Analysis: Ambika Cotton Mills Limited

Ambika Cotton Mills Ltd (ACML), incorporated in 1988, is a Coimbatore, Tamil Nadu (India) based company involved in cotton yarn manufacturing. ACML is listed on both the Bombay Stock Exchange and National Stock Exchange in India.

ACML specializes in manufacturing premium quality compact and Eli Twist yarn, which is used in making premium shirts. The company uses extra-long staple (ELS) cotton in its yarn manufacturing by importing high-quality Giza and Pima cotton from Egypt and the US respectively. ELS fibre provides extra strength while keeping the yarn thin. Thin yarn finds usage in premium quality cloth of higher counts.

Ambika Cotton Mills Ltd has the capability to manufacture yarn for counts varying from 24’s to 140’s allowing it to break free from the commodity products of a single count of other spinners. ACML is one of the established players in supplying yarn to almost all premium shirt manufacturers around the world.

One of the readers asked me to write in detail about my reasons for investing in Ambika Cotton Mills Ltd. I am holding the company since September 2014. I still invest in ACML because I found that ACML is growing at a healthy growth rate while maintaining its profitability margins. It has been increasing its production capacity without deteriorating its capital structure.

I find that Ambika Cotton Mills Ltd’s products have good demand in the market, which it is able to cater to by selling higher quantities at increasing prices. ACML has been realizing its profits as cash and utilizing this cash productively in capacity expansion and paying off debt. ACML has created a higher market value for its shareholders for each INR of profits retained by it.

After comparing Ambika Cotton Mills Ltd with its peers, I find that ACML provides an opportunity of investing in a conservatively financed consistent growth story with healthy profitability margins at attractive prices. ACML also offers a healthy margin of safety for its shareholders. After analyzing the management of ACML, I find that it has competent management that believes in the company’s future and cares about shareholders’ interests.

All these qualities present Ambika Cotton Mills Ltd as a good investment opportunity for me and I have been consistently increasing my investment in the company.

Below is my analysis of ACML, which I have done as per the framework described in my article “Selecting Top Stocks to Buy”. I have divided the analysis into four parts:

• Financial Analysis,
• Business Analysis,
• Valuation Analysis and
• Management Analysis.

In order to benefit the maximum from this article, an investor should focus more 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.

Financial Analysis of Ambika Cotton Mills Ltd

I have used the framework provided in the article: How to do Financial Analysis of a Company to analyze ACML’s financial statements for determining whether it has a sound financial position.

A) Analysis Of Profit And Loss Statement (P&L): 

i) Sales Growth & Profitability:

We can see that over the last 10 years (2005-14), Ambika Cotton Mills Ltd has increased its sales at a healthy rate of 21% per annum. It has been able to maintain its operating & net profit margins (OPM & NPM) at healthy levels of 20-22% and 8-10% respectively. When we would compare the NPM of ACML with its peers later in business analysis, we would realize that ACML has one of the best profitability margins in the industry.

ii) Tax Rate:

The general corporate tax rate applicable in India is 30%. However, the textile sector has been getting various tax incentives from Govt. to promote exports. Ambika Cotton Mills Ltd has been utilizing these incentives and paying tax at varying rates of 20-30% over the years. This healthy tax paid rate can be used to infer that company has been paying taxes due to it, which is a healthy sign.

iii) Interest Coverage:

Ambika Cotton Mills Ltd has been maintaining its leverage levels within comfortable levels of serviceability. The interest coverage ratio has always been more than 3 and is increasing recently. This is a sign of a healthy company.

B) Analysis Of Balance Sheet (B/S): 

i) Debt to Equity ratio (D/E, Leverage):

The debt to equity ratio of Ambika Cotton Mills Ltd has been reducing consistently from 2.5 in 2008 to 0.3 in 2014 as the company is using the cash generated from profits to pay off its debt.

I like such companies, which use the profits to improve their capital structure. Decreasing debt levels reduce interest costs and thereby improve the profitability of the company. If you revisit the profitability table above, ACML’s net profit margin increased from 6% (2012) to 10% (2014), which is the direct result of a decrease in debt of the company.

ii) Current Ratio (CR):

The current ratio of Ambika Cotton Mills Ltd is currently 1.3 and has been consistently above 1 meaning that current assets are sufficient to take care of current liabilities.

C) Analysis Of Cash Flow Statement (CF):

We can see that Ambika Cotton Mills Ltd has been consistently generating cash from its operations and using it for capital expenditure and paying off debt. If we refer to the Debt to Equity ratio above, it would substantiate this conclusion as the debt of ACML reduced from INR 260 Cr. (2.60 billion) in 2011 to INR 70 Cr. (0.70 billion) in 2014.

I prefer to keep such companies in my portfolio that generate cash from operations to take care of investments and debt servicing.

D) Cumulative PAT vs. cumulative CFO:

If we compare the cumulative PAT and CFO for the last 10 years (2005-14), we realize that Ambika Cotton Mills Ltd has collected cash more than its profits. It indicates that the company is able to collect its profits in cash and it is not stuck in receivables & inventory. It is a good sign for a healthy company.

Conclusion of Financial Analysis:

After analysing the financials of Ambika Cotton Mills Ltd for the last 10 years (2005-14), we realize that it is growing at a healthy growth rate while maintaining good profitability margins. ACML is able to increase its sale by capacity expansion without overly leveraging its balance sheet, as it has been using the cash generated from operations to pay off its lenders. The company is in a comfortable debt-servicing situation, which is reflected by its healthy interest coverage ratio.

Business Analysis of Ambika Cotton Mills Ltd 

I have used the 5 parameters highlighted by me in the article: How to do Business Analysis of a Company to analyze ACML’s business performance to determine whether it has a business advantage.

A) Comparison with Industry Peers:

We see that Ambika Cotton Mills Ltd has outperformed most of its peers over the last 10 years (2005-10) without compromising on its profit margins. Its net profit margin (NPM) is one of the best in the industry.

As discussed during financial analysis, we can notice that the growth of ACML has not come at the cost of impairment of capital structure. ACML is one of the most conservatively financed companies in its industries, which is reflected by the comparison of its D/E ratio with its peers.

B) Increase In Production Capacity And Sales:

The above table indicates that the sales growth achieved by Ambika Cotton Mills Ltd over the last 10 years has been contributed equally by product price increase (measured by revenue per spindle, assuming each spindle produced the same amount of yarn in 2005 and 2014) and increased quantity of product sold (measured by production capacity). This is a good sign that ACML is not relying solely on product price increases to achieve sales growth but also expanding its reach in consumer markets by selling higher quantities.

C) Conversion Of Sales Growth Into Profits:

We can see that though the profit margin has been fluctuating over the years, it has still been able to maintain it at respectable levels of 8-10%. Profit margin decreased during 2008-10 due to higher interest cost consequent to capital expenditure done by the company on capacity expansion as well as on wind power generation. The company now generates 110% of its power requirement by wind energy, thereby protecting itself from risks of fluctuating power cost and availability.

Advised reading: How to do Business Analysis of Wind Power Plants

D) Conversion Of Profits Into Cash:

The above table reflects that the profits of Ambika Cotton Mills Ltd are flowing to the company as cash. Profits are not being stuck in the receivables and inventory. This is a good sign.

E) Creation Of Value For Shareholders From The Profits Retained By The Company:

We can see that Ambika Cotton Mills Ltd passed the test of creating at least one INR of market value generation for its shareholders for each INR profit retained by it over the last 10 years.

Conclusion of Business Analysis: 

Upon testing ACML at all the 5 parameters to judge the business performance, we can safely conclude that it has passed on all the five parameters. It has demand for its products in the market that it is able to tap by selling higher quantities and able to pass on the increase in its costs as higher prices to its customers. Its profits are not being stuck in receivables & inventory and are realized as cash. The cash generated is being utilized productively in capacity expansion and debt reduction and it has created equivalent market value for its shareholders.

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

Valuation Analysis Ambika Cotton Mills Ltd 

I have used the framework provided in the article: How to do Valuation Analysis of a Company to analyse ACML’s share market data for determining whether it is available at attractive valuations.

A) Price To Earnings Ratio (P/E Ratio):

On February 6, 2015, Ambika Cotton Mills Ltd is available at a P/E ratio of 6.6, which is cheap when compared with its peers. If we see the whole package of conservatively financed growth rates while keeping healthy profitability margins, ACML comes out to be a clear winner among its peers.

B) P/E to Growth Ratio (PEG Ratio): 

If we compare the PEG ratio in the above table, we come to the same conclusion that ACML presents a case of healthy growth, which is available cheaply in the market. This is one of the desirable qualities of an investment-worthy stock.

C) Earnings Yield (EY) and Margin of Safety (MoS): 

At a P/E ratio of 6.6, Ambika Cotton Mills Ltd provides an earnings yield of 15.2%. If we compare it to the 10-year government securities (G-Sec) yields, which are currently in the range of 8.0-8.5%, then we realize that, as per Benjamin Graham’s teachings, ACML presents a good margin of safety for the investors. This margin of safety might provide a cushion to the price fall and might help to restrict the capital loss that an investor may suffer by investing in ACML.

D) Price to Book Value Ratio (P/B Ratio): 

I am not a big advocate of referring to the P/B ratio for manufacturing companies. The P/B ratio is relevant for companies operating in financial services. However, as it is one of the widely tracked measures of value and has been promoted by Benjamin Graham as well, I would analyze ACML for its P/B ratio as well.

The P/B ratio of ACML on February 6, 2015, is 1.04. P/B ratio of 1.04 is within the conservative valuation levels as per Graham.

E) Dividend Yield (DY): 

ACML paid a dividend of INR 12.5 for FY2014. At the current price (February 6, 2015) of INR 528, it provides a yield of 2.4%, which is a decent yield.

Conclusion of Valuation Analysis: 

After doing the valuation analysis of Ambika Cotton Mills Ltd and comparing it with its peers, we realize that ACML provides an opportunity of investing in a conservatively financed consistent growth story with healthy profitability margins at attractive prices when compared to its peers. Simultaneously, ACML also provides a healthy margin of safety for its shareholders.

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, a low PE ratio of the company’s stock may be sign of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

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

Management Analysis Ambika Cotton Mills Ltd 

I have used the framework provided by me in the article: How to do Management Analysis of a Company to analyse ACML’s management quality and performance to determine whether it has good & competent management that keeps shareholder’s interests in mind:

A) Background Check of Promoters & Independent Directors:

ACML is promoted by Mr. P.V. Chandran, who is an entrepreneur. He plays an active role in the management of ACML. The board consists of seven directors. Three directors are of the promoter’s group, three are independent directors and one nominee director of the lender (IDBI Bank). The composition of the board and the presence of the nominee director indicates the presence of sufficient oversight.

A web search about Mr. Chandran and other directors did not reveal any negative information.

B) Management Succession Plans and the Salary being paid to Potential Successors: 

Mr. P.V. Chandran has introduced his two daughters to the board of directors. Mrs. Bhavya Chandran was inducted in FY2008 and Mrs. Vidya Jyothish was inducted in FY2012 in the board as directors. Mr. Chandran is currently about 65 years of age and it is assumed that he would be able to train his daughters in the business before he takes retirement from active management of the company.

As per the FY2014 annual report, Mrs. Bhavya Chandra and Mrs. Vidya Jyothish were paid remuneration of INR 60,000 and INR 45,000 for the year, which is not exorbitant by any means.

C) Salary of Promoters vs. Net Profits: 

I have analysed the total remuneration being paid to Mr. P.V. Chandran viz-a-viz net profit of ACML:

The above table reflects that the remuneration of Mr. Chandran has been fluctuating in line with the profits of ACML. Mr. Chandran’s remuneration increased in FY2014 after the company recovered from the decline in profits witnessed post FY2011 when it doubled its profits from INR 24 Cr. to INR 48 Cr. His remuneration is about 2.5-3.0% of net profits which when compared with other promoter directors of Indian firms is reasonable. Many other Indian companies have promoters who draw remuneration almost at 8-10% of net profits.

D) Project Execution Skills: 

ACML promoters & managers have increased its production capacity from about 6,000 spindles in the early 1990s to 109,872 spindles currently. The company has also installed a wind power generation capacity of about 27.4 MW over the last decade. These instances reflect that promoters and management have good project execution skills. This experience would be useful for further capacity expansion projects that would be essential for future growth.

E) Consistent Increase in Dividend Payments: 

We can see from the above table that as net profits of the company have increased over the years, the dividend paid by Ambika Cotton Mills Ltd to its shareholders has also increased. In fact, dividend payout has increased at a higher rate than profits. This pattern indicates that the company is rewarding its shareholders by sharing the outcome of its growth over the years. This is one of the signs of shareholder-friendly management.

F) Promoter Shareholding and Insider’s Buying Pattern: 

The current shareholding of promoters in the company is 48.6% (December 31, 2014), which is a little below my comfortable level of a minimum of 51%. However, when I observe the pattern of promoters’ buying shares of ACML, I find that since July 2009, Mr. P.V. Chandran has bought 0.75 million shares of ACML on 46 occasions. He has increased his stake in ACML by 12.7% during this period (from 35.9% to 48.6%)

I draw comfort when promoters buy shares of their own companies. I believe that no one knows about a company better than its promoters do. Therefore, when promoters buy shares, investors should buy it too.

G) Foreign Institutional Investors (FII) Holding: 

I prefer investing in companies with nil or very low FII shareholding. I believe that if an investor invests in a company that initially have a low FII holding and then the company keeps growing consistently. The sustained good business performance of the company would bring it to the notice of other market participants including FIIs and create increased demand for its shares. This demand would increase the P/E multiple of the shares of the company. I have noticed that this P/E expansion might account for more than 75% of the total gains from an investment. (Read: How to Earn High Returns at Low Risk)

Ambika Cotton Mills Ltd has a 0.37% FII shareholding on December 31, 2014.

H) Other Remarkable Feature: 

ACML was hampered by the power crisis in the state of Tamil Nadu during 2007-2009 when companies were directed to draw only about 60% of the allotted power. ACML took a timely step and started installing wind power generation plants to shield it from such issues in future. Currently, ACML has 27.5 MW of wind power generation capacity, which is sufficient to meet the entire current power requirement of the company. This is also a sign of the timely steps taken by the management to deal with business hurdles.

Analysis Summary

After analyzing the management of Ambika Cotton Mills Ltd, we can notice that it has competent management, which cares about shareholders’ interests and believes in the company’s future. Mr. P.V. Chandran seems to have put in place a succession plan, which would enable the next generation to take over the company by the time Mr. Chandran retires from the day-to-day management of ACML.

I am a bottom-up fundamental investor following a value-investing approach for stock selection. I do not focus on any particular industry while picking stocks for investing. Therefore, you would notice that I have not discussed a lot about industry growth projections and supply & demand scenarios etc. I believe in investing for a long-term time horizon during which many cycles of supply & demand would pass. If a company has a good product and competent management, then it would be able to survive tough times and generate wealth for its shareholders.

I agree with Peter Lynch that moderate fast growers (20-25%) in non-growth industries are ideal investments.

Stock investing is full of uncertainties where assumptions might take a long time to materialize. There might be times when a company keeps on performing exceeding well, but the markets might keep on ignoring it for years. Moreover, the price may fall and investors may start questioning their analysis. However, every market correction in the past has been followed by a full recovery and investors of good companies have been highly rewarded. Therefore, an investor should buy stocks of a fundamentally good company and stay invested.

There is no price target for Ambika Cotton Mills Ltd in this report. It is deliberate because I agree with Nobel Laureate Nils Bohr, when he says, “Prediction is very difficult, especially if it’s about future.”

I believe that ACML has what it takes to grow its earnings in future. If it could succeed in growing consistently, then the market would recognize its potential and reward it with a high stock price. However, when it is going to happen is anybody’s guess. It might take a few months, years, or more.

Nevertheless, credit rating agencies have started to recognize the strong performance of Ambika Cotton Mills Ltd. Credit rating agency CARE Ltd has consistently upgraded ACML’s rating from BBB+ (2012) to A- (2013) to A (2014). Each rating upgrade lowers the cost of debt for ACML and smoothens its future growth path.

Therefore, the gist is “Buy Right & Sit Tight”.

And not to forget about regular monitoring. Read “How to Monitor Stocks in Your Portfolio”

Over time, readers have asked various queries related to Ambika Cotton Mills Ltd including its business, competitive advantages etc. I have compiled these queries and their responses below so that other readers can also benefit from them:

Addendum (March 19, 2015)

The management analysis section earlier described that Mr. P. V. Chandran is also a whole-time director on the board of Mathrubhumi.

ACML is promoted by Mr. P.V. Chandran, who is an entrepreneur. He plays an active role in the management of ACML. As per Bloomberg, he is also a whole-time director on the board of Mathrubhumi Printing and Publishing Co. Ltd, which publishes a Malayalam language newspaper Mathrubhumi. Mathrubhumi has a daily circulation of about 1.5 million. Further web search about Mr. Chandran and other directors did not reveal any negative information.

This information was based on the data available on Bloomberg, about Mr. P. V. Chandran. However, ACML provided clarification to Bombay Stock Exchange on March 17, 2015, in this regard:

Shri P.V.Chandran Chairman and Managing Director of Ambika Cotton Mills Ltd is in no way connected or associated with the Malayalam language newspaper Mathrubhumi. This Clarification is issued consequent to incorrect information appearing in the media ( i.e in Bloomberg) that he serves as a Wholetime Director of the said newspaper and it appears that it is inadvertent on account of the fact the name of the two individuals are identical.

In light of the above clarification, the relevant section of the management analysis section has been edited accordingly.

Answers to Investors’ Queries on Ambika Cotton Mills Ltd

Query

Hi Vijay, I am a banker by profession and am a Credit Manager in ME with an MNC Bank.

Your post has provided great insight into every aspect of company analysis. I am sure that I’ll be able to use the same in my day to day work.

In the above case, the only concern was the dip in financial ratios in 2009 but that too was covered later on attributed to a shortage of power supply.

One factor that could have been covered is the aspect of sourcing since the super quality of their products and the premium they demand is basically due to the high quality of the raw materials. Is the company looking beyond these two countries, especially Egypt? What is the level of dependency on Egypt for sourcing? My thoughts might be irrelevant but then supplier concentration may limit their growth going forward.

All said and done, am in agreement with your analysis. Yes, the scrip does look good to get in.

Author’s Response: 

Thanks for providing your feedback. I am happy that you found the article useful.

You are right that details of suppliers would provide additional insights about the company. However, I could not find the related information in the public domain.

The company works mainly on advance orders backed by LC (as reflected by low days of receivables outstanding) and it maintains an inventory of cotton raw material of about 100-125 cr. (as reflected in current assets). Hence I believe that ACML mostly buys and keeps required raw materials in advance for visible orders. It gives me some comfort.

Query

Hi Vijay

I have started investing in stocks in 2012 with V.S.T Tillers Tractors Ltd as my first stock.

Your systematic approach to finding the hidden gems is really appreciable. Thank you for the detailed report on Ambika Cotton Mills Ltd.

There should be a strong moat in the business, which I am not able to see here. I do not see the reason why peers shall not be able to import premium cotton (Giza & Pima) and stand in the competition to ACML. Do you see any moat in ACML?

Author’s Response:  

Thanks for your input! Congratulations that you have started on your stock investing journey!

Another reader has asked a similar question about moat factors in ACML. I am repeating the same reply here:

ACML is one of the few players capable of making yarn for varied counts cloths. As per information available on the internet, ACML yarn is used for almost all premium shirts. Its yarn is made from ELS cotton by a mix of high-quality cotton imported from US (Pima) and Egypt (Giza) which in turn commands a premium. It can provide customized products to buyers instead of commodity type single count product of other players. This business advantage allows it to work on advance orders backed by a letter of credit therefore its average days of receivables outstanding is 5 days!! Competent, honest & shareholder-friendly management is the largest moat above all other factors, which I believe ACML has.

You would agree that Moat might have many other factors in addition to raw material. It can be good management, relationships with suppliers or customers, distribution networks, good labour relations and many more. In my analysis, I do not try to find out each and every contributing factor leading to the moat. However, I try to analyse the financial results to find out whether these numbers speak of the presence of any moat.

In ACML, the reported numbers speak of a moat. Some factors leading to moat can be found in publicly available information. Others can be learned if an investor talks to the promoters. I have not interacted with promoters for finding out the moat.

Hope it clarifies your query.

Query

Hi Vijay, As usual, a great detailed article. Thanks for sharing. Where can we find the customer list of ACML? Their website says a nice premium shirt segment. But doesn’t provide the names of the customers, their geography etc. Would appreciate if you can throw some light on this.

Author’s Response: 

Thanks for your feedback! I am happy that you liked the article.

The details about customers of ACML is not available in the public domain. However, as mentioned by you, the only information disclosed by the company is that its material is used in almost all the premium shirting brands. You may contact the company directly to get customer details.

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

Regards,

Query

Thank you for this fantastic piece of work. I have 2 questions on the business side:

1. Why should the margins not go further down from here? Do we know the reasons why margins reset from 25-30% to 20-22%?
2. Do we have the list of major customers? Do we know which customers are likely to give repeat orders for a fairly long time?

Author’s Response:

Thanks for your feedback! I am happy that you liked the article.

Answer 1:

Margins may very well go down further. Cotton is an agro-commodity whose prices keep on fluctuating a lot. The company maintains a good amount of inventory of cotton, which may shield raw material price impact for a short period, but the impact will definitely be visible sooner or later. However, the company has been able to maintain margins over the past few years indicating that they might have some pass-through mechanism for costs.

Answer 2:

The details about customers of ACML is not available in the public domain. However, the only information disclosed by the company is that its material is used in almost all the premium shirting brands. You may contact the company directly to get customer details.

Regards,

Query

Dr. Vijay, Thanks for posting the detailed analysis. One question I have the DCF analysis and as per the DCF value what is the current value.

Author’s Response: 

Thanks for your feedback!

I do not rely on discounted cash flow (DCF) analysis for stock research. Therefore, I have not done DCF for ACML.

If you like, you may do the DCF for ACML and share it with the readers here.

Regards,

Query

Hello Vijay, I saw in Care ratings that a long term loan of Rs.325 crores for Ambika Mills is not shown on the balance sheet. Is it that this loan is not been used by Ambika Mills??

Author’s Response: 

Thanks for writing to me!

The balance sheet is as of March 31, 2014, whereas the enhancement of debt facilities which are mentioned in the CARE rating rationale dated November 7, 2014, might have happened after March 31, 2014. It would get reflected in the balance sheet of March 31, 2015.

The positive news is that CARE has upgraded its credit rating from A- to A, which would lower the cost of funds for ACML.

Regards,

Query

I read your blog on Ambika Cotton. It is good work. I have a couple of questions:

1. You do an analysis of CFO vs PAT to measure if PAT is translating into CFO. But, you are not deducting interest expense on CFO. This expense is being deducted in the calculation of PAT. So, to really compare apples to apples, shouldn’t you deduct interest expense from CFO and then compare that to PAT (or am I missing something?).
2. Is this is a no-growth stock that is (or was) cheap or does it have high growth prospects? Say, for example, if you look at Kitex Garments, there is a clear case that they have penetrated their customers only to a very small extent currently, and the opportunity for incremental business from the same clients is huge. Is there some kind of a similar story/ possible case in Ambika?
3. Surprisingly, more than 50% of their total sales are to East Asia and South-East Asia. I have not seen (maybe my ignorance) India exporting to these countries. So, which countries do they export to? India does not have much of a cost advantage to these countries? Then, why do these countries buy from Ambika? And give it such high margins? In turn, what is the moat here? It seems to be something more than a low-cost advantage which makes it interesting.
4. Exports to Europe were INR 15 crores in 2013 and INR 26 crores in 2014. Making in India and selling in Europe is a very compelling proposition generally. Is there a lot of untapped growth opportunity there?
5. Any idea of the current capacity utilization.
6. Any idea if the management is open to meeting shareholders for discussion.

Regards,

Author’s Response: 

Thanks for your feedback! I am happy that you liked the article.

Coming to your questions:

1. Broadly speaking, interest expense and depreciation are deducted from PAT, which is not deducted from CFO. (There are some other changes as well, but for conceptual discussion, let us limit the discussion to these two). You would notice that due to interest and depreciation adjustment, normally CFO should be a bit higher than the reported PAT. Therefore, it becomes significant when CFO is less than PAT over long periods of time. One should not interpret too much into PAT v/s CFO for shorter periods as the company may be facing tough times. However, over long periods (say 10 years) CFO should not be less than PAT, otherwise, there is some issue that should be analyzed in detail. Cumulative CFO and PAT are easily available data and can give an understanding of the company’s working capital management at a glance. (Read: Understanding Cash Flow from Operating Activities (CFO)
2. The past financial data indicates that the stock is growing at 15-20% per year and utilizing its enhanced production capacities well. Whether an investor would classify it under high or moderate growth, is the investor’s choice. I do not have information about repeat business from existing clients. It may or may not be there. However, management has been able to find buyers for increasing quantities of their product consistently.
3. Deciding about a moat can be a two-way process. It is like finding the best student in the class. One may check all the students for their IQ, analytical skills etc. and find out which students are the best and decide that these students have moat due to XYZ qualities. Or one may check the past results and see that certain student(s) have consistently topped/been in top-performing students year on year in past exams (published annual financial results) and decide that consistent performing students have a moat. I take the second approach. I was also impressed by the seemingly different export profile of Ambika and your concerns (which are good observations, in fact) lead me to believe that Ambika has a moat.
4. If a company is able to make a well-differentiated product at competitive prices, export demand will always be there. I am not being very specific in my answer to Europe or any other market, because tomorrow the business environment is going to change for sure. And what is working for the company today may not work in future. The company is facing and will face further competition for sure. It’s only honest and capable management that would be able to survive competition by introducing new products in existing/new markets. The data shows that Ambika has good management (remember top-performing student!). However, no one knows whether their current promising performance would continue in future. That would require consistent monitoring.

You may read about my monitoring criteria for stocks in the portfolio here:

How to Monitor Stocks in Your Portfolio?

5 You may find capacity utilization data in the annual report.

6 I did not contact management. You may try it yourself.

Hope it helps to resolve your queries!

Query

Excellent analysis, Vijay! I must congratulate you on the clarity and the level of detail you have presented in the analysis.

Ambika cotton mills Ltd was under my radar for quite some time in most of 2014 and could have easily bought it for under 50% of today’s price. However two things stopped me, and both are comments by Warren Buffet.

• The first one was where he explicitly mentioned that textiles were not a good business to own.
• Secondly, the observation that when a business with a bad reputation meets management with a good reputation, the reputation of the business remains intact! Notwithstanding the consistently good performance of this company the fact of it being in a commodity business and in textiles made me not buy in.

I’d like your views on whether there is a lesson to be learnt here, or this is just the opportunity cost of discipline.

Thanks

Author’s Response:

Thanks for your feedback! I am happy that you liked the article.

Both the reasons that you have cited for avoiding investment in Ambika Cotton are based on the assumption that textile is not a good business, which is a comment made by Warren Buffett. However, it is pertinent to note that these comments were made by Buffett for the US textile industry in a different setting.

You would also appreciate that industries do not face the same environment in India and the US. Many industries die in the US only because of the work shifting to India & other emerging markets (outsourcing).

Therefore, I believe that an investor should do rely on her own analysis and rely on it, even if it might seem in contradiction to what great investors might have said in different settings.

I also remember Peter Lynch when he said: Moderate fast growers (20-25%) in non-growth industries are ideal investments.

Whether Ambika would prove to be a good investment, we would come to know only in future. However, I would suggest that you should give more weightage to your own analysis.

Hope it clarifies your query!

Query

Hi Vijay. You hold Ambika cotton and I tried to research the company business. I was not able to gather much information about it. 60% of the revenue comes from export and they export yarn for the premium shirting segment.

Buffet says buy wonderful businesses. How can we confirm that Ambika’s business is a wonderful business?

Thanks

Author’s Response: 

Thanks for writing to me!

I analyse businesses from a few of their financial characteristics. These criteria may or may not be the same that Buffett calls wonderful businesses. You may read my criteria for business analysis of a company here:

How to do Business Analysis of a Company?

I am happy if any company meets these criteria. Ambika met these criteria as mentioned in my article on Ambika Cotton.

You may get further information about company business either from the company & its management or from publically available sources. I guess that you would already have gone through the annual report and other documents available on the ACML website. If not, then please go through them.

Then you should search the internet for the articles and opinions other investors have written about ACML. You would find a good discussion going on about ACML on the Valuepickr forum.

If after reading all these sources, you still feel that you require more information for making an investment decision, then you may contact the management.

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

Hope it helps!

Regards,

Query

Dear Vijay. I like your post. I have one question about your analysis. You did not mention EPS growth. Don’t you think that it will be part of the analysis? What I found out is that in many years there was (-) growth for EPS in the screener.

Along similar lines, how do you track even if a company growing but its share count is increasing, which has happened to many companies?

Author’s Response:

Thanks for writing to me! I am happy that you liked the article.

If there is no equity dilution year on year, then EPS growth and net profit growth would represent one and the same thing, whether the no. of shares remain the same or increase due to split or bonus shares. In such cases, the % ownership of existing shareholders remains the same.

However, these two would not remain the same if the number of shares increases due to the issuance of new shares which reduces the % shareholding of existing shareholders. In such cases from an investor’s perspective, EPS growth would be more pertinent than Net Profit Growth.

However, in both these cases, net profit would retain its significance in terms of profitability margins and the attractiveness of the business.

You can assess the dilution impact by looking at the share capital of the company. If share capital has increased then you should explore whether the same is due to bonus shares or the issue of new shares.

In Ambika, the share capital has been constant from 2006 till date at INR 5.88 cr.

Hope it helps!

Query

Dear Sir. After the recent sharp run-up of the stock, do you think a fresh entry can be made at this level?

Author’s Response: 

Thanks for writing to me!

Entry price criteria differ from investor to investor. The fact that trading happens in Ambika Cotton today, means that there were people buying it at today’s prices.

Everyone should have their own criteria for buying stocks and take decisions accordingly. You may find my criteria/checklist for buying stocks here:

Final Checklist for Buying Stocks

I would request you to make a decision as per your criteria/checklist.

In case you have not yet prepared your checklist, then I would suggest you read through the article series “Selecting Top Stocks to buy”. By the time you would complete this series of articles, you would have your stock selection checklist ready. You may read this series here:

Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

Regards,

Query

Hi Vijay, Thanks for your detailed analysis and for sharing your knowledge. I need 3 clarifications from the above analysis.

1. in current assets (CA) you showed ₹165cr, but my calculations show it as ₹142Cr. (Inventories 133 + receivables 6 + Cash 3, all data’s from Screener.in), could you help me with where I am missing?
2. from where to get the historical current liabilities (CL)? I am getting only the current CL from the Screener as ₹125Cr.
3. While comparing with peers, what is the key factor other than M-Cap to select a company as a peer?

Your guidance will be more helpful on this.

Author’s Response: 

Thanks for your feedback.

1. Data for CA & CL has been taken from money control. Current assets have been calculated as total current assets including short term loans & advances (₹23.5 cr). You may find it at the moneycontrol site.
2. You can get CL data from the moneycontrol website. The Screener does not provide separate data for CA & CL.
3. In addition to market capitalization, you may consider comparing peers based on annual sales turnover, the total asset size of the balance sheet and though not very commonly used but based on installed capacities.

Hope it helps to clarify your doubts.

Query

Hi Vijay, You have conducted a fantastic analysis and obviously it is needless to say that your stock selection approach is very much in-depth and comprehensive.

There have been a lot of positives pointed out by you in Ambika Cotton Mills Ltd and agree with all of them. However, I was just thinking from a sceptical angle about the asset turnover ratios and the replacement rate of machines required.

As of 31st March 2015, Ambika Cotton Mills Ltd had fixed assets worth ₹270 cr against which it clocked a turnover of ₹483 cr which turns out to be 1.79 times. My understanding is that generally low asset turnovers should be backed by higher margins and higher barriers to entry. I am clear that the margins of Ambika Cotton Mills Ltd are very superior but not too sure about barriers to entry. Also, the asset turnover, which I am counting is after the depreciated value. Let’s do a case with new capital expenditure.

If and only if it’s a relatively easy business to enter, then let’s try to extrapolate it to a situation of a moderate business cycle with the recently announced capex plan of ₹130 cr.

₹130 cr financed equally by debt and equity ₹65 cr by equity and ₹65 cr by debt

Approx. turnover achieved at current rate: ₹130cr x 1.79 = ₹232 cr

In the situation of business moderation (in case of down year/increase in competition), the turnover would become 75%. i.e. ₹232cr x 0.75 = ₹174 Cr

Considering deterioration in EBIT margin to 12% (low operational leverage or pricing pressure if the competitive business case) Ambika Cotton Mills Ltd will clock EBIT of ₹20.88 Cr (₹174cr*12%)

This gives a ROCE of 20.88/130 = 16.06%, which is still not bad.

However, the only concern is if the capacity utilization or margins fall further. Then I think return ratios could become shaky.

There is a primary assumption that the competitive intensity increases or capacity utilization goes down because of lower demand or even both may happen together.

If possible, can you highlight whether Ambika Cotton Mills Ltd enjoys any specific business entry barrier and why a new player would not enter such a high margin lucrative business? Why would Ambika Cotton Mills Ltd be so confident of further demand in a relatively mature market and weak business climate around the world? The recent capex announced is 50% of the fixed assets.

Author’s Response: 

Thanks for writing to me!

I appreciate the time & effort put in by you to provide your detailed inputs with the assumption and scenario building. It is helpful for other readers as well.

I understand that the primary concern that you have is about entry barriers/business advantage/moat for Ambika Cotton Mills Ltd. I had presented my views on the same while answering the query of “Rohan” in the current article. You may find his query and my reply in the comments below.

Allow me to copy my response about moat here:

Deciding about a moat can be a two-way process. It is like finding the best student in the class. One may check all the students for their IQ, analytical skills etc. and find out which students are the best and decide that these students have moat due to XYZ qualities. Or one may check the past results and see that certain student(s) have consistently topped/been in top-performing students year on year in past exams (published annual financial results) and decide that consistent performing students have a moat. I take the second approach.

I was also impressed by the seemingly different export profile of Ambika Cotton Mills Ltd and your concerns (which are good observations, in fact) lead me to believe that Ambika has a moat.

About the change in competition and business environment, I believe that it has been changing ever since and will keep on changing in future as well. However, it is the job of the management to deal with it. If we as investors, associate with the right management, then we can rest assured that competent management will take appropriate steps to tackle such challenges.

I believe that Ambika Cotton Mills Ltd has competent management.

Query

Hi Dr. Stock,

First of all huge thanks and congratulation for finding a gem like Ambika Cotton Mills Ltd.

Your analysis technique is really good and I have learnt a number of new things by reading your articles like comparing cumulative PAT with cumulative CFO. I don’t have any specific stock related query but want to know more about your stock finding technique as at the current level of the market it’s very difficult to find a new value investment by just screening. It would be better to look for the different business stories like you did in Ambika Cotton Mills Ltd.

I read your article How to do Financial Analysis of a Company where you talked about your technique. Can you tell me specifically which magazines/TV shows/blogs have better content than others and should be followed or which magazine do you read regularly where the author/host talks about the overall business rather than stock as it is very difficult to read the whole annual report and analyse the business over the web to check the quality of every business to find a good investment?

I will be very thankful if you can write an article about this on your blog and can discuss how you found Ambika Cotton Mills Ltd.

Thank you very much and keep doing good work

Good luck

Author’s Response: 

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

I believe that stock screening using filters is the best stock finding technique. It has served me well till now. Ambika Cotton Mills Ltd was found using stock filters. You may read about my stock selection criteria here:

Read: Final Checklist for Buying Stocks

Opportunities are always there in markets. However, during times of optimism, the search gets tougher and longer. Nevertheless, an investor should keep looking till the time she finds a good opportunity.

I read a few newspapers and magazines. But they have never led to a stock find. I have noticed that by the time a stock makes it to media like newspapers & magazines, it has already grown and run a lot. The market has already realized and factored in a lot of future growth by then. Therefore, an investor should try to grab a stock before it makes it to frontline media. Stock filtering screeners work perfectly for such causes as they give results without bias.

Reading the annual report is necessary for any investor to understand business. It might seem cumbersome at the onset; however, reading the annual report provides an investor to have her own original thoughts about the prospects of a company. I agree with many investors saying that it is difficult to make huge wealth in stock markets with borrowed wisdom. Therefore, an investor must do her original analysis and reading an annual report is the first step in this direction.

Read: Understanding Annual Report of a Company

I would suggest that you should rely more on your own inferences after reading the annual report than on analysis presented in various newspapers, magazines or blogs (like drvijaymalik.com).

All the best for your investing journey!

Query

Dear Sir,

Excellent article. Many thanks for sharing your knowledge with us. However, while analyzing companies with this new framework, surprisingly the SSGR for Ambika Cotton Mills Ltd is negative or in very low single digits! Could you please explain how an exceptional company like Ambika Cotton Mills Ltd can have such a low SSGR? I have checked and cross-checked the screener sheet for any calculation errors.

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

If we analyse the ROE through Du Point analysis, Ambika Cotton Mills Ltd has exceptionally improved its operating efficiency despite the declining equity multiplier.

I believe that this makes Ambika Cotton Mills Ltd as part of section C of your article, with difficulty in maintaining sustainable growth going forward.

Author’s Response:

You are right. Ambika Cotton Mills Ltd falls in part C. It has improved its inventory turnover as well as receivables days and has managed to reduce its debt and fund its growth by improving its operating efficiency.

Read: How to Analyse Operating Performance of Companies

Congratulations on your understanding of the concept and applying it correctly in the analysis.

All the best for your investing journey!

Regards,

Query

Dear Sir, a question on Nitin Spinners and Ambika Cotton Mills Ltd. Compared to Ambika, Nitin Spinners has a similar margin, bit better sales & Capacity. Yet the market cap of Ambika Cotton Mills Ltd is greater than Nitin Spinners. Any reason? I am missing something? Maybe like management issues, although I could not see them. Can you advise what could be the reason?

Author’s Response:

Hi, I believe that any attempt to explain the market valuation of any company or the difference in market capitalization between two companies is mere guesswork. It is always uncertain what factors the market might be weighing at any point in time.

Ambika Cotton Mills Ltd as well as Nitin Spinners, have been analyzed in different articles on the website. Request you to go through those articles and do your own analysis to arrive at the potential explanation for the difference in market capitalization of these two companies.

Read: Analysis: Nitin Spinners Ltd

You are most welcome to share your comparative analysis and observations with the readers and the author of this website.

Regards

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Disclaimer

• I am registered with SEBI as a research analyst under SEBI (Research Analyst) Regulations, 2014.
• At the date of writing this article, I own shares of Ambika Cotton Mills Ltd in my portfolio.