the company declined to ₹72 cr from ₹78 cr in FY2016, a decline of about 8%.

However, while analysing the annual report of FY2017 at page 53, an investor notices that the power and fuel cost of the company declined by about 45% in FY2017 to ₹3.50 cr from ₹6.36 cr in FY2016.

Such a sharp decline of 45% in the power & fuel costs in the year when the sales have declined only by 10% comes as a surprise to the investor. We believe that an investor may contact the company directly to understand the reasons for the significantly large decline in the power & fuel costs in FY2017 when compared to the sales decline. An investor may ask whether the company received any cheaper source of power during the year or any one-time power subsidy or it was a typographical error while preparing the annual report (less likely).

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

The Margin of Safety in the market price of Paushak Ltd:

Currently (July 26, 2020), Paushak Ltd is available at a price to earnings (PE) ratio of about 27 based on earnings of FY2020. The PE ratio of 27 does not provide any margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, 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, 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, Paushak Ltd seems a company that has been growing at a fast pace of about 20% year on year in the past (FY2011-2020). The company has faced competition from low-cost imports from China as well as pricing pressure from other Indian manufacturers. The competitive environment has led to volatile profit margins of the company where the operating profit margin (OPM) has seen large fluctuations year on year. However, despite competition and the dependence on ever-changing crude oil prices, Paushak Ltd has witnessed a significantly high OPM of 25-30% over the years.

One reason for the high OPM of Paushak Ltd is the restriction imposed by the govt. on handling and processing of its basic raw material, phosgene. Phosgene is a hazardous material and getting approvals from the govt. for capacity expansion may take 4-5 years. These restrictions act as a barrier to entry for new manufacturers leading to high-profit margins for the existing players.

Because of high-profit margins, the company has been able to generate a lot of surplus cash after meeting its capital expenditure requirements over FY2011-2020. Paushak Ltd has used this cash to give payouts to the shareholders in the form of dividends and buyback. In addition, an investor notices that the company has given a significant amount of money to promoter-owned entities.

Paushak Ltd has invested significant money in the preference shares, equity shares and other exotic instruments issued by promoter owned entities. Continuously, at least since FY2008, the promoter owned entities have maintained the money taken by them from Paushak Ltd. The promoter owned entities have extended the maturity of preference shares when they are due for payment. At times, the promoters have repaid money from one company and then taken money in a different company. At other times, the promoter entities received money from Paushak Ltd by way of equity investments, part of which were later converted into preference shares.

An investor notices that over the years, there have been continuous transactions involving money transfers between Paushak Ltd and the promoter-owned entities. In addition, the company has sold two land parcels to the promoter group companies in the recent past.

Currently, apart from Mr. Chirayu Amin, his son, Mr. Udit Amin is also a part of the board of directors of the company indicating a management succession plan in action. However, Mr. Udit Amin despite being a non-executive director is taking a remuneration that is higher than his father, the chairman, and the whole-time director & CEO of the company.

Going ahead, an investor should keep a close watch on the profit margins of the company in the light of competition from cheaper imports and dependence on crude oil. In addition, an investor should closely watch developments related to relaxation in the restrictions on the handling of phosgene. This is because; any relaxation by the govt. in giving approvals for phosgene plants would significantly increase the competition for Paushak Ltd and bring down the high-profit margins.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Paushak 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

P.S.

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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.