Analysis: Kanchi Karpooram Ltd

The current section of the “Analysis” series covers Kanchi Karpooram Ltd a manufacturer of camphor and its derivatives like gum rosin, value-added resins and fortified rosin. The company is based in Kanchipuram, Tamil Nadu.

“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.

Kanchi Karpooram Ltd Research Report by Reader

Respected Sir,

I am a new reader of your blog, which I discovered a few days ago. Currently, I have done my own analysis on a company called Kanchi Karpooram Limited.

Kanchi Karpooram Ltd is a Terpene and paper chemicals manufacturing company.

I am sending you this analysis because I want to learn how to dig deeper into the analysis of the company, which will definitely make me and others learn more.

I would appreciate your help & expert comments on my analysis.

Thanks,

Tejas

About Kanchi Karpooram Ltd:

Incorporated in 1992, Chennai base commodity chemical company

• Market capitalization: ₹111 Cr
• Share price: ₹269
• Debt – ST Bank Debt ₹23 Cr
• Enterprise Value: ₹134Cr
• Earnings per share: ₹36.6 Vs. 7.3

Kanchi Karpooram Ltd is a Terpene and Paper chemicals chemical company. It produces:

• Turpentine-based chemicals like Camphor (Religious use),
• Dipentine (a by-product use as paint solvent),
• Iso Bornyl Acetate (Fragrance formula of soaps),
• Sodium Acetate Trihydrate (a by-product use as a dye intermediate) etc. &
• Synthetic Resin like Gum rosin and its derivatives such as Fortified Rosin (use in the paper industry),
• Ester Gum (use as a soluble food additive),
• Phenolic / Maleic Resins (use in inks)

Kanchi Karpooram Ltd has its factory at Kanchipuram, Tamil Nadu.

Credit rating of Kanchi Karpooram Ltd:

• CRISIL (May-2018) B+ (Note: before the FY18 financials were finalized)
• India Rating (Mar-2017) BB-
• SMERA (April-2016) BB-

Sales mix of Kanchi Karpooram Ltd (FY17, FY16):

• Domestic (99%)
• Export (1%)

Raw material requirements of Kanchi Karpooram Ltd:

It imports huge raw materials woods of laurel tree (Kapur tree) & pine tree.

Promoter-management of Kanchi Karpooram Ltd:

Overall promoter stake – 41.67%

• Suresh Shah (MD) – Stake (8.14%) – Remuneration (₹20 Lac)
• Dipesh Jain (WTD – Son of Suresh – B. Tech (Chemical Engineering) – Stake (5.14%) – Remuneration (₹19 Lac)
• Arun Shah (WTD) – Brother of Suresh – B.com – Stake (0.93%) – Remuneration (₹11 Lac)
• K C Radhakrishnan (CFO) – Stake(0.7%) – Remuneration (₹15 Lac)

Other businesses of board of directors of Kanchi Karpooram Ltd:

• M/s Suresh Industries – Related party transaction ₹1.12 Cr (FY17) Vs. ₹0.91 cr (FY16)
• M/s Ambika Industries – Related party transaction ₹0.93 Cr (FY15)
• Lotus Intermodal Logistic

Industry analysis of Kanchi Karpooram Ltd:

• Intense competition from the domestic manufacturers as well as imports: The camphor industry faces stiff competition, with the presence of many domestic players as well as imports from China. The company also faces intense competition from international and domestic players in its other product categories such as perfumery chemicals, fragrances and flavours.
• In 2016, the global camphor tablets market was $88 mn, of which Asia specific market was $32 mn (36%).
• Indian annual camphor consumption as 7500 MT (As per FY2010-11 annual report)

Financials of Kanchi Karpooram Ltd:

1) Sales growth:

Over the last 8 quarters, the sales of Kanchi Karpooram Ltd grew at a CAGR of 15%. The sales increased because of the following reasons:

• Reason 1: In FY17, Kanchi Karpooram Ltd installed new plant & machinery (P&M) and increased production capacity
• Reason 2: Kanchi Karpooram Ltd added new clients & new products or tie-ups with a tie-up with any chemicals

2) EBITDA:

EBITDA of Kanchi Karpooram Ltd in the fourth quarter of FY18 vs the fourth quarter of FY17 rose due to a fall in other expenses. The EBITDA increased due to the following reason:

• Reason 1: Other expenses in 4Qs of FY18 Vs. 4Qs of FY17 reduced might new big client

3) Earnings before tax:

Kanchi Karpooram Ltd had constant earnings before tax (EBT) in 4Qs of FY18 vs. 4Qs of FY17

• Reason 1: New fix client to give constant order to Kanchi Karpooram Ltd

4) Debt to equity ratio:

Kanchi Karpooram Ltd had a quarterly fall in debt/equity trend (Almost a low debt company).

5) Total receivables/Sales of Kanchi Karpooram Ltd:

Almost nil

Peer analysis of Kanchi Karpooram Ltd:

• Mangalam Organics Ltd:
  • Terpenes (90% FY17 sales) and Synthetic Resin (10% FY17 sales) segments; FY18 sales ₹244 Cr Vs. FY17 sales ₹197 Cr
  • Camphor is the primary product, contributing 80% of Terpene sales, presence through distributors and retail outlets (also online presence)
• Saptagir Camphor
  • Only produces Turpentine-based chemicals FY17 sales ₹200 Cr
• Camphor & Allied Products (Oriental Aromatics) – Largest camphor manufacturer; FY18 sales ₹506 Cr Vs. FY17 ₹467 Cr
  • Camphor & Isoborneol (32.2%) – ₹163 Cr
  • Perfumery Chemicals (49.5%) – ₹250 Cr
  • Other (19.3%) – ₹93 Cr
  • Total manufacturing capacity in excess of 10,000 TPA – Consumes wood

Dr Vijay Malik’s Response

Hi Tejas,

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

Let us analyse the financial and business performance of Kanchi Karpooram Ltd over FY2010-2018.

Financial and business analysis of Kanchi Karpooram Ltd:

While analyzing the financials of Kanchi Karpooram Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 20% year on year. Sales of the company increased from ₹29 cr. in FY2010 to ₹115 cr in FY2018. For the last four quarters ended in Dec. 2018 i.e. from Jan-Dec 2018, the company had reported sales of ₹182 cr.

While analysing the performance of the company in the past, an investor would notice that the journey of Kanchi Karpooram Ltd has been quite eventful. The sales of the company increased significantly during FY2010-12. Sales increased from ₹29 cr in FY2010 to ₹49 cr in FY2012. However, after FY2012, the sales almost stagnated for the next five years. By FY2017, the company increased its sales only to ₹59 cr. Since FY2017, Kanchi Karpooram Ltd has witnessed a sharp increase in sales when the sales for the last four quarters ending Dec. 2018 have increased to ₹182 cr.

Such intermittent periods of good performance and stagnant performance in the sales growth of Kanchi Karpooram Ltd have also extended to the profitability of the company as well. An investor would notice that the operating profit margin (OPM) of Kanchi Karpooram Ltd has been following a cyclical pattern.

In FY2010, the operating profit margin (OPM) of Kanchi Karpooram Ltd used to be 12%, which declined sharply to 4% by FY2012. Thereafter, OPM increased again to 12% in FY2014 only to decline to 4% in FY2015. Since FY2015, OPM has been increasing and has reached 22% in FY2018.

Such a fluctuating pattern of profitability indicates that Kanchi Karpooram Ltd lacks the ability to pass on the changes in its raw material costs to its customers. Because of the weakness in its pricing power, whenever the raw material prices increase, the company finds it difficult to increase its product prices. Therefore, the company has to take a hit on its profitability. In times of declining raw material prices, the company is able to show improvement in its profit margins.

However, due to weak negotiating/pricing power, the company has witnessed its profit margins decline repeatedly in the past. In FY2012 as well as in FY2015, the OPM of Kanchi Karpooram Ltd declined sharply to 4% whereas a few years back, the company used to have an OPM of 12%.

An investor would appreciate that usually, the companies operating in non-differentiable/commodity type products face such weak pricing power over their customers. In such industries, the customer can easily replace the product of one company with the product of another company without any significant impact on the benefits derived from it. Moreover, when the products are simple/low in technology, then usually, such industries attract a lot of competition both from local manufacturers as well as from imports.

Kanchi Karpooram Ltd seems to face such a situation in its business where its key products camphor and its derivatives are simple commodity-type products and face a lot of competition from manufacturers in India as well as imports. As a result, the company finds it difficult to pass on the increase in raw material costs to its customers. The customer can easily replace the products of Kanchi Karpooram Ltd with other manufacturers. Therefore, during times of increase in raw material costs, the company has to bear the costs itself and its profitability suffers.

Further advised reading: How to do Business Analysis of a Company?

The credit rating agency, CRISIL, in its Oct. 2015 report for Kanchi Karpooram Ltd highlighted that the company faces intense competition when it downgraded its rating from BB+ to BB-.

The downgrade reflects CRISIL’s belief that KKL’s profitability will remain under pressure over the medium term owing to intense competition and muted demand from key customers.

In FY2012, the profitability of the company came under severe pressure and as a result, the company reported a net loss in the year.

While analysing the company, an investor comes across multiple sources of information, which have highlighted the difficult business situation of Kanchi Karpooram Ltd including the risk of raw material price changes as well as intense competition resulting in its poor pricing power.

In the FY2012 annual report, while explaining the reasons for the net loss, Kanchi Karpooram Ltd highlighted that it faced a double blow of increasing raw material prices and decreasing final product (camphor) prices. As a result, the company could hardly do anything to prevent losses.

FY2012 annual report, page 9:

Unprecedented increase in the price of raw materials,flucuations in foreign exchange & unforeseen reduction in camphor selling price had a major adverse role of the performance of the Company during the year under review.

The credit rating agency, CRISIL, highlighted this aspect in its April 2014 report for Kanchi Karpooram Ltd.

These rating strengths are partially offset by the company’s below-average financial risk profile, marked by high gearing and a small net worth, and its susceptibility to volatility in raw material prices and foreign exchange rates

In Sept 2015, another credit rating agency, SMERA, highlighted that the business model of Kanchi Karpooram Ltd is exposed to the risk of changes in raw material prices.

The ratings are supported by the extensive experience of KKL’s management, its long track record and market position in the camphor industry. These rating strengths are partially offset by the susceptibility of KKL’s profitability to foreign exchange fluctuations and volatility in raw material prices.

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

Similarly, in March 2017, credit rating agency, India Ratings, pointed out the attention of stakeholders towards fluctuation in EBITDA margins of Kanchi Karpooram Ltd due to the inability to pass on raw material costs.

The ratings reflect KKL’s small scale of operations, volatile EBITDA margin and weak credit metrics. Revenue was INR565 million in FY16 (FY15: INR528 million), while EBITDA margin fluctuated between 4.4% and 11.6% over FY13-FY16 due to volatile raw material prices.

In FY2011, Kanchi Karpooram Ltd pointed out to the shareholders that the supply of its key raw material is volatile and the situation is further complicated by the wide range of uses for this raw material.

FY2011 annual report, page 24:

Operational risks: The major raw material is distilled from tree produce and hence subject to weather conditions and other natural calamities. The raw material’s cost depends on supply and demand gap because of wide range of useage of raw material.

Considering the above discussion, an investor would appreciate that Kanchi Karpooram Ltd does not enjoy any strong competitive advantage over its peers. The supply of the company’s key raw material is volatile, which leads to frequent periods of high prices. Due to the simple and commodity nature of Kanchi Karpooram Ltd.’s product, it faces intense competition and as a result, it does not have any pricing power to pass on increases in raw material prices.

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

Therefore, an investor would notice that in the past the company witnessed periods of good profit margins, which were soon followed by periods of very low-profit margins and even net loss in FY2012.

As a result, an investor should keep a close watch on the recent improvements in the profit margins of Kanchi Karpooram Ltd and monitor closely the prices and supply of its key raw materials. This is because whenever there is an increase in its raw material prices, then Kanchi Karpooram Ltd may face difficulties to pass on the costs and it may again witness a decline in its profit margins like in the past.

Over the years, Kanchi Karpooram Ltd had a tax payout ratio of 30%-35%, which is in line with the standard corporate tax rate prevalent in India.

Further advised reading: How to do Financial Analysis of Companies

Operating Efficiency Analysis of Kanchi Karpooram Ltd:

a) Net fixed asset turnover (NFAT) of Kanchi Karpooram Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Kanchi Karpooram Ltd in the past years (FY2010-18), then she notices that the NFAT of the company has improved significantly from FY2011 to FY2016. The NFAT increased from 8.92 in FY2011 to 18.58 in FY2016.

While analysing the financials of the company, an investor would notice that during FY2011-2016, Kanchi Karpooram Ltd has not done any major capital expenditure (Capex). During this period, the company spent about ₹4-5 cr on capex, which seems to be the maintenance expenditure on existing plant & machinery. Therefore, an investor would appreciate that entire sales growth from ₹29 cr. (FY2010) to ₹56 cr (FY2016) has come from the utilization of spare capacity available in the existing manufacturing plants.

Investors would appreciate that this utilization of previously unutilized capacity to grow sales is called operating leverage. This, in turn, leads to the improvement of the operating efficiency of the company, as it is able to produce more goods from using existing infrastructure.

When an investor analyses the credit rating report prepared by India Rating for Kanchi Karpooram Ltd in March 2017, then she notices that even in 2017, the company had a lot of unutilized capacity in its existing manufacturing plants.

Based in Kanchipuram, KKL manufactures camphor and by-products dipentene, sodium acetate trihydrate and pine tar. The company has an installed capacity of 3,000 metric tons per annum, with a 65% capacity utilisation.

Therefore, during FY2011-2016, the NFAT of Kanchi Karpooram Ltd improved because of the utilization of spare manufacturing capacity (operating leverage).

Moreover, an investor would notice that the NFAT of the company, which has been in the range of 18-19, is very high considering the NFAT of other manufacturing companies. In the normal course of business, manufacturing companies usually have an NFAT in the range of 1-4. An NFAT of 18-19 indicates that the business of camphor production needs very low investment in plants and machinery.

As a result, any person with a small amount of effort can raise the capital and put up a camphor manufacturing plant. An investor would appreciate that this may be one of the reasons for the intense competition faced by Kanchi Karpooram Ltd because many firms in the unorganized sector may be able to compete with it by investing a small amount of money in a camphor manufacturing plant.

Read on: How to Assess Operating Efficiency of Companies

An investor would notice that in FY2017-2018, the NFAT has witnessed a sharp decline to levels of 5.5. This decline is primarily due to a sharp increase in the net fixed assets of the company from ₹3 cr in FY2016 to ₹18 cr in FY2017.

While reading the corporate announcements done by Kanchi Karpooram Ltd, an investor would notice that on May 31, 2018, had informed the stock exchanges about its reconciliation of equity as a part of the adoption of new accounting standards (IndAS). As a part of this disclosure, the company highlighted that it has revalued its land asset and increased its value by about ₹11 cr.

May 31, 2018, corporate announcement, page 2:

Therefore, out of the total increase of ₹15 cr in the net fixed assets in FY2017, ₹11 was because of revaluation of land to a higher value. The remaining ₹4 cr seems to be the investment in the plant & machinery.

In FY2018, the company has done a capital expenditure (capex) of ₹8.5 cr. This capex seems to be to increase capacity to meet the high demand as reflected by the sharp increase in the sales in the last 2 years.

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

b) Inventory turnover ratio of Kanchi Karpooram Ltd:

An investor would note that over the years, the inventory turnover ratios (ITR) of the Kanchi Karpooram Ltd was declining during FY2011-2015. The ITR declined from 4.7 in FY2011 to 3.4 in FY2015 indicating deteriorating efficiency in inventory management. However, since FY2016, the ITR has been improving and it has currently improved to 6.2 in FY2018.

Still, an investor would notice that over FY2010-2018, the inventory level of Kanchi Karpooram Ltd increased from ₹6 cr to ₹23 cr, which indicates that an amount of ₹17 cr has to be invested by the company to maintain the higher level of inventory.

Advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of Kanchi Karpooram Ltd:

Over the years, the receivables days of Kanchi Karpooram Ltd used to be nearly stable in the range of 22-24 days until FY2016. This indicated that the company used to collect its revenue in time. However, since FY2017, the receivable days have increased. This might be a result of new customers asking for a higher credit period.

An investor would notice that in the last two years, Kanchi Karpooram Ltd has increased its sales at a fast pace. It may be that the customers have asked for a higher credit period to order additional quantities.

Over the years, the level of trade receivables of Kanchi Karpooram Ltd increased from ₹1 cr in FY2010 to ₹10 cr in FY2018, which indicates that an additional amount of ₹9 cr has been consumed in the credit provided to customers by the company.

Going ahead, an investor should monitor the level of receivables days of Kanchi Karpooram Ltd.

Further Advised Reading: Receivable Days: A Complete Guide

When an investor looks at the inventory and receivables level of Kanchi Karpooram Ltd, then she realizes that the business of Kanchi Karpooram Ltd has consumed cash in its working capital. When an investor compares the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of the company for FY2010-18, then she notices that the company has been not been able to convert its profits into cash flow from operations.

Over FY2010-18, Kanchi Karpooram Ltd has reported a total cumulative net profit after tax (cPAT) of ₹25 cr. whereas during the same period, it reported cumulative cash flow from operations (cCFO) of ₹13 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 Kanchi Karpooram 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 Kanchi Karpooram Ltd, an investor would notice that the company has consistently had a low SSGR (-19% to -4%) over the years. Only in the latest year (FY2018), the SSGR has improved to 36%, which is primarily due to a sharp increase in profitability of the company in FY2018.

While studying the formula for the calculation of SSGR, an investor would understand that the SSGR directly depends on the 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 Kanchi Karpooram Ltd has been consistently very low and even negative (net losses) in the range of -1% to 3%. Therefore, the company consistently has had a negative SSGR over the years.

An investor would appreciate that the company has been growing at a rate of 20% over the years. However, the low SSGR indicates that the company does not seem to have the inherent ability to grow at the rate of 20% from its business profits. As a result, investors would appreciate that Kanchi Karpooram Ltd will have to raise money from additional sources like debt or equity to meet its investment requirements.

Therefore, it does not come as a surprise to the investor when she notices that over the past years (FY2010-18), Kanchi Karpooram Ltd had to raise additional funds from multiple sources:

• Debt (₹19 cr.): Total debt has increased from ₹5 cr. in FY2010 to ₹24 cr. in FY2018 (99 = 138 – 39)
• Equity: The Company has issued warrants and allotted shares to promoters in FY2019.

The corporate announcement, Feb 14, 2019:

The corporate announcement, March 20, 2019:

Further advised reading: Stock Warrants to Promoters: How to Analyse

Moreover, the low cash generation and continuous additional cash requirement nature of the business of Kanchi Karpooram Ltd has been highlighted by CRISIL in its report of the company in Dec. 2016 when it downgraded its rating from BB to BB-.

The downgrade reflects CRISIL’s belief that KKL’s business risk profile would remain weak over the medium term marked by muted revenue growth and low operating profitability. The company reported low cash accrual of Rs 4.2 million for fiscal 2016. Consequently, the dependence on working capital debt continued to remain high, which resulted in high gearing of 1.9 times as on March 31, 2016.

Therefore, an investor would appreciate that the tough business dynamics of the company limit the business growth that it can generate from its inherent profitability (as reflected by negative to low SSGR). As a result, in order to generate 20% of sales growth in the past years, the company had to put in all its business profits and in addition, it had to put in additional debt as well as equity to support the business growth.

An investor would appreciate that the recent increase in SSGR is due to a sharp increase in profitability in FY2018. However, the past financial performance of the company indicates that it does not have any sustained competitive advantage over its competitors. As a result, in the past, improved profit margins have repeatedly declined to low profits/losses. Therefore, an investor should be cautious while extrapolating her future projections based on recent high-profit margins.

An investor gets another evidence of the low cash-generating nature of the business of Kanchi Karpooram Ltd when she analyses the free cash flow position of the company.

b) Free Cash Flow Analysis of Kanchi Karpooram Ltd:

While looking at the cash flow performance of Kanchi Karpooram Ltd, an investor notices that during FY2010-18, the company had a cumulative cash flow from operations of ₹13 cr. However, during this period it did a capital expenditure (capex) of ₹18 cr. As a result, it had a negative free cash flow of ₹5 cr. (13 – 18).

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

As per the discussion above, an investor would appreciate that Kanchi Karpooram Ltd raised an additional debt of ₹19 cr to met this cash-flow gap. Investors would note that over the past years, the company had debt on its balance sheet, which was consistently increasing. The company needed to pay interest on this debt. Part of the interest, which was capitalized by the company as a part of the project cost is already factored in the capital expenditure (capex) of ₹18 cr discussed above. Over and above the capitalised interest, Kanchi Karpooram Ltd had to pay additional interest of ₹12 cr, which was expensed in the P&L.

Therefore, an investor would appreciate that the total cash-flow gap for the company comes out to be ₹17 cr (5 + 12). The company primarily relied on debt to meet this shortfall. However, as discussed above, the company has also opted for equity dilution to meet its funds’ requirement by issuing additional shares to promoters by alloting them preferential warrants.

Therefore, an investor would note that tough business dynamics of camphor and related products have led to a situation where the company has not been able to generate sufficient resources from its inherent business activities to meet its sales growth requirements. As a result, the company has to dilute its equity and raise additional debt.

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 Kanchi Karpooram Ltd:

On analysing Kanchi Karpooram Ltd, an investor comes across certain other aspects of the company:

1) Management Succession of Kanchi Karpooram Ltd:

While analysing Kanchi Karpooram Ltd, an investor notices that Dipesh Jain, son of founder promoter, Suresh Shah, is a part of the board of directors of the company. Dipesh Jain is currently working as a whole-time director of the company.

It indicates that the company has put in place a management succession plan in which the new generation of leaders are being groomed in business while the senior members are still playing an active part in the day-to-day activities.

The presence of a well thought out management succession plan is essential in businesses as it provides for a smooth transition of leadership over the generations and provides continuity in the business operations of any company.

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

2) A curious case of credit rating shopping and then non-cooperation with credit rating agencies by Kanchi Karpooram Ltd:

When an investor analyses the credit rating reports of Kanchi Karpooram Ltd, then she notices that the company has indulged in credit rating shopping. It indicates that the company kept on switching from one credit rating agency to another frequently. In this process, the company did not share the required information with credit rating agencies for the review of credit rating. As a result, the rating agencies labelled Kanchi Karpooram Ltd as a non-cooperating client.

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

a) Kanchi Karpooram Ltd rated by CRISIL for the first time in 2014:

In April 2014, the company was rated by CRISIL for the first time, CRISIL assigned a rating of BB+ to the company.

CRISIL has assigned its ‘CRISIL BB+/Stable’ rating to the long-term bank facilities of Kanchi Karpooram Ltd (KKL).

b) Non-cooperation by Kanchi Karpooram Ltd with CRISIL at the very first review of the credit rating in 2015:

In July 2015, CRISIL put out a note saying that Kanchi Karpooram Ltd has not provided it required information to review the credit rating.

CRISIL also identifies information availability risk as a key credit factor in the rating assessment as outlined in its criteria ‘Information Availability Risk in Credit Ratings’. CRISIL is awaiting adequate information from Kanchi Karpooram Ltd (KKL) and will provide updates on relevant developments from time to time.

c) Kanchi Karpooram Ltd switched its credit rating agency to SMERA in Sept 2015:

In Sept 2015, the company shifted its credit rating agency from CRISIL to SMERA. However, the company could not retain its earlier credit rating of BB+ and the new credit rating agency, SMERA, rated Kanchi Karpooram Ltd at BB-.

SMERA has assigned a long term rating of ‘SMERA BB-’ (read as SMERA double B minus) and short term rating of ‘SMERA A4+’ (read as SMERA A four plus) to the above mentioned bank facilities of Kanchi Karpooram Limited (KKL).

d) Kanchi Karpooram Ltd stopped cooperating with SMERA in 2017:

In Sept 2017, the credit rating agency SMERA highlighted that Kanchi Karpooram Ltd is not cooperating for the review of credit rating and has not provided it with the required information.

SMERA has been requesting for data, information and undertakings from the rated entity for conducting  surveillance & review of the rating. However, the issuer/borrower failed to submit required documents before due date. This rating is therefore being flagged as “Issuer not-cooperating”, in line with prevailing SEBI regulations and SMERA’s policies.

e) Kanchi Karpooram Ltd switched its credit rating again from SMERA to India Ratings:

In 2017, the company has shifted its credit rating from SMERA to India Ratings. In its credit rating report of March 2017, India Ratings assigned a rating of BB- to the debt of Kanchi Karpooram Ltd.

India Ratings and Research (Ind-Ra) has assigned Kanchi Karpooram Limited (KKL) a Long-Term Issuer Rating of ‘IND BB-’. The Outlook is Stable.

f) Kanchi Karpooram Ltd stopped cooperating with India Ratings in 2018:

In April 2018, India Rating highlighted that Kanchi Karpooram Ltd has not provided it required information and therefore, it has classified the company under the non-cooperating category.

India Ratings and Research (Ind-Ra) has migrated Kanchi Karpooram Limited’s (KKL) Long-Term Issuer Rating to the non-cooperating category. The issuer did not participate in the rating exercise despite continuous requests and follow-ups by the agency.

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

An investor would appreciate that such fluctuating behaviour of Kanchi Karpooram Ltd while dealing with credit rating agencies, frequent shifting and then non-cooperation even at the time of the first review raises many concerns about the company. An investor is left wondering whether the company values consistent disclosure of information to outside stakeholders in order to help them make informed decisions.

Frequent shifting of rating agencies one after another may be an attempt to get a higher credit rating from any rating agency that may entertain the company. It might be a case where the company tried to switch to a rating agency thinking that it may get a higher rating; however, when it did not get the desired rating, then it stopped cooperating with the existing credit rating agency and switched to another agency.

Recently, in May 2018, CRISIL downgraded the rating of Kanchi Karpooram Ltd to B+ based on publicly available information.

Non cooperation by Issuer: CRISIL has been consistently following up with Kanchi Karpooram Ltd (KKL) for obtaining information through emails and letter dated, 24th April 2018, among others, apart from telephonic communication. The issuer, however, remained non-cooperative.

An investor may appreciate that such incidences of credit rating shopping may be an attempt by companies to put forward a better picture of the company than the reality. An investor should be cautious while making decisions about companies in such cases.

3) The high interest rate charged by promoters for loans provided to Kanchi Karpooram Ltd:

While analysing the past annual reports of Kanchi Karpooram Ltd, an investor notices that for many years, the promoters have put money in the company in the form of loans. At the face of it, these loans seem a help by the promoters to the company to meet cash flow requirements.

However, when an investor notices the interest rate paid by the company on these loans from directors, then she notices that the interest cost on these loans is 13%, which is higher than the interest rate charged by banks to Kanchi Karpooram Ltd.

FY2018 annual report, page 66:

The loans taken by Kanchi Karpooram Ltd from lenders like HDFC Bank are in the range of 9.61% to 10.15%.

As a result, an investor would notice that the high cost of the interest rate paid by Kanchi Karpooram Ltd to directors does not seem to be in the best interest of the company.

Moreover, if an investor notices the interest rate available to individuals when they deposit money with banks, then she notices that an individual is able to get only an interest rate ranging from 5.75 to 7.00% from banks like SBI (Source: SBI website, May 10, 2019)

Therefore, the loans from promoters to Kanchi Karpooram Ltd might be an attempt to get a higher interest rate on their funds than the interest rate provided by banks on the fixed deposits as the promoters are getting an interest rate of 13% from the company whereas the banks may provide an interest of 6-7% on the fixed deposits

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

4) Transactions by Kanchi Karpooram Ltd with promoters/related parties:

While analysing the annual reports of Kanchi Karpooram Ltd, an investor notices that the company has entered into different transactions like sales, consulting assignments, loans etc. with different related parties/promoter group entities.

FY2018 annual report, page 75:

An investor would appreciate that the transactions with related parties have the potential of shifting the economic benefits from the company & minority shareholders to the promoters. Therefore, investors should be aware that in case, the value provided by the related parties in their dealings is not proportionate to the consideration paid by the company, then it might be a case of related parties benefiting at the cost of the company & minority shareholders.

Similarly, in case the sale transactions with related parties are not at an appropriate price i.e. the company selling goods to them at a lower price or buying goods from them at a higher price, then it might be a case of promoters benefiting at the cost of the company and minority shareholders.

Investors should be cautious while analysing the companies, which enter into transactions with related parties.

Moreover, in the FY2018 annual report, investors would notice that Kanchi Karpooram Ltd has proposed to increase the limit of sales to a related party, M/s Suresh Industries to ₹25 cr, which was approved in the AGM.

FY2018 annual report, page 14:

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

5) Transactions shown by Kanchi Karpooram Ltd FY2018 in deviation of accounting standards:

While analysing the FY2018 annual report, an investor notices that Kanchi Karpooram Ltd has shown interest cost of working capital loans as well as bank charges as an outflow under cash flow from operations (CFO). An investor would appreciate that the usual section to factor in interest expenses is cash flow from financing activities (CFF).

FY2018 annual report, page 59:

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

While analysing various previous annual reports of Kanchi Karpooram Ltd, an investor notices that the above instance is not the only case where the company seems to have deviated from normal accounting conventions.

In the FY2011 annual report, the auditor of Kanchi Karpooram Ltd highlighted that the provisions made by the company for liabilities under employee benefits were not in line with the applicable accounting standards.

FY2011 annual report, page 27:

Provision towards liability on account of employee benefits is made in deviation to the Accounting Standard – 15. The impact of the same on the Profit and Accumulated losses is not ascertainable.

Further advised reading: Understanding the Annual Report of a Company

In the same year, the management did not carry out the required inspection of its assets.

FY2011 annual report, page 28:

No Physical verification of fixed assets was carried during the year by the management; accordingly we are unable to offer our comment in regard to the discrepancies if any on Physical verification.

In addition, in FY2013, the annual report mentioned that the auditor of Kanchi Karpooram Ltd did not receive a confirmation from its suppliers/vendors and customers about the outstanding balances claimed by the company. As a result, there could be a possibility that the receivables claimed by Kanchi Karpooram Ltd might be under dispute by the customers.

FY2013 annual report, page 42:

Confirmation of Balances have not been received from Debtors, Creditors, and in respect of Loans & Advances, Deposits and other Liabilities.

In light of the above instances, investors should be cautious while analysing the reported financial information of the company.

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

6) Foreign exchange (forex) risk:

While analysing the financial performance of Kanchi Karpooram Ltd, an investor notices that the company spends a large amount of money on the import of raw material, whereas it does not have any compensating foreign exchange income (exports).

FY2018 annual report, page 34:

Your company has also earned foreign exchange of Rs.207.15 Lakhs through exports. The total Foreign Exchange utilized by the company during the year for the purchase of Raw Materials and others was Rs. 7393.83Lakhs.

An investor would note that in FY2018, the company had an import expense of about ₹74 cr whereas it had export earnings of only about ₹2 cr. As a result, the company is always at a risk of increasing import costs whenever Indian rupee declines in comparison to the US dollar.

Kanchi Karpooram Ltd highlighted the adverse foreign exchange movements as one of the reasons for the loss declared by it in FY2012.

FY2012 annual report, page 9:

Unprecedented increase in the price of raw materials, flucuations in foreign exchange & unforeseen reduction in camphor selling price had a major adverse role of the performance of the Company during the year under review.

Further advised reading: Understanding the Annual Report of a Company

The company, as well as the credit rating agencies, have highlighted the risk faced by Kanchi Karpooram Ltd because of foreign exchange fluctuations in their communication with stakeholders.

FY2011 annual report, page 24:

The main raw materials for manufacturing Camphor is imported and hence subject to foreign exchange fluctuations. Abnormal exchange variations may have adverse effect of the profits of the company.

Credit rating report by SMERA in April 2016:

However, the ratings remain constrained by the high dependence on import of alpha-pinene (used in the manufacture of camphor) and exposure to forex fluctuations.

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

An investor would appreciate that the changes in foreign exchange rates especially the decline of the Indian rupee against the US dollar can have a significant impact on the profits of Kanchi Karpooram Ltd. Therefore, an investor should keep a close watch on the impact of foreign exchange disclosed by the company in its result. In addition, investors may contact the company to understand its hedging policy and the steps it takes to mitigate the foreign exchange fluctuation risk.

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

7) Errors in the stock exchange disclosures done by Kanchi Karpooram Ltd:

While analysing Kanchi Karpooram Ltd, an investor comes across many instances where the information disclosed by the company to stakeholders contained errors. In some of the cases, the company issued revised disclosures to rectify the errors; however, at times, the errors in the documents like the annual report remain.

a) Q3 results declared by Kanchi Karpooram Ltd in Feb 2019:

The company made an error in the Q3-FY2019 results submitted to the stock exchanges in Feb. 2019 and later on filed a rectification on Feb 15, 2019.

We refer to our letter dated 14.02.2019 enclosing the Statement of Un-Audited Financial Results of the Company for the Quarter Ended 31st December 2018. As the Total Comprehensive Income for the Quarter Ended 31st December 2018 should be read as Rs. 621.35 Lakhs instead of Rs. 1,624.59 Lakhs. We are enclosing the report incorporating the correction.

Further advised reading: Understanding Quarterly Results Filings of Companies

b) Corporate announcement of the outcome of board meeting in Mar. 2019:

The company made an error in the value of warrants mentioned in the initial disclosure made to the stock exchanges and later on rectified the same with a revised disclosure.

We refer to our letter dated 18.03.2019, wherein the Value of warrants should be read as Rs. 4,50,00,000/-, Rs. 2,99,59,200/- and Rs. 7,49,59,200/- We are enclosing the details incorporating the correction.

Further advised reading: Stock Warrants to Promoters: How to Analyse

c) Change in promoters’ shareholding in FY2016 annual report:

As per the annual report of FY2016, during the financial year, the shareholding of the promoters of the company changed from 42.27% to 41.67%, which is a decline of 0.60%. However, on page 16 of the annual report, the company mentioned that the decline in the promoters’ shareholding was 1.43%.

FY2016 annual report, page 16:

Further advised reading: How to Monitor Stocks in your Portfolio

Whereas in the same annual report, on page 17, the company had correctly mentioned that the change in promoters’ shareholding during the year was 0.60%.

FY2016 annual report, page 17:

Margin of Safety in the market price of Kanchi Karpooram Ltd:

Currently (May 09, 2019), Kanchi Karpooram Ltd is available at a price to earnings (PE) ratio of about 5.1 based on standalone earnings of the last four quarters from January-December 2018.

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

In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be 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, Kanchi Karpooram Ltd seems like a company, which has been able to grow its sales at a growth rate of 20% year on year in the past. However, a deeper analysis of the sales growth along with its profitability presents a different picture. It turns out that Kanchi Karpooram Ltd is operating in a technologically simple and commodity type product where it faces intense challenges from multiple manufacturers in India and abroad. As a result, the company does not have any pricing power over its customers. Therefore, the company takes a hit on its profits whenever the raw material prices increase as it is not able to pass on the increase in raw material costs to its customers.

The lack of sustainable competitive advantage in the business model of Kanchi Karpooram Ltd is evident in the cyclical fluctuations in the profit margins of the company. The company has witnessed multiple periods of good profitability that were soon followed by periods of poor profits and net loss. As a result, an investor should be cautious while she makes future assumptions about the company based on recent sharp improvement in the profit margins of the company.

The business model of Kanchi Karpooram Ltd is very tough, which is reflected in a low self-sustainable growth rate (SSGR) as well as negative free cash flow (FCF) generation. The tough business model of the company has put a great strain on its cash generation ability. As a result, the company seems to have given a higher credit period to its customers to generate higher sales. This has resulted in a significant amount of money has stuck in working capital. Kanchi Karpooram Ltd could not fund this cash flow requirement from its business profits and has to rely on additional sources like debt and equity to meet this gap.

While analysing the history of the company, an investor notices that the company has switched its credit rating agencies very frequently and has stopped cooperating with all of them. Such behaviour points to attempted credit rating shopping by the company in which it tried to get the best credit rating for itself by dealing with multiple credit rating agencies. However, these attempts of Kanchi Karpooram Ltd seem to have not benefited the company as recently CRISIL despite the refusal of data sharing by the company, downgraded its credit rating to B+ based on publicly available information. A credit rating of B+ indicates a high risk of default in repayment of money to the lenders of the company.

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

Over the years, Kanchi Karpooram Ltd has taken loans from its promoters/directors. However, the interest rate charged by promoters to the company is very high when compared to the loans provided by banks to the company. In addition, Kanchi Karpooram Ltd has been dealing with related parties of the promoters’ group for consulting contracts, sales contracts etc. An investor should analyse these aspects in detail before she makes an investment decision about the company.

Kanchi Karpooram Ltd has presented certain transactions in a manner, which do not seem to conform to prevalent accounting norms. In the past, the auditors have highlighted deviations in the provisions for the liabilities of employee benefits. In FY2018, Kanchi Karpooram Ltd has deducted finance charges (interest expense and bank charges) as outflow to arrive as cash flow from operations (CFO) whereas normally, these charges are classified as an outflow under cash flow from financing activities (CFF). Investors may contact the company to seek clarifications in this regard.

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

An analysis of the financial performance of the company indicates that Kanchi Karpooram Ltd is exposed to very high raw material and foreign exchange fluctuations risk. As a result, in the past, it has seen its good profit margins turn into net losses very fast. Therefore, going ahead, the investor should keep a close watch on the supply and pricing situation of the key raw materials of the company. This is because extrapolation of current good profit margins of the company while ignoring these risks may bring negative surprises to investors.

Along with the profitability, an investor should closely monitor the debt levels and the related party transactions of Kanchi Karpooram Ltd. In case, investors notice that the profitability of the company begins to deteriorate, debt levels start to rise, cash flow generating ability does not improve, then they make take a decision accordingly.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Kanchi Karpooram Ltd. However, investors should do their own analysis before making any investment-related decision about the company.

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

Hope it helps!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

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