Analysis: Ion Exchange (India) Ltd

The current section of the “Analysis” series covers Ion Exchange (India) Ltd, an Indian company involved in water treatment plants, wastewater processing, sewage treatment, packaged drinking water, and seawater desalination etc.

“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.

Ion Exchange (India) Ltd Research Report by Reader

Hello Sir,

I hope that you are doing good and all the best towards your future road-trip adventures all over India.

I have analysed Ion Exchange (India) Ltd, which is into the water treatment industry. Below is the company’s analysis from my end.

Water Treatment Industry in India:

As per ASSOCHAM-EY report June 2019, the water market is majorly governed by the municipal segment, which falls under the utility sector. The utility market is set to top US$14 billion within five years, while annual spending in the industrial sector is estimated to approach US$2 billion. The wastewater treatment sector is expected to grow faster than water treatment, due to the central and state government’s renewed drive in mitigating and eliminating the pollution in India’s rivers, exhibiting a CAGR of 15.3% to reach US$6.78 billion in 2020, up from US$3.3 billion in 2015.

Making cities smarter is emerging as a key area of focus for governments. A smart city can be described as a city equipped with the core infrastructure with digital transformation to create a clean and sustainable environment. As a part of the smart city development, improvement in the water supply infrastructure and quality are top priorities.

NDA government indicated that the next five years of his government would be dedicated to water. In line with his promise, the government has proactively initiated the setting up of a Ministry of Jal Shakti, which under its “Jal Jivan Mission” and” Nal Se Jal” scheme, intend to provide clean drinking water to all households by 2024 and fight India’s water woes.

In a developing country like India, public water management is still predominant though there has been an increasing involvement of the private sector through PPP projects in recent years. Most of the time, the water treatment plants are designed and constructed by state public health engineering departments or the concerned water supply or sewerage boards. Their maintenance and operation, is however, carried out by the municipal corporations.

There are three PPP models on wastewater projects.

1) BOT end-user model:

BOT stands for build, operate and transfer. This model is a form of project financing, typically used to develop a discrete asset rather than a network. The revenue of the company is generated through a small fee to the government rather than charging the tariffs from consumers. BOT is extensively used in infrastructure projects and PPPs. The private entity is responsible for building the facility and operating as well as maintaining it. However, once it is constructed, there is a transfer of assets from the private to the public sector. The end-users are typically water-intensive industrial clusters located in water-deficient regions near urban areas. The end-user industry usually sources the water from the nearby urban spaces, develops, and operates the water treatment plant itself. The water generated is then reused for industrial purposes.

2) Design, build, operate model:

This is a kind of model where a single contractor is appointed to design a project, build it and then run it for a certain period. In this type of project, the funding is done by the government or a public agency. Given that this type of project does not simply involve financial delivery, the contractor theoretically must approach the project keeping its long-term success in mind, given that the contractor is also responsible for the operation and maintenance of the facility for a stipulated period. With regard to the wastewater, the private player designs and operates the plant basis specified output parameters. The capital expenditure for the plant is entirely borne by the public sector. The capital expenditure is usually reimbursed to the private player through an invoice (quarterly), while the operational expenditure payments are based on the performance of the private player.

3) Hybrid Annuity Model (HAM):

In financial terms, a hybrid annuity means making its payment over two-time periods. First, it pays a fixed amount for a considerable amount of time, and then a variable amount over the remaining period.

HAM was introduced by the central government to revive PPP in the area of highway construction but this model has been found to be applicable in other areas as well. In terms of features, HAM is a mix between two existing models – BOT and EPC (Engineering, Procurement, and Construction). An advantage of using HAM is that it provides liquidity to the developer and shares the risk with the government. While private players continue to bear the construction and maintenance risks, they do not have to bear the entire financial risk.

Financial Analysis of Ion Exchange (India) Ltd:

While looking at the financials of the company for the past 10 years, an investor notes that during FY2010- FY2013 the sales growth was consistent. There has been a negative growth in FY 2014. However, post that sales have increased gradually until FY 2019. However, the company has not witnessed a consistent growth rate unlike the phase between FY 2010- FY 2013.

The company has six manufacturing & assembly facilities across India and one each in Bangladesh and UAE.

Company has three segments for revenue viz:

1) Engineering (56%):

The engineering segment provides wastewater treatment including Sea Water desalination, Recycle and Zero liquid discharge plants to diverse industries. The key clients are ThyssenKrupp, Emirates Steel, JSW Steel and SAIL in the steel industry; L&T, Tata Projects and BHEL in engineering industry; NTPC, Adani Power in power industry; Cairn Oil & Gas, Essar, IOCL, Reliance, CPCL in petroleum refinery industry; sewage treatment at Navi Mumbai Municipal Corp. It also provides O&M contracts (operation and maintenance) services, which include pilot studies, surveys, Erection & commissioning etc. It has bagged a large water supply project with Sri Lankan Water Board signed in 2015 at USD 194mn. (approx. 1200-1250 cr @63-64 in 2015). The revenue recognition in such engineering projects is as per project execution stages.

As mentioned by Crisil Report, the engineering and capital goods industry is susceptible to economic cycles. During the economic downturn, industries like steel, power, refinery; which are key customers curtail capex affecting. During CY 2013 and H1 CY2014, the Indian economy had high inflation, high CAD, significant rupee depreciation and thereby monetary tightening and high cost of borrowing. These parameters lead to project delays and decline in gross fixed capital formation in a number of industries.

As per the MDA section of Annual report of FY 2014, it has been mentioned that the water treatment industry thereby took a hit in our country, since large players reduced fresh investments due to cash crunch. Thus, either a few projects were postponed or implementation of existing projects was slowed down, which affected sales in FY 2014. The sales witnessed declined in FY 2014 and FY 2015 from 5572 cr in FY 2013 to 4573 cr in FY 2015, post which they increased y-o-y to 6850 cr in FY 2019.

2) Chemicals (33%):

Chemicals segment provides a comprehensive range of resins, specialty chemicals, and customized chemical treatment programs for water, non-water, and specialty applications. These chemicals and resins are used as catalysts, removal of impurities and heavy metals like arsenic, iron, fluoride etc. Such specialty chemicals are used in mining, textile, cement, pharma, food and beverage and paper industries. Resins division is a supplier to the USA, Europe and has increased geographical presence in South East Asia. As per the MDA section, there is continued pricing pressure on raw materials and as per concall for FY 2019 pg. 12, one of the input cost is crude oil. Being a commodity, it is subject to global demand and cyclicality in nature. Whenever there is a spike in crude, input costs shoot up. However, the company is able to pass on certain cost burden to the customer with a time lag.

3) Consumer products (10%):

Consumer products segment caters to households, hotels, spas, educational institutions, hospitals, laboratories, railways, and defense establishments. It focuses on households and the point-of-use water purifiers and plans to increase its presence in rural drinking water treatment.

The company is a pioneer of Reverse Osmosis (RO) technology in India and ZERO B is its brand for water purifiers that was launched in the year 1986. The company has not sufficiently leveraged its market position to increase the reach of Zero B purifier product to households, unlike Eureka Forbes Tata PureIt. Company’s sales under this segment have grown marginally from 102.5 crs to 108.6 crs to 109.9 crs in FY 2016, FY 2017 and FY 2019 respectively.

As per the concall for FY 2019 pg. 13, management has mentioned that although it has launched new Zero B water purifier products, it does not want to spend much towards marketing and advertising expense, which is usually required in consumer segment. Company wants to be differentiator by looking at larger community usage products. Hence, it is more focused in rural areas, where communities are affected by water contamination and government/non-govt and CSR initiatives of corporates.

INDION Water Vending Machines, specially designed for the Indian Railways, are now successfully installed at a number of railway platforms across select clusters.

As mentioned in the annual report 2019, pg. 181, IEPDWPL has signed the service concession agreement with IRCTC to construct, operate and maintain the plant and supply packaged drinking water (PDW) in PET bottles (brand RAIL NEER) exclusively to the regulator for the period starting on the commencement date i.e. 20th December 2013 and ending on 30th September 2029. The plant will be transferred to IRCTC at the end of the service concession period. EPDWPL, in turn, has a right to charge the regulator at the agreed rate as stated in the service concession arrangement. Further, IRCTC has assured a minimum sales volume during the concession period.

One drawback of dealing with government agencies/ministries/companies is payment delays towards service fulfillment. This is visible under other financial assets Annual Report 2019 pg 144, where receivables due is around 8-9 crs for the past 3 financial years. It seems hard to judge, whether this business segment will be profitable if such a strategy is chosen by the management.

Looking at the tax amounts paid and tax rate calculated on PBT, it is significantly higher than the average 33-35% tax rate paid by corporates. The rate has been higher at 65% and 50% in FY 2014 and FY 2015 respectively. No company is so generous toward paying taxes to our government! Then why this one?

While going through concall report page 12 for Q1 FY2020, management has mentioned that losses of some of the group companies did not get credit in the consolidation of accounts. Hence, the tax rate is high.

Is this possible? How should an investor learn from this?

Activity Ratio/ Operating Performance analysis of Ion Exchange (India) Ltd:

1) The Net Fixed Asset Turnover (NFAT):

NFAT of the company has been 8-10 since FY 2010; however, it has come down to 7 in FY 2018 and 2019. The company had set up an RO membrane manufacturing plant in Goa in 2017. The capacity utilization of the plant is around 55% as mentioned by the management in the earnings concall for FY 2019 pg 15 and more capex around 50 crs is being undertaken this year in engineering and chemical segment towards capacity expansion.

It looks like the company is more focused on both these segments and not the consumer segment for business expansion to achieve future growth.

2) Receivables days of Ion Exchange (India) Ltd

Receivables days of the company have been around 5-6 months on average due to large execution orders in the engineering segment. This shows that the company’s business is not consumer-oriented, wherein customer payments are done immediately or by the end of the month (in case of utility business), without much delay. It is primarily B2B business. For FY 2014 and 2015, receivables days have increased to 160-165 days, due to the downturn in the economy, which lead to a cash crunch for its customers under the engineering segment.

However, it has decreased for FY 2019 to 135 days due to an increase in sales figures. With better capacity utilization, this figure should start to come down gradually. One to keep an eye on!

This looks like a working capital intensive business. The company has obtained working capital financing from banks (secured and unsecured) and bills discounting facility (page 153 of annual report FY 2019).

The cumulative PAT for the last 10 years has been 200 crs and cumulative CFO has been 616 crs during the same period. It looks like the company is comfortably able to convert cash into profits and exceed significantly.

Free cash flow analysis of Ion Exchange (India) Ltd:

The company’s cumulative Capex during the same ten-year period has been around 212 crs. Thus, free cash flow (CFO-Capex) has become 404 crs. FCF/CFO= 66%. Why is the company not getting rid of the debt? In fact, it has increased significantly since FY 2016 –FY 2018 from 90 crs to 164 crs. This has also lead to an increase in the interest expense during the same period. However, the interest expense ratio has improved y-o-y due to the increase in operating profit, from 1.9 in FY 2010 to 3 in FY 2015 to 5 in FY 2019.

The company has repaid the debt of around 55 crs in FY 2019 (as per the CFO statement on page 129 of the annual report FY 2019). This has led to an improvement in its Debt/Equity ratio from 0.7 to 0.4.

I understand that the inherent nature of EPC contracts, means to keep cash buffer, but is it justifiable to increase debt and sit on cash. It seems that the company is probably using cash as a guarantee towards loans given to subsidiaries.

As per the annual report 2019 page 147, Company has cash and cash equivalents have been approx. 67 crs in FY 2018 and 45 crs in FY 2019, with some portion earmarked for EPC contract execution.

Other cash balances maintained as deposits are approx. 87 crs and margin account money as 158 crs lien marked against bank guarantees.

Why so much money is kept with the bank, while incremental capital expenditure has been around 40-60 crs every financial year? There is no mention to whom the guarantee has been given and for what purpose?

Not enough justification is given. What should an investor analyze such a case? Require your inputs.

As per footnote 28. Under AR 2019, the company receives advances from customers every year (254 crs in FY 2018 and 290 crs in FY 2019), predominant one due to water supply project with Sri Lankan Water Board signed in 2015 at USD 194mn. (approx. 1200-1250 cr @63-64 in 2015). The management has stated that this will be majorly utilized towards project execution.

Shouldn’t the company use its surplus cash flow towards gradually retiring its debt? However, the company is taking a cautious pathway with surplus cash for growth capital, especially with delays and cost overruns involved in EPC contracts.

How should an investor analyze such a situation? Require your inputs.

Also looking at trade payables figure under footnote 26 page 154, one gets to know that company amount approx. 410 crs due to others. This figure is almost 38-40% of the annual sales, however, there is no additional information provided. This reminds of the famous quote Devil is in Details, but in this case, there are no further details.

How should an investor analyze such a case? Require your inputs.

The company has made satisfactory CSR expenditure (as a percentage of last 3 years’ profits) towards education, hygiene, healthcare and water treatment and availability measures in the state of Karnataka, Telangana, Andhra Pradesh, Goa and Madhya Pradesh.

The remuneration of the top management is given on page 46 of the AR 2019. The compensation of MD is 4 crs and 2 EDs is 1.75 crs each, while other directors earn approx. 1 cr in total. Clubbed together the amount comes to approx. 8.5 crs, which is 13 % of the PAT figure 65 crs in FY 2019. This exceeds the limit as per Peaceful Investing guidelines.

The company has paid a dividend for the last ten years. However, the payout ratio has been steadily decreasing over the years. The company’s management is sticking to the reasoning that it wants to keep cash buffer for future growth capital and to avoid the cash crunch scenario. However, the y-o-y sales growth has never been exceptional in the last ten years. As mentioned earlier, the company’s sales had dipped for FY 2014 and FY 2015; however, the dividend has still increased during those two years.

In addition, FCF of the company (CFO- Capex) has been in the negative territory, except for FY 2017. Thus, it is likely that the company might be paying dividends by raising debt raised from financial institutions.

Management Analysis of Ion Exchange (India) Ltd:

1) Promoters’ Shareholding:

The promoter and promoter group holding has been 44%. However, looking into details of the name of shareholders, one gets to know that the list of Promoter Trusts is beyond imagination! I have attached a couple of screenshots taken from moneycontrol website. The total list goes to 90 including cross-holdings by other subsidiary companies.

Is it that the top management has made so many trusts just to avoid paying taxes?

How should an investor assess this case?

2) Tax disputes of Ion Exchange (India) Ltd:

On page 60 of the Audit Report, there is a list of pending tax disputes at multiple forums, few being 15-20-year-old cases. Indirect tax dispute amounts to approx. 16 crs and direct tax dispute amounts to approx. 6 crs. The company has mentioned this as contingent liabilities on page 176; however, there are no provisions are being made.

This comment has made me skeptical, considering the current fiscal position of the government and burden on the IT department to meet steep tax collection targets.

There is also SEBI/SAT and Supreme Court order on CIS scheme dating back to 2003 on Ion Exchange Enviro Farms Ltd., subsidiary dealing with agro-industry. The company had been ordered to close this scheme; however, the case is still pending. I have attached a few snapshots related to this case. The management has disclosed in the AR FY 2019 page 114, concall for Q1 FY 2020 page 4, that scheme is closed, and deposits have been refunded to customers. Advocates have advised that on loss shall be borne on this account.

Such tax disputes and litigations have also led to an increase in legal fees y-o-y approx. 1 cr.

I am looking for investment opportunities in this company, since lack of wastewater management and zero-days are happening all over the world, especially with infrequent weather patterns. This company is a leader in the water treatment industry, with huge business opportunities in this industry.

However, litigation cases which could lead to huge liabilities, if the judgment does not come in favour of the company. Live example being the SC ruling on AGR guidelines putting a huge burden on the telecom industry of our country. In addition, its consumer segment is minuscule and that too loss-making in recent years and the strategy of mass engagement does not sound like a profitable one.

Regards,

Tanmay Ghate

Dr Vijay Malik’s Response

Hi Tanmay,

Thanks for sharing the analysis of Ion Exchange (India) Ltd with us! We appreciate the time & effort put in by you in the analysis.

While analyzing the past financial performance data of Ion Exchange (India) Ltd, an investor would notice that the company has created many subsidiaries and joint venture companies in India and abroad. As a result, Ion Exchange (India) Ltd provides both standalone financials as well as consolidated financials in its annual reports.

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. Consolidated financials of any company present such a picture. Therefore, while analysing Ion Exchange (India) Ltd, we have analysed its consolidated financials.

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

Let us analyse the consolidated financial and business performance of the company over the last 10 years.

Financial and business analysis of Ion Exchange (India) Ltd:

While analyzing the financials of Ion Exchange (India) Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 9%-10% year on year. Sales of the company increased from ₹522 cr. in FY2010 to ₹1,162 cr in FY2019. The growth of the company has been almost consistent year on year except in FY2014 when the sales of the company declined to ₹787 cr from ₹852 cr in FY2013.

As per the company, in FY2014, change in the macroeconomic environment was the primary reason for the decline in sales. In FY2014, almost the entire water treatment industry faced lower business and a cash crunch. This, in turn, was the result of challenges faced by the key sectors like power, steel etc., which provide business to the water treatment industry in the form of water treatment units at their manufacturing plants.

FY2014 annual report, page 28:

Water treatment industry as a whole faced challenges in the domestic market as both the large and the small players suffered due to reduced flow of new projects and severe cash crunch affecting the customers. Even some of the larger engineering focused players were under severe cash stress and were struggling to continue with the smooth $ ow of operations.

This dependence of the business performance of Ion Exchange (India) Ltd on the general economic scenario has been highlighted by the credit rating agency, CRISIL, as well. In its report for the company in Nov. 2018, CRISIL stated that the company is susceptible to slowdowns in the economy and the industry.

These strengths are partially offset by working capital-intensive operations and the susceptibility to economic downturns.

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

While analysing the operating profit margins (OPM) of Ion Exchange (India) Ltd, an investor would note that the OPM of the company over the years had been fluctuating within the range of 4%-6% until FY2017. From FY2018 onwards, the OPM of the company has surpassed 7.5% and is currently 9.5% based on the last 12 months (Oct. 2018-Sept. 2019).

While reading about the company to understand such a behavior of the profitability margins, an investor gets to know that recent change in performance of the company is primarily due to one large-sized order ($194 mn) received by the company from National Water Supply and Drainage Board, Sri Lanka (NWSDB) in FY2017.

FY2017 annual report, page 40:

Your company has started the execution for the USD 194 mn water supply project received from the Sri Lankan Water Board during the last quarter of FY17. Your company is hopeful that this project will add newer dimensions to the existing execution capabilities and help us to grow at a much faster rate in the future.

Before, the company received this order i.e. during FY2010-2016; the profit performance of the company indicates low single-digit margins, which kept on fluctuating in a cyclical manner between 4% to 6%. The key reason for such profit performance was the intense competition faced by the Ion Exchange (India) Ltd from Indian as well as foreign competitors in the water treatment field. As a result, of intense competition, the company faced difficulties in passing on the increase in raw material costs to its customers. As a result, the company had to take a hit on its profit margins whenever raw material costs increased.

The management of the company has pointed out this aspect of the business of the company on multiple occasions in past annual reports.

In the FY2012 annual report, the management pointed out that the increase in raw material costs affects its profit margins.

FY2012 annual report, page 8:

Price volatility in the cost of inputs continues to impact the margins. However, the timely measures taken by your Company has minimised the adverse impact to a large extent. It is expected that the volatile situation in the raw material costs will not change radically in the future. We will continue to take proactive measures to effectively minimise the impact of price volatility.

FY2012 annual report, page 14:

Margins in both resin and Industrial Chemicals were under pressure due to higher cost of raw material and sudden depreciation of the Rupee.

In FY2013, the company highlighted to the shareholders that intense competition in the industry and the increasing raw material prices are affecting its profit margins.

FY2013 annual report, page 16:

Adverse Impact on Margins: The restricted set of opportunities and the state of the economy has led to intense competition in the industry and consequently a downward pressure on margins. Another factor having an adverse impact on prices was raw material prices. Volatility in the raw material prices reduced during the year under review but, the high prices continued to put downward pressure on margins.

In FY2014, once again, the management of the company acknowledged its vulnerability to an economic slowdown and high raw material prices.

FY2014 annual report, page 29:

The slowdown in the Indian economy and weak recovery in the advanced economies affected this segment. Additionally, inflation, weak currency and subdued demand from overseas markets had an impact on this segment. There were also challenges considering number of projects being postponed and slow down in implementation of existing projects. This along with increased material costs had an impact on the margins of this segment.

In recent times, the profitability of the company has improved due to the high-margin large order from Sri Lanka. However, still, the company acknowledges that things have not changed for good and its profit margins are still susceptible to increases in the raw material prices.

FY2019 annual report, page 40:

This environment adversely affected procurement cost and impacted the margins in 1st half of 2018. This continues to remain a matter of concern for Indian Industry. While the management of your company remains vigilant of the situation and actively try to ensure that the costs are fairly passed on to customers, where possible; but it cannot completely overrule the company being impacted for some period due to cost increases.

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

Therefore, an investor would appreciate that even though Ion Exchange (India) Ltd has reported significant improvement in the operating profit margins (OPM) in recent years, it is primarily due to high-margin Sri Lanka order. This order is expected to be largely completed in June 2020.

Nov. 2019 conference call, page 11:

Kushal Deira: Sir, just wanted to ask on the Sri Lanka order. I understand roughly INR 750 Cr. would be pending as on date. And as you said, you plan to do INR 500 Cr. in FY20. So, are we on track to complete this order by June, which was I think the scheduled date for completion of this order?

N.M.Ranadive: The major portion will get completed within the contractual due date. However, some portion of contract will get extended by few months by mutual understanding with the customer.

Going ahead, investors need to keep a close watch on the profit margin in the future once the benefits of this order are over. This is because, as mentioned by the company in its FY2017 annual report, the competition in the industry is increasing and many international players are entering India by buying out domestic players.

FY2017 annual report, page 39:

The industry remains fragmented and continues to show signs of consolidation with several international parties participating in acquisition of Indian companies.

The net profit margin (NPM) of Ion Exchange (India) Ltd has largely followed the trend of its operating profit margin. NPM of the company used to be in the range of 1% to 2% until the recent year when it improved to 5.5% on the back of high-margin Sri Lanka order.

While analysing the tax payout ratio, an investor would notice that the company has been paying taxes at a rate of 35%-50% on its profit before tax (PBT), which is higher than the standard corporate tax rate prevalent in India.

Since FY2018, the updated format of the annual reports has stipulated that companies show the reconciliation of their tax expense/payout ratio viz-a-viz standard corporate tax rate applicable to them. As a result, while analysing the tax reconciliation table, an investor gets to know the reasons for a higher or a lower tax payout ratio, as the case may be for different companies.

When an investor analyses the tax reconciliation table in the FY2018 annual report, which has data for FY2017 and FY2018, then she is able to understand that the high tax payout ratio paid by the company in FY2017 (46%) and FY2018 (40%) is due to non-allowance of tax benefit on certain losses incurred by the company.

FY2018 annual report, page 159:

Further advised reading: Understanding the Annual Report of a Company

Looking at the above table an investor would notice that in FY2018, the tax expense as per standard corporate tax rate would have been about ₹22 cr, which increased to about ₹26 cr primarily because of non-allowance of tax benefit of about ₹4 cr due to the losses incurred by the company. Similarly, in FY2017, the tax expense as per standard corporate tax rate would have been about ₹18 cr, which increased to about ₹24 cr primarily because of non-allowance of tax benefit of about ₹6 cr due to the losses incurred by the company.

Losses incurred by the company in foreign locations may be one of the reasons for this non-allowance of tax adjustment and the resultant higher tax payout ratio. However, an investor may contact the company directly to understand more about these losses and the tax aspects.

Further advised reading: How to do Financial Analysis of Companies

Operating Efficiency Analysis of Ion Exchange (India) Ltd:

a) Net fixed asset turnover (NFAT) of Ion Exchange (India) Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Ion Exchange (India) Ltd in the past years (FY2010-19), then she notices that the NFAT of the company has been consistently very high over the years. The NFAT has been in the range of 8 to 10 over the years.

An investor would notice that in the normal course of business, manufacturing companies usually have an NFAT in the range of 1-4. An NFAT of 8-10 indicates that the business of water treatment plants’ production needs very low investment in plant and machinery.

As a result, any person/entity with a small amount of effort can raise the capital and put up a competing manufacturing plant. An investor would appreciate that this may be one of the reasons for the intense competition faced by Ion Exchange (India) Ltd because many firms in the unorganized sector may be able to compete with it by investing a small amount of money in the water treatment plant manufacturing set up.

Moreover, high NFAT also results from conditions when companies have a significant component of services, subcontracting and trading activities in their business. All these aspects of the business lend themselves to high competition.

An investor would note that historically, the net profit margins of Ion Exchange (India) Ltd have been in the range of 1-2% and only recently, due to high-margin Sri Lanka order, the profit margins have improved a bit. Low-profit margins are an indication of intense competition in the business faced by the company both from organized and unorganized sector players.

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

b) Inventory turnover ratio of Ion Exchange (India) Ltd:

While analyzing the inventory turnover ratios (ITR) of Ion Exchange (India) Ltd, an investor would note that during FY2010-2019, the ITR had been in a range of 10-12. There were periods in between (FY2012-2018) when the ITR declined from 12.3 to 9.1. However, in FY2019, the ITR seems to have improved to 10.1. Overall, it indicates that the inventory utilization efficiency has remained largely the same over this period.

Advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of Ion Exchange (India) Ltd:

An investor would notice that over the years, Ion Exchange (India) Ltd has kept its receivables days within the range of 140-150 days. There have been phases like in FY2014 when the receivables days deteriorated to 164 days, which coincided with the decline in sales due to industry-wide slowdown and cash crunch (as discussed above). It seems that during this period, the customers deferred new projects leading to lower sales for Ion Exchange (India) Ltd and delayed payments on existing projects leading to higher receivables days.

However, since then, the situation seems to have improved and in recent years, the company has received significant advance money from the National Water Supply and Drainage Board, Sri Lanka (NWSDB).

FY2018 annual report, page 155:

The company has to keep this advance in a dedicated current account (escrow account) for the specific project’s expenses.

FY2018 annual report, page 148:

Further advised reading: Understanding the Annual Report of a Company

Nevertheless, an investor would note that receivables days of 150 days is high for any business. Moreover, an analysis of the annual reports indicate that out of the receivables reported by Ion Exchange (India) Ltd, a significant amount is delayed. A large amount of receivables has always remained delayed for more than 6 months since the day they became due for payment.

Ion Exchange (India) Ltd disclosed the data of delayed receivables in its annual reports until FY2017. While reading the FY2017 annual report, an investor notes that in FY2017, the company had ₹77 cr worth of receivables delayed by more than 6 months since the day they become due. The same number for FY2016 was ₹88 cr.

FY2017 annual report, page 129:

An investor would note that the amount of significantly delayed receivables (FY2017: ₹77 cr and FY2016: ₹88 cr), are very high in comparison to the net profits (PAT) of the company for these years (FY2017: ₹30 cr, FY2016:₹15 cr).

An investor would acknowledge that large delays in the collection of receivables could create troublesome situations for any company. In case, it is not able to collect money from the customers, then all the previously reported profits will cease to exist i.e. will remain on paper only.

While reading the past annual reports, an investor notices that in some instances Ion Exchange (India) Ltd has used innovative methods to bring the receivables under control.

In FY2012, two subsidiaries of the company, Ion Exchange Asia Pacific Ptd. Ltd and Global Composites and Structurals Ltd allotted shares to the company in exchange for the receivables.

FY2012 annual report, page 71:

Ion Exchange Asia Pacific Pte. Ltd. subsidiary company and Global Composites and Structurals Limited. subsidiary company have dunng the year allotted 7,61,000 and 9,53,368 shares respectively against the receivables.

The practice continued in FY2013 as well, when four subsidiaries allotted shares to Ion Exchange (India) Ltd in exchange for receivables.

FY2013 annual report, page 77:

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

In addition, the company has been consistently writing off bad debts year on year. For example, FY2015 annual report, page 134:

In FY2014, the company had to write off the bad debt of ₹3.34 cr, which is about 60% of the net profit for the company in that year. In FY2015, the company wrote off bad debts of ₹4.27 cr, which is more than 40% of the net profits for the year.

It is the period when the company witnessed a decline in sales due to the economic slowdown and the cash crunch faced by the industry and its customers. The company acknowledged in the FY2014 annual report that the slowdown and cash crunch has increased the credit risk faced by the company as the customers have delayed payments.

FY2014 annual report, page 30:

The continued liquidity crunch and the resulting uncertainty regarding fund availability and the rising interest costs affected business sentiments. There is an overall increase in the credit risk faced by your company as projects are being deferred and existing projects are under stress due to delayed and slow payments.

In FY2019, the company wrote off bad debts of about ₹11 cr.

FY2019 annual report, page 156:

Since FY2018, the company has stopped disclosing the breakup of trade receivables according to the number of outstanding days of delays.

FY2018 annual report, page 145:

An investor would note that in the updated annual report format as per new Indian Accounting Standards (IndAS), in the note on trade receivables, companies are no longer providing details of receivables outstanding for more than 6 months like they used to do earlier. However, in the detailed disclosures in the annual report, under the “Credit Risk” section, the companies have started to provide an even greater breakup of receivables into multiple brackets under expected credit loss calculations. For example, the following table from the FY2018 annual report of Associated Alcohol & Beverages Ltd, page 132:

Further advised reading: Understanding the Annual Report of a Company

However, the recent annual reports of Ion Exchange (India) Ltd does not provide any such detailed breakup of trade receivables in the credit risk section.

FY2019 annual report, page 162:

Moreover, when an investor analyses the change in the amount of trade receivables of the company when it adopted the new Indian Accounting Standards (IndAS), then she notices that in the year of the first adoption, FY2018, the company restated the trade receivables for the previous two years i.e. FY2016 and FY2017.

Further Advised Reading: Receivable Days: A Complete Guide

While comparing the trade receivables of the company for FY2016 and FY2017 in the older annual reports and the annual report of FY2018, the investor notices that In FY2018 annual report:

• The trade receivables for FY2016 have declined by ₹41 cr, from ₹389 cr in the previous annual reports to ₹358 cr in the FY2018 annual report and
• The trade receivables for FY2017 have declined by ₹33 cr, from ₹466 cr in the previous annual reports to ₹433 cr in the FY2018 annual report.

FY2017 annual report, page 129 showing trade receivables of FY2016 and FY2017 as per previous reporting standards:

FY2018 annual report, page 143 showing trade receivables of FY2016 and FY2017 as per new IndAS reporting:

It seems that if an investor wishes to get more details about the amount of delays in the outstanding receivables and the reconciliation for the differences, then she may have to contact the company directly.

Nevertheless, if an investor notices that over the years, the receivables position of the company has remained under such delays, which is visible through the receivables days staying within the range of 140-150 days almost throughout the last 10 years and have seemed some improvement of 135 days in FY2019.

An investor would appreciate that such high receivables days of a company indicate that the operations are working capital intensive.

The credit rating agency, CRISIL, in its credit rating report of the company in Nov. 2018 has highlighted the working capital intensive aspect of the business of the company.

These strengths are partially offset by working capital-intensive operations and the susceptibility to economic downturns.

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

An investor would note that from FY2010 to FY2019, the trade receivables of the company have increased from ₹248 cr to ₹424 cr. It indicates that over FY2010-2019, ₹176 cr of funds of Ion Exchange (India) Ltd were stuck in its working capital because of trade receivables.

However, when an investor analyses the payables days of Ion Exchange (India) Ltd, then she notices that the company is able to get very generous terms from its suppliers. Over the years, the trade payables of the company have increased from ₹188 cr in FY2010 to ₹415 cr in FY2019. It indicates that the company could use ₹227 cr of money of suppliers in its operations, which is more than the money of Ion Exchange (India) Ltd that got stuck in trade receivables over the last 10 years (FY2010-2019).

The credit rating agency, CRISIL, in its credit rating report of the company in Aug. 2017 has highlighted that Ion Exchange (India) Ltd is able to control its working capital despite high receivables days because it is able to get back-to-back arrangements from its suppliers.

Weaknesses: Working capital-intensive operations: This is reflected in its high gross current assets of 276 days as of March 2017 (217 days as of March 2016). The increase was primarily on account of rise in cash levels owing to receipt of advance from the National Water Supply and Drainage Board, Sri Lanka (NWSDB). Receivables period was at 162 days due to adverse conditions in the client markets, especially in the power and metal industries where the group executes large orders. The group stores minimal inventory of around 43 days. Payables have remained steady, averaging about 220 days over the past few years. The group, to an extent, is protected against working capital issues due to back-to-back arrangements with suppliers.

As a result, when an investor compares the cumulative net profit after tax (cPAT) of the company with the cumulative cash flow from operations (cCFO) for FY2010-19, then she notices that Ion Exchange (India) Ltd has been able to convert its profits into cash flow from operations.

Over FY2010-19, Ion Exchange (India) Ltd has reported a total cumulative net profit after tax (cPAT) of ₹202 cr. whereas during the same period, it reported cumulative cash flow from operations (cCFO) of ₹616 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 Ion Exchange (India) 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 Ion Exchange (India) Ltd, an investor would notice that the company has consistently had a low SSGR (negative to 0%) over the years. Only in recent years (FY2018-FY2019), the SSGR has improved to 11%-13%, which is primarily due to a recent increase in the profitability of the company. Moreover, the company has been retaining more money with itself, which is visible by the recent decline in its dividend payout ratio, which has come down to 10%, which is an all-time low.

While studying the formula for calculation of SSGR, an investor would understand that the SSGR directly depends on the NFAT and net profit margin (NPM) of a company.

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

• SSGR = Self Sustainable Growth Rate in %
• Dep = Depreciation rate as a % of net fixed assets
• NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
• NPM = Net profit margin as % of sales
• DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

An investor would notice that the NPM of Ion Exchange (India) Ltd has been consistently very low in the range of 1% to 2% and the dividend payout ratio used to be high at 30%-60%. Therefore, the company consistently has a low SSGR over the years. In FY2019, the NPM has increased to 5.6% and the dividend payout ratio has declined to 10% indicating that the company is making more money from profits and is retaining most of it with itself for investment in the business. As a result, the SSGR has increased to 21% in FY2019.

An investor would appreciate that the company has been growing at a rate of 10% over the years. However, the historical low SSGR indicates that the company does not seem to have the inherent ability to grow at the rate of 10% from its business profits. As a result, investors would think that Ion Exchange (India) Ltd would have to raise money from additional sources like debt or equity to meet its investment requirements.

However, while analysing the growth history of the company, an investor notices that despite growing at 10%, the company has kept its debt levels under control. Over the last 10 years, the debt levels of the company have increased from ₹59 cr in FY2010 to ₹110 cr in FY2019 whereas there has been a significant increase in its cash & investments from ₹22 cr in FY2010 to ₹295 cr in FY2019

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 control debt over the years. In such cases, the 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 control debt levels.

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 Ion Exchange (India) Ltd:

While looking at the cash flow performance of Ion Exchange (India) Ltd, an investor notices that during FY2010-19, the company had a cumulative cash flow from operations of ₹616 cr. However, during this period it did a capital expenditure (capex) of ₹212 cr. As a result, it had a free cash flow of ₹404 cr. (616 – 212).

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

While analysing the past annual reports of Ion Exchange (India) Ltd an investor would notice that the company has used this FCF of ₹404 cr and incremental debt of ₹51 cr, total ₹455 cr (= 404 + 51) in various manners:

1. Payment of interest on the outstanding debt: ₹161 cr of interest expense over FY2010-2019. Please note that the capitalised interest is already factored in the capital expenditure over the last 10 years.
2. Payment of dividend to shareholders: ₹37 cr excluding dividend distribution tax.
3. Increase in cash & investments: ₹273 cr, an increase in cash & investments from ₹22 cr in FY2010 to ₹295 cr in FY2019 (272 = 295 – 22)

However, an investor would note that despite the presence of significant cash & investment balances, the company is not able to repay its debt completely to become debt-free. This is because of two reasons:

1. As discussed above, the cash balance also contains the money received from National Water Supply and Drainage Board, Sri Lanka (NWSDB) as advance, which has been kept by the company in a dedicated escrow account. This money can be used only for expenses of the Sri Lanka project and not for any other purpose.
2. In addition, the company has to give a lot of bank guarantees to other counterparties in the normal course of business like bidding for projects, tenders etc, which are secured by the cash deposited by the company with the banks. These deposits, even though visible in the cash & investment balance, can not be used for any other purpose till the time the bank guarantee issued by the respective bank is outstanding. As per the FY2019 annual report, page 146, about ₹158 cr of deposits are blocked as security for guarantees issued by the banks.

Margin money deposits with a carrying amount of Rs. 15,780.15 Lacs (31st March 2018: Rs. 14,345.19 Lacs) are subject to first charge to secure bank guarantees issued by banks on our behalf.

Investors may need to contact the company directly for details of the guarantees.

Nevertheless, the presence of free cash flow indicates that Ion Exchange (India) Ltd has been able to meet all its capital expenditure requirements from its cash flow from operations. As a result, the company could keep its debt level under check 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 Ion Exchange (India) Ltd:

On analysing Ion Exchange (India) Ltd and reading the annual reports since FY2011, an investor comes across certain other aspects of the company:

1) Management Succession of Ion Exchange (India) Ltd:

While reading the FY2013 annual report of Ion Exchange (India) Ltd, an investor gets to know about the history of the company.

• Investor notices that the water treatment company of the UK, Permutit, was represented in India by another UK company, J. Stone. (1930s)
• In 1952, Permutit decided to leave India due to falling business, but J. Stone convinced them to keep India business alive.
• Mr. G. Shankar Ranganathan, an employee of J. Stone worked hard and could improve the business significantly.
• Because of the improving business, Permutit formed an Indian subsidiary, Ion Exchange (India) Ltd, with 60% foreign holding in 1964.
• In 1984, when Permutit decided to leave India, then Ion Exchange (India) Ltd formed many employee welfare trusts, which bought the shares held by Permutit and the company became a wholly Indian owned entity.

FY2013 annual report, page 2:

G. Shankar Ranganathan, Founder and Chairman Emeritus

From small beginnings, with pioneering and entrepreneurial spirit, Mr. Ranganathan created the strong Ion Exchange edifice and raised it into a global player with a vision. In the 1930s J. Stone, a Calcutta based British Company, was Permutit’s agent in India. Their main business was from the Indian railways and textile mills. In 1952, because of dwindling sales, Permutit planned to shut shop in India but were persuaded by J. Stone to give it oa lost chance. A young Ranganathan joined J. Stone – with a staff of just two commissioning engineers and a steno-typist. Business picked up and Permutit accepted Ranganathan’s recommendation to form a subsidiary company and in 1964 Ion Exchange (India) Ltd., was registered with 60% equity by Permutit, 40% Indian. In 1984 when Permutit divested their holding, he advocated and set up employee welfare trusts, a pioneering concept for India and Ion Exchange become a wholly Indian company.

While reading additional aspects via annual reports of the company, an investor notices that effectively the trust got the money to buy the shares from Permutit from Ion Exchange (India) Ltd in the form of loans. As per the FY2017 annual report, page 97, Ion Exchange (India) Ltd disclosed that the purpose of its loans to the trust is to create a corpus for these trusts.

The trusts own 2,662,914 shares of the company. FY2017 annual report, page 97:

The trusts receive dividends of about ₹75-80 lac every year for the shares held by them and utilizing this dividend amount to repay the loans to the company for about ₹60 lac every year.

FY2017 annual report, page 96:

By the understanding received until now, an investor understands that originally, Ion Exchange (India) Ltd was led by Mr. G. Shankar Ranganathan and the employee welfare trusts owned a significant stake in the company. This seems like a professional corporate setup.

When an investor looks at the current Chairman & Managing Director of the company, Mr. Rajesh Sharma, then it looks like that he is not a blood relative of Mr. G. Shankar Ranganathan.

As per the FY2014 annual report, Mr. Rajesh Sharma joined the company in 1974 and then worked across various positions in his career with the company before becoming the current Chairman & Managing Director.

FY2014 annual report, page 9:

This seems like a leadership change where the leadership baton was passed from one professional to another professional of the company.

If an investor looks at the current senior leadership, then she notices that Executive Director, Mr. Dinesh Sharma, is the brother of current CMD, Mr. Rajesh Sharma. Moreover, among the other directors of the company are Executive Director, Mr. Aankur Patni and his father Mr. M. P. Patni. Therefore, it seems that now family relations are making their presence in the board of directors.

In addition, if an investor notices the change of shareholding of the senior management over the years, then she notices that the current leadership is increasing its stake in the company consistently by various means.

a) FY2011: Share allotment via exercise of employee stock options and private placement:

In FY2011, Ion Exchange (India) Ltd disclosed in its annual report that it has allotted 950,000 shares to key management personnel (KMP) and their relatives on the exercise of employee stock options and private placement.

FY2011 annual report, page 94:

While reading the details of related parties, an investor finds that the relatives of key management personnel are father, mother, wife and daughter of Mr. Rajesh Sharma, Mr. Dinesh Sharma and Mr. Aankur Patni.

FY2011 annual report, page 93:

Relatives of Key Management Personnel:

• Mr. Mahabir Patni – Father of Mr. Aankur Patni
• Mrs. Nirmala Patni – Mother of Mr. Aankur Patni
• Mrs. Aruna Sharma – Wife of Mr. Rajesh Sharma
• Mrs. Poonam Sharma – Wife of Mr. Dinesh Sharma
• Mrs. Nidhi Patni – Wife of Mr. Aankur Patni
• Ms. Pallavi Sharma – Daughter of Mr. Rajesh Sharma

Therefore, in FY2011, the current senior leadership of the company increased its stake by 950,000 shares via the exercise of employee stock options and private placement.

At the end of FY2011, the company reported a total number of 13,098,011 shares including the 950,000 shares issued to KMP and their relatives.

FY2011 annual report, page 74:

Therefore, in FY2011, the KMP and their relatives increased their stake in the company by 7.25% (= 950,000/13,098,011) in FY2011 by way of exercise of employee stock options and private placement.

Also read: How Promoters use Loopholes to Inflate their Shareholding

b) FY2014: Increase in stake of promoters of Ion Exchange (India) Ltd:

In FY2014, an investor notices that the shareholding of promoters in the company increased from 40.6% at the end of FY2013 to 44.44% at the end of FY2014.

FY2013 annual report, page 28:

FY2014 annual report, page 40:

In absolute terms, in FY2014, the promoters’ shareholding increased by 941,334 shares (= 6,458,727 shares at FY2014 – 5,517,393 shares at FY2013)

While analysing further details, an investor finds that the shareholding of CMD, Mr. Rajesh Sharma, and shareholding of Mr. M. P. Patni, the father of Executive Director, Mr. Aankur Patni, have increased in FY2014.

FY2014 annual report, page 108:

Further, in the FY2014 annual report, there is no mention of allotment of shares to KMP by way of exercise of employee stock options.

However, in FY2014, the share capital of the company increased significantly due to issuance of 1,070,282 new shares as a part of an amalgamation of one of the associate company, Ion Exchange Services Ltd (IESL).

FY2014 annual report, page 108:

While reading about the amalgamation of Ion Exchange Services Ltd (IESL), in the FY2013 annual report, an investor notes that Ion Exchange (India) Ltd held 41.58% stake in IESL and the remaining stake was owned by other parties.

FY2013 annual report, page 89:

As in FY2014, there is no allotment under the exercise of stock options to KMP; therefore, an investor can assume two possible situations leading to increase in stake of promoters by 941,334 shares:

1. The promoters bought 941,334 shares from the open market and increased their shareholding.
2. The promoters are the significant other parties in Ion Exchange Services Ltd (IESL) holding 58.42% stake (= 100 – 41.58) who are allotted most of the 1,070,282 new shares issued by Ion Exchange (India) Ltd in FY2014.

An investor may contact the company directly to get the clarification about the other counterparties in Ion Exchange Services Ltd (IESL) who were allotted shares on amalgamation and whether the KMP constituted these counterparties.

Also read: How Promoters use Loopholes to Inflate their Shareholding

c) FY2020: increase in stake of promoters:

From FY2014, until Sept 2019, the number of shares owned by the promoters of Ion Exchange (India) Ltd stayed constant at 6,458,727. Even though, the percentage shareholding declined from 44.44% in FY2014 to 44.04% in FY2019 because of the allotment of new shares on exercise of stock options to employees other than key management personnel (KMP).

Sept 2019 shareholding pattern as per the BSE website:

Even among the promoters, the number of shares owned by the KMP and their relatives seems to stay constant until Sept 2019 (Source BSE, March 2014, and Sept. 2019):

• Mr. Rajesh Sharma: 781,218 shares,
• Mr. Dinesh Sharma: 588,521 shares,
• Mr. Aankur Patni: 254,668 shares,
• Mr. M. P. Patni: 711,747 shares

However, in the current financial year, in Oct. 2019 and Dec. 2019, there have been certain transactions where the employee welfare trusts have sold shares and the KMP, their relatives, Independent Directors and other major shareholders have picked up the majority of those shares. These transactions have been reported under section BSE > Disclosures > Insider Trading 2015 at the BSE website.

BOARD OF DIRECTORS:

• Mr. Rajesh Sharma Chairman & Managing Director
• Mr. Dinesh Sharma Executive Director
• Mr. Aankur Patni Executive Director
• Dr. V. N. Gupchup Director
• Mr. M. P. Patni Director
• Mr. T. M. M. Nambiar Director
• Mr. P. Sampath Kumar Director
• Mr. Abhiram Seth Director
• Mr. Shishir Tamotia Director
• Ms. Kishori J. Udeshi Director

• On Oct. 31, 2019, out of 175,000 shares sold by the trusts, 171,875 shares have been bought by the key management personnel and their relatives and 3,125 shares have been picked by Mr. Bimal Jain who owns 2.82% stake (414,098 shares) in the company at Sept 30, 2019 (Source: BSE).
• On Dec. 20, 2019, out of 94,000 shares sold by the trusts, 90,500 shares have been bought by the Independent Directors and 3,500 shares have been picked by Mr. Anil Manocha, and Mr. Harminder Mohan Bareja.
• On Dec. 23, 2019, 2,900 shares were sold by the trusts, which have been bought by Parthasarathy Sampath Kumar (Independent Director).

As per the BSE website, the mode of disposal/acquisition of these 271,900 (= 175,000 + 94,000 + 2,900) shares is “Market Sale”/”Market Purchase”. Therefore, an investor may assume that these transactions indicate that the shares until now owned by the employee welfare trusts are now owned by individuals, which are primarily existing KMP and directors of the company.

An investor would note that the changes in the management and shareholding structure of the company over the last decade indicate that Ion Exchange (India) Ltd may be changing its character from an “Employee-owned, Employee-run” company to a “Promoter-owned, Promoter-run” company. Current increase in stake of key management personnel and directors in the company along with presence of blood relatives in the senior management and board of directors indicates that the nature of management succession in the company in future may be different from the last management succession when the leadership baton changed from one professional employee to another professional employee.

Going ahead, an investor should keep a close watch on the changes in the shareholding of the company. The investor should also watch whether the next generation of the key management personnel joins the company in executive positions.

Moreover, the investor should monitor future disclosures by the company like the FY2020 annual report to check whether the Trusts use the money received by them from the sale of 271,900 shares in Oct.-Dec 2019 to reduce the loans given by Ion Exchange (India) Ltd to them.

At March 31, 2017, the trusts had a loan of ₹20.64 cr outstanding from Ion Exchange (India) Ltd

FY2017 annual report, page 144:

At the current share price of about ₹750-800/-, the sale of 271,900 shares should provide the trust an amount of about ₹20-21 cr. If the investments of the trusts are exempt from capital gains tax and the trusts use this money to repay the loans given by Ion Exchange (India) Ltd to the trusts, then they can repay almost the entire loan.

It seems that in the annual reports of FY2018 and FY2019, Ion Exchange (India) Ltd has stopped disclosing the amount of loan outstanding in the case of the Trusts, as we are not able to find this information in these annual reports. Therefore, to ascertain the usage of the funds raised by the Trusts by selling 271,000 shares of the company to the directors, an investor may have to contact the company/management directly.

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

2) Subsidiaries and associate company holding shares of the parent company (Ion Exchange (India) Ltd):

While analysing the shareholding pattern of Ion Exchange (India) Ltd, an investor notices that the list of entities under promoters’ shareholders includes a few subsidiaries and an associate company of Ion Exchange (India) Ltd. At March 31, 2019, the following companies owned shares of the parent company:

1. Aqua Investments (India) Limited (subsidiary, 99.42% holding) owned a 1.73% stake (253,803 shares) of Ion Exchange (India) Ltd.
2. Watercare Investments (India) Ltd (subsidiary, 99.43% holding) owned 1.26% stake (184,071 shares) of Ion Exchange (India) Ltd.
3. Ion Exchange Financial Products Pvt Ltd (associate company, 24.02% holding) owned a 0.34% stake (50,422 shares) of Ion Exchange (India) Ltd.

Shareholding pattern, March 2019, BSE website:

FY2019 annual report, page 129 shows the subsidiary status of Aqua Investments (India) Limited and Watercare Investments (India) Ltd along with the stake owned by Ion Exchange (India) Ltd in these companies.

FY2019 annual report, page 129 shows the associate company status of Ion Exchange Financial Products Pvt Ltd along with the stake owned by Ion Exchange (India) Ltd in it.

We believe that where parent companies hold their own shares through subsidiary companies and show these as promoter shareholding, these cases create an illusion of a higher promoter shareholding than it might actually be.

For example, in the case of Ion Exchange (India) Ltd, we see that on March 31, 2019, the promoter shareholding is about 40%, out of which about 3% is owned by two subsidiary companies. These subsidiary companies are not owned 100% by promoters. These subsidiary companies are owned by all the shareholders of Ion Exchange (India) Ltd in proportion to their shareholding. Therefore, the promoters own only 40% of these subsidiaries and as a result, out of the 3% stake owned by these subsidiaries, only 1.2% (= 3% * 40%) belong to the promoters. Therefore, considering the shareholding of these two subsidiaries, the effective stake of promoters comes down to 38.2% from the reported stake of about 40% (= 40% – 3% + 1.2%).

On similar lines, if we adjust the promoters’ stake reported at March 31, 2019, for the shares owned by the associate company (0.54%) and the Employee Welfare Trusts (2,662,914 shares, 18.16% stake), then the effective stake of promoters will fall further below the reported stake of 40%.

When companies report the shares owned by subsidiaries, associate companies, and Employee Welfare Trusts under promoters’ shareholding, there is another aspect at play. The shares owned by these entities are purchased by funds, which effectively only partly belong to the promoters because promoters own only a part of these entities. Whereas the entire shareholding of these entities is reported under promoters’ stake. This creates a scenario where a party contributes only 40% of the money but enjoys 100% of the fruits.

Therefore, we believe that while assessing the promoters’ shareholding in such companies, investors may make relevant adjustments at their own end.

Also read: How Promoters use Loopholes to Inflate their Shareholding

In the case of Ion Exchange (India) Ltd, on March 31, 2019, as per the annual report, it seems that another associate company, Aquanomics Systems Ltd, holds shares of Ion Exchange (India) Ltd. This is because the name of Aquanomics Systems Ltd appears in the list of related parties that are paid a dividend by Ion Exchange (India) Ltd.

FY2019 annual report, page 106:

However, the name of Aquanomics Systems Ltd is not present in the shareholding details at the BSE website for March 2019. Investors may contact the company directly for any clarifications.

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

3) Legal dispute with SEBI under Collective Investment Scheme (CIS) regulations:

While reading the annual reports of Ion Exchange (India) Ltd, an investor gets to that one of the subsidiary companies; Ion Exchange Enviro Farms Limited (IEEFL) is facing a legal dispute with Securities and Exchange Board of India (SEBI) under the Collective Investment Scheme (CIS) regulations.

The recent legal hearing of this case happened in the Securities Appellate Tribunal (SAT), which passed a decision on the appeal of the IEEFL on Oct. 18, 2019. The judgment document of the SAT (click here) provides a brief history of the case and position of various counterparties. It is advised that every investor interested in Ion Exchange (India) Ltd should go through this judgment document of SAT (12 pages).

The briefs of the case are as below:

• IEEFL raised a sum of ₹23.44 crore from 891 investors for its scheme in the early 2000s.
• On November 27, 2003, SEBI directed IEEFL to refund the amount collected from the investors as it was doing the business of Collective Investment Scheme without obtaining a certificate of registration from SEBI.
• IEEFL appealed before SAT, which dismissed the appeal on May 5, 2006.
• Then IEEFL before the Honorable Supreme Court of India, which also dismissed its appeal February 26, 2013.
• As the company had exhausted its legal options, SEBI issued a recovery order to the company on December 30, 2015, asking it to deposit ₹20.06 cr
• On February 3, 2017, IEEFL appealed to SAT saying that it already refunded/paid most of the investors. In the hearings before SAT, the company stated that it has:
  • Given land parcels to 690 investors who had contributed ₹17.84 crores;
  • Given cash to 122 investors (₹3.23 crore), and
  • Only payment to 79 investors who had contributed ₹ 2.37 crore is remaining.
  • For these 79 investors, IEEFL has deposited cash of ₹2.37 crore and the land of worth ₹5.95 crores with SEBI. Therefore, no further liability of IEEFL remains.
• The lawyer of SEBI argued the following:
  • IEEFL never claimed that it had refunded money to investors to SEBI (2003), to SAT (2006) or to the Honorable Supreme Court of India (2013). After 16 years, now they are claiming this for the first time.
  • There is evidence that the land being claimed to have returned to 690 investors is mostly under the control of IEEFL only.
  • Moreover, the direction to the company was to refund the money and not return the land.
• On Oct. 18, 2019, after hearing both the parties, SAT dismissed the appeal of IEEFL stating that:
  • IEEFL has been given many opportunities to give documents to SEBI. However, IEEFL is just making bold statements with part documentation by which no conclusion can be reached to prove the refund of money to the investors.
  • A large number of plots are still being maintained by IEEFL, which is not disputed by the company.

As per the Q2-FY2020 results disclosure by the company, it is considering an appeal against the order.

FY2020 Q2 results, page 8:

The appeal was heard and vide order dated 18th October 2019, SAT has dismissed the appeal. Based on the legal advise received IEEFL’s is evaluating further course of actions of filing review petition and appeal against the said order.

Until now, Ion Exchange (India) Ltd has invested about ₹41 cr in IEEFL by following means:

• Equity: ₹0.55 cr
• Debentures: ₹15 cr and
• Loans: ₹25.32 cr

FY2019 annual report, page 113:

The company has an investment of INR 54.70 Lacs (31st March 2018: INR 54.70 Lacs) in equity shares and 1,500,000 (31st March 2018: 1,500,000) 7% Secured Redeemable Non-Convertible Debentures of INR 100 each fully paid up, in Ion Exchange Enviro Farms Limited (IEEFL), a subsidiary company as at 31st March 2019 and it has also granted loans and advances as at 31st March 2019 aggregating INR 2,531.92 Lacs (31st March 2018: INR 2,178.85 Lacs) to IEEFL. As at 31st March 2019, the accumulated losses of IEEFL have substantially exceeded its paid-up share capital.

Further advised reading: Understanding the Annual Report of a Company

Reading through the above arguments, an investor would note that the company has not been able to convince/prove to the legal authorities about its stance multiple times: SEBI (2003, 2015), SAT (2006, 2019) and Hon. Supreme Court (2013).

In case, the company is not able to convince the appellate courts in future and it has to make the payment of ₹20.06 cr (may have to pay interest on the same as well), then the total loss of value to the shareholders may exceed ₹60 cr including the investments done in IEEFL and the payments to SEBI.

It is advised that an investor should keep a close watch on the developments related to the appeal process in relation to this legal dispute.

4) Corporate restructurings, Capital allocation decisions and bailing out associate/JV partners:

While reading the past annual reports of Ion Exchange (India) Ltd, an investor notices that the company has done frequent corporate restructuring exercises like the formation of new subsidiaries, transferring business segments, merging subsidiaries and associate companies. An investor also finds that many capital allocation decisions of the management have not generated significant value for its shareholders. In addition, at times, the company has to pitch into buyout its associate/joint venture partners when the said business incurred losses and it felt like the other partner may no longer be interested to continue with the venture.

a) Ion Exchange Waterleau Ltd to Ion Exchange Environment Management Ltd:

In the FY2019 annual report, Ion Exchange (India) Ltd intimated its shareholders that it had acquired the stake held by its Belgian partner, Waterleau Group N.V. in the joint venture (JV) company Ion Exchange Waterleau Ltd. As a result, the former JV company has now become the wholly-owned subsidiary of Ion Exchange (India) Ltd and its name is changed to Ion Exchange Environment Management Ltd.

FY2019 annual report, page 23:

During the year, your Company acquired entire share holding of Waterleau Group N.V., a Belgium based Company. The Company has become our wholly owned subsidiary with effect from 20 th August, 2018. The name of the Company has been changed from Ion Exchange Waterleau Limited to Ion Exchange Environment Management Limited with effect from 21 st December, 2018

While analysing the investments done by Ion Exchange (India) Ltd in this JV Company, an investor notes that until FY2018, the company had made a total investment of ₹17.68 cr in the JV:

• Equity: ₹2.51 cr and
• Loans & advances: ₹15.17 cr

In FY2019, the company acquired full stake in the company and the investment done by Ion Exchange (India) Ltd in the company increased to ₹21.43 cr:

• Equity: ₹5.01 cr and
• Loans & advances: ₹16.42 cr.

FY2019 annual report, page 76:

FY2019 annual report, page 112:

Therefore, an investor notices that there has been an investment of about ₹20 cr done by the partners in Ion Exchange Waterleau Ltd over the years.

To ascertain the results of this investment when an investor analyses the financial performance of Ion Exchange Waterleau Ltd, then she notices that the company is making losses. In FY2019, it made a loss of ₹1.25 cr on an income of ₹1.78 cr.

FY2019 annual report, page 177:

An investor would note that revenue of ₹1.78 cr on an investment of about ₹20 cr is very low and the resultant loss of ₹1.25 cr indicates that the business of the entity leaves a lot to be desired.

While analysing the past performance of Ion Exchange Waterleau Ltd, an investor notices that Ion Exchange (India) Ltd has disclosed the financial performance of the JV company since FY2015 onwards and for each of the years; the company has made a loss on a minuscule revenue.

• FY2018, the company made a loss of ₹1.41 cr on revenue of ₹1.66 cr
• FY2017, the company made a loss of ₹1.26 cr on revenue of ₹1.88 cr

FY2018 annual report, page 183:

• FY2016, the company made a loss of ₹1.70 cr

FY2016 annual report, page 149:

• FY2015, the company made a loss of ₹2.50 cr

FY2015 annual report, page 148:

Therefore, an investor would note that at least since the reported history of FY2015, Ion Exchange Waterleau Ltd has never made any profit. Moreover, the revenue generated by the company is very low in the range of ₹1.50 cr – ₹2.00 cr on an investment of about ₹20 cr. It indicates that the business of the company has not been doing well despite multiple years of existence.

As a result, it might be a situation where the joint venture partner, Waterleau Group N.V. has expressed its unwillingness to continue with the JV and Ion Exchange (India) Ltd had to give exit to the JV partner by buying out its stake for ₹2.50 cr (= increase in equity investment in FY2019).

An investor may note that if the business of Ion Exchange Waterleau Ltd is not able to generate any return on its investments, then any further capital allocation to the company may be throwing good money after bad money.

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

b) Ion Exchange Projects and Engineering Ltd:

In FY2011, an investor gets to know that Ion Exchange (India) Ltd is planning to conduct a corporate restructuring in which it would transfer its project division involved in executing domestic turnkey projects to a wholly-owned subsidiary, Ion Exchange Projects and Engineering Limited (IEPEL).

FY2011 annual report, page 10:

RESTRUCTURING OF BUSINESS: The Board of Directors at their meeting held on 22nd February 2011, accorded their approval for the proposal to sell its Project Division (covering domestic turnkey projects) on a going concern basis to Ion Exchange Projects and Engineering Limited, a wholly owned subsidiary company.

The restructuring exercise was completed in the next financial year.

As the domestic projects division is now present in a separate subsidiary, Ion Exchange (India) Ltd started to report its financial performance in each of its subsequent annual reports. While analysing this financial performance, an investor notices that Ion Exchange Projects and Engineering Limited (IEPEL) has never made any profits at least since FY2011 until FY2018.

• FY2011: loss of ₹5.6 cr.
• FY2012: loss of ₹8.5 cr.

FY2012 annual report, page 71:

• FY2013: loss of ₹0.6 cr.
• FY2014: loss of ₹5.5 cr.

FY2014 annual report, page 71:

• FY2015: loss of ₹4.5 cr. (FY2015 annual report, page 147)
• FY2016: loss of ₹9.1 cr. (FY2016 annual report, page 148)
• FY2017: loss of ₹6.9 cr. (FY2017 annual report, page 149)
• FY2018: loss of ₹0.6 cr. (FY2018 annual report, page 190)

The company reported a minuscule profit of ₹0.3 cr in FY2019.

FY2019 annual report, page 190:

Until now, Ion Exchange (India) Ltd has made a total investment of about ₹39 cr in the company in the form of equity ₹14.2 cr and loans of ₹24.8 cr.

FY2019 annual report, page 110:

FY2019 annual report, page 112:

In addition, Ion Exchange (India) Ltd has given guarantees of about ₹27.8 cr of loans taken by the company.

FY2019 annual report, page 112:

Therefore, an investor may notice that the domestic turnkey projects business of the company under Ion Exchange Projects and Engineering Limited has almost never made any profits on the business done by it despite a direct investment of about 39 cr and indirect investment (guarantee) of ₹28 cr.

Such business performance of the water treatment turnkey projects division of the company, which has been specializing in the water treatment business for more than 5 decades, indicates that there seem to be fundamental issues with this business division.

Investors need to monitor the performance of this business division going ahead to track whether the profits of ₹0.3 cr reported by the division sustain going ahead or the division reverts to reporting losses. Until now, the performance of this division and as a result, the capital allocated to the same has not created a lot of wealth for the shareholders of the company.

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

c) Consumer products division of Ion Exchange (India) Ltd:

While analysing the segmental performance of the company, an investor notices that Ion Exchange (India) Ltd has a business division dealing in water purification products for retail/institutional customers under its consumer products division.

In the FY2019 annual report, the investor notes that this division has made losses in the last two years.

• FY2019: loss of ₹2.68 cr
• FY2018: loss of ₹3.00 cr

FY2019 annual report, page 168:

Similarly, when the investor reads the history of the financial performance of this division in the available annual reports since FY2011, then the consumer notes that the division has only rarely reported profits and that too very low amount of profits in comparison to the large losses in other years.

• FY2017: loss of ₹3.49 cr
• FY2016: loss of ₹3.67 cr
• FY2015: loss of ₹1.57 cr
• FY2014: loss of ₹0.25 cr
• FY2013: profit of ₹2.75 cr
• FY2012: loss of ₹1.96 cr
• FY2011: profit of ₹0.66 cr
• FY2010: loss of ₹0.12 cr

An investor would note that in the last 10 years (FY2010-2019), the consumer products division has reported losses in 8 out of 10 years. An investor may look at this performance in the light that the consumer brand of the company “Zero B” is in existence since 1986 and the company is making consumer products since 1998.

June 2019 presentation of the company, page 10:

1986: Zero-B Launched with Suraksha tap attachment.

1998: Consumer products manufacturing started at Goa.

Therefore, an investor may note that despite creating the consumer brand Zero B more than 30 years back and working towards creating a sustainably profitable business out of it for the last 20 years, the company is not able to generate profits out of the same.

Moreover, while answering a query of an analyst on the consumers products division, the management of the company disclosed that is still uncertain when the consumer products division will turn profitable.

Conference call, Nov. 2019, page 8:

Arun Kumar: And do we expect profits next year then or the year after?

Management: It’s a difficult guess to make, we are hoping we will be close to achieving that sooner. But on a conservative basis, I would say that probably next year.

Going ahead, an investor needs to monitor the performance of the consumer products division closely whether it starts generating profits and in turn returns on the capital invested in this business. Otherwise, it may be a case of poor capital allocation by the company.

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

d) Astha Technical Services Ltd:

In FY2018, Ion Exchange (India) Ltd merged one of its associate companies, Astha Technical Services Ltd (ATSL) into its subsidiary Total Water Management Services Limited (TWMSL).

Ion Exchange (India) Ltd held a 44.89% stake in Astha Technical Services Ltd (ATSL) and a 99.99% stake in Total Water Management Services Limited (TWMSL) before this merger of the ATSL into TWMSL. ATSL had made a loss of ₹15.6 lac in FY2017.

FY2017 annual report, page 150:

After the merger the stake of Ion Exchange (India) Ltd in TWMSL fell down from 99.99% to 70.19% as the TWMSL gave a 29.80% stake (= 99.99 – 70.19) to the other parties owning 55.11% stake in ATSL (= 100 – 44.89).

While analysing the financial performance of ATSL over the years, an investor notices that the loss made by the company in FY2017 is not an isolated incidence. The company reported losses in previous years as well:

• FY2016: loss of ₹20.14 lac (FY2016 annual report, page 149),
• FY2015: loss of ₹22.28 lac (FY2015 annual report, page 148),

Ion Exchange (India) Ltd has not disclosed the financial performance of ATSL in annual reports before FY2015.

Therefore, an investor would note that the case of Astha Technical Services Ltd (ATSL) might be similar to Ion Exchange Waterleau Ltd in which the continuous losses in the business may have caused unwillingness in the associate partner to continue with the business. As a result, Ion Exchange (India) Ltd had to give exit to the associate partners by giving them a 29.80% stake in an alternate business Total Water Management Services Limited (TWMSL).

However, if the business of Astha Technical Services Ltd (ATSL) is not an optimal business to run then the value of 29.80% stake of Total Water Management Services Limited (TWMSL) divested by Ion Exchange (India) Ltd may be a case of throwing good money after bad money and bailing out the associate partners.

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

e) IEI Environmental Management Sdn. Bhd.

In FY2017, the company acquired a 40% stake from minority shareholders in IEI Environmental Management Sdn. Bhd (IEMSB) where it previously owned a 60% stake and in turn made IEMSB a wholly-owned subsidiary of the company.

When an investor analyses the financial performance of IEMSB, then she notices that the subsidiary has been making continuous losses in the past.

• In FY2016, IEMSB reported a net loss of ₹0.27 cr (FY2016 annual report, page 148).

Even after acquisition to convert IEMSB to a wholly-owned subsidiary, the company continued to report losses.

• In FY2017, IEMSB reported a net loss of ₹0.66 cr (FY2017 annual report, page 149).
• Only in FY2018, it reported a minor profit of ₹0.06 cr (FY2018 annual report, page 190).
• In FY2019, the company again returned to making losses and reported a loss of ₹0.23 lac (FY2018 annual report, page 182).

Therefore, an investor would note that IEMSB might be one more case in which the continuous losses in the business may have caused unwillingness in the minority shareholders to continue with the business. As a result, Ion Exchange (India) Ltd had to give exit to the minority shareholders by buying out their stake.

However, if the business of IEMSB is not an optimal business to run then the money spent by the management to buy out minority shareholders may be a case of throwing good money after bad money and bailing out the minority shareholders of IEMSB.

f) Other investments of Ion Exchange (India) Ltd performing poorly:

In addition to the investments in the associates, joint ventures, business divisions discussed above, while reading the FY2019 annual report, an investor notices that the auditor has brought the attention of investors to additional investments of about ₹81 cr (= 37 + 44), where the current value of assets has declined significantly.

FY2019 annual report, page 113:

Further, book values of certain other long term investments in subsidiaries measured at cost, aggregating to INR 3,748.10 Lacs (2017-18: INR 3,438.67 Lacs) are lower than its cost. The company has also granted loans and advances to these subsidiaries as at 31st March 2019 aggregating INR 4,406.83 Lacs (31st March 2018: INR 5,334.17 Lacs).

Further advised reading: Understanding the Annual Report of a Company

An investor may note that such a disclosure may be the sign of erosion of the value of the investments done by the company in its subsidiaries, which it may have to write off in the future. Therefore, it is advised that an investor keep a close watch on the performance of different subsidiaries of the company going ahead.

5) Noncompliance with the statutory requirements by Ion Exchange India Ltd and its group entities:

While reading the annual reports of Ion Exchange India Ltd, an investor comes across many instances where either the company or its subsidiaries/JVs/associate companies have not complied with the statutory requirements like payment of dues on time.

• FY2011: delays in payment of undisputed statutory dues (FY2011 annual report, page 30):

Undisputed statutory dues including provident fund, investor education and protection fund, employees’ state insurance, income-tax, sales-tax, wealth-tax, service tax, customs duty, excise duty, cess and other material statutory dues have generally been regularly deposited with the appropriate authorities though there have been delays in some cases.

• FY2012: delays in payment of undisputed statutory dues (FY2012 annual report, page 26).
• FY2013: delays in payment of undisputed statutory dues (FY2013 annual report, page 32).
• FY2014: delays in payment of undisputed statutory dues (FY2014 annual report, page 44).
• FY2015: (annual report, page 103-104):
  • One associate company did not deposit an advance tax of ₹7.62 lac.
  • One subsidiary and one associate company did not deposit VAT, Central Sales Tax and Service Tax even after 6 months delay.
  • One associate did not transfer money due to Investor Education and Protection Fund for FY2007.
• FY2016: (annual report, page 105):
  • one associate did not transfer money to the Investor Education and Protection Fund pertaining to years ended 31st March 2007 and 31st March 2008
• FY2019: (annual report, page 121):
  • One associate did not transfer money to the Investor Education and Protection Fund pertaining to the year ended March 31, 2011.

The above instances had been related to the undisputed statutory dues to the govt. authorities. However, in FY2015, one subsidiary of the company defaulted to make payment to the banks on time.

FY2015 annual report, page 104:

financial institutions, where applicable, except one of the subsidiary companies has defaulted in repayment of loans and interest to banks which ranges from 21-335 days in case of repayment of Interest on various term loans aggregating to Rs. 45 Lacs and the overdue unpaid interest and principal as at 31st March 2015 is Rs. 31.50 Lacs and Rs.132.87 Lacs respectively.

Further advised reading: Understanding the Annual Report of a Company

Looking at the above instances of delays in payments to govt. authorities and even to the banks raise the concerns of the investors. This might be a case of genuine cash crunch, financial difficulties faced by the company and its subsidiaries etc., which otherwise is not coming out in the financial statements. Alternatively, it might be a lax attitude of the company towards paying its liabilities on time.

In either case, it is advised that investors may contact the company for clarifications whenever they notice that the company or its subsidiaries are delaying undisputed payments.

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

6) Remuneration availed by the Promoters in excess of statutory limits:

While reading the past financial performance of Ion Exchange (India) Ltd, an investor comes across certain instances where the promoters/key management personnel have taken remuneration, which exceeded the statutory limit stipulated under the Companies Act. As a result, the company had to apply for special approval from the central govt. to regularize the excess remuneration paid by the company to the promoters.

• In FY2011, the Executive Directors took a remuneration, which was ₹2.50 cr in excess to the statutory limits.

FY2011 annual report, page 28:

The remuneration paid to the Executive Directors is in excess of the limits specified in Schedule XIII of the Act by Rs. 2,50,66,516 for which steps have been taken by the Company to obtain Central Government approval.

• In FY2015, the Directors took a remuneration, which was ₹0.74 cr in excess to the statutory limits.

FY2015 annual report, page 100:

The company has paid remuneration to the directors as per the terms of their respective service contracts with the company which were approved by the board of directors and shareholders. In view of inadequacy of profit in the current year, pursuant to provision of section 197 read with section II of part II of Schedule V of the Companies Act 2013. the company has made an application with the Central Government for payment of the excess remuneration amounting to Rs. 73,74,532 to the said directors, which is pending approval.

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

Margin of Safety in the market price of Ion Exchange (India) Ltd:

Currently (Dec 23, 2019), Ion Exchange (India) Ltd is available at a price to earnings (PE) ratio of about 13.16 based on the last four quarters consolidated earnings from Oct. 2018 to Sept 2019.

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, Ion Exchange (India) Ltd seems like a company, which has been able to grow its sales at a growth rate of 10% per annum over the last 10 years (FY2010-19). However, this journey has been faced with intense competition from organized as well as unorganized and Indian as well as foreign competitors. Because of the competition, the company has faced difficulties to pass on the increase in raw material costs to its customers and reported net profit margins in the range of 1%-2%. Recently, the company received a high margin project from Sri Lanka, which has led to growth in revenue as well as improvement in profit margins. It remains to be seen whether the company would be able to sustain the current improvement of its profit margins after the Sri Lanka project gets complete in 2020.

Ion Exchange (India) Ltd executes projects for large customers like power plants, steel plants etc. who have a higher negotiating power over the company. As a result, the company faces frequent delays in collecting receivables from its customers. Significant amounts of receivables have been delayed more than 6 months from the due date. Therefore, the company had to frequently write-off receivables as well. The company passes on the pressure from the delay in the collection of receivables from its customers, to its suppliers and enjoys high payable days. This helps the company to keep its working capital under check and report free cash flows.

In the past, Ion Exchange (India) Ltd used to be an employee-owned, employee-managed company where the Employee Welfare Trusts used to own significant shareholding and the leadership baton passed from one long-term employee to another long-term employee. However, recently, it seems that the nature of the company is changing towards the promoter-owned, promoter-managed company as the blood relatives are now part of the board of directors and the shareholding is shifting from Employee Benefit Trusts to individual directors and key management personnel.

Ion Exchange (India) Ltd seems to have invested in many subsidiaries/JVs/associate companies that have not made meaningful profits over a long period. In most of these cases, the company has ended up buying out the associate/joint venture partners and minority shareholders. Even though this may be interpreted as a benevolent gesture to the selling shareholders; however, it may be a case of throwing good money after bad money as well.

Many divisions of the company like consumer products and domestic turnkey projects division are not performing up to the mark and are leading to suboptimal capital returns.

The company is facing a legal dispute with SEBI for raising money from investors under the collective investment scheme (CIS). SEBI directed it to refund money to the investors in 2003. However, the matter has been under different legal forums since then and the company has failed to convince SEBI, twice; SAT, twice; and Hon. Supreme Court, once about its position over the last 16 years. Recently, in Oct. 2019, SAT has dismissed the appeal of the company and it is considering going for another appeal against the order. It remains to be seen whether the dispute is settled in favor of the company in the future. The company has invested about ₹41 cr in the subsidiary involved in this dispute and there is an additional demand of about ₹20 cr from SEBI from the company.

Going ahead, an investor should closely monitor the profit margins of the company, shareholding changes with respect to the trust and directors, performance and investments in the subsidiary companies, suboptimal performing divisions like consumer products, timely collection of trade receivables and payment of trade payables, loans and statutory dues, buyout of outside shareholders in the subsidiaries/associates etc.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Ion Exchange (India) Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”

I hope it helps!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

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