Analysis: Associated Alcohols and Breweries Ltd

The current section of “Analysis” series covers Associated Alcohols and Breweries Ltd, an Indian distillery based in Madhya Pradesh dealing in country liquor, extra neutral alcohol, rectified spirit and Indian made foreign liquor (IMFL).

Associated Alcohols and Breweries Ltd produces foreign brands like Vat69, Black & White, Black Dog, Captain Morgan and Smirnoff etc under franchise arrangements, brands like Bagpiper Whisky, MC Dowell No. 1 Celebration Rum, White Mischief Vodka, Blue Riband Gin, and Director Special Black under license agreements. The company’s own brands include Central Province Superior Grain Whisky and Titanium Triple Distilled Vodka.

“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.

Associated Alcohols and Breweries Ltd Research Report by Reader

Dear Sir

I would like to submit my analysis of Associated Alcohols and Breweries Ltd (AABL) to you for inputs.

Thank You

Gurjeev Anand

Financial Analysis of Associated Alcohols and Breweries Ltd:

1) Sales:

Associated Alcohols and Breweries Ltd has grown its sales at a moderate pace of 14% cagr in the last 10 years. Sales have grown from ₹97 Cr in 2009 to ₹324 cr in 2018. Sales have further grown to ₹349 in trailing 4 quarters which shows that the trend of the growth to continue. The sales have grown more than 3x in the last 10 years with two drops in 2011 and 2016 by 16% and 4% respectively. The incremental in sales is attributed to IMFL sales because of the license agreement with USL.

India is the third largest liquor market with a potential retail size of 25 Billion $. The state of MP has witnessed steady growth in Country Liquor and IMFL from last 5 years. With an established position of AABL operations in MP, it is well positioned to cater to the growing demand of CL and IMFL in the state.

India has 5.1 liters of per capita consumption if liquor that is one of the lowest in the world, Asian average is 21 liters. This gives us a sense of the multifold opportunity for liquor consumption increment, which is there. In today’s time, the younger generations consume more and more. Today India has 30% population alcohol consuming.

Associated Alcohols and Breweries Ltd has exclusive license from USL in Madhya Pradesh. The focus of USL (largest liquor company) from mid segment to premium segment also creates the opportunity. Seeing these growth opportunities, the company expanded their existing capacities from 3 cr liters to 4.5 cr liters (an increment of 50% in 17-18) which they further plan to increase to 9 cr liters in the second phase by 2021.

The expected market size of ENA consumption is 27 cr liters in 2017 which is growing @ 6% and expected to go to 38 cr liters by 2023 (this gives a sense of the growing opportunity size). The

Associated Alcohols and Breweries Ltd has ventured out in Karnataka, Kerala, and New Delhi to increase their business operations and room for growth. AABL plans to be fully automatic production process driven by 2022.

2) Profitability:

Associated Alcohols and Breweries Ltd has been able to sustain a healthy operating profit margin (OPM) over the years. Not only it has been able to maintain the OPM; it has also managed to increase the same over the years. OPM has gone up from 6% to 16% over the last 10 years. This gives us a sense that Associated Alcohols and Breweries Ltd has some pricing power element in the business. As due to the cost of inflation the cost of production rises the company is able to pass on the increase to its customers. Not only pass on but also negotiate better rates and increase profitability. This is mainly because of the focus of sales of value-added IMFL brands.

The profitability of the business has steadily grown over the last 2-3 years because of increased sales and improved operating efficiency.

What we note here is in 2016 sales dropped by 4% but OPM increased. The operating profit in 2015 was ₹31 cr and instead of sales drop of ₹10 cr, the operating profit in 2016 was ₹39 cr. That gives a sense that even on a minor slow down the business was able to protect its margin and grow the same.

The NPM has followed a similar trend of increase over the years as the operating margins. NPM has increased from 1% in 2009 to 8% in 2018.

The contribution of IMFL sales grew from 9% of total operating income (TOI) in FY17 to 18% in H1FY18, owing to commencement of sales of IMFL in Karnataka through a manufacturing agreement with a local distillery.

In 2018, Associated Alcohols and Breweries Ltd has been able to save in power and fuel cost which could have resulted in increasing of margins. However, the company also had to bear with the added load of increase in royalty payment for their agreement with USL.

3) Taxation:

Associated Alcohols and Breweries Ltd is paying more tax as a percentage to PBT than what is standard prescribed of 30-33% as per rules. Since the government regulates the industry and imposes heavy taxes on the liquor industry this is a likely situation in the normal course of business. The government imposes several restrictions from time to time.

The industry is in the dilemma awaiting clarification from the state authority and central authority on levy of GST or VAT on the sale of Extra Neutral Alcohol (ENA)/ Rectified Spirit. In absence of any clarity in respect to levy of Goods & Service Tax (GST) on sale of Rectified spirit (RS) & Extra Neutral Alcohol (ENA), Associated Alcohols and Breweries Ltd continued to collect Value Added Tax (VAT) and Central Sales Tax (CST) for intrastate and interstate respectively on sale of these products

The management has withheld ₹1.97 Cr of Vat collected from the period of 1/July/17 until 31/March/18. They have stated in their communication to the shareholders that they would deposit the same with the authorities on clarification. Being late in depositing statuary dues is not a good sign.

3.1) Income Tax Search:

This being a sensitive issue the management has stated that they have cooperated with the authorities and they are hopeful that there would be no adverse information out from this that could have a material impact on the operations of their business.

4) Interest Coverage:

Associated Alcohols and Breweries Ltd has very comfortable interest coverage of 16 times. This is because the company is reducing its debt obligations to continuously from the last 5 years. Debt has reduced from ₹92 Cr to ₹21 Cr in the last 5 years. The continued repayment of debt has increased the interest coverage ratio of Associated Alcohols and Breweries Ltd to very comfortable levels.

5) Barriers to Entry:

The alcohol industry is highly regulated and to get a new license from the government, establish distribution, setting up a distillery is not an easy task.

Cash flow analysis of Associated Alcohols and Breweries Ltd:

The business was not consistent in generating cash flows until 2014 until where every alternate year they were cash negative at operating levels. From 2015 onwards, Associated Alcohols and Breweries Ltd is able to generate cash flows from operations until date.

The net cash generated (taking into account the cash negative years) over the last 10 years is ₹140 Cr whereas the net profit generated over the last 10 years is ₹85Cr. CFO significantly higher than PAT shows that Associated Alcohols and Breweries Ltd has managed its working capital well. It has been able to convert its profits to cash from its operations.

Out of ₹140 Cr generated in cash, Associated Alcohols and Breweries Ltd has spent ₹135 Cr as capex to grow its business that leaves only ₹5 Cr as free cash flow. This means that the business model of Associated Alcohols and Breweries Ltd is such that it needs investments in the business for the efficient functioning of the same. Any slowdown, delay in cash generations could affect the operations of the business and force the management to add on debt or dilute equity as the free cash generated from operations is very less as compared to the size of the operations of the company.

Out of the free cash flow of 5 Cr generated by Associated Alcohols and Breweries Ltd, it has distributed ₹4.97 as dividends (managers that do not generate free cash flow usually take debt to pay dividends and look smart on the street. It is good the manager has not done that, taken additional debt to give lucrative dividends.)

These dividends have been paid out in last 3 years as earlier the business of Associated Alcohols and Breweries Ltd was not generating free cash flow for the same (and it is sane for the promoters not to indulge in dividends payment in earlier years without the generation of free cash flow).

Operating efficiency analysis of Associated Alcohols and Breweries Ltd:

1) Fixed assets turnover:

Associated Alcohols and Breweries Ltd has been able to maintain its fixed asset turn around 3 from last 10 years. The asset turn dropped from 3.31 to 2.18 and again rose to 3.91. Associated Alcohols and Breweries Ltd has used 95% of the cash flow it generated into growing the business. Maintaining the fixed asset turn around quiet similar levels shows the efficiency of the management in running the business. This could also be a well-planned manner of investments into assets for their smooth functioning. It is usually seen that after investing in any new fixed asset, it takes time to start generating revenues immediately. In the last 2-3 years, the fixed asset turns are on a rising trend.

2) Receivable days of Associated Alcohols and Breweries Ltd

Associated Alcohols and Breweries Ltd was efficient enough to bring down its receivable days from as high as 54 down to 10 days. Again due to poor negotiating terms with its customers and loose controls by the management the receivable days have gone up to 21 (it has been decreasing from last 3-4 years).

3) Inventory turnover of Associated Alcohols and Breweries Ltd:

The company is good at rotating its inventory. The same has increased from 5.7 times to sub 10 times. This shows the management is quick in selling its finished goods to generate revenues for the business.

Peer analysis of Associated Alcohols and Breweries Ltd:

• Associated Alcohols and Breweries Ltd has been growing at 10% that is faster than the growth of the industry. ENA market in India has been growing at CAGR (2010-17) of 6% with the current production volume capacity at 3 billion liters (2017) and expected to reach until 4 billion liters by 2023.
• The operating margin of Associated Alcohols and Breweries Ltd is at 16%, which is better than the peers are. In fact, the trend of the OPM is rising over the years that means Associated Alcohols and Breweries Ltd is able to better negotiate their selling prices to cover the rising costs of raw material. Not only to cover but improve their margins. The company has shown better margins on NPM front also.
• Barring GM Breweries, which sells in cash the debtor days of Associated Alcohols and Breweries Ltd, is under 1 month, which is efficient in today’s tough business times.
• Associated Alcohols and Breweries Ltd is a smaller player as compared to the size of the operations as its peers. As per the management commentary, the company has increased its production capacity by 50 % to 4.5 cr liters which they plan to rise to 9 cr liters in the future. They are able to do it with internal accruals or opt for dilution/debt would give us the efficiency of the management in project execution/expansion skills.
• As the trend of the industry, the business operating in this segment are able to manage their working capital well. They are profitable and are able to convert their profits to cash (which does help the business to keep their debts under control to an extent)
• Associated Alcohols and Breweries Ltd has been able to create a value of ₹5.85 for every ₹1 it has retained in the business.

Debt to Equity and Debt Service analysis of Associated Alcohols and Breweries Ltd:

The management is paying off its debt from the last 3-4 years. As of March 2018, the debt of Associated Alcohols and Breweries Ltd is ₹21 Cr vs its equity of ₹121 C that is a debt to equity ratio of 0.2 times. The company has generated ₹39 cr of cash flow in 2018. Seeing those metrics, the debt can be paid off in 1 year from the cash flows.

Associated Alcohols and Breweries Ltd has pledged the fixed and current assets with the financial institutions for availing the loans / working capital loans.

Credit Rating Reports of Associated Alcohols and Breweries Ltd

Associated Alcohols and Breweries Ltd was awarded an exclusive license for 5 brands of USL for 3 years starting 2018. They have a good record of accomplishment of continuous growth in Country Liquor (55-60% of their revenue) from a long time. The increasing disposable income, a major percentage of the population in legal drinking age, increased penetration via distribution and reach, rise In consumption are few aspects which give us the sense for growth in the future for the business.

We should also not forget that Associated Alcohols and Breweries Ltd comes under a sin stock category. The working capital fund based limit usage of the business has come down which is a sign of improvement in the business dynamics.

Exclusive USL Licenses:

Associated Alcohols and Breweries Ltd has been awarded an exclusive license for bottling, branding, and selling for 5 IMFL brands of USL in lieu of royalty payment of ₹6.5 Cr to USL per year. This will able Associated Alcohols and Breweries Ltd to scale up its business and achieve greater profitability.

Risks:

The business of Associated Alcohols and Breweries Ltd has revenue concentration risks as its 55-60% of its revenue is from country liquor and from Madhya Pradesh. The business operates in an industry, which is highly regulated and comes under heavy tax pressure from the government. Maintaining the profitability in highly volatile raw material conditions could be tough going forward. The business has risk from sudden regulatory changes, ban in the state, steep increases in taxes and entry/exit restrictions from the state.

Income Tax authorities also conducted a search on the company premises on Nov 2017. That is a serious issue to take into consideration.

Raw Material:

Associated Alcohols and Breweries Ltd.’s main raw material is non-food grain with a high percentage of starch. Over the last 2 years, there has been a steep increase in the prices of food grains as they are dependent upon monsoon. Associated Alcohols and Breweries Ltd has been able to pair with these fluctuations, as it has been able to maintain multi-grain feedstock for manufacturing alcohol.

Management analysis Associated Alcohols and Breweries Ltd:

1) Management:

Associated Alcohols and Breweries Ltd is promoted by Anand Kedia and Prasaan Kedia family, which entered the liquor business about two decades ago. The Promoters hold a 58.5% stake in the company. No shares of the promoters are pledged. The company is the leading supplier of country liquor in Madhya Pradesh. There are 332 employs on the company’s payroll as of 31 March 2018.

2) CSR Spends:

Associated Alcohols and Breweries Ltd has only spend ₹12.05 lacs on CSR activities where they had to spend ₹47 lacs. The amount unspent on CSR is ₹34.98 lacs. It is necessary that the company should give proper details that why they are unable to spend the amount equal to 2% of their average profits of the last 3 years, which is a mandatory necessity.

Associated Alcohols and Breweries Ltd working in Madhya Pradesh has registered address of Kolkata.

3) Management remuneration of Associated Alcohols and Breweries Ltd

Management salary is ₹25.16 lac (WTD + Other Directors) which comes to 1% of the Net Profits of the business in 2018. That is a good sign that the managers are not only focused to fill their own pockets but also work for the flourishing the business.

4) Succession planning of Associated Alcohols and Breweries Ltd:

Presence of family members in the promoter pedigree ensures that the management is slowly grooming the next generation in due course of time over the years.

5) Related party transactions of Associated Alcohols and Breweries Ltd:

The remuneration to the related parties and the relatives of related parties is increasing. The remuneration from ₹7.23 Cr in 2016-17 has gone up to ₹9.46 Cr same way the relative’s remuneration has gone up from ₹95 lacs to ₹1.82 crore. One should grill the management and get to the roots for this remuneration.

Associated Alcohols and Breweries Ltd has also shown balance receivable from KMP of ₹3.26 cr. Why and for what purpose this amount is given. Is it interest-free loan?

6) Project execution skills:

Associated Alcohols and Breweries Ltd has recently expanded from 3 cr liters production capacity to 4.5 cr liters capacity. The further plan to increase this to 9 cr liters. The 1^st phase of 50 % expansion (3 cr to 4.5 cr that is an addition of 1.5 cr liters) has been completed. Since Associated Alcohols and Breweries Ltd been working on optimum capacity utilization, the further added capacity would lead to the growth in business operations. As per the management, they will go for the phase 2 of the expansion that is from 4.5 cr liters to 9.0 cr liters after they have fully stabilized and reached optimum capacity utilization of phase 1 of capacity enhancement.

7) Increase in Royalty Fee by USL:

Associated Alcohols and Breweries Ltd has to bear the burden of increased royalty fee by USL as per their agreement clauses.

8) Dividend Payout / Insider Activity:

Associated Alcohols and Breweries Ltd has been paying a dividend of 7% to 11% including the dividend tax. This is on the lesser side as the company plans to keep funds for the planned expansion it is going through. There has been no insider activity by the promoters / KMP in the last 2 years.

Thank You

Gurjeev Singh Anand

Dr Vijay Malik’s Response

Hi Gurjeev,

Thanks for sharing the analysis of Associated Alcohols and Breweries Ltd (AABL) with us! We appreciate the time & effort put in by you in the analysis.

While analyzing the past financial performance data of the company, an investor would notice that until FY2012, Associated Alcohols and Breweries Ltd used to disclose only standalone financials. However, since FY2013, the company started reporting both standalone as well as consolidated financials. This is because in FY2013, Associated Alcohols and Breweries Ltd formed a subsidiary, Vedant Energy Pvt. Ltd and as a result, it started reporting consolidated financials, which included the business performance of AABL as well as Vedant Energy Pvt. Ltd.

FY2013 annual report, page 36:

The company continued to report consolidated financials until FY2015. However, from FY2016 onwards, the company stopped reporting consolidated financials and reported only standalone financials. This is because, in FY2016, the company disposed of its investment in the subsidiary company, Vedant Energy Pvt. Ltd.

FY2016 annual report, page 13:

The continuation of investment in subsidiary M/s Vedant Energy Pvt. Ltd. was not relevant for the company, hence the company dispose of the shares of the subsidiary during financial year.

We believe that while analysing any company, the investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire group. Therefore, while analysing Associated Alcohols and Breweries Ltd, we have analysed standalone financials from FY2009-FY2012, consolidated financials from FY2013-FY2015 and standalone financials from FY2016 onwards until FY2019.

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

Financial and business analysis of Associated Alcohols and Breweries Ltd:

While analyzing the financials of Associated Alcohols and Breweries Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 15% year on year. Sales of the company increased from ₹97 cr. in FY2009 to ₹324 cr in FY2018. Further, the sales of the company have increased to ₹403 cr in FY2019.

While analysing the performance of the company in the past, an investor would notice that over the last 10 years, Associated Alcohols and Breweries Ltd has reported consistently improving operating profit margins (OPM). The OPM of the company has increased from 6% in FY2009 to 14% in FY2019. The net profit margin (NPM) of the company has also followed a similar trend. NPM has increased from 1% in FY2009 to 8% in FY2019.

The consistently increasing profit margins give an impression that Associated Alcohols and Breweries Ltd has a lot of pricing power over its customers and in turn, has the ability to pass on the increase in the cost of raw material to its customers. However, a deeper analysis of the company reflects a different picture.

While reading past annual reports and the credit rating reports of Associated Alcohols and Breweries Ltd, an investor notices that the company does not have any pricing power in its largest product segment, country liquor. State governments allot the licenses for country liquor and in turn, grant monopoly rights of selling country liquor to different companies in allotted districts at a price determined by the state govt. Once the state govt. fixes the selling price of country liquor, then the alcohol producers cannot increase the price even if the cost of their raw material increase.

The credit rating agency, CARE, has explained the position of limited pricing power of Associated Alcohols and Breweries Ltd in its credit rating report for the company in March 2019:

Volatility in input prices with limited pricing power: AABL’s main raw materials are non-food grade grains which contain higher percentage of starch. Production of food grains in India is dependent upon the vagaries of the monsoons and consequently the prices remain volatile. The food grain prices are also controlled by the Government through setting of minimum support prices. On the other hand, the main product of AABL, viz. CL, is supplied to the government at fixed rates. Hence, AABL’s production costs are vulnerable to the agricultural commodity price cycles.

The report illustrates that the main raw material used by Associated Alcohols and Breweries Ltd for producing alcohol is food grain. The production of food grain depends on monsoon and in turn, the production, as well as price of food grain, is highly volatile. However, the state government predetermines the price of country liquor. Country liquor producers like Associated Alcohols and Breweries Ltd do not get an increase in selling price when the prices of food grains increase.

Because of low pricing power, any increase in food grain prices affects the profit margins of the company adversely.

The same risk in the business model of the company is highlighted by another credit rating agency, CRISIL in its report for the company in March 2015, page 1:

These rating strengths are partially offset by the vulnerability of operating margins to fluctuations in raw material prices, and the company’s exposure to regulatory risks in the liquor segment.

Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

Associated Alcohols and Breweries Ltd has also acknowledged its limited pricing power due to stiff competition in the liquor industry in its FY2014 annual report, page 13:

Stiff competition in the market does have an impact on the product pricing policies and put the operating margins under pressure.

Similarly, in the FY2018 annual report, page 36:

THREATS: Agricultural prices: The liquor industry is heavily dependent on the agriculture industry for raw materials and any fluctuation on upper side in prices directly impacts the liquor industry.

When an investor analyses the impact of goods and services tax (GST) on the company, then she notices that the Associated Alcohols and Breweries Ltd believes that it will have to bear the 2-3% cost increase due to GST on its own. The company does not seem to be in a position to pass on this cost increase.

Investors’ presentation, December 2017, page 13:

Following the implementation of the GST, a cost increase of 2-3% is expected. However, AABL’s strong fundamentals, economies-of-scale and efficient backward integration should allow it to cushion the impact of the same.

Therefore, an investor would acknowledge that Associated Alcohols and Breweries Ltd does not have pricing power in its largest product segment of country liquor. However, she is surprised to see the significant increase in the profit margins of the company over the last 10 years. As a result, the investor would appreciate that the company must have taken certain steps to protect itself from the tough business situation of variable raw material prices and fixed selling prices.

While analyzing the past annual reports, an investor finds out that Associated Alcohols and Breweries Ltd undertook a few steps to strengthen its business model to protect itself from the low pricing power position in the country liquor segment.

1) Investment in the multi-grain processing facility:

In FY2017 annual report, Associated Alcohols and Breweries Ltd intimated its shareholders that the company has invested in a production facility, which can process different grains as raw material. This multi-grain processing facility provides the benefit of shifting from one food grain to another to produce alcohol whenever the prices of one food grain increase.

FY2017 annual report, page 27:

Multi-feed security: The AABL management selected to invest in equipment that would accommodate multi-grain feedstock as opposed to relying on molasses. This decision widened the company’s flexibility in being able to draw on diverse grain sources and moderate the impact of unforeseen cost increases by shifting from one grain source to another, particularly relevant in a business marked by a high raw material cost

As a result, Associated Alcohols and Breweries Ltd could protect its profit margins by controlling its raw material costs by using cheaper food grains to produce alcohol.

2) Focus on Indian made foreign liquor (IMFL):

Over the years, Associated Alcohols and Breweries Ltd has increased its focus on selling Indian made foreign liquor (IMFL), which has higher profits. The share of IMFL in the overall sales of the company has increased year on year and as a result, its profit margins have increased.

The credit rating agency, CARE, has highlighted this aspect of the business of Associated Alcohols and Breweries Ltd in its credit rating report of January 2018 when it upgraded the credit rating of the company from BBB+ to A-.

The revision in the ratings assigned to the bank facilities of Associated Alcohols and Breweries Limited (AABL) takes into account growth in the company’s scale of operations during FY17 (FY refers to the period April 01 to March 31) along with continuous improvement in profitability, mainly on the back of increased focus on sales of value added Indian Made Foreign Liquor (IMFL).

The company has also acknowledged in FY2018 annual report that the sale of premium liquor has led to the improvement of profit margins.

FY2018 annual report, page 11:

The increased share of premium products in the sales portfolio enhanced margins over steady merchant ENA sales.

Further advised reading: Understanding the Annual Report of a Company

Therefore, an investor would acknowledge that improving profit margins may give an impression that Associated Alcohols and Breweries Ltd has a lot of pricing power over its customers. However, in reality, the company does not have pricing power in its largest product segment of country liquor.

Despite the tough business environment of fluctuating raw material costs, fixed selling price, and intense competition, the company has been able to increase its profit margins because of a few key business decisions. The company could control its costs by switching to a multi-grain processing facility due to which it could use cheaper food grains to produce alcohol. In addition, the company increased focus on the sale of Indian made foreign liquor (IMFL), which provide higher profit margins. As a result, Associated Alcohols and Breweries Ltd witnessed its profit margins improve over the years.

It is advised that investors may compare the business dynamics of Associated Alcohols and Breweries Ltd with other alcoholic beverages companies whose analysis is present on our website:

• Analysis: Globus Spirits Ltd
• Analysis: GM Breweries Limited
• Analysis: SOM Distilleries & Breweries Ltd
• Analysis: India Glycols Ltd

Over the years, Associated Alcohols and Breweries Ltd had a tax payout ratio in line with the standard corporate tax rate prevalent in India.

Further advised reading: How to do Financial Analysis of Companies

Operating Efficiency Analysis of Associated Alcohols and Breweries Ltd:

a) Net fixed asset turnover (NFAT) of Associated Alcohols and Breweries Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Associated Alcohols and Breweries Ltd in the past years (FY2010-18), then she notices that the NFAT of the company declined during the initial period. The NFAT of the company declined from 3.31 in FY2010 to 2.17 in FY2013. The key reason for the decline in NFAT during this period was the investments done by the company to set up a PET bottle manufacturing plant in order to do backward integration as well as the expansion of manufacturing capacity.

FY2012 annual report, page 4:

During the year company has gone ahead for backward integration by setting up PET bottle manufacturing unit at the adjacent to it’s distillery complex. The company has chalked out an ambitious plan for expansion cum modernization of the distillery unit.

FY2013 annual report, page 6:

The expansion cum modernization project of the distillery unit undertaken by the Company is on the verge of completion

An investor would appreciate that whenever any company undertakes an expansion plan, then it might take some time for the newly added capacity to reach optimal utilization level. As a result, for the initial period, the company witnesses lower NFAT. The NFAT improves over the years, as the utilization level of the newly added capacity increases.

In the case of Associated Alcohols and Breweries Ltd, the NFAT started improving after the expansion plan was complete. NFAT increased from 2.17 in FY2013 to 3.91 in FY2018 as the utilization level of the manufacturing capacity increased to an optimal level. In December 2017, Associated Alcohols and Breweries Ltd informed its shareholders that it has been using its manufacturing capacity at full utilization levels for the last three years.

Investors’ presentation, December 2017, page 16:

Achieved 100% capacity utilisation in the last three years.

An investor would appreciate that as Associated Alcohols and Breweries Ltd was using its plant at full utilization level since last few years, therefore, it has started its next stage of capacity expansion. The company intends to increase its distillation capacity from existing 31 million liters per annum to 90 million liters per annum by FY2021.

FY2018 annual report, page 3:

In view of this, your Company embarked on a decisive extra neutral alcohol capacity expansion programme: from 31 million litres in 2017 to 45 million litres in 2018 in the first phase and to 90 million litres per annum in the second phase by 2021

As per March 2019 credit rating report of the company prepared by credit rating agency, CARE, Associated Alcohols and Breweries Ltd completed its first phase of capacity expansion in October 2018.

Credit rating report, CARE, March 2019, page 2:

AABL increased its production capacity from 314 LLPA to 450 LLPA at a total cost of Rs.26.54 crore, funded through a term debt of 10 crore and balance through internal accruals. The project was completed within envisaged cost and time parameters and commenced commercial operations from October 2018.

An investor would appreciate that due to recent capacity addition, Associated Alcohols and Breweries Ltd may witness its NFAT levels decline a bit in coming years. However, if the company is able to utilize the newly added capacity to optimal levels, then it will witness its NFAT level increase to higher levels.

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

b) Inventory turnover ratio of Associated Alcohols and Breweries Ltd:

An investor would note that over the years, the inventory turnover ratios (ITR) of the Associated Alcohols and Breweries Ltd has increased over the years. The ITR has increased from 5.4 in FY2010 to 9.7 in FY2018.

An increasing ITR indicates that Associated Alcohols and Breweries Ltd has been able to manage its inventory efficiently over the years.

From the discussion on the profitability of the company above, an investor would notice that Associated Alcohols and Breweries Ltd controlled its raw material costs by investing in multi food grain processing ability, which could use cheaper food grains to produce alcohol. Such initiatives of the company might have contributed to efficient inventory utilization by the company and as a result, the inventory turnover has improved over the years.

Advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of Associated Alcohols and Breweries Ltd:

An investor would notice that over the years, Associated Alcohols and Breweries Ltd has kept its receivables days under control. Receivables days have improved from 54 days in FY2010 to 21 days in FY2018, which is a good improvement despite increasing business.

An investor would also notice that the receivables days of the company witnessed sharp improvement during the initial period when it declined from 54 days in FY2010 to 10 days in FY2015. Even though the receivables days have increased in FY2016-2018, still, the level of receivables days seems under control. An investor should keep a close watch on the trend of receivables days going ahead.

Further Advised Reading: Receivable Days: A Complete Guide

When an investor looks at the inventory and receivables level of Associated Alcohols and Breweries Ltd, then she realizes that the company managed its inventory and receivables efficiently. As a result, the working capital of the company has not consumed a lot of cash.

This aspect of the business of Associated Alcohols and Breweries Ltd get established when an investor compares the cumulative net profit after tax (cPAT) of the company with the cumulative cash flow from operations (cCFO) for FY2010-18. She notices that the company has been able to convert its profits into cash flow from operations.

Over FY2010-18, Associated Alcohols and Breweries Ltd has reported a total cumulative net profit after tax (cPAT) of ₹85 cr. whereas during the same period, it reported cumulative cash flow from operations (cCFO) of ₹140 cr.

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

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

Margin of Safety in the Business of Associated Alcohols and Breweries Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Further advised reading: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

While analysing the SSGR of Associated Alcohols and Breweries Ltd, an investor would notice that the company has consistently had a low SSGR (-3% to 7%) over the years. However, the company has been growing at a rate of 15% over the years.

The sales growth achieved by Associated Alcohols and Breweries Ltd over the years is higher than its SSGR. Therefore, investors would expect that the company would have to raise debt from additional sources to fund its growth. However, in the case of Associated Alcohols and Breweries Ltd, the company has kept its debt levels under control. The company has reduced its debt from ₹23 cr in FY2009 to ₹21 cr in FY2018.

While reading the SSGR article shared above, the investor would notice that we have highlighted a situation (Case C), where companies that have SSGR less than the current growth rate but still manage to reduce debt over the years. In such cases, efficient working capital management ensures that the company has a significant amount of CFO, which is not stuck in the working capital needs of the company. As a result, the cash is available from the internal sources for the capital expenditure needed for growth and reduce debt.

An investor is able to observe this aspect of the company’s business when she analyses the cumulative cash flow position including free cash flow for the company over the last 10 years (FY2009-18).

b) Free Cash Flow Analysis of Associated Alcohols and Breweries Ltd:

While looking at the cash flow performance of Associated Alcohols and Breweries Ltd, an investor notices that during FY2009-18, the company had a cumulative cash flow from operations of ₹140 cr. However, during this period it did a capital expenditure (capex) of ₹135 cr. As a result, it had a free cash flow of ₹5 cr. (140 – 135).

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

The presence of free cash flow indicates that the Associated Alcohols and Breweries Ltd has been able to meet all its capital expenditure requirements from its cash flow from operations. As a result, the company could expand its production capacity and simultaneously reduce its debt over the last 10 years.

Free cash flow (FCF) is one of the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Additional aspects of Associated Alcohols and Breweries Ltd:

On analysing Associated Alcohols and Breweries Ltd, an investor comes across certain other aspects of the company:

1) Project execution skills:

While analyzing the capacity expansion project of Associated Alcohols and Breweries Ltd, an investor gets to know in the credit rating report by CARE that the company completed the expansion project within predicted time and estimated cost. This is good because many times delays in project completion leads to significant cost increases as well as lost revenue opportunities.

Credit rating report by CARE, March 2019, page 2:

AABL increased its production capacity from 314 LLPA to 450 LLPA at a total cost of Rs.26.54 crore, funded through a term debt of 10 crore and balance through internal accruals. The project was completed within envisaged cost and time parameters and commenced commercial operations from October 2018.

2) Alleged unaccounted cash, black money, shell companies, money laundering, an income tax raid and allegedly missing promoters:

While searching about the company, an investor comes across information about a search operation conducted by income tax authorities in November 2017 at 40 locations of Kedia group in 12 cities of six states. (Indore: Kedia group owners go ‘missing’ after I-T raids. Source: Freepressjournal)

The following are the key highlights of the article:

• Authorities seized ₹5 crore cash and documents of 350-acre land
• The team also traced more than 24 shell companies of the group during the action on Wednesday, which primarily used to launder money
• The company had deposited ₹13.5 crore during the period of demonetization
• The company had declared black money worth ₹1 crore under Pradhan Mantri Garib Kalyan Yojna.

While reading the FY2017 annual report, which contains the details of deposit of demonetized currency notes by companies in their bank accounts, an investor gets to know the background to this income tax raid.

FY2017 annual report, page 91:

The company has deposited cash amounting to ₹ 1360.21 Lakhs, mainly consisting of cash sales collections and other receipts, in its bank accounts during 9th November 2016 to 30th December 2016. During the course of enquiry of such deposits by Income-tax authorities, the company was unable to furnish confirmations to the satisfaction of the Income-tax authorities for a sum of ₹ 100 Lakhs. Therefore, in the month of March 2017, in order to avoid harsher tax consequences and unwarranted future litigation, the company has declared a sum of ₹ 100 Lakhs, received in part payment of ‘Other Receivables’ and deposited in bank account, as undisclosed income under the Pradhan Mantri Garib Kalyan Yojana, 2016 (PMGKY 2016) and paid applicable tax, surcharge & penalty aggregating to ₹ 49.90 Lakhs. As required under the PMGKY 2016, the company has made a deposit of ₹ 25 Lakhs in the Bond Ledger Account maintained with Reserve Bank of India in respect of Pradhan Mantri Garib Kalyan Deposit Scheme, 2016

In the above disclosure, Associated Alcohols and Breweries Ltd accepts that it could not provide a satisfactory explanation to the authorities for part of the cash money deposited by it during demonetization. Therefore, the company decided to disclose this amount under undisclosed income (black money) in the Pradhan Mantri Garib Kalyan Yojana, 2016.

The above disclosure by the company in the FY2017 annual report and the data points used in the article in Freepressjournal corroborate with each other.

Investors may track the developments related to this income tax raid for the search operation and further proceedings and decide accordingly.

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

3) A curious case of role of promoter family members in Associated Alcohols and Breweries Ltd:

While analyzing the annual reports of the company, an investor gets to know that two members of the promoters’ family, Mr. Anand Kumar Kedia, and Mr. Prasann Kumar Kedia are acting at positions of Chairman and Vice-Chairman in the company.

FY2018 annual report, page 2:

Mr. Anand Kumar Kedia and Mr. Prasann Kumar Kedia are the key promoters of the Company.

Mr. Anand Kumar Kedia, Chairman – Business Promotion & Development, possesses a rich sectoral experience across almost three decades. He spearheads the strategic initiatives of the Company.

Mr. Prasann Kumar Kedia, Vice Chairman – Operation & Business Development, has been involved with the Company for more than two decades and oversees day-to-day operations.

However, when the investor analyses further then she notices a few peculiarities in the manner in which the company has dealt with the disclosures of their positions within the company.

a) Names of Chairman and Vice-Chairman (promoter family members) not shown as a part of the board of directors:

While looking at the annual reports of the company, an investor notices that Associated Alcohols and Breweries Ltd has not included the names of Mr Anand Kedia and Mr. Prasann Kedia as a part of details of the board of directors of the company.

FY2018 annual report, page 73:

BOARD OF DIRECTORS
Mr. Tushar Bhandari, Whole Time Director
Mr. Nitin Tibrewal, Independent Director
Mr. Manish Kumar Tibrewal, Non Independent Director
Mrs. Abhijit Nagee, Independent Director

An investor would notice that the names of Mr Anand Kedia and Mr. Prasann Kedia are not included in the members of the board of directors. Their names are not included even in the disclosures of the attendance in the meetings of the board of directors.

FY2018 annual report, page 36:

The above disclosures seem to indicate that the positions of Mr Anand Kedia and Mr Prasann Kedia namely Chairman and Vice-Chairman are not indicative of their roles in the board of directors. Instead, their designations of Chairman – Business Promotion & Development and Vice Chairman – Operation & Business Development may represent the positions within the functional departments of the company instead of the board of directors of the company.

FY2018 annual report, page 2:

Mr. Anand Kumar Kedia and Mr. Prasann Kumar Kedia are the key promoters of the Company.

Mr. Anand Kumar Kedia, Chairman – Business Promotion & Development, possesses a rich sectoral experience across almost three decades. He spearheads the strategic initiatives of the Company.

Mr. Prasann Kumar Kedia, Vice Chairman – Operation & Business Development, has been involved with the Company for more than two decades and oversees day-to-day operations.

In case, it is true that the promoter family members, Mr Anand Kedia, and Mr Prasann Kedia have decided to stay as a part of the management team of the company and not the members of the board, then it may seem perfectly fine. However, it poses other challenges.

b) Remuneration of highest paid employees of the company (promoter family members) avoids approval of shareholders:

While analyzing the remuneration of key management personnel including the directors of Associated Alcohols and Breweries Ltd, an investor gets to know that the two promoter family members, Mr Anand Kedia, and Mr Prasann Kedia, take the highest remuneration from the company.

In FY2018, Mr Anand Kedia and Mr Prasann Kedia have taken a remuneration total remuneration of ₹8.88 cr from the company (₹4.44 cr. each).

FY2018 annual report, page 55:

Mr. Anand Kumar Kedia, 53, Post Graduate in Commerce, Chairman – Business Promotion & Development, 01/04/1990, 28 years, ₹444.32 Lakh, Mr. Prasann Kumar Kedia, 46, MBA, Vice Chairman – Operation & Business Development, 01/04/1994 , 24 years, ₹444.32 Lakh.

If an investor considers this remuneration in comparison with the net profits of the company for FY2018 (₹25 cr), then she notices that the members of the promoter family have taken home a salary, which is more than 35% of the PAT (8.88/25 = 35.5%)

An investor would appreciate most of the times; the promoters of the company are a part of the board of directors of the company. As a result, their remuneration has to be approved by the shareholders of the company. In case, shareholders believe that the promoters are taking very high remuneration, then they may vote against such a proposal.

In the recent past, shareholders protested the very high remuneration of promoters of Apollo Tyres Ltd by rejecting the proposal of reappointment of managing director, who is a member of the promoter family.

Shareholders reject re-appointment of Apollo Tyres MD (Source: Economic Times)

As per the article, the MD was drawing very high salary despite declining profits of the company.

Kanwar took home an annual compensation of ₹42.8 crore in 2017, a 43% hike over his take-home of ₹30 crore in 2016. Apollo’s annual standalone net profit in 2017 was ₹622.4 crore, a decline of 23% over last year. Annual consolidated net profit also declined by 34% at ₹724 crore.

Because of the defeat of the proposal, the promoters of Apollo Tyres Ltd took a 30% reduction in their salaries.

Apollo Tyres’ Onkar, Neeraj Kanwar agree to 30% salary cut (Source Livemint)

Therefore, an investor would appreciate that when promoters are a part of the board of directors, then their appointment to the board along with their remuneration has to be approved by the shareholders. If the shareholders believe that the promoters are taking very high salaries, then they may vote against it.

In the case of remunerations of Mr Anand Kedia and Mr Prasann Kedia, an investor would notice that it has been in the range of 35-50% of the net profits of Associated Alcohols and Breweries Ltd.

However, in the case of Mr Anand Kedia and Mr Prasann Kedia, Associated Alcohols and Breweries Ltd has not put their appointment and remuneration to the shareholders for approval at least since FY2010.

(Please note that only the annual reports of the company from 2010 are available in public domain. We are not sure whether shareholders before FY2010 approved their remunerations as those annual reports are not available in the public domain.)

Therefore, the investor would notice that in the case of promoters of Associated Alcohols and Breweries Ltd, the company has paid about ₹28 cr to Mr Anand Kedia and Mr Prasann Kedia in remuneration since FY2015-2018. However, the shareholders of the company did not have an opportunity to express their opinion about their remunerations.

(Please note that the annual reports before FY2015 do not disclose the remunerations of Mr Anand Kedia and Mr Prasann Kedia and the annual report for FY2019 has not yet shared by the company on its website.)

Further advised reading: How to identify Promoters extracting Money via High Salaries

c) Remuneration of promoter family members and the limit put by Companies Act 2013:

An investor would appreciate that Companies Act puts a maximum limit of 11% of net profits on the remuneration of directors of the companies. In case, any company wishes to pay higher remuneration to its directors, then apart from shareholders’ approval, the company needs to take approval from the central government as well.

In most of the cases, the promoters of the company are also a part of the board of the directors of the company. Therefore, their remuneration proposals are put to vote by the shareholders. If the remuneration proposed by the company is high and the shareholders approve it, then the company needs to take central govt. approval for the same.

However, in cases like Associated Alcohols and Breweries Ltd, where the promoters do not seem to be a part of the board of directors, then we are not sure whether the statutory limit on the remunerations and the central govt. approval is applicable to their salaries. Moreover, it is not clear whether Associated Alcohols and Breweries Ltd has taken such approval from central govt.

Investors may approach the company to seek clarification about the applicability of shareholders and central govt.’s approval to the remuneration of Mr Anand Kedia and Mr Prasann Kedia. For any further guidance, investors may consult any lawyer/chartered accountant/counsel specializing in Companies Act. 2013.

Investors may note that the statutory ceiling of 11% of net profits put on the remuneration of directors of the companies by the Companies Act, stipulates the calculation of net profits as per section 197 of the act. The broad adjustments to the PAT, which approximate it close the net profit as per the section 197 are mainly: income tax and the remuneration of the directors though there are many other adjustments need for exact calculations.

However, from our assessment purpose, we believe that the investors should compare the managerial remuneration with the net profit after tax (PAT). We have seen that most of the times the promoter directors take remuneration of about 2-4% of the profits, which includes the commission of about 2% of the profits and the rest being salary and other components.

Further advised reading: How to identify Promoters extracting Money via High Salaries

4) Using resources of Associated Alcohols and Breweries Ltd for supporting multiple promoter group companies:

While analyzing the annual reports of the company, an investor notices that Associated Alcohols and Breweries Ltd is supporting many companies by making investments in them, giving them loans, giving corporate guarantees to their bankers for the loans taken by them etc.

FY2018 annual report, page 136:

The above table details the names of different companies, which are benefiting using the resources of Associated Alcohols and Breweries Ltd by way of loans, investments, guarantees etc.

An investor would notice that the largest amount of support has been provided to Mount Everest Breweries Limited (MEBL). Associated Alcohols and Breweries Ltd has provided monetary support of more than ₹12 cr including investment and loans and guarantee to its bankers for ₹52 cr. An investor should note that in case of a corporate guarantee, the bank gives loan to the recipient by taking the comfort of repayment from the guarantee provider. In case, the recipient of the loan (MEBL in this case) is not able to pay the principal or interest, then the bank will force Associated Alcohols and Breweries Ltd to make payments on behalf of MEBL.

This obligation of Associated Alcohols and Breweries Ltd to repay loans of MEBL becomes further clear when an investor read the credit rating report of MEBL prepared by credit rating agency, CARE in March 2019. In the credit rating report, CARE clearly highlights that it has taken the entire credit comfort on the corporate guarantor to the extent that the entire credit rating report provides a description of only the corporate guarantor (Associated Alcohols and Breweries Ltd). CARE has summed up its analysis process of MEBL in its report as below:

Analytical approach: Credit enhancement by way of corporate guarantee of AABL for the bank facilities of MEBL. The guarantor’s standalone financials are considered for analysis.

Therefore, when an investor reads the credit rating report of MEBL, then she realizes that for all practical purposes, the entire responsibility for the repayment of this loan seems to be on Associated Alcohols and Breweries Ltd.

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

While analyzing the relationship of Associated Alcohols and Breweries Ltd and MEBL, an investor comes across certain other aspects.

5) Non-disclosure of the promoter group entity (MEBL) in the related parties section of the annual report:

While reading past annual reports of Associated Alcohols and Breweries Ltd, an investor notices that the investment by the company in MEBL goes back to FY2010 when it invested ₹2 cr for in MEBL.

FY2010 annual report, page 16:

In FY2010 annual report, Associated Alcohols and Breweries Ltd reported MEBL as a related party over which the key management personnel have significant influence.

FY2010 annual report, page 22:

However, from FY2011 onwards, Associated Alcohols and Breweries Ltd stopped reporting MEBL as a related party. For example, let us see the related parties’ disclosures in the following annual reports.

FY2011 annual report, page 33:

FY2015 annual report, page 46:

FY2018 annual report, page 120:

It might be a case where the ownership or directorship structure of MEBL has undergone such a change after FY2010 that Associated Alcohols and Breweries Ltd no longer needs to include its name in the table of related parties. However, when an investor reads the credit rating report of MEBL prepared by CARE in March 2019, then she notices that CARE has described MEBL as a Kedia group company.

Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

Therefore, it seems that MEBL is a part of the promoter group. However, Associated Alcohols and Breweries Ltd has not disclosed it under related parties.

Looking at the above section of CARE rating rationale, an investor may also note that in FY2017 and FY2018, MEBL reported a net profit of ₹1.30 cr and ₹2.36 cr respectively. Looking at such lower levels of net profits, an investor would note that the loan of ₹52 cr, which is guaranteed by Associated Alcohols and Breweries Ltd, seems a very large loan.

An investor may seek clarifications from the company about the classification of MEBL as a related party. Going ahead, investors should keep a close watch on the additional investments, loans, and guarantees made by Associated Alcohols and Breweries Ltd in MEBL, as they may be a way to support the large loan repayment of MEBL.

This is essential because many times, such arrangements result in shifting of economic benefits from the public shareholders of listed companies to the shareholders of investee/beneficiary/promoter group companies.

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

6) Curious case of investments in subsidiary company, Vedant Energy Pvt. Ltd.:

As discussed above, an investor would remember that Associated Alcohols and Breweries Ltd created a subsidiary company Vedant Energy Pvt. Ltd (VEPL) in FY2013 and disposed of it in FY2016. As a result, the company reported consolidated financials for the period FY2013 to FY2015.

When an investor analyses VEPL, then she comes across the following aspects.

a) Associated Alcohols and Breweries Ltd gets only 50.71% stake in Vedant Energy Pvt. Ltd despite making more than 90% share of investment:

While reading FY2013 annual report, the year in which the subsidiary company VEPL was formed, an investor gets to know the details of the investments done by Associated Alcohols and Breweries Ltd in the subsidiary company.

As per the disclosures, Associated Alcohols and Breweries Ltd invested an amount of ₹1.36 cr in the shares of VEPL.

FY2013 annual report, page 37:

While looking at the total capital structure of VEPL, the investor notices that the total equity owned by VEPL is ₹1.49 cr, which is held as ₹0.27 cr as share capital and ₹1.22 cr as reserves. (1.49 = 0.27 + 1.22).

FY2013 annual report, page 68:

Therefore, when an investor notices that Associated Alcohols and Breweries Ltd had invested ₹1.36 cr in a company with total equity of ₹1.49 cr., then she realizes that the total investment done by Associated Alcohols and Breweries Ltd is 91% of the capital of VEPL (1.36/1.49 = 91.3%).

However, she is surprised to note that Associated Alcohols and Breweries Ltd has got only 50.71% share in the VEPL despite making 91% share of investment.

FY2013 annual report, page 68:

Investors may seek clarification from Associated Alcohols and Breweries Ltd about the reasons for getting only 50.71% stake in VEPL despite making 91% share of investments. Moreover, investors may do further due diligence to know about the other investors in VEPL who received almost 49% of the equity stake by making only about 9% share of investments.

This is because such an investment and capital structure lead to a situation where the other counterparty/shareholder enjoys 49% economic benefit by committing only 9% of the capital. This may effectively look like a case where the other shareholder is benefiting at the cost of shareholders of Associated Alcohols and Breweries Ltd.

Further advised reading: How to Identify if Management is Misallocating Capital

b) Subsidiary company, VEPL, used primarily to make investments in other companies, which finally led to losses:

While analyzing the financial performance of the subsidiary company, VEPL, an investor gets to know that it had used its entire capital to make investments instead of creating operating fixed assets.

FY2015 annual report, page 70:

Looking at the above table an investor notices that VEPL had used almost its entire capital to make investments instead of fixed assets. Investments form more than 98% of the total assets of VEPL (146.15/148.55 = 98.4%).

Moreover, when Associated Alcohols and Breweries Ltd disposed of its subsidiary company, VEPL, in FY2016, then it recognized a loss of ₹0.6 cr in its profit & loss statement for sale of investments, which could be the loss upon disposal of VEPL.

FY2016 annual report, page 56:

Investors may seek clarifications from the company about the requirements for establishing a separate company to make investments and the reasons for losses on the investments.

Further advised reading: How should investors contact Companies/Management for clarifications or additional information?

7) Noncompliance with statutory guidelines and regulatory requirements:

When an investor analyses the past annual reports of Associated Alcohols and Breweries Ltd, then she notices that in multiple instances in the past, the company did not comply with the regulatory requirements. Many times, the auditors have pointed out these instances of non-compliances. Let us look at some of these instances.

a) Lack of internal controls and internal audit system for a long time:

The past annual reports indicate that Associated Alcohols and Breweries Ltd did not have proper internal controls as well as appropriate internal audit system until FY2014.

FY2010 annual report, page 10-11:

FY2013 annual report, page 23:

In our opinion and according to the information and explanations given to us, there are no adequate internal control procedures commensurate with the size of the company and the nature of its business with regard to purchases of inventory, fixed assets and with regard to the sale of goods. As there are not adequate internal control, we are unable to comment on weakness in internal control.

The Company has no internal audit system. It needs to be implemented and to make it commensurate with the size and nature of the company’s business.

An investor would appreciate that in a situation of lack of internal control processes and the audit system, the record keeping of the company suffers, and the chances of misrepresentation of the financial information increase.

In case of Associated Alcohols and Breweries Ltd, the auditors have pointed out that until FY2013; the company was not maintaining a proper record of its fixed assets.

FY2012 annual report, page 15:

The Company has not maintained proper records of fixed assets to show full particulars including quantitative details and situation of fixed assets.

Similarly, auditors have pointed out that the company needs to improve its record keeping of inventory. FY2012 annual report, page 15:

The records of inventory maintained by the company need to be improved with respect to timeliness of entries and adjustments, location and reconciliation of stock at third party location and the priced store ledger.

Further advised reading: Understanding the Annual Report of a Company

An investor would acknowledge that the lack of controls and audit process leads to deteriorating confidence of reliability on the reported data of fixed assets, inventory, and other financial information.

In light of the history of lack of controls and processes, it does not come as a surprise to the investor that the company ended up having excess cash with itself that it could not explain to income tax authorities and it had to report the cash as undisclosed income (black money) in FY2017.

b) Publishing results without auditors’ opinion. Audit committee meetings without statutory auditor:

In FY2013 annual report, the auditor of Associated Alcohols and Breweries Ltd pointed out that the company had published its quarterly results without the mandatory limited review of the auditor. The auditor also pointed out that the company has conducted its audit committee meetings without the participation of the auditor.

FY2013 annual report, page 19:

In our opinion and to the best of our information and according to the explanations given to us, and the representations made by the directors and the management, we certify that subject to our observations that (i) quarterly financial results of the Company were considered and published without having them limited reviewed by the auditors and (ii) meeting of audit committee held without auditors participation, the Company has complied with the conditions of Corporate Governance as stipulated in the above-mentioned Listing Agreement.

c) Delays in deposit of undisputed statutory dues/taxes etc.:

Auditors of Associated Alcohols and Breweries Ltd have pointed out multiple instances where the company delayed depositing its tax liabilities, which were not under any dispute. E.g. In FY2012, the company delayed in depositing excise duty, income tax, wealth tax and fringe benefit tax for more than six months.

FY2012 annual report, page 16:

According to the information and explanations given to us, no undisputed amounts payable in respect of the aforesaid dues were outstanding as at 31st March, 2012 for a period of more than six months from the date of becoming payable except for Excise Duty amounting to Rs. 1.75 lacs, Income Tax of Rs. 6.72 Lacs, Wealth Tax of Rs. 0.42 Lacs and Fringe Benefit Tax of Rs. 1.01 Lacs. However the same have since been deposited

In FY2015, the company did not transfer the unpaid dividends in the Investor Education and Protection Fund and delayed the deposit of undisputed entry tax and service tax for more than six months.

FY2015 annual report, page 30:

The Company has not transferred the amount of ₹ 1,05,251/- required to be transferred to investor education and protection fund in accordance with the relevant provisions of the Companies Act, 1956 (1 of 1956) and rules made thereunder.

FY2015 annual report, page 29:

According to the information and explanations given to us, no undisputed amounts payable in respect of the aforesaid dues were outstanding as at 31st March, 2015 for a period of more than six months from the date of becoming payable except for Service Tax of ₹ 2,773/- and Entry Tax of ₹ 11,51,270/-

It seems that the company has not been able to regularize its process of complying with statutory requirements until now. In FY2018 as well, the company delayed the deposit of undisputed liability of value-added tax for more than six months after it became due.

FY2018 annual report, page 80:

According to information and explanations given to us, no undisputed amounts payable in respect of provident fund, employees’ state insurance, income tax, service tax, sales tax, duty of customs, duty of excise, value added tax, goods and services tax, cess and other statutory dues were outstanding at the year end , for a period of more than six months from the date they become payable except non Deposit of VAT on sale of Rectified Spirit and ENA  amounting to ₹ 50.54 Lacs.

d) Delays in spending money under corporate social responsibility (CSR):

An investor notices that the company has delayed spending money under CSR for many years altogether. In one such instance, it did not spend any money on CSR for three continuous years FY2015-2017).

FY2017 annual report, page 97:

8) Classification of payment of interest under cash flow from operating activity instead of cash flow from financing activity:

While analyzing the cash flow statements of Associated Alcohols and Breweries Ltd, an investor notices that over the years, the company had classified interest payments as a cash outflow under cash flow from operations (CFO). The investor would note that the usual practice is to classify interest payments as a cash outflow under cash flow from financing (CFF).

FY2011 annual report, page 39:

Associated Alcohols and Breweries Ltd continued this practice of classifying interest payments as a cash outflow under CFO until FY2017.

FY2017 annual report, page 82:

First time in FY2018, the company stopped this practice and correctly classified the interest payments as a cash outflow under cash flow from financing instead of CFO.

The changing methods of classification of interest payments under the cash flow statement add to the previous observations that Associated Alcohols and Breweries Ltd has been interpreting regulatory guidelines differently.

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

9) Fluctuating production capacity of Associated Alcohols and Breweries Ltd:

As per the discussion above, an investor would remember that Associated Alcohols and Breweries Ltd has commenced a capacity expansion program from FY2018 in which plans to increase its production capacity from existing 31.4 million liters per annum to 90 million liters per annum by FY2021 in two phases. As a part of this expansion program, the first phase of expansion of capacity from 31.4 million liters to 45 million liters per annum was completed in October 2018.

FY2018 annual report, page 51:

The company’s much awaited capacity expansion project of the first phase of expansion is on the verge of completion and the existing capacity will be increased from 31.4 Million Bulk Liters per annum to 45 Million Bulk Liters per annum. As the company has been operating at optimum capacity from the last 3 years the additional capacity will increase the market base of the products of the company. The second phase of capacity expansion from 45 Million Bulk Liters to 90 Million Bulk Liters will be commencing upon the stabilization of the production in due course.

The above discussion indicates that before the start of the current expansion plan, Associated Alcohols and Breweries Ltd had a production capacity of 31.4 million liters per annum. However, when an investor reads the past annual reports of the company, then she gets to know that the company had a production capacity of 42 million liters per annum in FY2010.

FY2011 annual report, page 37:

Investors may contact the company to get clarification about the implied reduction in production capacity from 42.0 million liters per annum in FY2011 to 31.4 million liters per annum in FY2018.

10) Risk of losing allotted districts where Associated Alcohols and Breweries Ltd has a monopoly for country liquor:

The company has communicated to the shareholders that the country liquor producers enjoy a monopoly position in the allotted districts.

FY2018 annual report, page 39:

The company observed steady volume growth in the category, the Company continues to enjoy the monopoly over the allotted districts. This business mainly composes of cash & convey. However geographical boundary is the limitation in this category.

Such a situation leads to a belief about assured production and sales in the investors. However, investors should always be aware that the licenses for sale of country liquor are allotted/renewed at regular intervals and there is no guarantee that existing license holders will always get their licenses renewed.

Over the years, Associated Alcohols and Breweries Ltd has witnessed a change in the number of districts, which were allotted to it by Govt. of Madhya Pradesh.

As per the May 2008, investors’ presentation, page 9, the company used to have a license to sell country liquor in 10 districts.

Country Liquor (CL): Leader in Madhya Pradesh. Sells CL in 10 districts through the Government. Sales of approx 2.5 mn cases annually.

As per credit rating agency, CARE, in FY2017, the number of allotted districts declined to eight.

Credit rating report, Feb 2017, CARE, page 1:

AABL has an established track record of more than two decades in the liquor industry and with an installed capacity of manufacturing 104 KLPD of rectified spirit (RS), it is the second largest grain-based distillery in Madhya Pradesh. AABL has been allotted 8 districts by the GoMP for sale of CL at pre-determined price during FY17.

As per credit rating agency, CARE, in FY2018, the number of allotted districts increased to nine.

Credit rating report, March 2019, CARE, page 1:

AABL has been allotted 9 districts by the Government of Madhya Pradesh (GoMP) for the sale of CL at pre-determined price.

Therefore, an investor would acknowledge that the so-called monopoly position of country liquor producers is subject to license renewals. In the light of intense competition for these licenses, it may happen that the existing license holders may not get their license renewed. As a result, they may witness the sales from their largest production segment decline.

Therefore, going ahead, an investor should keep a close watch on the renewal of licenses for Associated Alcohols and Breweries Ltd and the number of districts that it is able to retain for selling country liquor.

Margin of Safety in the market price of Associated Alcohols and Breweries Ltd:

Currently (June 06, 2019), Associated Alcohols and Breweries Ltd is available at a price to earnings (PE) ratio of about 13 based on earnings of FY2019. The PE ratio of 13 hardly provides a margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

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

In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

• Further advised reading: 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
• Read: How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
• Further advised reading: Hidden Risk of Investing in High P/E Stocks

Analysis Summary

Overall, Associated Alcohols and Breweries Ltd seems like a company, which has been able to grow its sales at a growth rate of 15% year on year in the past. The company has been able to increase its sales with improving profitability. The analysis of the business model of the company indicates that it has very limited pricing power in its largest product segment, country liquor. As a result, the company seems to have improved its profit margins by taking initiatives to limit costs by investing in multi-grain processing facilities and by focusing on sales of premium Indian made foreign liquor. These business initiatives have resulted in significant improvement in the profit margins of the company despite the tough business environment of country liquor sales.

The company has grown its business by utilizing its production capacity at an optimal level with efficient management of inventory and receivables. As a result, the company has managed to grow using its business profits and reduce its debt over the years without witnessing a lot of money being stuck in working capital.

Associated Alcohols and Breweries Ltd has displayed good project management skills by completing the capacity expansion project within stipulated time and cost estimates.

However, there are certain aspects of the company, which need improvement and therefore, require the enhanced focus of investors. These aspects relate to the internal control process of the company, which have expressed themselves in the form of unexplainable cash income etc., which have led to a search operation by income tax authorities.

The company had a history of lack of internal audit system and proper internal control process, which have been highlighted by the auditor in multiple annual reports. The company had delayed the deposit of undisputed statutory dues/taxes multiple times. The auditor had found the inventory and fixed assets record keeping insufficient in the past. The company has conducted audit committee meetings without the presence of statutory auditor. The company has published quarterly financial result without the mandatory limited review by the auditor. All these aspects indicate that investors should increase their alertness while analyzing the data reported by Associated Alcohols and Breweries Ltd.

The company has been paying a high remuneration to the promoter family members, Mr Anand Kedia and Mr Prasann Kedia as compared to the net profit after tax (PAT) of the company. However, the company has not put their remuneration to the approval of shareholders. This apparently because the promoter family members are not present in the board of directors as members. However, the decision by promoter family members to stay out of board position has denied the shareholders an opportunity to express their opinion on their remuneration by way of explicit voting.

Associated Alcohols and Breweries Ltd has supported many promoter group companies by making investments, giving them loans, and providing guarantees to their bankers for their loans. Moreover, the company has stopped disclosing the key beneficiary of these transactions, Mount Everest Breweries Ltd., as a related party in the annual report.

In FY2013, Associated Alcohols and Breweries Ltd invested in a subsidiary company, Vedant Energy Pvt. Ltd. (VEPL). However, investors notice that the company got only 50.71% stake in VEPL despite making more than 90% share of investments.

Until FY2017, Associated Alcohols and Breweries Ltd the company used to disclose interest payments as an outflow under cash flow from operations, instead of an outflow under cash flow from financing. The company rectified this practice in FY2018.

Going ahead, investor should keep a close watch on the renewal of licenses by the Govt. of Madhya Pradesh, investments & guarantees of the company in promoter group entities, signs of weakness in internal control process & compliance with statutory & regulatory guidelines, outcome of the income tax search operation & investigation, and the profit margins of the company.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Associated Alcohols and Breweries Ltd. However, investors should do their own analysis before taking any investment related decision 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”

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.