The current section of the “Analysis” series covers Monte Carlo Fashions Ltd, an Indian manufacturer of woollen and cotton garments under the brand “Monte Carlo”. The company is a part of the Nahar group of companies.
“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.
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.
Monte Carlo Fashions Ltd Research Report by Reader
Dear Sir,
I was working on this company – Monte Carlo Fashions Limited (MCFL). While I like the business, as a potential stock idea given current valuations seem undemanding. There are many potential red flags that I came across, which I want to take your views on.
Regards,
Rohit Kadam
Company brief:
Monte Carlo Fashions Ltd is a leading player in North India in the winter wear segment with their brand ‘Monte Carlo’. It is a part of the Nahar Group, which is a sizeable player in worsted woollens and other fabric and yarn manufacturing. The company is based out of Ludhiana, Punjab. The company is owned and run by members of the Oswal family who started the group back in 1949.
Until 2012, Monte Carlo Fashions Ltd was a part of Oswal Woollen Mills Ltd (OWM), which is a worsted woollen manufacturing company of the group. In 2012, Samara Capital, the private equity player took a 20% stake in MCFL for an enterprise valuation of ₹9 billion (current market capitalization: ₹7 billion) and the same was demerged from OWM. The idea was to have Monte Carlo Fashions Ltd listed separately since it would be a pure consumer branded business with ownership of the Monte Carlo brand.
Monte Carlo Fashions Ltd.’s main business is selling branded woollen sweaters and jackets, which makes the bulk of its revenues with a strong market share in North and East India. Over time, the company has diversified away from woollens, and into cotton garments, which today make up ~60% of sales. Apart from winter wear, the company has diversified into non-winter wear, home furnishings and kid’s apparel. However, winter wear remains the dominant segment making up ~50% of sales. The business thus exhibits high seasonality with ~55-60% sales accruing in the December quarter.
The business model of Monte Carlo Fashions Ltd:
This is a branded apparel business like that of peers – Page Industries Ltd (Page), TCNS Clothing Co. Limited (TCNS) and Kewal Kiran Clothing Limited (KKCL). The strength of Monte Carlo Fashions Ltd is the woollen portfolio under the Monte Carlo brand (~25% of sales). Within its segment, this has an estimated 50% market share of the organized segment. Monte Carlo woollen sweaters command high gross margins and this segment is the main source of income for the company. The problem has been that the woollen business has been a dog in terms of growth (sub 5% growth). The woollen portfolio is well penetrated the northern and eastern parts of the country and has a limited market in the warmer parts. It grows in the mid-single digits, at best.
Monte Carlo Fashions Ltd has been investing in growing its non-woollen portfolio, which is cotton apparel. Within cotton too, a fair share of the portfolio is tilted towards winter wear (jackets) but the same is suitable for relatively less harsh winter regions of the country. The share of cotton has grown steadily over the years and now makes up 60% of sales. Other growth drivers have been segments such as home furnishings and kids’ apparel, which together make up ~15% of sales.
Historically, woollen apparel has been made in-house with all the raw material sourced from the erstwhile parent and now group company, OWM. For cotton apparel, some of the job work is outsourced to another group company – Nahar Spinning Mills Ltd.
Monte Carlo Fashions Ltd makes gross margins of 47-48%, which, at a headline level, are lower than Page (60%), KKCL (60%) and TCNS (65%). In my view, margins are higher in the woollen portfolio at ~65% while they would be lower at ~40% in cotton. Cotton margins are lower as the manufacturing is outsourced but the more important reason is that brand strength in cotton is relatively weak. Trade margins are also higher.
In terms of distribution, Monte Carlo Fashions Ltd has had an over-reliance on the multi-brand outlets (MBO) channel (50% +) in the past but that has been under some stress post demonization and introduction of goods and services tax (GST). The company has attempted to correct the same in the last few years with a larger focus on LFS (large format stores) and online channels. The latter come with lower margins, call for discount sharing and buy on a consignment basis. At the same time, they are important given they attract an incrementally higher number of consumer footfalls. LFS and online, each contribute ~10% of sales and are fast-growing.
Monte Carlo Fashions Ltd also draws a fair share of 40% from the exclusive brand outlets (EBO) channel (300+ EBOs). EBO count has grown at 5% CAGR over the last seven years with EBO sales growing 10% i.e. ~6% implied same-store sales growth (SSSG). 85% of the EBOs are franchised with a store closure rate of 35% (stores closed/stores opened). These metrics are not ideal, and the company should look to invest more in their own EBOs as well. The store closure rate is on the higher side, too. However, on both these metrics, Monte Carlo Fashions Ltd scores much better than KKCL. Also, please notice that the implied store SSSG of 6% is healthy and suggests potentially good store economics. The company’s own EBO count has doubled from 20 to 40 between FY18 and FY21. This is a move in the right direction.
Past sales performance and key future drivers:
At an aggregate level, Monte Carlo Fashions Ltd has shown an ability to grow sales by 8-9%. Growth is clearly divergent with the mature woollen’s portfolio growing at low single digits. Cotton and home furnishing are growing at high teens and are driving nearly 40% of incremental sales between FY14-20. This trend should continue in the coming years given the management has demonstrated an ability to diversify away from core woollen wear.
The Monte Carlo brand is being used beyond woollens in other categories also and in my view, ~70% of total sales come under this main brand. The management does not disclose the sales of other brands except Cloak & Decker (~6% of sales) and thus, it seems that other brands are still small. There is nothing wrong with extending the Monte Carlo brands to other segments and categories as it does have a high recall.
Monte Carlo Fashions Ltd draws 95% of its sales from North, East and Central India. It has been trying to diversify its presence in the West and South. So far, they have seen limited success as the share of West and South has stagnated at single digits for many years. One clear challenge here is that consumers in the South and West do not buy winter apparel and have no connection with the Monte Carlo brand. The company thus needs to invest aggressively in building its brand in these regions for other non-winter products.
Profitability and return metrics, future direction:
Gross margins for Monte Carlo Fashions Ltd have been steady over the years at 47-48%. These are decent for an apparel category but lower than what some of the other listed peers have. However, Monte Carlo Fashions Ltd makes healthy EBITDA margins of 17-18%, which are at the top end of the listed apparel peers. Despite lower gross margins, it makes higher EBITDA margins due to the following factors:
1) Low rental costs as the bulk of the EBOs are franchised.
2) Staff costs as a percentage of sales are lower than industry standards (by 300-400bps). This is maybe a sign that not enough quality professional talent has been inducted. Directionally, staff costs have moved up 300 bps over the last six years.
Monte Carlo Fashions Ltd has a fixed asset turnover of ~3.5x, which is on the lower side versus industry peers. This is a bit surprising given it does not invest much in company EBOs. While they manufacture woollens in-house, cotton apparel is outsourced. In that context, asset turnover seems lower than expected. For comparison, TCNS has asset turns of 20x (completely outsourced), KKCL has 6x (partially in-house) and Page has 8-10x (70% in-house).
Receivable days for Monte Carlo Fashions Ltd used to range around 75 days until FY2015 but have increased sharply to 125 days over the last few years. This remains a key monitoring parameter going forward. In my view, the reasons for the same could be:
1) Stress in the MBO channel, which needs higher credit.
2) Higher growth in the large format stores (LFS) channel, which buys on consignment and asks for credit.
3) The company may have extended higher credit to drive growth.
The company has managed to keep its overall working capital steady by increasing payable days to the same effect (70 to 100+). Since ~25-30% of payables are to group entities, the pain has been managed well. Would they be able to stretch payable days in such a manner, were they not to group entities? Peer KKCL, which has also suffered from rising receivable days, has not been able to stretch its payable cycle because all its vendors are independent with no related party involved.
Monte Carlo Fashions Ltd makes a core return on capital employed (ROCE) (post-tax) of 13-14%, which is much lower than other peers in the branded apparel business. While its margins are good, the lower fixed asset turnover and more recently, the stretched working capital cycle, has dragged down its ROCE. Having said that, the ROCE is acceptable as it is still higher than the cost of capital (10-11%). The ROCE is also higher than the growth rate, which allows Monte Carlo Fashions Ltd to grow with internal accruals. The company has remained debt-free and closed FY2021 with net cash of ₹1 billion (~14% of market capitalization).
Regards,
Rohit Kadam
Dr Vijay Malik’s Response
Dear Rohit,
Thanks for sharing the analysis of Monte Carlo Fashions Ltd with us! We appreciate the time & effort put into the analysis.
While analysing Monte Carlo Fashions Ltd, an investor would notice that throughout the last 10-years (FY2012-FY2021), the company did not have any subsidiary and therefore, until now, it has reported only standalone financials.
In the current financial year (FY2022), Monte Carlo Fashions Ltd has established a wholly-owned subsidiary, Monte Carlo Home Textiles Limited on December 3, 2021 (Source: BSE). Therefore, going ahead, it is expected that the company would report both standalone as well as consolidated financials.
We believe that while analysing any company, an investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire company including its subsidiaries, joint ventures etc. The consolidated financials of a company present such a picture. Therefore, if a company reports both standalone as well as consolidated financials, then in such a case, it is advised that the investor should prefer the analysis of consolidated financials of the company, whenever they are present.
Further advised reading: Standalone vs Consolidated Financials: A Complete Guide
In the case of Monte Carlo Fashions Ltd, as until now, the company has reported only standalone financials; therefore, we have used the standalone financials in the analysis.
With this background, let us analyse the financial performance of the company.
Financial and Business Analysis of Monte Carlo Fashions Ltd:
While analyzing the financials of Monte Carlo Fashions Ltd, an investor notices that the sales of the company have grown at a pace of 6% year on year from ₹364 cr in FY2012 to ₹622 cr in FY2021. Further, the sales of the company have increased to ₹793 cr in the 12-months ended September 30, 2021, i.e. during Oct. 2020-Sept. 2021.
While analysing the sales growth of the company over the last 10-years, an investor notices that the sales of the company increased every year from FY2012 to FY2016 from ₹364 cr in FY2012 to ₹618 cr in FY2016. However, thereafter, for the next 2 years, the sales of the company declined to ₹576 cr in FY2018. Subsequently, the sales of Monte Carlo Fashions Ltd increased to ₹726 cr in FY2020 only to decline once again to ₹622 cr in FY2021.
Similarly, the profitability of Monte Carlo Fashions Ltd has also witnessed sharp fluctuations with the operating profit margin (OPM) fluctuating between 13% and 22% during the last 10 years (FY2012-FY2021). Monte Carlo Fashions Ltd reported an OPM of 22% in FY2012, which declined to 13% in FY2017. Subsequently, the OPM showed recovery and the company reported an OPM of 20% in the 12-months ended September 30, 2021, i.e. during Oct. 2020-Sept. 2021.
To understand the reasons for such changes in the performance of Monte Carlo Fashions Ltd, an investor needs to read the publicly available documents of the company like annual reports, conference calls, credit rating reports, as well as its corporate announcements.
After going through the above-mentioned documents, an investor notices the following key factors, which influence the business of Monte Carlo Fashions Ltd. An investor needs to keep these factors in her mind while she makes any predictions about the performance of the company.
1) Pricing power of Monte Carlo Fashions Ltd:
While analysing the performance of Monte Carlo Fashions Ltd under different business conditions and the explanations provided by the management of the company about its profit margins under various circumstances, an investor gets to know that Monte Carlo Fashions Ltd is in a peculiar position with respect to the pricing power over its customers.
An investor realizes that on the one hand, Monte Carlo Fashions Ltd has strong pricing power over its customers in the sense that it is able to safely pass on the increase in raw material costs to its customers almost every year. On the other hand, the investor witnesses that even the main brand “Monte Carlo” of the company does not have sufficient pricing power to hold on to the prices when its competitors start offering discounts on their products.
Therefore, the business of Monte Carlo Fashions Ltd presents a dichotomous situation where it can pass on the increases in the raw material costs to the customers by increasing the prices of its garments. However, when its competitors start to offer discounts to customers, then Monte Carlo Fashions Ltd has to match the discounts; however, early the competitors start the discounts or however, deep discounts they provide.
Let us see the business situations, which demonstrate the dichotomous pricing power of Monte Carlo Fashions Ltd.
1.1) Monte Carlo Fashions Ltd has strong pricing power over its customers:
While analysing the business of Monte Carlo Fashions Ltd, an investor comes across multiple instances that indicate that the company has a very strong pricing power over its customers, which includes almost the entire value chain i.e. the retailers like exclusive brand outlets (EBOs), multi-brand outlets (MBO) etc. as well as the final consumer.
An investor comes across multiple instances where Monte Carlo Fashions Ltd was able to increase the prices of its garments whenever the raw material costs like wool and cotton increased.
In FY2021, the company could pass on the increase in the cost of yarn by increasing the prices of its products.
Conference call, May 2021, page 9:
Mihir Desai: I understood, Sir. If the yarn prices, which have been increasing will it be a pass on for us or it will impact our gross margins to some extent?
Sandeep Jain: No, it is already passed on. Whatever yarn prices have increased we have increased our prices for the winter products for approximately 5% to 6%, so we have passed on that high to the product prices.
Even in the current year, FY2022, the company witnessed an increase in the cost of cotton, which it could pass on to the customers.
Conference call, August 2021, page 3:
Sandeep Jain: …As far as your question about the high cotton prices are concerned yes there have been increase in the cotton prices but fortunately, we have been able to pass all the cost increase to our garments
The company has been able to pass on the increase in the cost of raw materials in the past as well. In November 2016 conference call, the company intimated to its shareholders that it has been able to pass on the increase in raw material costs almost every year.
Conference call, November 2016, page 2:
Sandeep Jain: Yes to some extent woollen it has gone up, but I do not think it is going to affect us because we have been able to pass on the price increase every year
Once again, in the February 2017 conference call, the company confirmed that it has always been able to increase prices to cover up the increase in the cost of raw materials. At times, it had taken prices increases of up to 12%-13% as well.
Sameep Kasbekar: When was the last time we took a price hike?
Sandeep Jain: Every year we are doing a price hike, it is a nominal 3% to 4%, sometimes it is 7% to 8%, sometimes it was even 12% to 13% also.
In FY2018, when the branded apparel industry witnessed an increase in taxes due to the application of goods and services tax (GST), then Monte Carlo Fashions Ltd could pass on the impact of higher taxes and avoid any impact on its profit margins due to a higher GST.
Conference call, August 2017, page 17:
Sandeep Jain: We have increased price of around 4%-5% on various category of garments which were above the Rs. 1000 range and that has already been accepted by the market also. So as far as we are concerned, we are not having any effect on our margins because of GST.
In the November 2021 conference call, the company intimated to its shareholders that despite an increase in product prices, it has witnessed a healthy increase in order bookings.
Conference call, November 2021, page 10:
Sandeep Jain: …we had to increase 19% across our product to absorb this increase in the cotton yarn prices and thankfully the brand has the power that in spite of increasing 18% our trade show witnessed a booking increase of 25% to 30%.
While analysing the negotiating power in the relationship of Monte Carlo Fashions Ltd and the retailing supply chain like exclusive brand outlets (EBO), multi-brand outlets (MBO) as well as commission agents, an investor notices that the company has an upper hand in the negotiations.
In one of the conference calls, the company highlighted to its investors that when it organizes trade shows for displaying its products to the retailers, then the retailers have to pay an advance to make the bookings. The company stressed that normally in the industry, the retailers do not need to pay an advance for making bookings. Therefore, as per the company, the practice of retailers making advance payment for bookings shows its strong negotiating power over them.
Conference call, November 2019, page 10:
Sandeep Jain: We have a tradeshow where we invite all the retails across India who comes and book with us, they pay advance to us along with the booking, this you would not hear in any other trade segment they pay advance also along with the booking then only we close the book
On similar lines, in the case of exclusive brand outlets (EBO) and multi-brand outlets (MBO via commission agents), the company starts production of garments for the season only after receiving the orders from the retail outlets. Therefore, the production is only against pre-booking. In addition, the company does not have any sales-return clauses with the MBOs; therefore, even if the garments remain unsold with the MBOs, Monte Carlo Fashions Ltd is not liable to accept them as a return. Such a practice shows the strong negotiating position of Monte Carlo Fashions Ltd over the retailing outlets.
FY2015 annual report, page 47:
Over 90% of our sales are through the outright sale basis. We manufacture on the basis of pre-booking of orders for apparels. Therefore, the Company does not have any major inventory risk. With the MBOs, there is no stock correction as well as no discount sharing
An investor also notices that Monte Carlo Fashions Ltd manufactures garments against pre-booking where it factors in the prevailing prices of the raw material. As a result, the company protects itself from the year-on-year changes in raw material prices.
Conference call, November 2016, page 4:
Sandeep Jain: See both the inventories like before we go to the booking we book the raw material and then only we go for booking. So we are insulated as far as one season is concerned.
Moreover, in the case of exclusive brand outlets (EBO), Monte Carlo Fashions Ltd may shut down the outlet whenever it wants by only taking back the unsold inventory. As per the company, it does not have to give any other compensation to the franchise owner when it decides to close the outlet.
Conference call, November 2015, page 11:
Hiren Dasani: Let us say when you close down a particular showroom do you have to take any write offs?
Sandeep Jain: We just call our inventory back so that is a kind of write back because those inventory definitely goes at a lesser price which we use to sell normally otherwise there is no write back on company as a whole.
Hiren Dasani: But do you have to compensate if let us say the store kind of closes down or something?
Sandeep Jain: No, we do not have any agreement clause like that. It is only that we need to take back all the goods whatever we have supplied.
From the above disclosures, an investor would appreciate that Monte Carlo Fashions Ltd can close any showroom/exclusive brand outlet if it is not satisfied with its performance by only taking back the unsold inventory of garments.
An investor would appreciate that setting up a showroom involves a lot of investment by the franchise owner in the store interiors, lease/rental payments etc. In the case of EBOs of Monte Carlo Fashions Ltd, the franchise owner has to prepare the showroom as per the standards and the design requirements of Monte Carlo Fashions Ltd.
As per the disclosures in the red herring prospectus (RHP) of Monte Carlo Fashions Ltd dated November 21, 2014 (click here), the company had hired a design firm to give a consistent experience to the consumer in all of its EBOs including company-owned as well as franchise-owned.
RHP, November 21, 2014, page 116:
we have entered into an agreement with an architect firm, Design Affairs Private Limited, to provide the design for each of the ‘Monte Carlo Exclusive Brand Outlets’ including the ones owned and operated by the franchisees. This ensures that all our ‘Monte Carlo Exclusive Brand Outlets’ have the standard store design and the in-store experience.
Therefore, an investor would appreciate that owning and operating the showroom/exclusive brand outlet of “Monte Carlo” would include significant investment by the franchise owner. However, as per the company, it can close down the showroom without any compensation to the franchise owner. Such a situation represents the strong negotiating power of Monte Carlo Fashions Ltd over the retailers.
Moreover, an investor finds another sign of the strong negotiating power of Monte Carlo Fashions Ltd over its retailers when she notices that the company charges interest on any delay in the payment by the retailers.
Conference call, August 2019, page 6:
Sandeep Jain: …if the economy does not pick up there may be a delay of 15 to 20 days or maybe a maximum about a month, because they have to pay interest also on the late payments, so they cannot delay more and we do not allow whole of our MBOs to delay payment more than 30 to 35 days. And we charge interest on that also
An investor gets to know that Monte Carlo Fashions Ltd engages commission agents to supply goods to multi-brand outlets (MBOs). These commission agents are responsible for making payments to the company for the goods ordered by the MBOs. In addition, if any MBO cancels an order after placing it, then the commission agent has to bear the expenses and any loss incurred by Monte Carlo Fashions Ltd on such cancellation.
RHP, November 21, 2014, page 117:
we had 21 commissioned agents who work as an interface between the MBOs and our Company. All our commissioned agents are exclusive agents to our Company… Our commissioned agents are contractually liable for timely payment to our Company for the products supplied to the MBOs through the commissioned agents. In the event the dealers of the MBOs cancel the orders before or after the products have been dispatched by us to the MBOs, the commissioned agents are liable to pay all expenses incurred and any other losses suffered by our Company due to such cancellation.
From the above discussion, an investor would appreciate that Monte Carlo Fashions Ltd has strong negotiating and pricing power over the supply network including commission agents, MBOs as well as EBOs. Monte Carlo Fashions Ltd dictates terms as per its preferences whether it is related to pre-booking of orders, advance payments for bookings, holding commission agents liable for payments, cancellations and losses as well as no sales-return and no discount sharing with MBOs. It can shut down any exclusive showroom (EBO) at any time without any compensation to the franchise owner by only taking back the unsold goods.
Advised reading: How to do Business Analysis of Organised Retail Companies
In addition, every year, Monte Carlo Fashions Ltd increases the prices of the garments to pass on any increase in its cost of raw materials like wool and cotton.
All these aspects of the business of Monte Carlo Fashions Ltd show that it has a very strong negotiating and pricing power over its customers.
However, at the same time when an investor analyses the competitive landscape of the branded apparel industry, then she notices that Monte Carlo Fashions Ltd does not have any superior competitive advantage even if its main brand “Monte Carlo” is a well-established brand in the Indian market.
Let us see business situations, which indicate that Monte Carlo Fashions Ltd does not have any superior competitive advantage or pricing power in the industry.
1.2) Monte Carlo Fashions Ltd does not have any superior pricing power in the industry:
While analysing the business of Monte Carlo Fashions Ltd, an investor comes across multiple instances where she realizes that the company is completely at the mercy of competitors in the terms of prices at which it can sell its garments to the customers. The company has clearly highlighted to the shareholders that it has to follow the market. If the competitors start discounts early, then it has to start it too. If the competitors start the discounting season with deep discounts, then it has to offer deep discounts as well.
In FY2018, when Monte Carlo Fashions Ltd witnessed a decline in its sales turnover, then it highlighted that deep discounts offered by all the brands even before the actual discounting season started led to a fall in the sales revenue as well as profit margins.
Conference call, May 2018, page 5:
Sandeep Jain: The brands have started going for discount even before the actual discount season starts and that is the big reason, which is actually hurting the margin as well as it is cutting the revenues also.
Monte Carlo Fashions Ltd stressed that no brand; however strong, whether Indian or international can survive without discounts.
Conference call, May 2018, page 5:
Sandeep Jain: Sir I think in today’s scenario, we see all the leading brands not only Indian brands but the international brands also, no brand can survive without discounts so when it is end of season discount sale every brand be it a strong brand or a weak brand has to adjust to the market conditions.
In FY2019, Monte Carlo Fashions Ltd reported a sharp decline in the profit margins when its OPM declined from 20% in FY2018 to 15% in FY2019, then the company mentioned that it had to offer deep discounts because its competitors started giving large discounts right at the start of the discounting season. As a result, its profit margins suffered.
Conference call, May 2019, page 16:
Dinesh Gogna: normally the discounts are in January and February and starts at 20% and then it goes to 30%, then 40%, then 50%, but this year most of the brands have started from 20% immediately by January 20, 2019 they went to 40% and 50%, so we have to increase our discounts accordingly to get rid of the stocks…so we never anticipated that and that has actually hurt our margins that is why ₹18 Crores extra discount has been given in the fourth quarter.
Monte Carlo Fashions Ltd highlighted in the current scenario, no brand can survive without discounts. The company highlighted that the intense competition and the resulting discounts are a major threat to its business.
FY2018 annual report, page 49:
Heavy Discounts: All the leading brands i.e Indian and International are going for early discounts/ sales…In such a scenario to keep the walk-ins intact every brand has to offer discount and no brand can survive without discounts. We fear that going forward also the discounting sales will continue in same fashion or may rise going forward due to intense competition in this space.
Monte Carlo Fashions Ltd told investors that the competitive pressure in the terms of discounts is so much that the company is finding it difficult to maintain its profit margins.
Conference call, May 2021, page 17:
Sandeep Jain: The discount months are actually expanded. It used to be only one month at one point of time, now it has gone to around two-and-a-half months in one particular season so the discount is applicable in all the categories and all brands have started discounts so it is a challenge to maintain the EBITDA
An investor may believe that a company may not participate in the discounts and in turn hold on to the inventory so that it may use it in the next season to protect its profitability. However, she should note that in the case of apparel changing fashion trends lead to the current designs going out of favour very soon. Therefore, the demand for the garments produced in the current season may not sustain for the next season. As a result, companies intend to get rid of the current inventory within the current season even by giving very high discounts.
The credit rating agency, ICRA highlighted this aspect of the business of apparel manufacturers in its rating guidelines in November 2015 (click here), page 4:
Given the fast changing fashion trends, apparels can face fast obsolescence and witness a sharp decline in their realizable value, if not sold within the marketing season they were manufactured for. Accordingly, inventory management is most critical for the profitability of a branded apparel player.
From the above discussion, an investor would appreciate that the branded apparel business is highly competitive where all the brands whether Indian or international are cutting each other on pricing, which makes it very difficult for the brands to maintain profit margins.
In such a situation, an investor notices that even the main brand of the company “Monte Carlo”, which is a well-known name, does not have any distinct competitive advantage over its competitors. When the competitors reduce prices, then Monte Carlo Fashions Ltd cannot afford to hold on to its prices. It has to match the discounts offered by the competitors even if it hurts its profitability.
Such kind of intense competition where industry players undercut prices and Monte Carlo Fashions Ltd has to follow the path shows that the company does not have any pricing power.
Therefore, from the above discussion, an investor would appreciate that the pricing/negotiating power of Monte Carlo Fashions Ltd over its consumers is dichotomous. It has a very strong negotiating power over its supply chain network where it can dictate terms to the commission agents, brand outlets (EBOs and MBOs) and increase the prices of goods to pass on the increase in costs. On the other hand, it does not have any distinct competitive advantage over its peer and has to follow them whenever other players start discounts early or go for deep discounts.
Going ahead, an investor needs to keep these contrasting dynamics of the business of Monte Carlo Fashions Ltd in her mind when she attempts to understand and project the business performance of the company in the future.
Moreover, while analysing the business of Monte Carlo Fashions Ltd, an investor comes across other aspects of its business, which are essential for her to understand.
Further advised reading: How to do Business Analysis of a Company
2) Intense competition in the apparel industry:
An investor would appreciate that the apparel industry has very high competition. This is because the apparel industry is highly fragmented and is dominated by the unorganized sector. As per the company, in India, the share of organized players is only about 19% as compared to about 80% market share in the developed markets.
FY2015 annual report, page 47:
The Indian apparels market is highly fragmented, with organised players commanding only ~ 19% market share, in stark contrast to the United States and European markets where organised players have more than 80% market share.
Even in the case of winter-wear garments, in India, the share of the unorganized sector is much higher at 70% when compared to the share of the organized sector at 30%.
FY2015 annual report, page 43:
In India, the winter wear market is clearly segmented between branded and unbranded players. The ratio is 70:30, with 70% players belonging to the unbranded sector.
The main reason for a very high share of the unorganized sector in the apparel industry is that it has very low barriers to entry. As a result, the market has witnessed the presence of numerous players. Monte Carlo Fashions Ltd highlighted the low barriers to entry in the apparel industry as one of the major threats to its business of selling branded apparel.
FY2015 annual report, page 48:
Low entry barriers: The absence of significant entry barriers leads to an increase in the number of players, especially the unorganised players. This can escalate the degree of competition, making market penetration and sustaining of higher margins even tougher.
The company acknowledged to its shareholders that the cotton apparel business is very less capital intensive.
Conference call, February 2016, page 4:
Sandeep Jain: knitted cotton is basically very less capital intensive industry even if we would like to put up facility for 10 lakhs T-shirts it has been our cost is more than 1.5 to 2 Crores
Therefore, an investor would appreciate that anyone with a moderate level of financial resources can enter the apparels business making the industry one with low barriers to entry.
One of the effects of low entry barriers and the presence of many unbranded players is that Monte Carlo Fashions Ltd and other branded players face very high competition to get a share of the limited market available to the branded apparel players. Cutthroat competition among branded players is one of the challenges faced by Monte Carlo Fashions Ltd.
FY2015 annual report, page 48:
This has led to great deal of competition among the organised players to grab the largest share of the pie. With an increase in the number of international brands entering India and many looking to enter soon, the competition is expected to intensify further
The competition in the industry is so severe that at times, Monte Carlo Fashions Ltd had to shut down some of its outlets, as they could not survive the competition.
Conference call, November 2020, page 10:
Sandeep Jain: Actually, we are closing some of our smaller MBOs because they are not able to survive because of competition
Because of intense competition among branded players and the presence of a large number of unbranded players, Monte Carlo Fashions Ltd has to spend a lot of money on the advertisement of its products, which at times has led to a decline in the profit margins of the company.
As per the credit rating agency, ICRA, one of the key reasons for the decline in the operating profit margin (OPM) of the company in FY2019 to 15% from about 20% in FY2018 was the high marketing spending done by the company to maintain its market share.
Credit rating report by ICRA, Sept. 2019, page 3:
The intense industry competition mandates high marketing spends to maintain market presence, particularly when there is a demand slowdown. This was also witnessed in FY2019, wherein the operating margin declined to 15.0% from 19.6% in FY2018 to maintain market share.
Advised Reading: Credit Rating Reports: A Complete Guide for Stock Investors
Monte Carlo Fashions Ltd has to continuously spend on marketing because it has competition from many of the well-established large international apparel brands, which have a bigger financial strength and bigger brand recognition.
Red herring prospectus, Nov. 2014, page 14:
Many of our competitors, specifically the international brands, have significant competitive advantages, including longer operating histories, larger and broader customer bases, more established relationships with a broader set of suppliers, greater brand recognition and greater financial, research and development, marketing, distribution and other resources than we do.
From the above discussion, an investor would be able to appreciate the very high level of competition in the apparel industry. As a result, the branded players are willing to cut prices in the terms of higher discounts to sell garments and as discussed above, Monte Carlo Fashions Ltd has to follow the same path.
In fact, when Monte Carlo Fashions Ltd decided to enter South and West India with the range of its cotton garments, then it had to compete based on the pricing. A lower price was the main offering made by Monte Carlo Fashions Ltd to the consumers.
Conference call, August 2016, page 10-11:
Deepan Shankar: Sir in these south and west markets so only the price being competitive advantage for us in the cotton segment?
Sandeep Jain: I think the competition is definitely on the price front also because when somebody is established either we have to offer something which is completely different so that the question of price does not come up or we have to compete with the prices in the brand…So price becomes one of the important factor
However, even after many years of struggling in the South India market, Monte Carlo Fashions Ltd could not make a significant break. The company acknowledged that it is finding it tough to establish itself in the South Indian market.
Conference call, May 2019, page 22:
Sandeep Jain: …one thing we will admit that south was not that easy which we thought of in the earlier year’s report, so we are definitely facing challenge as far as south India market is concerned
Conference call, November 2019, page 11:
Sandeep Jain: I think we would admit that there have been difficulties in penetrating in the south and we did not anticipate that the growth as far as south is concerned… So, I could take back my words particularly as far as southern region is concerned and it is actually not doing well for us
From the above discussion, an investor would appreciate that the competition faced by Monte Carlo Fashions Ltd is intense and it is not able to establish itself or take market share away from existing players on the strength of its brand. It has to follow the discount levels offered by competitors to attract customers to its stores and to get rid of the inventory at the end of season sales. In addition, in the South Indian market, it could not penetrate despite offering its products at a lower price than what its competitors offer.
It indicates that Monte Carlo Fashions Ltd does not have a distinct competitive advantage over its consumers when compared to its peers.
Further advised reading: How to do Business Analysis of Textile Companies
3) Online sales/e-commerce is pushing Monte Carlo Fashions Ltd.’s margins down:
While reading about the development of the business of Monte Carlo Fashions Ltd over the years, an investor notices that at first, the company attempted to treat the online sales channel/e-commerce as just an additional sales channel with no special consideration. Monte Carlo Fashions Ltd attempted to keep its prices/MRP and discounts for the online channel at the same level as its offline channel (retail stores, EBO, MBO etc.).
Conference call, February 2019, page 5:
Sandeep Jain: We started this online business, we maintained one policy that our prices at all the channels will remain same, whether we sell at EBO or LSS or MBO, we have the same policy if we are selling an MRP in online we are also selling MRP in offline and other channels also, and the discount is also same, when we go for EOSS, end of year sales discount the price remains same in all the channels and the same discount is being offered
However, soon the company realized that its strategy of keeping the prices and the discounts the same for both online and offline channels is not giving the desired results. Therefore, the company started providing higher discounts/lower prices on the online channel.
Conference call, November 2020, page 8:
Devendra Pandey: And what would be the ballpark number, the difference between the average realization through our own shops and through the online channel?
Sandeep Jain: It is almost 4% discount it will more in online channels as compared to offline channels.
In addition, the company realized that the online channel is changing consumers, expectations about discounts. It realized that, nowadays, consumers expect discounts all the time and online channel/e-commerce is forcing brands to give discounts during the peak of the summer/winter season instead of the usual practice of offering discounts at the end of the season.
In 2018, the company intimated to its shareholders that the discount sales in the market started on May 1, 2018, when the summer season had not yet peaked.
Conference call, May 2018, page 6:
Shailesh Kumar: To what extent this is true that the online sellers are forcing established brands to give this kind of discounting and all these things?
Sandeep Jain: Yes, you rightly said it is one of the factor which is actually influencing the brand to go for the discount sales because these customers are now getting habitual to discount sales as the discount sales starts very early, now even if the summer has not peaked but we have a discount sale which is beginning from May 1, 2018 itself most of the brands have gone for discount sales.
From the above discussion, an investor would notice that initially Monte Carlo Fashions Ltd attempted to treat online sales/e-commerce channels as just another channel with no special considerations. However, soon, it realized that the effects of online sales channels on consumer behaviour have started to impact offline sales also.
As a result, first, it started offering a higher discount/lower prices for online sales than offline channels. Further, the company even decided to launch a separate clothing range, especially for the online channel where it could give higher discounts.
Conference call, August 2021, page 8:
Rishabh Oswal: we have launched a new exclusive range for online partner, which is not available offline, which gives them the freedom to use discounting on leverage terms as they could be with the brand Monte Carlo.
In the past, the company had acknowledged to the shareholders that the profit margins in the online sales channel are lower than profit margins on offline sales.
Conference call, February 2016, page 10:
Tanmai Sharma: Sir margins there would be lower in the online because discounts are quite common there?
Sandeep Jain: Yes, margins are a little lower as compared to other sales in online sales.
Moreover, in the online channel, the company has to bear the full impact of discounts on its own instead of offline sales like MBO (no discount sharing) and EBO (5%-17.5% discount sharing). In addition, the company’s sales to offline channels are almost without recourse. In the case of MBOs, the company does not accept any returns whereas for EBOs it accepts about 5% returns. However, the sales to the online channel partners are almost with full-recourse (consignment sales i.e. sales or return, SOR) indicating that the entire unsold inventory can be handed over back to the company.
FY2015 annual report, page 47:
With the MBOs, there is no stock correction as well as no discount sharing, whereas, with EBOs, there is 5% stock correction and discount sharing ranging from 5% to 17.5%.
Conference call, May 2016, page 12:
Sandeep Jain: there are national chain stores, yes, there we fully participate in the discount whenever they go for discounts and e-commerce there we fully participate,
Conference call, June 2020, page 6:
Sandeep Jain: our business has progressed so the other channels like SIS and large format retail and the online sales channels and more of the EBO, which are doing consignment sales have added.
Therefore, an investor would appreciate that the emergence of online sales has forced Monte Carlo Fashions Ltd to first offer a higher discount on its garments and thereafter, launch clothes, especially for the online channel that will be sold at a lower price. These steps lead to a decline in the profit margins of the company.
As the contribution of the online sales increases in the revenue of Monte Carlo Fashions Ltd, it is expected that the profit margins of the company may come down. In addition, as highlighted by the company, online sales are changing consumers’ expectations and nowadays, discounts start even at the peak of the season even on offline channels. Therefore, going ahead, it may be a challenge for the company to earn a higher profit margin.
An investor needs to keep these aspects in her mind when she attempts to project the financial performance of the company and its profit margins in the future.
In recent years, the profit margins of Monte Carlo Fashions Ltd have seen a sharp increase with the operating profit margin (OPM) increasing from 15% in FY2019 to 20% in the 12-months ended September 2021 (i.e. Oct. 2020-Sept. 2021). The key reason for the increase in the margin is the reduction in the expenses associated with the coronavirus related lockdowns e.g. advertising, business promotion, salary expenses etc.
Conference call, November 2020, pages 14-15:
Sandeep Jain: See the reason being is cut down in the expenditures, so if you see in the presentation we have cut down the advertising, we have cut down on the salary part, we have cut down on other expenses as well, so all these things I think has helped us to improve the gross margins.
Sandeep Jain: we used to hold trade shows for our retail bookings twice in a year where we used to spend almost 4.5 Crores to 5 Crores expense, but that has been cut down and we are doing the virtual booking
Conference call, February 2021, page 10:
Sandeep Jain: we used to spend around Rs 5 to 6 Crores on theaters in full financial year, but no movies have been released and there have not been any advertising as far as cinemas are concerned, so that has also saved the cost.
As per the FY2021 annual report, page 120, the advertisement and business promotions expenses have declined from about ₹30 cr in FY2020 to about ₹11 cr in FY2021.
Therefore, an investor may note that the increase in the profit margins in recent years seems due to a decrease in expenses like advertising, business promotions, salary etc. She should keep this aspect in her mind when she attempts to project the profit margins of Monte Carlo Fashions Ltd in the future.
4) Over-reliance of Monte Carlo Fashions Ltd on Q3 (October to December) for its business:
While analysing the business of Monte Carlo Fashions Ltd, an investor notices that the October-December quarter (Q3) is the only period when it makes the profit for the entire year. In addition, the investor would also notice that as a routine, Monte Carlo Fashions Ltd makes losses in the Q4 (January-March) and Q1 (April-June) months.
The following table showing the financial performance of the last 12 quarters, from December 2018 to September 2021 shows that in each of the years, Monte Carlo Fashions Ltd reported losses in the January-March quarter and April-June quarters.
Monte Carlo as a brand is well known for its winter garments. At one point in time, it used to sell only woollen garments; however, over time, its share has come down and in FY2021, woollens contributed only 27.7% of its turnover (Investors presentation, November 2021, page 7). An investor may think that the increasing share of cotton garments in its sales, which is 51.4% in FY2021 (Investors presentation, November 2021, page 7) would reduce the dependence of the company on winters. However, she notices that the majority of cotton garments sold by Monte Carlo Fashions Ltd are also winter-wear.
As per the company, in FY2020, 70% of cotton wear sold by the company were winter-wear like sweatshirts, jackets, tracksuits etc.
Conference call, June 2020, page 16:
Sandeep Jain: When we talk about the cotton segment, it is not only the summer segment, it is basically around 70% of the winter segment. When we talk about sweatshirts, when we talk about jackets, it comes under the cotton category. When we talk about the tracksuits in winters, so basically the cotton category comprises of around 70% of the winter category and 30% of summer categories.
Therefore, an investor would appreciate that despite hard efforts by the company, Monte Carlo is perceived as a winter-wear brand and the company is not able to break this perception. Monte Carlo Fashions Ltd highlighted this challenge in its red herring prospectus.
RHP, November 2014, page 12:
we may face risks in relation to delayed acceptance of our products due to limited brand recognition, as well as the perception that we are a cold-weather apparel brand.
Therefore, an investor would note that despite the best efforts of the management, Monte Carlo Fashions Ltd is not able to reduce its dependence on the December quarter for its sales.
Such a dependence of the business on a limited period during the year exposes Monte Carlo Fashions Ltd to a huge risk. An investor would appreciate that if due to any reason, the business faces disturbance or headwinds during the December quarter, then the whole year is washed out for the company.
The company has faced such tough times in the past.
An investor would remember that on November 8, 2016, the Indian govt. had announced the demonetization of high denomination currency notes. As a result, the availability of cash became a huge challenge, which hurt consumption. Unfortunately, this period was Q3 (October-December) quarter, which is the most important for Monte Carlo Fashions Ltd.
No wonder that during FY2017, Monte Carlo Fashions Ltd witnessed a sharp decline in sales from ₹618 cr in FY2016 to ₹577 cr in FY2017 and the net profit after tax (PAT) of the company declined by almost 25% from ₹59 cr in FY2016 to ₹44 cr in FY2017.
Conference call, February 2017, page 3:
Sandeep Jain: but after 9th because there was definitely a cash crunch in the market and the smaller retailers who sell these categories do not have the credit card machines installed in their shops. Even a normal request when they gave it took almost one month for the bank to install the credit card machines on the shops. So, that was the reason why we were badly affected in November and almost middle of December before the sales started picking up.
Therefore, an investor would appreciate that due to the concentration of sales in the December quarter, the impact of any adverse development during these 3 months (October-December) is usually very significant for Monte Carlo Fashions Ltd.
Even if an investor assumes that events like demonetization are not very frequent, still, an investor has to understand that over-reliance of Monte Carlo Fashions Ltd on the winter season for its sales has affected its business every-time India had a weak winter season.
While analysing the business of Monte Carlo Fashions Ltd, an investor notices that whenever winter is weak during any year, then its adverse impact on the business is not limited to this year. In fact, it affects the next years’ sales for the company as well. In the current year, the sales are low because the winter is weak and people do not buy many winter clothes. In the next year, the retailers do not place many orders for winter wear because they have unsold inventory from the previous year.
Monte Carlo Fashions Ltd highlighted this risk to the investors in its red herring prospectus before its IPO.
RHP, November 2014, page 12:
weather conditions also have a material impact of our sales as a longer winter ensures higher sales while a mild and short winter adversely affects our results of operations. A mild and short winter may also have a material adverse effect on our next season sales as most of the multi brand outlets (“MBOs”) and ‘Monte Carlo Exclusive Brand Outlets’ may have unsold stocks from the previous season and might place smaller orders compared to the last season.
In the last 10-years, Monte Carlo Fashions Ltd was affected multiple times by its over-dependence on the winter season for sales. Every time, the weak winter in one year affected its sales for the next year as well.
For example, in FY2012, India had a short winter and it affected the sales of Monte Carlo Fashions Ltd for FY2013 as well.
RHP, November 2014, page 12:
our sales were negatively impacted by the short winter in fiscal 2012, which led to a decrease in consumption of woollen yarn, woven fabric and knitted cloth and our cost of materials consumed decreased by ₹ 91.59 million, or 8.23%, from ₹ 1,112.97 million in fiscal 2012 to ₹ 1,021.38 million in fiscal 2013, which was caused by decline in the demand of our apparel products.
The company faced a similar situation again in FY2016 and FY2017. In FY2016, the winter season was weak, which resulted in lower sales; however, it affected the sales of FY2017 as well because the retailers had unsold inventory from FY2016. The company intimated it to the shareholders in the FY2017 annual report.
FY2017 annual report, page 10:
This Financial Year, the Company has a negative growth of 6.02%…as you all are aware that December, 2015 was a year of very low winter and resulting thereof the stocks remain unsold with the franchisees and as well as Multi Brand Outlets (MBO). In the normal trend of our business this effects our sales for the immediately succeeding year.
Conference call, February 2017, page 2:
Sandeep Jain: As you all know that the last year winter was very bad for us and the impact of bad winter is always felt in the next year as the stocks are piled up in the retail channel,
Therefore, an investor would note that over-reliance on a very short period of the year for its overall business performance puts Monte Carlo Fashions Ltd in a very risky position. Any disturbance to its business during the December quarter can wipe out the whole year for the company.
If sales of the company are impacted in the December quarter, then it cannot hope to make up for the same in the next quarter because, in March quarter, the end of season sales start, which reduce the selling prices significantly. In addition, in Q4 (January-March) every year, the company gets the return of unsold inventory, which it has to sell in its factory outlets at a loss.
Conference call, August 2017, page 8:
Sandeep Jain: And these returns basically we sell it on our factory outlets. We have around 22 factory outlets all across India where we sell these returns….Actually it is not sale which have profit. Profit comes from the 90% of the sale which goes in fresh. So this is a sale, which actually we have to incur some loss to get rid of the stock.
Therefore, an investor would appreciate that in Q4, every year; Monte Carlo Fashions Ltd suffers a loss due to deep discounts on the garments in the end of season sale and selling the returned-unsold garments in its factory outlet for a loss.
Therefore, any investor who wishes to project the financial performance of Monte Carlo Fashions Ltd in the future should always keep in her mind its over-dependence on the short period of time (October-December) every year for its full years’ financial performance. She should always be aware of the risk that the business of Monte Carlo Fashions Ltd carries due to a short window to generate profits.
She should be aware that in addition to natural factors like a short/weak winter, any other disturbance like demonetization, if it happens in the December quarter, then it could severely affect the business performance of Monte Carlo Fashions Ltd for the whole year.
5) Monte Carlo Fashions Ltd has a heavy reliance on outsourcing for garment manufacturing:
While analysing the company, an investor notices that Monte Carlo Fashions Ltd relies heavily on outsourcing to get its garments. As per the company, it manufactures woollens (about 27% of sales in FY2021) and about 15% of cotton garments, (total cotton garments constitute about 51% of sales in FY2021). As a result, Monte Carlo Fashions Ltd outsources the manufacturing of about 85% of cotton garments and entire home furnishing goods to third parties.
Therefore, an investor would appreciate that Monte Carlo Fashions Ltd acts more like a marketing company instead of a majorly manufacturing company.
Conference call, May 2021, pages 8-9:
Sandeep Jain: …it is only woollen side, which is being manufactured at our place and cotton side it is just 15% of our total production and we are basically more of a marketing company rather than production-based company, so most of the products are outsourced in our case.
Until now, the home furnishing business of Monte Carlo Fashions Ltd is a complete trading business i.e. it purchases blankets, quilts and bedsheets etc. in a readymade condition and sells it under the Monte Carlo brand name.
Conference call, August 2016, page 11:
Anand Krishnan: Sir, with respect to your home furnishing business is that actually a trading business or is it also being manufactured by you?
Sandeep Jain: Sir, it is a trading business only.
An investor would appreciate that when a company becomes predominantly a marketing company and relies on third parties for manufacturing, then there are chances that it may face supply disruptions in meeting demand from retailers due to excessive reliance on outsiders.
Monte Carlo Fashions Ltd had also realized the same and it gave certainty in the supply dynamics as one of the reasons when it established its manufacturing plant in the past.
Conference call, August 2015, page 12:
Sandeep Jain: There is the reason for that, one is that because when you’re 100% dependent on the outside suppliers in some of the vendor sales it makes difficult to supply on time…the reason for putting up in-house production is to match the timelines given by our retailers.
In addition, Monte Carlo Fashions Ltd intimated to investors in its RHP that the third parties manufacturing garments for it are not bound exclusively to supply to it. In addition, there are no long-term supply contracts with these third parties. As a result, there is a risk that these third parties may start supplying the same or similar goods to their competitors.
Red herring prospectus (RHP), November 2014, page 210:
We generally do not enter into agreements with our third party manufacturers from whom we buy finished products for sale under our ‘Monte Carlo’ brand and typically transact business on an order-by-order basis
Red herring prospectus (RHP), November 2014, page 17:
Since such third party manufacturers are not contractually bound to deal with us exclusively, we may face the risk of our competitors offering better terms to such third party manufacturers, which may cause them to cater to our competitors alongside, or even instead of us.
Therefore, an investor would appreciate that reliance on outsourcing for a major portion of its goods exposes the company to risks of supply chain disruptions and its designs leaking to competitors.
In FY2021, the company intimated to the shareholders that its sales of jackets declined during the year as it could not get the required cotton fabric from overseas suppliers. On the other hand, the production of woollens did not face challenges, as its production is in-house.
Conference call, February 2021, page 5:
Sandeep Jain: …the major drop is in jackets the reason being is that we are not able to get some fabrics from China, Korea and Italy as there have been some restrictions… As woollen sweaters are in-house so we did not face many difficulties in producing the woollen sweaters
In the recently announced capital expenditure, Monte Carlo Fashions Ltd has plans to manufacture rugs and the mink blankets fabric in the proposed plant, which will offer a good control on the supply of home furnishing business, especially the mink-blankets.
Conference call, November 2021, pages 3-5:
Sandeep Jain: The proposed subsidiary company will manufacture rugs 13 million square meter per annum and mink blanket fabric 20 tons per day
Dinesh Gogna: business of Monte Carlo of this blanket will not be affected at all rather it will help because raw material will be procured in-house only and we will be controlling even the fabric
Sandeep Jain: we import all our blankets from China, so we pay lot of freights and also the duties, which is increasing the cost, so one is that it will reduce the cost
An investor would appreciate that the proposed manufacturing will reduce outsourcing requirements for the mink blankets for Monte Carlo Fashions Ltd and the existing outsourcing requirements for the majority of cotton garments and other products like quilts, bedsheets etc. will continue in future.
Further advised reading: How to do Business Analysis of a Company
In addition, as per the management, the proposed manufacturing plant would lead to incremental revenue of about ₹600 cr in the next 5 years.
Conference call, November 2021, pages 4, 9:
Sandeep Jain: … total (investment) will be around Rs.355 Crores overall and that would have the turnover of around Rs.600 Crores in next five years
Majorly it will come from rugs and you can assume around 60% will come from the rugs and balance will come from the mink blanket fabric
As per the company, the revenue from the new plant will commence from FY2025.
Conference call, November 2021, page 11:
Anil Jain: Congratulations on the good set of numbers. I missed the part when the revenue from the subsidiary will start generating?
Sandeep Jain: 2024 – 2025
Therefore, an investor would appreciate that if she factors in incremental revenue of about ₹600 cr from FY2025, which would be from in-house manufacturing activities in the newly formed wholly-owned subsidiary, then on an overall basis, the company would have about 75% of the total revenue from in-house manufacturing. This includes assumptions of complete in-house manufacturing of woollen wear (27% of FY2021 revenue), home furnishing (14% of FY2021 revenue), 15% of cotton wear (51% of FY2021 revenue) and ₹600 cr of revenue from in-house manufacturing of the proposed plant.
As per the above assumptions, the new plant would reduce the share of outsourcing significantly in the overall revenue of the company and therefore, may reduce the risks associated with outsourcing discussed above. Nevertheless, an investor should keep a close watch on the developments related to the progress of the proposed manufacturing plant.
While analysing the tax payout ratio of Monte Carlo Fashions Ltd., an investor notices that for most of the years, the tax payout ratio of the company has been in line with the standard corporate tax rate prevalent in India.
In recent years, the tax payout ratio has declined to 25% from the previous years’ level of above 30%, which seems to be in line with the recent changes in the corporate tax rates implemented by India.
Further advised reading: How to do Financial Analysis of a Company
Operating Efficiency Analysis of Monte Carlo Fashions Ltd:
a) Net fixed asset turnover (NFAT) of Monte Carlo Fashions Ltd:
When an investor analyses the net fixed asset turnover (NFAT) of Monte Carlo Fashions Ltd in the past years (FY2013-21), then she notices that the NFAT of the company has stayed in the range of 3.6-5.0. (An investor may note that while calculating the NFAT, we have removed the impact of the right of use assets created by the company under lease accounting.)
The NFAT of the company had declined during FY2013-FY2015 when NFAT decreased from 5.1 in FY2013 to 3.3 in FY2015.
An investor would note that during FY2014-15, the company had completed a manufacturing plant to produce cotton t-shirts and thermals.
Conference call, August 2015, page 3:
Sandeep Jain: In April last year we put in a facility for manufacturing cotton T-shirts and thermals.
An investor would appreciate that whenever a company makes a manufacturing plant, then it takes some time for the company to increase its utilization levels to the optimal level. As a result, during the initial phase, the investment done by the company in the plant does not produce commensurate revenues, which leads to a decline in the net fixed asset turnover (NFAT) of the company. Thereafter, as the capacity utilization of the plant increases, then the NFAT of the company increases.
In the case of Monte Carlo Fashions Ltd as well, the NFAT of the company increased from 3.3 in FY2015 to 5.1 in FY2020.
Moreover, from the above discussion on the business of Monte Carlo Fashions Ltd, an investor would remember that the company relies a lot on outsourcing for getting cotton garments, and home furnishing goods. Therefore, as the share of cotton garments and home furnishing goods has increased in the overall revenue of Monte Carlo Fashions Ltd, the NFAT of the company has increased.
As per the recent announcements by Monte Carlo Fashions Ltd, it is going to invest about ₹355 cr in a new manufacturing plant to make rugs and mink-blanket fabric. This is a large investment when compared to the existing fixed asset base of the company.
Conference call, November 2021, page 3:
Sandeep Jain: The proposed subsidiary company will manufacture rugs (carpets) 13 million square meter per annum and mink blanket fabric 20 tons per day. The total investment is Rs.355 Crores over a period of five years
As per the company, the new plant is going to generate a sale of about ₹600 cr from FY2025 onwards, which amounts to an NFAT of about 1.7 (= 600/355). Therefore, going ahead, when the new plant becomes functional, then Monte Carlo Fashions Ltd may witness a decline in the NFAT.
Going ahead, an investor should keep a close watch on the progress of the newly announced project and the capacity utilization levels of Monte Carlo Fashions Ltd so that she can assess whether the company is utilizing its assets efficiently or not.
Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors
b) Inventory turnover ratio of Monte Carlo Fashions Ltd:
While analysing the efficiency of inventory utilization by Monte Carlo Fashions Ltd, an investor notices that over the last 10 years (FY2013-FY2021), the inventory turnover ratio (ITR) of the company has stayed in the range of 3.0 to 3.5.
An investor would appreciate that an inventory turnover of 3.0 indicates that about 4-months’ worth of sales of Monte Carlo Fashions Ltd is tied up in the inventory for the company. This is a large amount of inventory that Monte Carlo Fashions Ltd carries on its books.
The credit rating agency, ICRA, explained the reasons for the large inventory requirement by apparel manufacturers, in its rating guidelines for the sector. The key reasons are multiple designs, colours etc.; the need to keep stocks in warehouses and sales returns.
The apparel industry is working capital intensive, primarily on account of the high inventory levels…For a branded apparel player, the inventory is due to the requirement to stock apparels for multiple designs, colours and sizes in the stores which typically averages ~3~4 months of store sales, stock apparels in warehouses to ensure good fill rates in the stores and inventory on account of season leftovers.
Further advised reading: How to Analyse New Companies in Unknown Industries?
Nevertheless, over the years, Monte Carlo Fashions Ltd has kept its inventory turnover ratio within a tight range indicating that it has maintained its inventory utilization efficiency. The company has highlighted to its investors that it has kept inventory risks under control by ensuring that most of the garments are produced only after getting bookings from the retailers and selling them on an outright basis to the retailers without any large amount of returns of the unsold inventory.
FY2015 annual report, page 2:
A majority of our revenues are contributed by these MBOs and Franchisee EBOs, where the merchandise is primarily sold on a pre-ordered and outright basis. This has insulated us from major inventory risks and keeps us adequately protected from the routine hazards faced by the branded apparel business.
Large-format stores (LFS) or national chain stores (NCS), follow the model of consignment sales i.e. sale or return where the stores send back all the unsold garments to the manufacturer. This creates a large inventory risk for the apparel manufacturers like Monte Carlo Fashions Ltd, which may be stuck with a large amount of returned inventory. To reduce this risk, Monte Carlo Fashions Ltd seems to have decided to go slow on LFS and NCS stores even though these seem to be growing at a very fast pace.
Conference call, August 2016, page 10:
Sandeep Jain: I think as compared to last year, last year in this LFS business, Large Formal Stores will be growing by 20% to 25%, but we do not have aggressive plan of 50% to 60% growth, the point you mentioned very rightly is the inventory risk. So we are cautiously moving ahead… So we do not want to put ourselves in a problem by supplying to each and every outlet wherever we do not have expertise and then having the return, which are beyond our limits.
As per the company, it has processes to deal with the unsold inventory received from the outlets. Seasonal designs are sold at a deep discount in the factory outlets whereas classic designs, which are sold every year, it dry-cleans and repackages for sale in the next season.
RHP, November 2014, page 114:
After end of season sales, unsold items in the ‘Monte Carlo Exclusive Brand Outlets’ are cleared through liquidation channels such as discount stores or factory outlets. However, some of the unsold products, specifically the basic design products, are returned to our manufacturing facility for dry cleaning and re-packaging for the next season.
The company sells the unsold inventory in the factory outlets at a discount of 40% to 50%.
Conference call, February 2019, page 6:
Sandeep Jain: there are some returns from our exclusive stores and some LSS, but those pieces are getting sold in our factory outlets where we give around 40%, 50% discount
Those items, which are not sold in the discount stores/factory outlets are sold by the company to buyers in the areas, which do not affect its regular markets.
Conference call, August 2017, page 12:
Giriraj Daga: No, but the things, which has not been sold also in the factory outlet, then what?
Sandeep Jain: So they are a very small portion of like, I would say that 0.5%-0.6% that we sell it to some of the buyers, which are based at in certain parts of India, which is not affecting our market.
Therefore, an investor would notice that Monte Carlo Fashions Ltd does not write off any inventory. It either repackages the basic designs for sale in the next season or sells seasonal designs in the discount stores/factory outlets or to the buyers in areas outside its normal markets.
An investor would appreciate that due to these processes, Monte Carlo Fashions Ltd has been able to maintain its efficiency of inventory utilization.
In FY2020, the company witnessed an increase in the inventory because the retailers did not take shipments due to the coronavirus related lockdown in March 2020.
Conference call, June 2020, pages 4-5:
Sandeep Jain: After March 15, 2020, retailers did not take any deliveries and that happened for south also… After the lockdown, we are stuck with more than Rs 32 Crores of inventory, which is lying in our godown, which was to be dispatched to various parts of India.
Going ahead, an investor should monitor the inventory turnover ratio of Monte Carlo Fashions Ltd so that she can assess whether the company is utilizing its inventory efficiently or not.
Further advised reading: Inventory Turnover Ratio: A Complete Guide
c) Analysis of receivables days of Monte Carlo Fashions Ltd:
While analysing the receivables days of Monte Carlo Fashions Ltd, an investor would notice that the receivables days of the company have continuously increased from 61 days in FY2014 to 141 days in FY2021. An investor would appreciate that this is a very significant increase in the receivables days for the company.
While analysing the business of the company, an investor gets to know that the main reason for such a significant increase in the receivables is the changing nature of the sale channel composition of Monte Carlo Fashions Ltd. As per the company, in the past, the business was primarily driven by MBOs who used to make immediate payment for the garments supplied to them. However, nowadays, the business is primarily focused on EBOs, and an additional contribution from shop-in-shop (SIS), large format stores (LFS), national chain stores (NCS) and online channels that make payments only when the goods supplied to them are sold to the final consumer.
Conference call, June 2020, page 6:
Sandeep Jain: See the reason for increasing the receivable was that the model is completely changing from the last five year to this year. Mostly we were doing with MBOs at that point of time, so MBOs receive the goods and make the payment immediately, but as our business has progressed so the other channels like SIS and large format retail and the online sales channels and more of the EBO, which are doing consignment sales have added. so when all these have been added, they only give the payments when they actually sell the products, so that is why the receivable it is showing more as compared to last five years
In addition, one of the reasons for a sharp increase in receivables in FY2020 was the coronavirus related lockdown, when the retailers faced poor sales and financial difficulties due to the shutdown of the business. As per the company, it gave an additional credit of 2-3 months to the retailers due to Covid related issues.
Conference call, June 2020, page 15:
Sandeep Jain: Fortunately in our business at this present moment we do not have any default arising out of this COVID cases, but, yes there are some delayed payments for which we have given some extension for two to three months
Thereafter, in FY2021, the company focused on the recovery of receivables and as a result, its receivables declined from ₹252 cr in FY2020 to ₹230 cr in FY2021.
Conference call, November 2020, page 14:
Sandeep Jain: See, the payment positions have actually improved as compared to last year, so we have put a lot of focus on the recovery of payment rather than promoting the sales
After a few months, in May 2021, when the analysts asked the promoters about the recoverability of money as the receivables days were continuously on the rise, then the promoters said that they are fully confident about the recovery of the receivables.
Conference call, May 2021, page 12:
Nitin Khandkar: So, you are saying that you are confident that the receivables are fully collectable, right?
Sandeep Jain: 100% confident, no doubt about that
However, when the annual report for FY2021 came out later, then investors got to know that the company has written off an amount of ₹2.71 cr. (FY2021 annual report, page 120).
Further advised reading: Why We cannot always Trust What Management Claims
In the past, the company intimated to its shareholders that its business model is free from credit risk and it never had any default on its receivables.
Conference call, August 2018, page 3:
Sandeep Jain: I would like to highlight that till date we have experienced almost zero bad debt in our business, which stands testimony to our strong business model based on a zero-credit risk policy for the company.
However, when an investor analyses the ageing of receivables provided by the company in its annual reports, then she notices that routinely Monte Carlo Fashions Ltd has more than 10% of its receivables due for more than when they became due for payment. For example, in each of FY2017, FY2018 and FY2019, Monte Carlo Fashions Ltd had more than 10% of its receivables outstanding for more than 6-months from the due date.
FY2019 annual report, page 106:
At times, the company even had receivables, which were due for more than one year from the payment due date. In FY2018, Monte Carlo Fashions Ltd had about 7% of receivables due for more than one year from the payment due date.
FY2018 annual report, page 97:
Therefore, it looks like the company had a practice of not writing off its receivables and keeping them on its books and providing for them. It is evident from the information that in the last few years the company continuously had receivables days over 100 days whereas according to the company, it offers a credit period of about 60-75 days to different retailers.
Conference call, November 2017, page 5:
Sandeep Jain: There is no difference in credit period for cotton or woollen it is 75 days for MBOs and for EBOs it is 60 days and for national channel store it is consignment so when they sell the good, they give the payment in 15 days.
Therefore, it seems that the company has continuously witnessed a delay in payments from its retail outlets. However, it has been only from FY2020 onwards that Monte Carlo Fashions Ltd has started providing for long overdue receivables.
FY2021 annual report, page 131:
Excluding provision for expected credit loss amounting to ₹72.63 lakhs (as at 31 March 2020: ₹51.85 lakhs).
In the RHP of the company, in November 2014, Monte Carlo Fashions Ltd had disclosed that it had shut down some of the retail outlets when they did not pay the money due to the company.
RHP, November 2014, page 18:
In the past, for example, certain franchisees did not pay sales proceeds due to us, resulting in the termination of our arrangements with such franchisees and to the closure of the exclusive brand outlets that they operated.
Going ahead, an investor should carefully monitor the receivables position of the company and analyse the ageing of the receivables provided by it in the annual report so that she can ascertain whether the company is able to collect its receivables on time. This is because, as per the company, whenever its customers delay payments to it, then it has a practice of delaying payments to its suppliers.
Conference call, August 2016, page 6:
Sandeep Jain: …increased in debtors, because of slow recovery from our MBOs. So, that is why the working capital has increased, but at the same time it is little bit compensated by the increasing creditors also. So, what we did is that we used to make payments in 60 to 65 days, which we have increased to 100 days to our creditors, if you see that the creditors which were 72.27 has gone to 91.55 so 70% to 75% of increase has been compensated by the increase of creditors also and we will keep the same process in coming quarters also
An investor would appreciate that delaying payment to the supplier has the potential of creating financial difficulties for them, which in turn can push them to competitors. An investor would remember from the earlier discussion that the third parties from whom Monte Carlo Fashions Ltd sources its garments etc. are not contractually bound to supply exclusively to the company and at such times, competitors can benefit by offering better terms to the third-party suppliers.
Red herring prospectus (RHP), November 2014, page 210:
We generally do not enter into agreements with our third party manufacturers from whom we buy finished products for sale under our ‘Monte Carlo’ brand and typically transact business on an order-by-order basis
Red herring prospectus (RHP), November 2014, page 17:
Since such third party manufacturers are not contractually bound to deal with us exclusively, we may face the risk of our competitors offering better terms to such third party manufacturers, which may cause them to cater to our competitors alongside, or even instead of us.
From the above discussion, an investor would remember that the receivables position of the company has started deteriorating in recent years, as the contribution from EBOs, LFS, online sales increased. However, during her analysis, an investor gets to know that the company intends to focus more on EBOs in the future.
Conference call, November 2020, page 17:
Sandeep Jain: We are focusing definitely on the EBOs because there has been some issue with the MBO channels…so I think to grow in some of the regions, we need to open more EBOs so that we can have the potential, which is available in that particular area
Therefore, an investor must keep a close watch on the receivables position of the company.
Further advised reading: Receivable Days: A Complete Guide
From the above discussion, an investor would appreciate that the business of Monte Carlo Fashions Ltd is a working-capital intensive business where it has to keep a lot of inventory of different designs, sizes, colours, and stock its warehouses to supply to retailers and take returns of unsold inventory. In addition, the changing composition of the sales channel has led to continuously increasing receivables days for the company. Therefore, an investor would appreciate that the company needs to continuously monitor its working capital position so that it stays under control.
When an investor compares the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of Monte Carlo Fashions Ltd for FY2012-21, then she notices that over the last 10-years (FY2012-FY2021), the company has almost converted its profit into cash flow from operations.
Over FY2012-21, Monte Carlo Fashions Ltd reported a total net profit after tax (cPAT) of ₹572 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹566 cr.
It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than the PAT.
Further advised reading: Understanding Cash Flow from Operations (CFO)
The Margin of Safety in the Business of Monte Carlo Fashions Ltd:
a) Self-Sustainable Growth Rate (SSGR):
Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company
Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it can 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.
An investor may calculate the SSGR using the following formula:
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)
While analysing the SSGR of Monte Carlo Fashions Ltd, an investor would notice that over the years, the company had an SSGR of 12%-18%. Over the same period, the company has grown its sales at a CAGR of about 6%.
As the company has grown its sales within its SSGR; therefore, despite growing its sales from ₹364 cr in FY2012 to ₹622 cr in FY2021, the company has been able to keep its debt levels under check without raising money from equity.
The initial public offer (IPO) done by the company in FY2015 was an offer for sale where the existing shareholders had sold their shares to the public. There was no fresh issuance of shares in the IPO, which might have given some money to the company.
RHP, November 2014, page 28:
As this Offer is an offer for sale of Equity Shares by the Selling Shareholders, the proceeds from this Offer will be remitted to the Selling Shareholders and our Company will not benefit from such proceeds.
In FY2021, the company is net-debt free as it has reported a debt of ₹32 cr (excluding the lease liabilities as per IndAS) whereas it has cash & investments of ₹218 cr.
An investor arrives at a similar conclusion when she analyses the free cash flow (FCF) position of Monte Carlo Fashions Ltd.
b) Free Cash Flow (FCF) Analysis of Monte Carlo Fashions Ltd:
While looking at the cash flow performance of Monte Carlo Fashions Ltd, an investor notices that during FY2012-2021, it generated cash flow from operations of ₹566 cr. During the same period, it did a capital expenditure of about ₹284 cr.
Therefore, during this period (FY2012-2021), Monte Carlo Fashions Ltd had a free cash flow (FCF) of ₹282 cr (=566 – 284).
In addition, during this period, the company had a non-operating income of ₹154 cr and an interest expense of ₹112 cr. As a result, the company had a total free cash flow of ₹324 cr (= 282 + 154 – 112). Please note that the capitalized interest is already factored in as a part of the capex deducted earlier.
While looking at the overall cash-flow position of Monte Carlo Fashions Ltd over the last 10 years (FY2012-2021), an investor notices that the company has used the FCF in the following manner:
- Dividends: ₹133 cr: the company has paid dividends of about ₹133 cr (excluding dividend distribution tax, DDT) to its shareholders from its free cash flow. Over and above ₹133 cr, the company would have paid a DDT of about 20% i.e. about ₹25 cr.
- Buyback: ₹55 cr: in FY2019, the company has bought back 1,000,000 equity shares at ₹550/- per share. (FY2019 annual report, page 26).
- The rest of the money is available with the company in the form of an increase in cash & investments.
Going ahead, an investor should keep a close watch on the free cash flow generation by Monte Carlo Fashions Ltd to understand whether the company continues to generate surplus cash from its operations.
Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF
Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) are the main pillars of assessing the margin of safety in the business model of any company.
Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing
Additional aspects of Monte Carlo Fashions Ltd:
On analysing Monte Carlo Fashions Ltd and after reading annual reports, DRHP, its credit rating reports and other public documents, an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.
1) Management Succession of Monte Carlo Fashions Ltd:
Monte Carlo Fashions Ltd, a part of the Nahar group, is promoted by the Oswal family. Currently, the following members of the Oswal family are present on the board of directors:
- Mr Jawahar Lal Oswal (aged 78 years) is the Chairman & Managing Director of the company.
- Ms Ruchika Oswal and Ms Monica Oswal (both aged 49 years), daughters of Mr Jawahar Lal Oswal as Executive Directors.
- Mr Sandeep Jain (aged 50 years), spouse of Ms Ruchika Oswal and son in law of Ms Jawahar Lal Oswal as Executive Director.
- Mr Rishabh Oswal (aged 29 years), grandson of Mr Jawahar Lal Oswal and nephew of Ms Ruchika Oswal and Ms Monica Oswal as Executive Director.
Monte Carlo Fashions Ltd has explained the relationship of the directors of the Oswal family on multiple occasions in its annual reports.
FY2016 annual report, page 42:
Sh. Sandeep Jain is spouse of Smt. Ruchika Oswal and Smt. Ruchika Oswal and Smt. Monica Oswal are daughters of Sh. Jawahar Lal Oswal, Chairman and Managing Director.
FY2018 annual report, page 9:
Sh. Rishabh Oswal is the Grandson of Sh. Jawahar Lal Oswal and nephew of Smt. Ruchika Oswal and Smt. Monica Oswal.
Therefore, an investor would note that currently, three generations of the Oswal family are present on the board of directors in executive positions.
The presence of younger family members at executive positions within the group, while the senior members are still handling responsibilities, looks like a good succession plan. This is because the young members can learn about the fine nuances of the business under the guidance of senior members until the seniors decide to take retirement.
Going ahead, an investor may keep a close watch on the relationships among the promoter’s family members to understand whether any ownership issues arise between them. An investor may contact the company directly for any clarifications in this regard.
Further advised reading: How to do Management Analysis of Companies?
2) Remuneration paid by Monte Carlo Fashions Ltd to Ms Monica Oswal and Ms Ruchika Oswal:
While analysing the management structure of Monte Carlo Fashions Ltd, an investor notices that two daughters of Mr Jawahar Lal Oswal, Ms Monica Oswal and Ms Ruchika Oswal are present on the board of directors and the company is paying a very good remuneration to them.
The following table shows the remuneration paid by the company to Ms Monica Oswal and Ms Ruchika Oswal over the last 10-years.
From the above table, an investor would notice that the company is currently paying a remuneration of about ₹1 cr each to both Ms Monica Oswal and Ms Ruchika Oswal. Over the last 10-years (FY2012-FY2021), Monte Carlo Fashions Ltd has paid a total remuneration of over ₹15 cr to Ms Monica Oswal and Ms Ruchika Oswal.
From the remuneration data as well as from the designation of Executive Directors, an investor would estimate that Ms Monica Oswal and Ms Ruchika Oswal would play a very important role in the management of the company. However, when an investor looks at the disclosures made by Monte Carlo Fashions Ltd about its senior management, then she notices that the company has not highlighted their names as a part of the senior management.
Investors’ presentation, Q1-FY2022, page 20:
In the above slide taken from the Q1-FY2022 investors’ presentation, an investor notices that Mr Rishabh Oswal, aged 29 years has a total experience of 8 years (FY2021 annual report, page 19) and was appointed on the board only in June 2018 as a director, is highlighted as a senior manager. Whereas Ms Monica Oswal and Ms Ruchika Oswal, both aged 49 years and having experience exceeding 21 years each (FY2021 annual report, page 19) are not highlighted as senior managers.
In addition, when an investor analyses the remuneration of senior management for FY2021, then she notices that the company has paid a remuneration of ₹1.22 cr to Mr Rishabh Oswal, which is more than the remuneration of about ₹0.95 cr each paid to Ms Monica Oswal and Ms Ruchika Oswal.
From the above discussion, an investor would notice that despite paying a hefty remuneration to Ms Monica Oswal and Ms Ruchika Oswal, Monte Carlo Fashions Ltd is not highlighting their names as senior managers to the investors. In addition, it is now paying a comparative higher remuneration to Mr Rishabh Oswal, who is nephew of Ms Monica Oswal and Ms Ruchika Oswal and has a much lower working experience than they have and is highlighting him as a senior manager to the investors.
From the above disclosures, an investor gets confused about the value being added by Ms Monica Oswal and Ms Ruchika Oswal to the company.
Therefore, an investor may contact the company directly to understand the role played by Ms Monica Oswal and Ms Ruchika Oswal in the active day-to-day management of the company. She may ask the company the reasons why despite seeming to be one of the most senior resources available with the company, their names are excluded from the list of senior managers presented to investors whereas the name of a younger manager with much lower experience is included in the list of senior managers.
Further advised reading: How to identify Promoters extracting Money via High Salaries
3) Related party transactions of Monte Carlo Fashions Ltd:
When analysing the business of the company, an investor notices that Monte Carlo Fashions Ltd is involved in numerous purchase and sale transactions with its promoter-group entities belonging to the Nahar group.
As per the various disclosures by the company in different reports, an investor notices that Monte Carlo Fashions Ltd buys almost 90%-95% of its woollen yarn from Oswal Woollen Mills Ltd and about 10% of cotton fabric & garments from other promoter-group entities.
Conference call, August 2017, page 7:
Sandeep Jain: See, as far as woollen yarn is concerned, we buy almost 90%-95% of our requirement from our sister concern Oswal Woollen Mills at arm’s-length pricing and which is the only mill actually who manufactures these kind of pure wool yarns in these categories. And as far as cotton yarn, cotton fabric, cotton woven garments is concerned, around 10% comes from our sister concern company, 90% comes from the various manufacturers of these kind of fabrics all over India and world.
As per the disclosures in the related party transactions section of its annual reports, Monte Carlo Fashions Ltd makes purchases of about ₹100 cr every year from promoter entities like Oswal Woollen Mills Limited, Nahar Spinning Mills Limited, Nahar Industrial Enterprises Limited, and Cotton County Retail Limited.
An investor would appreciate that the related party transactions between the listed entity and the promoters/their entities provide opportunities for shifting economic benefits from the minority/public shareholders to the promoters. If the listed entity pays a price to the promoters, which is higher than the market price of those services/rent, then effectively, these transactions may benefit promoters at the cost of minority/public shareholders.
Apart from the purchase transactions, over the years, Monte Carlo Fashions Ltd has had other business arrangements with Nahar group companies like:
Initially, a promoter-group company, Vanaik Spinning Mills Limited, used to run all the company-owned-company-operated EBOs and its e-commerce website (www.montecarloshop.in)
“About Us” section of Monte Carlo Fashions Ltd website
readymade garment business was demerged from Oswal Woollen Mills to Monte Carlo Fashions Limited in the year 2011-12 and Vanaik Spinning Mills Limited was selected as its franchisee and to look after of its Ecommerce business
RHP, November 2014, page 16:
one of our Group Companies, Vanaik Spinning Mills Limited operates an online shopping website www.montecarloshop.in through which they sell our products online.
RHP, November 2014, page 180:
Some of the exclusive Company owned showrooms were operated and managed by the Company, which are taken by the Company on lease. With effect from 01 April 2012, these showrooms were transferred to Vanaik Spinning Mills Limited.
Therefore, from the above arrangements, an investor would notice that from the overall profit pool of the Monte Carlo brand value (i.e. from manufacturing branded garments and selling them to the final consumers) a portion of profit i.e. the part earned in the final retailing step in the offline showroom and the online channel was shifted from Monte Carlo Fashions Ltd to Vanaik Spinning Mills Limited.
As of date, the original e-commerce website of Monte Carlo Fashions Ltd (www.montecarloshop.in) is defunct. Currently, the products of the company are sold through the website www.montecarlo.in.
However, when an investor checks the ownership details of www.montecarlo.in, then she notices that this website is owned by its group company, Oswal Woollen Mills Ltd (Source: whois). Therefore, even today, Monte Carlo Fashions Ltd does not own the domain name of the website where it is putting a lot of resources to build its online presence. Instead, the domain name is owned by one of the promoter group companies.
In its red herring prospectus (RHP) shared with the investors in November 2014, Monte Carlo Fashions Ltd had highlighted the risk of related party transactions between the company and the promoter group entities.
RHP, November 2014, page 19:
Conflicts of interest may arise out of common business objects shared by our Company and our Group Companies.: In cases of conflict, our Promoters may favour other companies in which our Promoters have interests. There can be no assurance that our Promoters or our Group Companies or members of the Promoter Group will not compete with our existing business or any future business
Therefore, the investor should always do a deeper due diligence on the related party transactions between the listed company and the promoter owned entities.
On its part, Monte Carlo Fashions Ltd has appointed an auditor, Grant Thornton, to check the transfer pricing terms i.e. related party transactions between the company and the promoter group entities in order to give an assurance to the investors that the related party transactions are at market prices.
Conference call, August 2017, page 9:
Dinesh Gogna: we have engaged Grant Thornton specifically to check that all our purchases from the sister concern are at a transfer pricing formula we are adopting…As an auditor also the check and as an independent their team like to see that all purchases from the sister concern are at the market price.
Therefore, the presence of an auditor to check the transactions between Monte Carlo Fashions Ltd and the promoter-group entities may provide some comfort to the investors. However, an investor should keep in her mind that in almost all the cases of big corporate incidences where the investors were over-smarted by the promoters, one or the other reputed firms was present as an auditor. For example, Enron was audited by Arthur Anderson, and Satyam was audited by PwC.
Therefore, the presence of a reputed auditor should not lead an investor to stop her own due diligence in the related party transactions.
Advised reading: How Promoters benefit from Related Party Transactions
4) Aggressive accounting followed by Monte Carlo Fashions Ltd:
While reading the public disclosures of the company, an investor gets to know about instances where Monte Carlo Fashions Ltd used aggressive accounting assumptions to show a higher sales revenue.
An investor would appreciate that usually, as per proper accounting assumptions, companies recognize revenue only when the risk and reward associated with the sales are duly transferred from the seller to the buyer. However, during FY2012 and FY2013, Monte Carlo Fashions Ltd recognised sales even in the cases where risk and reward were not transferred to the company’s customers.
As a result, later on, the company had to reverse the said transactions and show the revised statements in the RHP to the investors before its IPO.
RHP, November 2014, page 182:
During the years ended 31 March 2013 and 2012 the Company had recognised sales of ₹ 6.28 million and ₹ 8.35 million respectively for which risk and reward had not been transferred before the year end. Accordingly, such sales have been reversed in those years and adjusted in the respective years.
Going ahead, an investor should keep a close watch on the accounting assumptions followed by the company so that she may notice any deviation by the company from the normal accounting standards.
Advised readings: 7 Signs to tell whether a Company is cooking its Books: “Financial Shenanigans”
5) Weakness in the internal processes and controls at Monte Carlo Fashions Ltd:
While going through the annual reports of the company, an investor comes across many instances that indicate that the internal processes of the company leave scope for improvement. Let us see a few examples of such instances.
5.1) Delays in depositing undisputed statutory dues to govt. authorities:
While analysing the financial position of Monte Carlo Fashions Ltd, an investor notices that the company has always been a cash-rich company, which has maintained a cash & investment balance of more than ₹100 cr ever since FY2013. However, an investor notices that every year since FY2012, the company has delayed depositing undisputed statutory dues to the govt. authorities. An investor may check about the delays highlighted by the auditors of the company in its various reports.
- FY2012: RHP, November 2014, page 180:
There have been delays in depositing undisputed statutory dues including provident fund, employees state insurance, income tax, sales tax, cess, service tax and any other material statutory dues as applicable to it with the appropriate authorities. Undisputed amounts payable in respect of abovementioned dues amounting to ₹ 1.96 million were in arrears as at 31 March 2012 for a period more than six months from the date they become payable.
Advised Reading: Understanding the Annual Report of a Company
Similar disclosures for other years can be found in the following sections:
- FY2013 and FY2014: RHP, November 2014, pages 180-181
- FY2015 annual report, page 50
- FY2016 annual report, page 63
- FY2017 annual report, page 53
- FY2018 annual report, page 53
- FY2019 annual report, page 57
- FY2020 annual report, page 64
- FY2021 annual report, page 83
Looking at this scenario where a cash-rich company is delaying in depositing undisputed statutory dues, an investor can only assume that the company does not have strong processes to check whether its statutory liabilities are paid on time. As a result, every year, it delays depositing its dues to the govt., which are undisputed and the company also accepts that it has to pay these dues.
An investor may contact the company directly to understand why it continuously delays the deposit of undisputed statutory dues to govt. authorities.
5.2) Delays in paying interest, which is due for payment to lenders:
Similarly, in its various annual reports, Monte Carlo Fashions Ltd disclosed that for many years, the company had the interest to the lenders, which was due for payment but was not paid by the company.
For example, the following section from the FY2016 annual report shows that Monte Carlo Fashions Ltd had not paid the interest of ₹1.34 cr at the end of FY2016, which was due to the lenders but it had not paid it despite disclosing a large cash & investment balance. In the same table, an investor can also see that at the start of FY2016 i.e. at the end of FY2015, the company had an interest due but not paid of ₹0.18 cr.
FY2016 annual report, page 35:
Similar disclosure about interest due to the lenders but not paid by Monte Carlo Fashions Ltd for other years can be found in the following sections:
- FY2017 annual report, page 27
- FY2018 annual report, page 25
- FY2019 annual report, page 89
- FY2020 annual report, page 97
- FY2021 annual report, page 117
Once again, looking at the scenario where a cash-rich company is delaying payment of interest, which is due for payment to the lenders, an investor can only assume that the company does not have strong processes to check whether its debt payments are paid on time.
An investor may contact the company directly to understand why it did not repay the interest due to the lenders on time despite seeming to have sufficient cash balance for the payments.
5.3) Delay in appointment of chief financial officer (CFO):
In the FY2019 annual report, the secretarial auditor of the company pointed out that Monte Carlo Fashions Ltd did not have a CFO for more than one year. This was because the company appointed the new CFO on November 30, 2018, more than one year after the resignation of the previous CFO on November 13, 2017.
FY2019 annual report, page 26:
The Board of Directors has appointed Mr. Raj Kapoor Sharma as Chief Financial Officer (KMP) on 30th November 2018 in their meeting, to fill the vacancy caused by the resignation of Mr. Raman Kumar on 13.11.2017.
The lack of strong processes in the company was also visible when in August 2015; it could not upload its financial results on the stock exchange websites before it initiated its conference call with investors. As a result, for the initial part of the conference call, the analysts did not have access to the results of the company and as per one analyst; they were shooting in the dark.
Conference call, August 2015, page 6:
Mehul Sawla: We have a high interest in this company but unfortunately the results are not available either on BSE or on NSE. So in the absence of having the results in our hand it becomes very difficult to utilize your valuable time and get feedback. My request will be to you and Edelweiss is maybe next time when you are doing the conference please keep it a day later so that at least we have the results with us and we can make use of this opportunity more meaningfully because otherwise it’s like just shooting in the dark right now.
In another instance, in May 2016, the company could not upload the investors’ presentation on the stock exchanges’ websites before the conference call.
Conference call, May 2016, page 5:
Sunil Jain: None of the investor I think have gone to investor presentation, it is not available on the BSE or NSE website also.
An investor would appreciate that companies that have weaknesses in controls and processes are at a higher risk of fraud. In the case of Monte Carlo Fashions Ltd, it has faced instances where its showrooms attempted to sell unbranded garments as Monte Carlo garments.
RHP, November 2014, page 18:
we have faced instances in the past of our franchisees passing off unbranded apparel under our “Monte Carlo” brand.
In addition, in the RHP, the company also cautioned its investors about the risk of unauthorized removal of inventory from its locations i.e. theft.
RHP, November 2014, page 21:
We may also be adversely affected by unauthorized removal of inventory and products from ‘Monte Carlo Exclusive Brand Outlets’, MBOs, our manufacturing facilities and our distribution centers.
To understand more about the risks that any company may face due to weakness in internal processes and controls, an investor may read the case of National Peroxide Ltd, a Wadia Group company. The managing director of National Peroxide Ltd attempted to take advantage of the weaknesses in the internal processes and controls and did fraud on the company: Analysis: National Peroxide Ltd
Therefore, going ahead, an investor should keep a close watch on such incidences indicating a weakness in the internal processes and controls of the company
6) Previous business initiatives of Monte Carlo Fashions Ltd that did not work out:
While analysing the business of the company, an investor comes across two business initiatives taken by Monte Carlo Fashions Ltd, which did not work out as planned by the company.
The first initiative was an entry into the leather accessories business starting with shoes. In August 2016, the company intimated to its shareholders that it has planned to enter into the shoe business by lending its brand name to a contract manufacturer who would make and sell shoes under the Monte Carlo brand.
Conference call, August 2016, page 12:
Sandeep Jain: Shoes business we have entered into an agreement with a company, which will manufacture, distribute and market our shoes as Monte Carlo brand and will be getting the 9% royalty from the sales
However, soon thereafter, the deal did not work out and after a delay of a few months; Monte Carlo Fashions Ltd intimated that the plan to enter into the shoe business has been dropped.
Conference call, February 2017, page 8:
Sameep Kasbekar: Okay, similar levels to last year. Any update on the footwear segment that we were planning to enter in December, has that been delayed?
Sandeep Jain: No. This we have dropped actually.
The second initiative was an entry into the manufacturing of masks and personal protective equipment (PPE) kits. In June 2020, Monte Carlo Fashions Ltd intimated to its shareholders that it has imported machinery to manufacture masks and PPE kits for about ₹3.5 cr and it plans to generate a revenue of about ₹12-15 cr from masks.
Conference call, June 2020, pages 12 and 17:
Sandeep Jain: No, it is not a CSR; it could be a profitable venture for Monte Carlo…We have already imported the machines, the productions have already started, so we assume that this financial year we should do a turnover of around Rs 12 to Rs15 Crores out of this mask line.
Sandeep Jain: Approximately Rs 3.5 Crores has been invested in the mask making machines.
However, after a few months, in February 2021, the company intimated that the masks business is closed and it has about 3-4 lakh masks, which are lying unsold with it.
Conference call, February 2021, page 11:
Sandeep Jain: we produced I think around 40, 50 lakh masks I think only 3 to 4 lakh masks are pending, which we already sold out and now the demand for masks and PPE kit is almost zero there is no demand right now so that segment we already closed.
Going ahead, an investor should continuously monitor the progress of the new business initiatives by Monte Carlo Fashions Ltd and let the new business initiatives establish themselves before she starts factoring in the potential sales and profits from new initiatives in her financial projections.
The Margin of Safety in the market price of Monte Carlo Fashions Ltd:
Currently (December 28, 2021), Monte Carlo Fashions Ltd is available at a price to earnings (PE) ratio of about 12 based on consolidated earnings of the last 12-months (Oct. 2020-Sept. 2021).
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, which 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.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
Analysis Summary
Overall, Monte Carlo Fashions Ltd seems a company, which has grown its sales at a moderate growth rate of 6% year on year for the last 10 years. The sales of the company were growing continuously year-on-year from FY2012 to FY2016; however, thereafter, intermittently, its business was hit by demonetization, weak winters and lockdowns due to the coronavirus pandemic. The heavy reliance of Monte Carlo Fashions Ltd on the December quarter for its business worked against it in FY2017 when demonetization announced in November 2016 affected consumer demand and the company reported its lowest ever operating profit margin in FY2017.
Monte Carlo Fashions Ltd enjoys a very strong negotiating position over its retailers. It sells its garments to retailers on an outright sale basis with a limited option of returning the unsold inventory. Similarly, it does not share any discounts given by MBOs in the end of season sales. The company is able to increase the prices of garments whenever its costs increase be it prices of wool, cotton or higher taxes on GST implementation.
However, the company does not have any distinct competitive advantage over its competitors as it is not able to withstand the market pressure when the competitors start the discounting season early or when they offer deep discounts very early in the season. As per the company, all brands, whether Indian or international, have to follow the market trend for discounts to bring walk-ins in the stores and to get rid of the inventory.
The intense competition in the industry due to low entry barriers has led to the branded apparel players competing with each other on price. In addition, the emergence of the online sales channel and the expectation of consumers for continuous discounts is forcing companies to start discounting season early and give deep discounts, which is making it difficult for Monte Carlo Fashions Ltd to maintain profit margins.
The business of the company is working capital intensive, as it has to maintain a large amount of inventory of different designs, sizes and colours, a large stock in warehouses to supply to its showrooms and returned-unsold inventory. In addition, the increase in the share of EBOs, LFS, NCS and the online sales channel in its sales has led to an increase in receivables days of the company. However, Monte Carlo Fashions Ltd has been able to maintain its working capital efficiency without any deterioration.
The company is cash-rich. It has generated significant free cash flow during the last 10-years, which it has used to pay dividends, do a buyback and has the balance as cash & investments. The company is net debt-free on March 31, 2021.
Currently, three generations of the promoter Oswal family are present on the board of directors of the company in executive positions. Monte Carlo Fashions Ltd is paying significant salaries to the daughters of CMD; however, it is not highlighting their names as senior managers to investors in its presentations.
The company does a lot of related party transactions like the purchase of material from its promoter-group entities, which increases the risk of promoters benefiting at the cost of public shareholders. The company has engaged Grant Thornton as an auditor for checking transfer-pricing norms in its related party transactions; however, an investor should do her own due diligence in this matter.
While reading the annual reports of the company, an investor comes across instances of aggressive accounting to show higher sales, delays in payment of undisputed statutory dues to govt. authorities, non-payment of interest to lenders even when it was due, and delay in appointment of CFO even after one year of the resignation of existing CFO. Most of these instances indicate that the internal controls and processes of the company leave scope for improvement.
Currently, Monte Carlo Fashions Ltd has announced a large capital expenditure to manufacture rugs and mink-blanket fabric. The past experience of new business initiatives taken by the company in the form of entering the shoe market and making masks and PPE kits show that the plans did not work out as planned. Therefore, an investor should wait for the new manufacturing plant to be established before she should start factoring it into her financial projections and therefore, in her stock price assumptions.
Going ahead, an investor should closely monitor the profit margins of the company to assess whether the company is able to maintain its profit margins in the face of severe competition and challenges of online sales and deep discounts. She should watch out for signs where excessive reliance on outsourcing might affect its supply chain. She should keep a close watch on the receivables days of the company and see if it is able to bring it under control or it has to do many write-offs.
The investor should closely monitor the progress of the newly announced manufacturing plant and also watch out for the signs of weakness in the internal controls & processes as well as any signs of fraud that might appear under the weak processes.
An investor should deeply analyse the related party transactions of Monte Carlo Fashions Ltd with its promoter-group entities to safeguard herself from landing in a situation where promoters are able to take away economic benefits from public shareholders.
Further advised reading: How to Monitor Stocks in your Portfolio
These are our views on Monte Carlo Fashions 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.
