Analysis: Skipper Limited

This article provides an in-depth fundamental analysis of Skipper Limited, a leading Indian manufacturer of transmission towers and PVC pipes.

In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

Skipper Limited Research Report by Reader

Metric Analysis of Skipper Limited:

Skipper Limited is increasing its sales at a CAGR of 22.6% in the last 7 years, although the growth rate has slowed down to 16.6% CAGR in the last 3 years. Further, management has guided for 20% volume growth in the engineering segment for FY18. In the last 7 years, debt has increased from Rs 199.3 crore to Rs 437.84 crore in FY17. Although the interest coverage ratio has improved from 3.0 in FY 10 to 3.71 in FY17, suggesting a higher rate of growth in operating profit compared to debt. Going forward, the management has guided for Rs 85 crore capex in FY18. Depending upon the cash flow, we will have to see if the company will do the capex from debt funding or internal accrual.

Operating profit margin (OPM) has improved from 8.5% in FY10 to 14.9% in FY17. This improvement is largely due to better plant utilization, backward integration of the engineering products and economy of scale. Management claims that the company has the best-operating margins in the engineering products segment (83% of total sales) due to the backward integration of the manufacturing process, lower steel prices in West Bengal as compared to the rest of India and the fact that the company is only product supplier, not the EPC contractor. Between FY10 to FY17, the net profit margin also improved from 3.22% to 6.55%.

The return ratio for the company in FY17 is at a comfortable level (ROTC: 20%, ROE: 30%). The ROTC has improved from 10% in FY11 to 20% in FY17, while ROE has improved from 16% in FY11 to 30% in FY17. The net fixed asset turnover has come down in the same period from 6.15 in FY10 to 4.01 in FY17. This is mainly due to the high capital investment company is incurring to fuel growth.

Looking deep into the finance cost that the company is reporting, we find that apart from the interest on the debt the company is also paying bank charges and commission of around Rs 7-8 crore, which is not included in the finance cost. Adding this to the interest paid by the company will further reduce the interest coverage ratio of the company.

In the Q2 FY18 concall, the management claimed that the cost of debt for the company has come down to 8%, but adding the extra commission the company is paying to the banks in the interest cost will take the cost of debt to around 14%-15% which is on the higher side.

Looking at the capital management of the company, we find that in the last 7 years (from FY11 to FY17) the company has earned cash flow from operation (CFO) of Rs 521.7 crore.  Capex done by the company in that period is Rs 421 crore, giving us a free cash flow of around Rs 100 crore. Out of this Rs. 100 crores, the company has paid a total dividend of Rs 86 crore leaving us with a cash flow of only Rs 14 crore. Between FY11 and FY17, the company paid a total interest of around Rs 340 crore and a total bank commission of around Rs 46.4 crore.

To pay for this cash outflow company has taken the debt of Rs 87.4 crore between FY11 and FY17. Now since there is no fresh equity infused by the promoters, it raises the question of where the company is paying for the cash outflow of around Rs 140 crore. In the balance sheet company, have cash and cash equivalent of ~Rs 25 crore out of which ~Rs 23.5 crore is pledged to the bank for a bank credit facility, and cannot be used freely by the company.  It is advisable that the investors should clear this before investing in the company.

The working capital cycle of the company is very steep with the sum of receivable days and inventory days equal to 175 days in FY17. Historically working capital days remained in this range only. The primary reason for high inventory is that the company has to fill up inventories in advance before executing the order. Apart from this, the company has also given advances of around Rs 42 crore to suppliers and capital goods.

Sales Distribution Analysis of Skipper Limited:

Skipper Limited produces engineering products (83% FY17 revenue) and polymer products (12% FY17 revenue) and is involved in infrastructure products (5%).

In the engineering products segment, the company makes transmission and distribution (T&D) towers and claims to be the third-largest T&D tower manufacturer in India. As of Q2 FY18, the order book stands at Rs 2580 crore, around 50% of which is from Power Grid Corporation of India (PGCIL). Management anticipates a slowdown in demand from PGCIL as legacy orders in this space is exhausted, but it believes this should be offset by an increase in demand related to private and state-owned power generation projects and thus expects revenue in the engineering products segment to rise 15% YoY over the next two years.

Geographically, 80% of the engineering product order book is domestic and 20% is export orders. For the Polymer business, 100% of sales are domestic. Further, 50% of engineering product order book is PGCIL, 30% SEB’s and 20% export. The company has come a long way in terms of order concentration as four years ago 90% of the order book was from PGCIL compared to 50% at present. Management expects to further reduce this concentration going forward. 

Peer Comparison of Skipper Limited:

As 83% percent of the revenue is from the engineering products business, we will compare the performance of Skipper Limited from power T&D companies only. In the power T&D business, two major competitors are Kalpataru Power Transmission Ltd and KEC International.

Skipper Limited is outperforming its peers in all the parameters. Management claims that the better margins for Skipper Limited are due to backward integration of the manufacturing process, cheaper steel prices in West Bengal and the fact that the company only supplies equipment and does not get involved in EPC contracts.

Further, looking deep into the numbers we will find that KEC international is free cash flow (total cash flow from operation- total capex) positive while Skipper Limited is not. Despite having better margins and a working capital cycle the company is not able to generate enough cash to fuel growth. 

Shareholding Pattern of Skipper Limited:

In the shareholding pattern, higher promoter holding signifies higher confidence of promoters in the company and is considered a positive. Higher institution holding and lower retail holding are considered positive for the company as institution money is considered smart money and stable money.

In the case of Skipper Limited promoter holding is 70%, which is much higher than the cutoff level of 51% that we consider as comfortable although holding is decreasing continuously. However, if we look at institutional holding we will find that it is increasing continuously, which is a good sign and gives us more confidence in the company’s future prospects.

Credit Rating Analysis of Skipper Limited:

The credit rating of Skipper Limited is done by CARE Ratings. CARE has given the company CARE A+ for its long-term instruments and CARE A1+ with a stable outlook for its short-term instruments.

In the analysis, the rating agency has mentioned a few strengths as the experienced promoters and the satisfactory track record of the promoters, strategic location of plant and expansion plan in PVC business, satisfactory order book position and decent financial risk profile. In the weakness section, the agency has mentioned the working capital-intensive operations of the company, and the moderate capital structure of the company. CARE has also mentioned that the efficient management of working capital and reduction in debt will be the key points to further improvement in the company’s ratings.

Management Analysis of Skipper Limited:

The key management personnel of the company include Mr. Sajan Kumar Bansal (Managing Director), Mr Sharan Bansal (Whole Time Director), Mr. Devesh Bansal (Whole Time Director) and Mr. Siddharth Bansal (Whole Time Director). 

Mr. Sajan Kumar Bansal has been the Managing Director of Skipper Limited, since October 2007. Mr. Bansal is having an experience of over 25 years in steel and engineering industry. He has been a Director at Skipper Limited since October 26, 1984. He serves as a Director of Bansal TMT Steels Ltd., Skipper Limited Infrastructure Ltd., Cement Manufacturing Co. Ltd., Skipper Limited Tele – Link Ltd., Swasti Agencies Pvt. Ltd., Riangdo Veneers Pvt. Ltd. and Transcend Infrastructure Ltd. He served as an Independent Director at Century Plyboards (India) Limited from July 8, 2013, to May 6, 2014. He served as Director of Century Plyboards (India) Limited from December 2006 to March 18, 2011. He is a Commerce graduate.

(Source: Bloomberg)

Looking at the remuneration of KMP of the company, we can see that each year the percentage of remuneration as compared to profit is increasing and now exceeded the allowable limit of 10%. We should keep a keen watch on management remuneration and should take it as a negative sign in case of any further increase in percentage.

In the related party transactions, the company is involved in frequent transactions with promoters and nine promoter-related companies in the form of loans.  These nine companies related to promoters are not subsidiaries or associate companies of Skipper Limited.

The company has eight persons on the board of directors, four of them are independent and the other four are executive directors (Mr Sajan Kumar Bansal and his three sons). Auditing for the company is done by Singhi and Co.

Points of Caution for Skipper Limited:

• The company’s operations are capital intensive and a slight dip in the order book will make it difficult for the company to manage its expenses.
• The company is paying bank commissions along with interest on the debt, which takes the company’s cost of debt to 14%-15%.
• The company is free cash flow negative; it is advisable to watch closely in future if the company’s operations turn into free cash flow positive.
• Apart from providing credit to dealers, the company is also paying advances to its suppliers, which is further adding strain to the already strained working capital cycle.
• The company has total debt of ~Rs 440 crore, but CARE rating only rated the company’s debt instrument of only ~Rs 175 crore.

Why we should invest in Skipper Limited:

• The power sector is among the high priority of the government agenda and huge investment from the government is expected from the government in the coming year.
• Among its peers, the company has the best margins and best returns on equity.

Regards, 

Manu Agarwal

Dr Vijay Malik’s Response

Hi Manu,

Thanks for sharing the analysis of Skipper Limited with us! We appreciate the time and effort put in by you in the analysis of the company.

Let us first try to analyse the past financial performance of Skipper Limited. The source of data we use: Screener provides the financial data for the last eight years for the company (FY2010-17). Therefore, we have taken the past eight years’ data into consideration for doing the financial analysis of Skipper Limited. Further, we have taken certain financial data points directly from the annual reports of the company from the detailed notes to the financial statements like capital expenditure, total debt etc.

Financial Analysis of Skipper Limited:

Skipper Limited has been growing its sales at a brisk pace of 15-20% over the last 8 years (FY2010-17). An investor would notice that the profit margins of the company have witnessed an improvement over the years. The operating profit margins (OPM) of the company have improved from 8% in FY2010 to 15% in FY2017.

Further advised reading: How to do Financial Analysis of Companies

An improving profit margin indicates that over the years, the company is able to improve its negotiating position with the customers and is able to pass on the changes in the raw material costs to its customers. Such contracts allow the company to protect/improve its profit margins even when the prices of raw materials move against the company.

An investor gets to know about such nature of the contracts of the company, when she analyses the transcript of the Feb 2018 conference call (concall) of the company, page 4:

Sharan Bansal: No it has robust. In fact we have been getting regular orders from more APTRANSCO and TSTRANSCO, which is Telangana Transco. This quarter also inflow order from Telangana Transco has been to the tune of about Rs.150 Crores.

Bhalchandra Shinde: Okay and Sir these orders will be in line with the clauses, which PowerGrid provides or it will be slightly fixed price contracts?

Sharan Bansal: No most these orders are also variable price contracts.

During the concall, the management of the company highlighted that the orders received by it are variable price orders. This indicates that if there is an increase in raw material costs after an order is granted to Skipper Limited, then as per the formula contained in the contract, the final price of the goods will increase to maintain profitability in the contract.

On further analysis, an investor would note that in the presentation of the Q3-FY2018 results, page 53, the company has disclosed rising commodity prices as one of the factors behind the sales growth:

Strong Engineering Volume Execution & Rising Commodity Prices, led to growth.

Such kind of orders/contracts is a good feature of any business, as they tend to protect the company’s profitability from the ever-changing commodity prices.

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

An investor would notice that the net profit margin (NPM) of the company has witnessed similar improvement over the years as the operating profit margin (OPM) of the company. However, the NPM has witnessed sharp fluctuations over the years from 1% in FY2012 to 7% in FY2017.

An investor would notice that the companies, which have high finance & depreciation costs usually, show more variations in the NPM as compared to OPM. Skipper Limited also falls into the same bracket as it also has considerably high finance costs and depreciation costs when compared to the overall profitability of the company. This aspect of the financial performance indicates that the company operates in a relatively capital-intensive industry (characterized by high depreciation) where it has used debt to fund its growth needs (characterized by high-interest costs).

Until now, the tax payout ratio of Skipper Limited has been in the range of the standard corporate tax rate applicable in India. However, going ahead investors may find that the company reports a lower tax payout ratio because of the commencement of the manufacturing plant of the company in Guwahati, which has tax benefits for both direct tax (income tax) as well as indirect tax (GST) for the next 10 years.

The company has disclosed the commencement of the Guwahati plant and the tax benefits in a stock exchange filing to BSE on March 28, 2017:

In terms of Regulation 30 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, this is to inform that the Company has successfully commenced commercial production at its new unit in Palasbari (near Guwahati), Assam on 27th March, 2017.

Further advised reading: How to do Financial Analysis of Companies

Operating Efficiency Analysis of Skipper Limited:

While analysing the net fixed asset turnover (NFAT) of the company over the year, an investor would notice that the NFAT has improved from 2.95 in FY2010 to 4.01 in FY2017. An improvement in the NFAT indicates that the company is able to operate more efficiently and is able to generate a higher amount of sales from its assets.

While analysing the company, an investor would notice that the company has increased its capacity consistently over the years. Moreover, despite continuous addition to its fixed assets, the company has been able to improve its NFAT over the years. This aspect of the performance of the company draws the attention of the investors because, in most of the cases of capital expansion by companies, we notice that the companies undertake large capital expansion, which results in the NFAT declining immediately after the expansion is complete. The NFAT in these cases increases slowly over the years, as these companies slowly achieve higher capacity utilization of the newly added capacity.

However, in the case of Skipper Limited, the NFAT has been consistently increasing despite continuous capacity addition by the company. While analysing the FY2017 annual report, the investor comes across the strategy disclosed by the company on page 31:

Despite the buoyant environment, Skipper has expanded capacity conservatively, thereby achieving high utilisation, operating leverage and consuming capital slowly. Thus, the debt equity has improved from 1.70x in FY2014 to 0.89x in FY2017, even as the capacity doubled. As a result, the Company Engineering Segment has been able to maintain high average capacity utilisation of 85% over the last many years.

Further advised reading: Understanding the Annual Report of a Company

According to the company, it has resorted to conservative capacity expansion by undertaking the capacity increase in small phases, which in turn has led to good utilization along the way. Such a graded capacity expansion has resulted in efficient utilization of the newly added capacities and in turn an improving NFAT.

Looking at the inventory turnover ratio (ITR), an investor would notice that Skipper Limited has been able to improve its inventory utilization efficiency over the years. The ITR has improved from 3.9 in FY2011 to 5.5 in FY2017.

An investor would notice that the receivables days of the company have increased significantly from 55 days in FY2011 to 80 days in FY2017. The company operates a business, where it needs to get the funds released from Govt./PSU enterprises. Many times, collecting receivables from PSU organizations may take some time, which can be a reason for relatively high receivables. However, unless the nature of the business changes, the receivables days are expected to remain on similar levels, if the company is dealing with the same counterparties over the years.

Further advised reading: How to Analyse Operating Performance of Companies

Therefore, it is essential that an investor should analyse the increase in receivables days further. She may seek clarifications from the company whether there is any dispute regarding the receivables claimed by the company or whether the company has to give a higher credit period to the customer to gain orders.

An investor would appreciate that increasing receivables days would increase the working capital demand for the company.

Further Advised Reading: Receivable Days: A Complete Guide

The credit rating agency, CRISIL has highlighted this aspect of the business operations of the company in its credit rating report for the company in December 2017:

The operation of Skipper is working capital intensive in nature as reflected in gross current asset (GCA) of 175 days as on March 31, 2017. The same is driven by high inventory period of about three months and credit period of around two and half months offered to customers.

Further advised reading: 7 Important Reasons Why Every Stock Investor Should Read Credit Rating Reports

Margin of Safety in the Business of Skipper Limited:

i) Self-Sustainable Growth Rate (SSGR):

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

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

Conversely, if any company was attempting 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 would notice that Skipper Limited has witnessed an SSGR ranging from 10-15% over the years. The sales growth achieved by the company over the years is about 20%, which is higher than its SSGR. Therefore, investors would expect that the company would have to raise debt from additional sources to fund its growth.

An investor would notice that the company has increased its sales at a rate of 23% year on year from ₹409 cr in FY2010 to ₹1,703 cr in FY2017. During the same period, the debt of the company increased from ₹109 cr at the start of FY2010 (i.e. at the end of FY2009) to ₹438 cr in FY2017.

Please note that we have taken the data on total debt from the information memorandum (IM) submitted by the company to BSE for a direct listing of its shares at BSE. An investor may access the IM here: click here.

Information Memorandum, page 21:

An investor is able to observe this aspect of the company’s business when she analyses the cumulative cash flow position including free cash flow for the company over the years (FY2010-17).

Free Cash Flow Analysis:

Over FY2010-17, the company increased its sales from ₹199 cr. to ₹1,703 cr. by doing a capital expenditure (capex) of about ₹552 cr. (Please note that we have taken the capex figure from year on year the additions in the gross fixed assets from the annual reports of the company).

Over the same period (FY2010-17), the company generated a cash flow from operations of ₹533 cr.

While analysing the cash flow statements of the company over the years, an investor would notice that until FY2013, the company was following a practice of deducting interest costs as an outflow under CFO instead of the customary practice of treating interest costs as an outflow under cash flow from financing (CFF):

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

The FY2011 annual report, page 61:

The FY2013 annual report, page 47:

The company stopped deducting the interest from CFO from FY2014 onwards:

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

Therefore, we have adjusted the CFO and CFF for the period FY2010 to FY2013 by shifting the interest cost as an outflow from CFO to CFF. i.e. we added back in the CFO the amount of interest costs deducted by the company from the CFO and then we deducted an equal amount of interest cost from the CFF as an outflow. This adjustment ensures that the interest cost is finally treated as an outflow under CFF.

After making these adjustments, an investor would notice that the company had a negative free cash flow (FCF) of ₹19 cr (552-533) over these years. Moreover, the company had to incur interest costs of about ₹393 cr to service the debt over FY2010-17. Therefore, the total cash shortfall of the company seems to be about ₹412 cr. (19+393).

An investor would notice that the company could not meet its capex requirements and interest requirements from its CFO. As a result, it had to rely on raising additional debt as well as equity.

As mentioned above, the debt levels increased from ₹109 cr at the end of FY2009/at the start of FY2010 to ₹438 cr in FY2017 indicating ₹329 cr of additional debt. Moreover, the company had to resort to raising additional equity in FY2013 when it issued 2.7 cr additional shares and raised ₹54 cr from this equity dilution.

The FY2013 annual report, pages 51-52:

An investor would notice that in FY2013, the company issued 2.7 cr additional shares, which had a face value of ₹1 each. She may calculate the total amount of equity money raised by the company by the following formula:

No. of shares issued * face value + increase in securities premium account

Therefore, the total amount of equity raised comes to ₹54 cr. (54 = 2.7*1 + 51.3)

An investor would appreciate that apart from the CFO, the company could raise a total of ₹383 cr from incremental debt and equity (383 = 329 + 54). However, the total cash shortfall because of capex and interest cost, as discussed above, is ₹412 cr (19+393), which leads to a gap of ₹29 cr (412-383). In addition, an investor should focus on the following aspects:

• The company has paid out dividends of about ₹49 cr (excluding dividend distribution tax) over FY2010-2017. These dividend payments would have needed about 15-20% additional outgo in terms of dividend distribution tax i.e. about ₹7.5-10 cr.
• The company witnessed an increase in cash & investments of about ₹16 cr over FY2010-2017 as its cash & investments increased from about ₹9 cr in FY2010 to ₹25 cr in FY2017.

An investor would appreciate that we have not been able to find the generation of the above funds of about ₹72.5 cr (49+7.5+16) from any source under the CFO, additional debt and additional equity raised by the company. Therefore, it is advised that investors should seek clarification from the company in case, we have missed any sources of funds for the company over these years (FY2010-2017) or in case any of the above calculations have any error.

It is essential that investors should understand the overall cash flow dynamics of the company before they arrive at any final conclusion about the company.

Free cash flow (FCF) and SSGR 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 and annual report analysis of Skipper Limited:

On analysing Skipper Limited, an investor comes across certain other aspects of the company, which are essential for making any final opinion about the company: 

1) Management Succession:

Investors would notice that Mr. Sajan Kumar Bansal currently heads the management of the company and the next generation of the family represented by Mr. Sharan Bansal, Mr. Devesh Bansal and Mr. Siddharth Bansal provide assistance by focusing on different business functions.

It looks like an arrangement where the senior in the family is grooming the next generation under his direct guidance so that the next generation may take the leadership ahead in future.

However, investors should keep a close watch for the sign of the nature of the relationship shared by Mr. Sharan Bansal, Mr. Devesh Bansal and Mr. Siddharth Bansal with each other. This is because many times, animosity/differences in opinions between the family members may cause ownership-related issues, which in turn may hurt the business and the interest of minority shareholders.

Further advised reading: Steps to Assess Management Quality before Buying Stocks (Part 3) 

2) Project execution skills: 

While analysing Skipper Limited, an investor would notice that the company has been able to consistently increase its manufacturing capacity over the years in both the key segments of engineering products (transmission towers) and polymers (pipes).

Moreover, the company has planned these capacity addition steps in such a manner that it could continuously keep an optimal capacity utilization level over the years, which is reflected in the increasing NFAT over the years. 

3) The decline in the promoters’ shareholding: 

Since March 2016, the shareholding of promoters has declined in the company by about 2% from 72.37% on March 31, 2016, to 70.35% on December 31, 2017. 

Going ahead, investors should keep a watch on the change in the shareholding of the promoters and revisit management assessment in case there is a steep decline in their shareholding. 

Further advised reading: How to do Management Analysis of a Company

4) Delays in interest payment: 

An investor would notice that the company has been declaring an amount under the heading “Interest accrued and due”. FY2017 annual report, page 150:

The above details indicate that interest of ₹1.7 cr was due to be paid by the company to its lenders on March 31, 2017, and also an amount of ₹1.7 cr was due to be paid by the company to its lenders on March 31, 2016. However, due to some reason, the company did not or could not pay this interest to its lenders on the due date. 

We believe that investors should keep a close watch on the cash flow position of the company going ahead. This is because such signs of interest getting due and not paid by the company on the requisite date may be the initial signs of impending liquidity stress in any company.

Further advised reading: How to do Financial Analysis of Companies 

5) The sharp increase in trade payables: 

An investor would notice that in FY2017, the company witnessed a steep increase in trade payables from ₹212 cr on March 31, 2016, to ₹289 cr on March 31, 2017.

The FY2017 annual report, page 149:

Further advised reading: Understanding the Annual Report of a Company 

Moreover, the trade payables increased further to ₹389 cr on Sept 30, 2017.

We believe that investors should keep a close watch on the payables levels of the company. This is because whenever any company faces liquidity stress, then vendors/suppliers are the first counterparties to whom payments are delayed by any company. As a result, increasing trade payables may be the first sign of impending liquidity stress in any company. 

Therefore, it is advised that investors should closely monitor the financial position of the company going ahead.

6) Dividend funded by debt or equity dilution: 

An investor would remember from the discussion on the free cash flow position of the company that it could not meet its capex and interest payment requirements from its CFO and as a result, the company had to raise additional debt as well as do equity dilution. 

In such a scenario, an investor would appreciate that the dividends are usually funded out of the debt proceeds or the money received from the issuance of new equity shares. 

We believe that in the cases where dividends are funded by debt or equity dilution, investors should not take any comfort of the dividend yield because such dividends may be stopped at any time whenever the cash flow position of the company deteriorates. 

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

7) Asset light strategy of capacity expansion: 

The company has stated that it is now following a strategy of being asset-light. The FY2017 annual report, page 35:

Pursue mix of equipment rental cum asset lightness cum equipment portability

The company has stated that esp. in the polymer business, it intends to take the land on the lease and only do expenditures on the plant & machinery. 

An investor would appreciate that in case, the company does not own the land, then if in future, the business of the company is doing well, then the landowner can coerce the company to pay higher lease rentals and in turn reduce its profitability. 

Therefore, investors should take clarifications from the company about its plans for the kind of landowners that it plans to deal with. There might be cases that the company may take the land on lease only from the Govt. agencies in dedicated industrial zones or from the promoters/their entities or from private parties. 

Based on the clarifications received, the investor may make her appropriate opinion in this regard. 

8) Further clarifications needed about the calculation of cash flow from operations (CFO): 

An investor would remember from the above discussion that until FY2013, the company had shown interest costs as an outflow under CFO, which is usually shown as an outflow under cash flow from financing (CFF). We could mitigate the impact of interest costs on the CFO by making the adjustments as detailed above. 

Moreover, in the FY2017 CFO calculations, the company has shown ₹24.6 cr as an inflow from trade and other receivables, which is not getting reconciled when compared with the balance sheet data: 

The FY2017 annual report, page 140:

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

Looking at the above image, an investor would assume that the company has witnessed a reduction in receivables of about ₹24.6 cr in FY2017, which is shown as an inflow in CFO. Whereas in the balance sheet of the company, the trade receivables are almost constant at ₹372 cr in FY2017 and FY2016. 

The FY2017 annual report, page 138:

If we assume that the company has clubbed “Short-Term Loans and Advances” under receivables, even then, the inflow should be about ₹19.5 cr as the Short-Term Loans and Advances have witnessed a reduction from ₹90.7 cr in FY2016 to ₹71.2 cr in FY2017. 

Similarly, in CFO calculation in FY2016, the company has shown ₹57 cr of outflows under “Trade and Other Receivables”, which are not reconciled with the balance sheet data. 

The FY2016 annual report, page 119:

If we look at the balance sheet, then we find that in FY2016, there was hardly any change in trade receivables. Moreover, if we include the “Short-Term Loans and Advances” under the “Trade and Other Receivables” for CFO calculation, then we find that the change in “Short-Term Loans and Advances” in FY2016 is ₹45 cr and not ₹57 cr, which is reflected in the CFO calculations.

Therefore, we believe that investors may ask the company about the items that it has taken under “Trade and Other Receivables” for calculating CFO so that the calculations may be reconciled. 

9) Multiple lending transactions with related parties: 

While analysing the annual report of FY2017 of the company, an investor would notice that the company has entered into many transactions with related parties, which involved taking loans and repaying them to the promoters and their entities. 

The FY2017 annual report, page 164:

We believe that once an entity is listed on stock exchanges, then promoters should desist from entering into such lending transactions with the company as it has the potential of raising questions on corporate governance. 

Moreover, such lending transactions may also reflect the last-minute funding provided by the promoters in case the company is facing liquidity stress and is about to fail to meet its financial obligations. In such a case, investors should be cautious and alert to pick up the red flags of financial stress in the company.

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

10) Non-disclosure of the amount of a contingent liability (entry tax): 

An investor would notice that in the section on contingent liabilities in the FY2017 annual report, page 156, the company has disclosed that the issue of liabilities because of entry tax in the state of West Bengal is under legal proceedings and therefore, it is disclosed under contingent liabilities. However, the company has not provided an estimate of the amount of liabilities, which may arise in future.

It has been legally advised that the levy of Entry tax in the state of West Bengal would not pass the acid test of discrimination in as much as the Hon’ble Supreme Court has categorically stated that “State Legislature in exercise of its taxing power can grant exemption / set off to locally produce and manufactured goods only to a limited extent based on the intelligible differentia which is not in the nature of the general / unspecified exemptions.” There is a blanket, unlimited and unspecified exemption provided by the state of West Bengal on the intra-state movement of goods, which may contradict the guidelines laid down by the Hon’ble Supreme Court.

In view of the above fact and as per the legal opinion received, management is of the view that no provision is required on account of entry tax.

We believe that the company should inform the investors about the amount of the tax involved in this case irrespective of the probability of payment. As an investor, any person would want to know whether the liability would be about ₹1 cr or about ₹1,000 cr in case it materializes in future. From the currently disclosed information, an investor may find it difficult to assess the amount of this contingent liability. 

Therefore, we believe that investors may seek this information from the company directly.

Further advised reading: Understanding the Annual Report of a Company 

11) Strong competition in the polymer (pipes) market segment: 

The company has disclosed that in the PVC pipes segment, it is currently a relatively small player. During the discussion of the Q3-FY2018 results in the conference call in Feb 2018, the management of the company disclosed that it sells its products at about a 3-4% discount to the market leader in order to generate volumes. Moreover, currently, due to oversupply in the market, the players are undercutting prices to gain volume share to fill their additional capacities. 

Feb 2018 conference call transcript, pages 7-8:

Devesh Bansal: In all the markets that we operate in, we generally are benchmarked at roughly 3% to 4% from the market leader in that region, but obviously our numbers are much smaller still as compared to most of the higher selling brands in each region. So on a price level we are at 3% to 4% discount, but on a volume level we are obviously still growing right now

Feb 2018 conference call transcript, page 7:

Devesh Bansal: Again because the segment is not growing and all the organized players had ramped up capacities in expectation of the segment growing at 15% odd, there is obviously a lot more pressure on all the companies to fill up their capacities and that is where we are seeing some amount of undercutting happening in the market and consequently a pressure on the margins.

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

While analysing one of the peers of the company, Finolex Industries Limited (FIL), which is one of the larger players in the PVC pipes segment, an investor notices that FIL is resorted to reducing prices to gain market share.

Finolex Industries Limited witnessed its operating profit margins (OPM) decline steeply to 10% in Sept 2017 quarter and while discussing the results, the management of the company explained that they had to give a lot of discounts in order to grow volumes. The management further stated that if the company had tried to maintain its profitability (16% OPM in June 2017 quarter), then it would have had almost zero or negative volume growth. (Conference call of FIL Nov 2017 transcript, page 3):

Maulik Patel: Second question is on the pipe margin and we have seen in your competitors numbers also the margin has come down because there was a significant restocking in the month of July, August, which is also seen in your volume number, but we have to give such a high discount that the margin has come down to such a low number?

Prakash Chhabria: It is not necessarily high discount, I would say it is a volume game, so for volume sometimes you have to do go into the market to try and capture whatever is there. Now what we had expected on July 1, 2017 that first whole July month will go and by the time we will recover be August, September that did not happen. Actually middle of July only the volume starts picking up and when we saw the volume in the market we had to take corrective action and either we could have had less volume or even negative volume and may be higher profitability, but we said it would be better to try out a better volume game because as you know we were working aggressively on our capacity, so with a higher capacity we want to test what is to see and very happy, see to be able to physically ship out 23% higher volume terms in pipes and fittings also is a big exercise, so it is helping us to look forward to have a better and healthier future

Further advised reading: Analysis: Finolex Industries Limited

Such a situation in the industry indicates that the intense competition would make it difficult for the players to earn good profit margins. Investors should keep it in mind when they make an opinion about the polymer segment as well as the overall business environment of the company.

Margin of Safety in the market price of Skipper Limited:

Currently (March 09, 2018), Skipper Limited is available at a price-to-earnings (P/E) ratio of about 19.5 based on trailing 12 months’ earnings.

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

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

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

Analysis Summary

Overall, Skipper Limited seems to be a company, which had been growing at a brisk pace of about 20% year on year. The company has been able to improve its profitability along with its growth, which has resulted from the variable price order contracts entered by it with its customers. Such contracts allow Skipper Limited to pass on the increase in raw material costs to its customers and in turn protect its profit margins. Moreover, the company also seems to have benefitted from operating leverage and in turn increase the profit margins as it sold higher volumes.

The company has been able to improve its inventory utilization over the years. However, the performance of the company on the front of receivables collection has been far from satisfactory as the receivables days for the company have been increasing over the years. Deteriorating receivables collection has put pressure on the working capital needs of the company. In light of delays in the collection of receivables, it hardly comes as a surprise to investors when they notice that the trade payables of the company have been increasing steeply over recent years. It might be that the company is facing difficulties to make payments to its vendors. It is advised that investors should seek clarifications from the company in this regard.

The company has been able to plan its capacity expansions well, which has resulted in optimal utilization of its assets, as they become operations. As a result, the company has witnessed about 85% utilization of its capacities over the years and its NFAT has been increasing year on year despite frequent capital expenditure.

The company operates in a capital-intensive industry and as a result, it had to invest more money in its capacity expansion plans to fund its growth than what it could generate from its operations (CFO). As a result, the company has faced a negative free cash flow (FCF) situation, which it has tried to resolve by taking on additional debt and by raising additional equity. However, if an investor notices the amount of capex done by the company, interest expense, dividends and the increase in cash & investments, then on preliminary calculations, it seems that there are some gaps in the cash flow reconcilement. Therefore, it is advised that investors should seek clarifications from the company about its cash flow over the years.

The accounting steps used by the company, especially to arrive at CFO over the years leave a lot of doubts in the minds of investors whether it is the deduction of interest costs as an outflow in CFO until FY2013 or non-reconciling of changes in the “Trade and Other Receivables” with the balance sheet numbers. Therefore, it is advised that investors should approach the company and understand the steps used by it to calculate CFO over the years.

The company has disclosed that at the year-end dates, it had some amount of interest payment pending to be made to its lenders, which are already overdue. Such delays in interest payments do not reflect well on the face of the company as these may be a sign of financial stress in the company. Moreover, the company has been resorting to numerous lending transactions with its promoters/their entities, which in addition to raising flags about corporate governance; also raise issues related to a remote possibility of liquidity stress in the company, which the company might have met by raising loans from promoters.

The company seems to be following good management succession planning where the senior member of the promoter family is grooming the next generation into leadership positions. However, as there are three members of the next generation, who are currently on the board of directors, therefore, it is advised that investors should continuously monitor their relationships with each other. Such monitoring is needed to avoid getting into a situation where different members of the family are fighting with each other over ownership issues and as a result, the company’s business and minority shareholders’ interests suffer.

The company has been expanding into the polymer business (PVC pipes). However, currently, the PVC pipes business seems to be entering an oversupply phase where existing players are undercutting prices to gain market share. This fact in addition to the small scale of operations of Skipper Limited in this segment leading to selling pipes at a 3-4% discount to the market leader, has resulted in lower profit margins for the company in the PVC pipes business.

The company has been paying regular dividends to its shareholders. However, looking at the cash flow situation, it comes out that the dividends are primarily funded by debt or additional equity. Therefore, it is advised that investors should not take any comfort in dividends while valuing the company.

In order to increase the returns to the shareholders, the company seems to have started executing an asset-light strategy for its polymer business. Under this strategy, the company plans to lease the land and only spend money on the plant and machinery for the factories. It is advised that investors should know who would be the landowners in such plants so that they may avoid getting into a situation where once the business is successful, then most of the returns are cornered by the landowner by increasing the lease rentals.

While reading the annual reports, an investor realizes that there are certain aspects, which need further clarification/more information from the company. One such aspect is the entry tax under contingent liabilities where the company has not provided an estimate of the amount of the liability in case it had to pay, however, low the possibility of such payment may be. We believe that investors should contact the company to know about the amount of such liability.

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

Going ahead, investors should monitor the company for operating profit margin, debt levels, receivables days, amount of trade payables, promoters’ shareholding, their relationship with each other, loans from related parties etc. Investors should get clarification from the management about the calculation of cash flow from operations and entry tax etc.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views about Skipper Limited. However, investors should do their own analysis before taking any investment-related decision about the company.

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

Hope it helps!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

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