Analysis: Valiant Organics Ltd

Modified: 28-Aug-21

The current section of the “Analysis” series covers Valiant Organics Ltd, an India speciality chemical manufacturer producing Chlorophenols, Para Nitro Aniline (PNA) etc. It is a part of the Aarti group, which has Aarti Industries Ltd and Aarti Drugs Ltd among the prominent 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.

Valiant Organics Ltd Research Report by Reader

Hello Sir,

Please find below my analysis for Valiant Organics Ltd.

Regards,

Shreyas Nevatia

Business analysis of Valiant Organics Ltd:

Valiant Organics Ltd. manufactures different types of chlorophenols, which is a chemical that has several applications mainly in agrochemical, pharmaceutical, dyes, cosmetics and veterinary drugs. The company has a manufacturing facility at Sarigam Industrial Estate with a capacity of 4,800 MTPA.

Its pricing power may be compromised if imports are not available, banned, or protected by the government.

According to Valiant Organics Ltd, there is limited competition in India, allowing it competitive advantages.

In conclusion, we can say that Valiant Organics Ltd is not immune to volatility in raw material prices; however, it can pass the price to customers.

Ratio analysis of Valiant Organics Ltd:

The company has not been able to convert its profits into cash. It has a PAT of ₹321 crores vs CFO of ₹293 crores.

It has an SSGR better than its sales growth, which has allowed it to be conservative on debt. However, higher growth in the last 3 years has led to a debt increase.

It has a high ROCE throughout its existence because of high gross margins indicating competitive advantage, which was mentioned in its DRHP as well.

Promoter Remuneration of Valiant Organics Ltd:

Promoter remuneration is reasonable and nothing excessive (₹1 crore on a profit of ₹25 crores). It has not crossed the threshold during its public life.

Other matters:

Labour expenses increased from ₹44 lacs to ₹1 crore in FY2017. However, there has been no large capital expenditure (capex) during the year nor there has been high sales growth. We need clarification from management on this aspect.

There are no details on the merger with Abhilasha Tex Chem in the annual reports and no management commentary is present. There is an investment in Dhanvallabh Ventures LLP ₹7.22 crores in FY2020; however, the company has not provided any explanation.

The company did a merger with Amarjyot Chemicals Ltd in FY2019. Why did Amarjyot Chemicals was sold at a discount of ₹64 crores (on page 87 of FY2019 annual report) while it was a profitable company of ₹17 crores? What were the benefits available with the merger?

The company is using company funds for equity investments and real estate investments. In 2018, its investments increased from ₹6.6 crores to ₹7.1 crores.  The company can use the money to reduce debt instead of doing equity investments from company funds.

In 2018, ₹6.92 crores are receivable from related parties.

Valuation of Valiant Organics Ltd:

The current PE ratio of the company is 37, which does not offer any margin of safety and is already pricing in high growth.

Regards,

Shreyas Nevatia

Dr Vijay Malik’s Response

Dear Shreyas,

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

Valiant Organics Ltd, which is a part of the Aarti group, came up with its initial public offer (IPO) in 2016. Therefore, the company’s website has annual reports from FY2017 onwards. However, the draft red herring prospectus (DRHP) of the company available in the public domain contains the financial performance of the company for many previous years. Therefore, reading the DRHP of Valiant Organics Ltd becomes an essential exercise for any investor to understand the company in detail.

While analysing the past financial performance of the company, an investor notices that Valiant Organics Ltd was involved in a couple of restructuring exercises where the Aarti group merged some of its companies in Valiant Organics Ltd. Abhilasha Tex Chem Ltd merged with Valiant Organics Ltd in FY2018. In addition, Amarjyot Chemicals Ltd merged with Valiant Organics Ltd in FY2020.

As a result of these mergers, Valiant Organics Ltd reported only standalone financials until FY2018 and started reporting consolidated financials from FY2019 onwards. As per the latest results declared by Valiant Organics Ltd for Q4-FY2021 (page 10), it has the following three subsidiaries:

  • Dhanvallabh Ventures LLP
  • Bharat Chemicals (Partnership Firm)
  • Valiant Speciality Chemical Limited

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. Consolidated financials of any company, whenever they are present, provide such a picture.

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

Therefore, in the analysis of Valiant Organics Ltd, we have analysed standalone financial performance until FY2018 and consolidated financial performance after that.

With this background, let us analyse the financial performance of the company.

Valiant Organics Limited Financials FY2012 FY2021

Financial and Business Analysis of Valiant Organics Ltd:

While analyzing the financials of Valiant Organics Ltd, an investor notices that the sales of the company have grown at a pace of about 42% year on year from ₹33 cr in FY2012 to ₹755 cr in FY2021. As discussed above, Aarti Group of Companies has done a few restructuring exercises in the past where some of its group companies were merged with Valiant Organics Ltd like Abhilasha Tex Chem Ltd and Amarjyot Chemicals Ltd. These mergers have played a big role in the increase in the business size of Valiant Organics Ltd including its sales and profits.

While looking at the profit margins of Valiant Organics Ltd, an investor notices that its operating profit margin (OPM) used to be about 20% during FY2012-FY2015, which increased sharply to 30% in FY2016. Thereafter, the OPM declined to 22% in FY2018 and now, has recovered to 27% in FY2021.

To understand the reasons for such fluctuations in the profitability, the impact of different mergers and the factors affecting the business of Valiant Organics Ltd, an investor needs to read the DRHP of the company as well as its annual reports and credit rating reports in detail. An investor comes across the following key characteristics of the business of Valiant Organics Ltd.

1) Valiant Organics Ltd is the leading producer of India for its key products:

The largest contribution to the sales of Valiant Organics Ltd is from two products: Chlorophenols and Para Nitro Aniline (PNA). As per Valiant Organics Ltd, it is the main producer in India for both these products.

FY2018 annual report, page 18:

Your Company is at present the leading manufacturer of Chloro Phenol and Para Nitro Aniline in India and has the best economic scale to compete the other domestic manufacturers in India.

In 2016, in the DRHP before its IPO, Valiant Organics Ltd said that the demand for its products is more than the supply. As a result, it was operating at near-full capacity utilization.

DRHP, page 25-26:

Over the years we have built our goodwill amongst our customers and export markets and we believe the demand for our products are more than our supply capacity

We currently operate at almost full utilizations of our installed capacities.

While reading the DRHP further, an investor notices that the capacity utilization of Valiant Organics Ltd had been increasing continuously over the last 3-years (FY2014-FY2016) and it had reached 99.76% in FY2016.

DRHP, page 78:

Valiant Organics Ltd Capacity Utilization FY2014 FY2016

In FY2017, Valiant Organics Ltd stated that it had achieved 100% capacity utilization.

FY2017 annual report, page 21:

During the last year we have achieved record production and have achieved 100% capacity utilization of the plant capacity

From the above disclosures by Valiant Organics Ltd, an investor would appreciate that the segment in which the company operates does not have many players competing for customers. The demand for its products is more than the supply capacity. As a result, Valiant Organics Ltd is able to fully utilize its manufacturing capacities.

From the above information, an investor may also interpret that higher demand for products than the supply, gives Valiant Organics Ltd a higher negotiation power over its customers. A higher negotiation/pricing power gives a company the ability to pass on any increase in its input costs to its customers and protect its profit margins.

Let us see if Valiant Organics Ltd has such pricing power.

2) Valiant Organics Ltd claims to have pricing power over its customers:

In the DRHP at the time of its IPO in 2016, Valiant Organics Ltd claimed that markets that there are no dedicated producers of its key product, Chlorophenols in India as well as its export markets. Therefore, it does not face a lot of competition for its products and as a result, it is able to get good pricing from its customers.

DRHP, page 72-73:

We believe that there are not many dedicated manufacturers of this product in India or in our export markets and hence we are able to price our products without substantial competition.

The credit rating agency, CRISIL, in its report for Valiant Organics Ltd in December 2020, highlighted that the company has the ability to pass on the changes in its raw material costs.

The integrated operations, order backed sales, and pass on of volatility in raw material prices to customers, will continue to support VOL’s business risk parameters.

While reading more about the raw material used by Valiant Organics Ltd, an investor notices that its key raw material are derivatives of crude oil. As a result, their prices are very volatile.

Credit rating report by CRISIL, December 2020:

The prices of raw material inputs, which are derivatives of crude oil, are volatile, thus impacting profitability. The international market prices of raw materials follow the petrochemicals cycle.

An investor would appreciate that the prices of crude oil are very volatile. The following chart of the history of crude oil prices for the last 20-years from Macrotrends clearly shows the significant fluctuations over the years. She would notice that in 2020, the crude oil prices reached the same level that they were more than 20 years back.

Crude Oil Price History Chart 2000 2020

Therefore, an investor would notice that over the years, the prices of both crude oil and accordingly, the prices of derivatives of crude oil, have fluctuated a lot. Nevertheless, due to the ability of Valiant Organics Ltd to pass on the changes in the cost of its raw materials, it has been able to maintain its profit margins.

Advised reading: How to do Business Analysis of a Company

An investor would notice that during FY2012-2015, the operating profit margin (OPM) of the company was almost stable at 19%-20% despite volatility in crude oil prices. It indicates that the company could pass on the changes in the raw material costs.

Moreover, during FY2016, when the crude oil prices declined sharply from about USD 110 per barrel to about USD 35 per barrel, the business performance of Valiant Organics Ltd showed two changes.

First, the sales of the company declined in FY2016 to ₹52 cr from ₹59 cr in FY2015. The company disclosed that this declined was due to a sharp reduction in the raw material prices. The company had to pass on the benefit of lower raw material prices to its customers.

DRHP, page 141-142:

The decrease in the year 2016 was due to lower revenue from sale of products as compared to last year as well as overall drop in commodity prices.

The decrease was mainly due to considerable decrease in import value of raw material Phenol.

It seems that as the raw material costs for Valiant Organics Ltd declined, it had to reduce the price of its products, which resulted in lower sales. This was despite an increase in capacity utilization by the company during FY2016 to 99.76% from 94.48% in FY2015. From the capacity utilization table shared earlier, an investor would notice that the company produced 4,788 MT of chlorophenols in FY2016 as compared to 4,535 MT in FY2015.

At the same time, an investor would notice that despite a reduction of product prices by Valiant Organics Ltd in FY2016, its OPM increased to 30% in FY2016 from 19% in FY2015. This indicates that the company could retain some of the benefits of the lower raw material prices. As a result, despite a decline in sales from ₹59 cr in FY2015 to ₹52 cr in FY2016, the operating profit margin of Valiant Organics Ltd increased from ₹11 cr in FY2015 to ₹16 cr in FY2016.

It seems that due to good pricing power, Valiant Organics Ltd could retain some benefits of the lower raw material prices and did not pass on the entire reduction in raw material prices to its customers.

Even in the later years, after mergers with Abhilasha Tex Chem Ltd and Amarjyot Chemicals Ltd, the OPM of Valiant Organics Ltd, after declining to 22% in FY2018, has recovered to 27% in FY2021, which as stated by CRISIL, indicates its ability to pass on the changes in the raw material costs to its customers.

Nevertheless, an investor may note that the ability of any company to maintain its profit margins by passing on the changes in the raw material costs is dependent on the competition in the industry. If the competition level is low, then the company may enjoy stable or improving profit margins. However, as the competition increases, then maintaining profit margins becomes difficult. This is because, as the competition becomes intense in any industry, then many producers/suppliers/manufacturers compete for the same customers by cutting down prices, which results in lower profit margins for all the manufacturers.

Moreover, as the competition in the industry increases, the customers also have the option to buy products from many producers. Therefore, they also tend to negotiate as low prices as possible from their suppliers. If one supplier refuses to offer lower prices, then the customers can easily switch to other suppliers. As a result, the pricing power shifts from suppliers to the customers.

Therefore, as the competition increases in any industry, the manufacturers face the tough situation where during the periods of increasing raw material prices, they have to take a hit on their profit margins because all the producers target the same customers with lower prices than others. On the contrary, when the raw material prices decline, then the manufacturers have to reduce their prices for the customers because, otherwise, the customers can switch to other suppliers.

To read a live example of how the pricing/negotiating dynamics change when in any industry the customers gain high pricing power and how the manufacturers end up making low-profit margins, which fluctuate wildly when the raw material prices change, an investor may read the analysis of an auto-ancillary manufacturer, Jamna Auto Industries Ltd.

Advised reading: Analysis: Jamna Auto Industries Ltd

Therefore, while analysing Valiant Organics Ltd and making an opinion about the prospects of its business, an investor should assess how the competition in its industry is expected to evolve. This is because, if the competition increases, then it will affect the ability of Valiant Organics Ltd to pass on changes in the raw material costs and its profitability.

An investor should always keep in mind that both the raw material suppliers as well as the customers of Valiant Organics Ltd are a part of cyclical and volatile industries.

Credit rating report of Valiant Organics Ltd by CRISIL, December 2020:

rating strengths are partially offset by VOL’s exposure to volatile commodity prices and cyclicality in domestic end-user industries.

Therefore, an investor should be aware that whenever the industry of Valiant Organics Ltd witnesses an increase in the competition, then the factors of cyclicity of demand and volatility of prices in the raw material as well as customer industries would affect Valiant Organics Ltd and its stable profit margins may become cyclical.

3) Valiant Organics Ltd does not have long-term contracts with its customers:

When an investor analyses the business characteristics of Valiant Organics Ltd in detail, then she notices that the company does not have any long-term contracts with its customers. Its sales to the customers are on an order-to-order basis. It means that once Valiant Organics Ltd has delivered goods against an order from the customer, then contractually, there is not further long-term commitment from the customers and they can start buying from any other supplier without any consequences.

Valiant Organics Ltd highlighted this aspect of its business in its DRHP before the IPO.

DRHP, page 12:

we have not entered into any specific contracts with these customers and we cater to them on an order-by-order basis. As a result, our customers can terminate their relationships with us without any notice and, without consequence, which could materially and adversely impact our business. Consequently, our revenue may be subject to variability because of fluctuations in demand for our products. Our Company’s customers have no obligation to place order with us and may either cancel, reduce or delay orders.

Even in recent times, the credit rating agency, CRISIL, highlighted in its report of December 8, 2020, that Valiant Organics Ltd primarily only has sales, which are backed by orders that may indicate that it is still not able to get long-term contracts for sales with its customers.

The integrated operations, order backed sales, and pass on of volatility in raw material prices to customers, will continue to support VOL’s business risk parameters.

Advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

An investor would appreciate that such short-term business arrangements expose any company to the risk when it plans any capacity addition and intends to invest any large sum of money in capital expenditure. Long-term contracts with the customers reduce the risk of the manufacturing plant lying idle in the absence of orders.

Moreover, in the case of companies that have only short-term order based contracts with their customers, the impact of adverse developments in the operating environment is seen immediately. This is because whenever the customers face a decline in the demand, they can immediately cancel their orders and the manufacturing plants of the suppliers have to be shut for the lack of orders. Such kind of short-term contracts with customers make long-term production planning very difficult.

4) Valiant Organics Ltd does not have any long-term agreement with its raw material suppliers:

While analysing the business of Valiant Organics Ltd, an investor notices that the company does not have any long-term supply agreement with its raw material suppliers.

An investor would appreciate that in the absence of long-term supply commitments, the raw material suppliers may sell their products to anyone who is willing to offer a higher price and in turn, a company like Valiant Organics Ltd may not be able to get the raw materials when it needs them.

The company highlighted this aspect of its business in the DRHP in 2016.

DRHP, page 11:

there are no fixed suppliers for our raw material purchases and we have not entered into any fixed supply agreement or MoU or any other arrangement with any of our suppliers… We typically transact on an invoice basis for each order… in the absence of written agreements, our suppliers are not bound to supply goods to us and can withdraw their commitments from us at any time. There can be no assurance that there will not be a significant disruption in the supply of raw materials from current sources…

Valiant Organics Ltd also highlighted to the investor that its raw materials are toxic and therefore, sensitive in nature and as a result, their supply is regulated by the governments. As a result, if the existing suppliers were not able to supply raw material to it, then it would be difficult to find another approved raw material supplier willing to sell goods to it.

DRHP, page 11-12:

Most of our raw materials are of sensitive nature and their supply may be regulated by various government / regulatory authority. If we are unable to maintain our relationship with our current raw material suppliers it may prove difficult to obtain the same from other regulated players.

An investor would appreciate that in a situation where the raw materials used by any company are sensitive and regulated and there are limited approved suppliers for the same, then the absence of long-term supply contracts can expose the company to the risk of business disruption. If the existing suppliers refuse to give the required raw material to the company when needed, then the company would have to urgently run around seeking other suppliers. In such a situation, in all probability, the company would have to pay a higher price to get the raw material supplies, which would affect the profitability of the company.

This fear came true for the company in the very next year, in FY2017 when it could not get its key raw material, which it imports from overseas suppliers (primarily, Phenol). The import shipment was delayed and as a result, Valiant Organics Ltd had to buy the raw material from other suppliers at a very high price, which affected the profits of the company.

FY2017 annual report, page 20:

Net profit was ₹ 9,83,39,846/- against ₹ 10,24,47,074/- which is marginally lower by 4% because of delay in import shipments and due to which Company had to source the RM from the spot market at much higher rates for the last full quarter.

In FY2017, the operating profit margin (OPM) of the company declined to 25% from 30% in FY2016.

An investor may contact the company directly to understand whether it has now entered into long-term supply agreements with its raw material suppliers or it is still bearing the risk of business disruption and lower profitability if any of its suppliers refuse to sell goods to it taking advantage of order-to-order based short-term supply commitments.

Going ahead, an investor should try to understand the nature of the contractual arrangements of Valiant Organics Ltd with its customers as well as raw material suppliers and the increase in the competition in the industry. An investor should note that the key competitors of the company are Chinese manufacturers.

DRHP, page 17:

There are very few manufacturers of chlorophenol in India. We see Chinese manufacturers of chlorophenols as our primary competitors.

In the past, the Chinese chemical manufacturers have faced challenging times due to strict environmental regulations in China, which benefited chemical manufacturers of other countries, including India.

FY2019 annual report, page 13:

Our major Asian rival China’s specialty chemicals market has seen a downturn in recent years, for more reasons than one, the most prominent being the introduction of stringent environmental and safety norms, which have led to the shutdown of several chemical plants. The cost of compliance has increased as well.

However, going ahead, an investor should keep a close watch on the level of chlorophenol production by the Chinese manufacturers. This is because continued if the company continues the use of short-term contracts with its customers and suppliers and the competition in the industry increases, then Valiant Organics Ltd would not be able to retain its pricing/negotiating power over its customers. As a result, the company may end up facing a deterioration in its business strengths that may lead to cyclically fluctuating sales and profit margins.

While looking at the tax payout ratio of Valiant Organics Ltd., an investor notices that the tax payout ratio of the company has been in line with the standard corporate tax rate prevalent in India. The decline in the tax payout ratio in recent years seems to be in line with the reduction of the corporate tax rate by India from earlier 30% to the current rate of 25%.

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

Operating Efficiency Analysis of Valiant Organics Ltd:

a) Net fixed asset turnover (NFAT) of Valiant Organics Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Valiant Organics Ltd in the past years (FY2013-21), then she notices that the NFAT of the company increased during the initial period from 3.4 in FY2013 to 7.7 in FY2019. However, afterwards, the NFAT declined sharply to 2.0 in FY2021.

To understand the reasons behind such a contrasting change in the efficiency of asset utilization by Valiant Organics Ltd, an investor needs to understand how the business of the company has evolved over the years.

An investor would recollect that initially, Valiant Organics Ltd used to be a single product company. It used to deal only in Chlorophenols.

DRHP, page 11:

We derive our entire operational revenues from sale of chlorophenols in the domestic as well as overseas market.

From the above discussion on the business of Valiant Organics Ltd, an investor would remember that during FY2012-FY2017, the capacity utilization of the company was continuously increasing and it had reached 100% capacity utilization by FY2017.

FY2017 annual report, page 21:

During the last year we have achieved record production and have achieved 100% capacity utilization of the plant capacity

An investor would appreciate that increasing capacity utilization improves asset utilization efficiency. As a result, during this period when the company was only dealing in Chlorophenols, its NFAT was continuously increasing. Thereafter, Valiant Organics Ltd got involved in mergers with Aarti group companies, namely, Abhilasha Tex Chem Ltd (in FY2018) and Amarjyot Chemicals Ltd (in FY2020).

An investor would appreciate that after mergers, the nature of the business taken over by Valiant Organics Ltd would influence the consolidated asset utilization efficiency of the company.

In FY2018, Valiant Organics Ltd merged Abhilasha Tex Chem Ltd (ATCL) with itself. As per the audited financials of ATCL provided by Valiant Organics Ltd on its website, an investor notices that the business of ATCL had an NFAT of 3.08 in FY2016 and 3.02 in H1-FY2017.

Abhilasha Tex Chem Limited Net Fixed Asset Turnover

Therefore, an investor would notice that the business of ATCL taken over by Valiant Organics Ltd had a lower NFAT than the Chlorophenols business of Valiant Organics Ltd. As a result, in FY2018, after the merger, the consolidated NFAT of Valiant Organics Ltd declined.

When an investor analyses the financial position of Amarjyot Chemicals Ltd (ACL) from the audited financials provided by Valiant Organics Ltd on its website, then she notices that the business of ACL had an NFAT of 2.06 in FY2017 and 2.47 in 9M-FY2018.

Amarjyot Chemicals Limited Net Fixed Asset Turnover

An investor would appreciate that when a business of lower NFAT is merged with the business of a higher NFAT, then the consolidated business would have a lower NFAT than earlier. As a result, an investor would notice that after the merger of ACL with Valiant Organics Ltd, the consolidated NFAT of the company declined.

Moreover, an investor would notice that the decline in the NFAT after the merger with ATCL in FY2018 was minimal whereas there was a very sharp decline in the NFAT of Valiant Organics Ltd after its merger with Amarjyot Chemicals Ltd (ACL) in FY2020. The key reason was that Amarjyot Chemicals Ltd (ACL) was a much bigger company than ATCL. Therefore, the impact of its low NFAT business on the overall NFAT of the combined entity was much more than the merger with ATCL.

In addition, during FY2020 and FY2021, Valiant Organics Ltd did a lot of capital expenditure to create additional capacities. In FY2020, the company completed its capacity expansion for hydrogenation, ammonolysis as well as chlorophenols. The company was nearing the completion of plants for Para Amino Phenol (PAP) and Ortho Amino Phenol (OAP).

FY2020 annual report, page 7:

We have increased the capacities of our hydrogenation products from the earlier 18,000 MT per annum to 26,000 MT per annum. Further, we are increasing the Ammonolysis capacity at Tarapur and Vapi plants from ~13,000 MT per annum to 16,000 MT per annum. We are likely to commence operations of Para Amino Phenol (PAP) and Ortho Amino Phenol (OAP), which are import substitutes, in the second half of FY 2020-21.

FY2020 annual report, page 12:

During the year, we completed the expansion of Chloro Phenols capacity at Sarigam. With this, we achieved a capacity of 18,000 MT per annum in the expected timeframe. Thus, from 4,800 MTPA in FY 2017-18, we have trebled our capacity within a span of two years.

An investor would appreciate that when any company completes a new expansion project, then it takes some time for the company to start optimal/full utilization of the new plant. It takes some time to find customers to sell the new production. As a result, until the optimal utilization level of the new plant is achieved, its asset utilization efficiency remains subdued.

Therefore, an investor would note that during the recent years of FY2020 and FY2021, the merger of a large business of Amarjyot Chemicals Ltd (ACL), which had a low NFAT and the large capital expenditure done by Valiant Organics Ltd had led to a sharp decline in the NFAT of the company.

Going ahead, an investor should monitor the NFAT of Valiant Organics Ltd to understand whether it is able to efficiently use its assets.

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

b) Inventory turnover ratio of Valiant Organics Ltd:

While analysing the efficiency of inventory utilization by Valiant Organics Ltd, an investor notices that during the last 10 years, the inventory turnover ratio (ITR) of the company has been in the range of 10-12. At times, the ITR has fluctuated significantly like increasing to 25.2 in FY2019 and then declining to 12.9 in FY2021. However, it seems primarily the impact of the merger with Amarjyot Chemicals Ltd (ACL). This is because if an investor notices the level of inventory of the company over the last 10-years (FY2012-2021), then she would notice that Valiant Organics Ltd used to maintain inventory of about ₹7 cr to ₹9 cr whereas, after merger with ACL, the inventory levels suddenly increased significantly to the range of ₹45 cr to ₹70 cr.

Going ahead, an investor may keep track of the inventory level of the company to understand whether the company is able to maintain its inventory utilization efficiency after mergers.

Further advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of Valiant Organics Ltd:

Over the last 10 years, the receivables days of Valiant Organics Ltd have stayed in the range of about 70 days. Even though, in between, the receivables days improved to 47 days in FY2019. However, in FY2021, the company reported receivables days of 70 days, which is almost at the same level as the receivables days reported in FY2013 of 69 days.

It indicates that the company has maintained stable credit terms with its customers over the last 10-years.

Further advised reading: Receivable Days: A Complete Guide

When an investor notices that Valiant Organics Ltd has maintained a stable inventory turnover ratio as well as stable receivables days over the last 10-years, then she can understand that the company has kept its working capital efficiency at a stable level.

When an investor compares the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of Valiant Organics Ltd for FY2012-21 then she notices that the company has converted almost 95% of its profits into cash flow from operating activities.

Over FY2012-21, Valiant Organics Ltd reported a total cumulative net profit after tax (cPAT) of ₹433 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹414 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)

Learning from the article on CFO will indicate to an investor that the cCFO of Valiant Organics Ltd is a little lower than the cPAT due to the increased requirement of funds in the inventory and receivables as the size of its business has grown from sales of ₹33 cr in FY2012 to ₹755 cr in FY2021. During this business growth, the inventory of the company increased from ₹3 cr in FY2012 to ₹72 cr in FY2021. In addition, the amount of trade receivables increased from ₹6 cr in FY2012 to ₹157 cr in FY2021.

The Margin of Safety in the Business of Valiant Organics 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 Valiant Organics Ltd, an investor would notice that up to FY2018, the company has an SSGR in the range of 30%-35%, which increased in the recent years (FY2019-FY2021) to more than 60%. However, an investor notices that Valiant Organics Ltd has attempted to grow at a very high CAGR of about 84% every year in the last 3 years and a CAGR of 71% in the last 5 years.

As during the recent years, Valiant Organics Ltd has attempted to grow at a pace higher than what its internal resources could afford; therefore, in recent years, the company has to rely on additional capital in the form of debt to meet its funds’ requirement. As a result, the total debt of the company has increased from less than ₹1 cr in FY2018 to ₹186 cr in FY2021.

An investor arrives at the same conclusion when she analyses the free cash flow (FCF) position of Valiant Organics Ltd.

b) Free Cash Flow (FCF) Analysis of Valiant Organics Ltd:

While looking at the cash flow performance of Valiant Organics Ltd, an investor notices that during FY2012-2021, it generated cash flow from operations of ₹414 cr. During the same period, it did a capital expenditure of about ₹578 cr.

Therefore, during this period (FY2012-2021), Valiant Organics Ltd had a negative free cash flow (FCF) of (₹164) cr (=414 – 578).

In light of the same, an investor would appreciate that the company had to use debt to meet its cash shortfall. During FY2012-FY2021, the total debt of the company increased by ₹184 cr from ₹2 cr in FY2012 to ₹186 cr in FY2021.

Going ahead, an investor should keep a close watch on the free cash flow generation by Valiant Organics Ltd to understand whether the company is able 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 Valiant Organics Ltd:

On analysing Valiant Organics 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 Valiant Organics Ltd:

Valiant Organics Ltd is a part of the Aarti group. The company has given the status of Chairman Emeritus to Mr Chandrakant V. Gogri who is the founder of the Aarti group.

FY2020 annual report, page 8:

Mr. Gogri is a stalwart in the Indian chemical industry and the founder of the Aarti Group of Companies.

A look at the list of entities under the promoters’ shareholding on March 31, 2021 (Source: BSE) shows that apart from members of the Gogri family, members of the Chheda and Gala families are present as promoters.

Currently, Mr Arvind Chheda (age 62 years as per FY2019 annual report, page 128), one of the promoters is the Managing Director (MD) of the company. From May 26, 2021, the company has appointed Mr Mahek Manoj Chheda (age 30 years as per FY2017 annual report, page 10) as Chief Financial Officer (CFO) of the company.

As per the FY2017 annual report (page 14), Mr Mahek Manoj Chheda was appointed as a director of the company on July 6, 2017.

As per the DRHP of the company, page 49 and the FY2017 annual report, page 40, a person named Ms Meena Manoj Chheda owned 12.50% shares of the company before its IPO. Ms Meena Manoj Chheda sold about a 4.5% stake in the IPO under offer for sale and at the end of FY2017, held an 8% stake in the company.

Valiant Organics Ltd Shareholding Of Meena Manoj Chheda

On March 31, 2021, Ms Meena Manoj Chheda is classified under public shareholders and owns a 2.15% stake in the company (Source: BSE)

An investor would notice the similarity in the names Mr Mahek Manoj Chheda (CFO) and Ms Meena Manoj Chheda (a large investor). She would appreciate how names in many communities in India are written with father or husband’s name written as the middle name. She would note that it might be a situation where Mr Mahek Manoj Chheda (CFO) and Ms Meena Manoj Chheda are related to each other.

If this is the case, then the appointment of Mr Mahek Manoj Chheda (aged 30 years) as a director in FY2017 and his appointment as CFO in May 2021 may indicate that the company has started to give a higher responsibility to the members of the next generation of promoters/large shareholders.

The presence of younger family members at executive positions within the group, while the senior members are still handling responsibilities, is a preferable 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.

To form a firm opinion in this regard, an investor may contact the company directly and seek information on whether Mr Mahek Manoj Chheda (CFO) is related to Ms Meena Manoj Chheda who was one of the large shareholders of the company before IPO. She may seek clarifications whether he is a part of the family, which is close to the promoters or other large shareholders, which do not fall under the technical definition of promoters.

Further advised reading: How to do Management Analysis of Companies?

2) Merger of Abhilasha Tex Chem Ltd with Valiant Organics Ltd:

While reading the annual reports of Valiant Organics Ltd, an investor gets to know that the company merged with one of the companies of the Aarti group, Abhilasha Tex Chem Ltd (ATCL) with itself in FY2018. As consideration for the merger, Valiant Organics Ltd issued 2,224,030 shares to the existing shareholders of ATCL on March 15, 2018.

FY2018 annual report, page 9:

The Company had allotted additional 2,224,030 Equity Shares of ` 10/- each on March 15, 2018 to the shareholders of Abhilasha Tex-chem Limited (Transferor Company) in terms of the said Scheme.

As per the BSE website, the closing share price of Valiant Organics Ltd on March 15, 2018, was ₹830/- (before the impact of the 1:1 bonus issue of FY2021). As a result, an investor may ascertain that by issuing 2,224,030 shares to the shareholders of ATCL, Valiant Organics Ltd paid a consideration of ₹184.6 cr (=2,224,030 * 830).

To assess the value of assets received by the shareholders of Valiant Organics Ltd by paying a consideration of ₹184.6 cr, an investor needs to study the financial position of ATCL before the merger.

As per the audited financials of ATCL provided by Valiant Organics Ltd on its website, an investor notices that as per the recent most data, ATCL reported a profit after tax (PAT) of ₹2.76 cr in H1-FY2017, which can be annualized to ₹5.52 cr for 12 months (=2.76 * 2). ATCL had reported PAT of ₹4.34 cr in FY2016 and ₹4.19 cr in FY2015.

Therefore, an investor would note that before the merger, the business of ATCL had a net profit in the range of ₹4.2cr – ₹5.50 cr. If an investor compares it with the price paid by Valiant Organics Ltd (₹184.6 cr), then it equals a price to earnings ratio (PE ratio) of 35 to 45.

If an investor attempts to assess the merger of ATCL from another valuation parameter of price to book value ratio (PB ratio), then an investor notices that before the merger, on Sept 30, 2016, ATCL had a net worth (book value) of ₹17.75 cr. When an investor compares it with the price paid by Valiant Organics Ltd (₹184.6 cr), then it equals a PB ratio of 10.4.

An investor would notice that from both the parameters of PE ratio as well as PB ratio, ATCL had enjoyed a rich valuation while it was merged with Valiant Organics Ltd.

When an investor wishes to analyse the shareholding of ATCL, then she notices that ATCL was an Aarti group company as the Gogri family members owned a significant stake of ATCL as well as Valiant Organics Ltd and were classified as promoters of both the companies.

Notice of the court-convened meeting of shareholders, dated July 7, 2017, page 16:

Abhilasha Tex Chem Ltd Shareholding Of Gogri Family

An investor would appreciate that if a company owned by promoters is merged with a public-listed company at a rich valuation, then it effectively means a transfer of economic benefits from minority/public shareholders to the promoters.

An investor may do deeper due diligence in the merger of ATCL with Valiant Organics Ltd and may contact the company for any clarification to make up her mind about the valuation paid by Valiant Organics Ltd to the shareholders of ATCL.

Advised reading: How Promoters benefit from Related Party Transactions

3) Merger of Amarjyot Chemicals Ltd with Valiant Organics Ltd:

While reading the annual reports of Valiant Organics Ltd, an investor gets to know that the company merged another company of Aarti group, Amarjyot Chemicals Ltd (ACL) with itself in FY2020. As consideration for the merger, Valiant Organics Ltd issued 6,482,868 equity shares, 1,833,087 optionally convertible preference shares (OCPS) and 38,400 Redeemable Non-cumulative Preference Shares (RNPS) to the shareholders of ACL.

FY2020 annual report, page 29:

Valiant Organics Ltd Allotment To Shareholders Of Amarjyot Chemicals Ltd

Each OCPS was convertible into one equity share of Valiant Organics Ltd. FY2020 annual report, page 110:

OCPS (convertible into Equity in the ratio of 1:1)

Out of the total allotted 1,833,087 OCPS, 1,427,526 were converted into equity shares of Valiant Organics Ltd on October 11, 2020 (Source: BSE)

38,400 Redeemable Non-cumulative Preference Shares (RNPS) of ₹100/- each represented a debt of about ₹0.38 cr taken by ACL from its shareholders, which was taken over by Valiant Organics Ltd.

Therefore, if an investor assesses the predominant value received by the shareholders of ACL upon its merger with Valiant Organics Ltd, then it amounts to 8,117,955 equity shares (= 6,284,868 shares + 1,833,087 OCPS) on May 4, 2019.

As per the BSE website, the closing price of Valiant Organics Ltd on May 3, 2019 (Friday) was ₹1,829.90 and on May 6, 2019 (Monday) was ₹1,919.80 (before the impact of the 1:1 bonus issue of FY2021).

As a result, an investor may ascertain the value paid by Valiant Organics Ltd to the shareholders of ACL was ₹1,558 cr (=8,117,955 * 1,919.80 share price after allotment of shares & OCPS). An investor may note that the share price on May 6, 2019, is expected to reflect all the changes due to the allotment of additional shares and OCPS, which happened on May 4, 2019. An investor may note that the markets change the share price of the stocks at the ex-date even before the allotted shares are credited to investors’ accounts. Therefore, we believe that the share price of Valiant Organics Ltd on May 6, 2019, incorporates the impact of allotment of shares done to the shareholders of ACL on May 4, 2019.

An investor may also ascertain the value of allotted shares and OCPS by comparing the proportion of the market capitalization represented by them.

From the above table on share allotment, an investor would notice that before allotment on May 4, 2019, the existing shareholders of Valiant Organics Ltd had 5,864,350 shares. After allotment, the total shares and OCPS of the company increased to 13,982,305. Therefore, on May 6, 2019, when the market opened, the existing shares represented 42% of the total number of shares (= 5,864,350 / 13,982,305) and the newly allotted shares and OCPS represented 58% of the total number of shares (= 8,117,955 / 13,982,305).

On May 6, 2019, the market capitalization of Valiant Organics Ltd was about ₹2,600 cr. Out of this, the existing shares represented ₹1,092 cr (= 2,600 * 42%) and the newly allotted shares and OCPS represented ₹1,508 cr (=2,600 * 58%).

Therefore, from both aspects, an investor realizes that after the merger was completed, the shareholders of ACL accounted for about ₹1,500 cr of the market capitalization of Valiant Organics Ltd.

To ascertain the valuation of the business brought in by the shareholders of ACL as a part of the merger for which they received ₹1,500 cr worth of equity shares and OCPS, an investor needs to see the financial position of ACL.

An investor may find the latest available financial position of Amarjyot Chemicals Ltd (ACL) of FY2018 from the audited financials provided by Valiant Organics Ltd on its website as a part of the notice dated October 15, 2018, for the court-convened meeting of shareholders. In the FY2018 financials, the investor would notice that the business of ACL had a net profit after tax (PAT) of ₹25.9 cr for FY2018.

Amarjyot Chemicals Ltd Net Profit FY2018

Moreover, when an investor reads the annual reports of Valiant Organics Ltd, then in the FY2019 annual report, on page 87, the company intimated to its shareholders that in the merger with ACL, it had received net assets/net worth of ₹73.7 cr.

Amarjyot Chemicals Ltd Net Assets Taken Over And Purchase Consideration

Please note that in the above table, the purchase consideration of ₹8.50 cr paid by Valiant Organics Ltd for ACL is only the face value of the different types of shares allotted by the company. An investor would remember that the market value of these shares on May 6, 2019, was more than ₹1,500 cr.

Looking at the PAT of ACL in FY2018 of ₹25.9 cr and the acquired net worth of ₹73.7 cr, an investor would appreciate that the value paid by the shareholders of Valiant Organics Ltd (more than ₹1,500 cr) is a price to earnings ratio (PE Ratio) over 57.9 (=1,500 / 25.9) and a price to book value ratio over 20 (= 1,500 / 73.7).

An investor would notice that from both the parameters of PE ratio as well as PB ratio, Valiant Organics Ltd had paid a rich valuation to the shareholders of ACL on the merger.

When an investor wishes to analyse the shareholding of ACL, then she notices that ACL was an Aarti group company as the Gogri family members owned a significant stake of ACL as well as Valiant Organics Ltd and were classified as promoters of both the companies.

Notice of the court-convened meeting of shareholders, dated October 15, 2018, page 14:

Amarjyot Chemicals Ltd Shareholding Of Gogri Family

Moreover, the credit rating agency, CRISIL, has also highlighted the strong linkages of Amarjyot Chemicals Ltd and Aarti group in its report for ACL on April 4, 2019:

Association with Aarti Industries: Amarjyot procures bulk of its raw material, and derives a substantial portion of its job-work revenue, from Aarti Industries. The latter’s promoters hold one-third stake in Amarjyot in their personal capacity, along with Aarti Corporate Services Ltd (wholly-owned subsidiary of Aarti Industries).

Moreover, in the notice dated October 15, 2017, for the court-convened meeting of shareholders for approving the merger of ACL with Valiant Organics Ltd, on page 8, ACL had mentioned “csteam@aartigroup.com” as its email address, which might indicate that for all practical purposes, the corporate teams of Aarti group control major aspects of ACL.

The e-mail id for the Transferor Company is csteam@aartigroup.com.

An investor would appreciate that if a company owned by promoters is merged with a public-listed company at a rich valuation, then it effectively means a transfer of economic benefits from minority/public shareholders to the promoters.

In addition, in the notice dated October 15, 2017, for the court-convened meeting of shareholders for approving the merger of ACL with Valiant Organics Ltd, on page 126, ACL has disclosed Valiant Organics Ltd as one of the promoters of Amarjyot Chemicals Ltd (ACL).

Valiant Organics Ltd A Promoter Of Amarjyot Chemicals Ltd

An investor may do deeper due diligence in the merger of Amarjyot Chemicals Ltd with Valiant Organics Ltd and may contact the company for any clarification to make up her mind about the valuation paid by Valiant Organics Ltd to the shareholders of ACL.

Advised reading: How Promoters benefit from Related Party Transactions

4) Withdrawal of capital by the promoters of Valiant Organics Ltd from the company:

While analysing the history of the company, an investor comes across various instances where the promoters of Valiant Organics Ltd have withdrawn capital from the company.

i) Offer for sale in the IPO in 2016:

An investor would notice that the IPO of Valiant Organics Ltd in 2016 was purely an offer for sale where existing shareholders sold their shares to the public. The company did not get any part of the IPO proceeds.

DRHP, July 2016, page 53:

The objects of the Offer are to achieve the benefits of listing the Equity Shares on the Stock Exchanges and to carry out the Offer for Sale… Our Company will not receive any proceeds from the Offer and all proceeds from the Offer shall go to the Selling Shareholders.

The IPO of Valiant Organics Ltd was a fixed price offer where the public was offered 964,800 shares at a fixed price of ₹220/- per share. Therefore, effectively, via the IPO, the promoters of Valiant Organics Ltd withdrew ₹21.2 cr (=964,800 * 220).

ii) Selling shares during H1-FY2021:

While analysing the trend of shareholding of promoters in Valiant Organics Ltd, an investor notices that the promoters’ shareholding in the company declined from 47.77% on March 31, 2020 (Source: BSE) to 42.26% on September 30, 2020 (Source: BSE).

An investor would note that a decline in the shareholding by 5.51% (= 47.77 – 42.26) within 6-months is a significant change in the promoter’s shareholding.

An investor would notice that during H1-FY2021, the share price of Valiant Organics Ltd (without the impact of 1:1 bonus issue in December 2020) increased from ₹1,025/- on April 1, 2020, to ₹2,925.45 on September 30, 2020.

An investor notices that the share price of Valiant Organics Ltd increased a lot during H1-FY2021. It nearly tripled during this period. Therefore, the sale of about 5.51% stake by the promoters during this period might look like a situation where the promoters capitalized on the sharp up move in the stock price to withdraw capital from their investment in the company.

It might represent a situation where the promoters are booking profits on their investment in the company.

An investor may contact the company directly to understand the reasons for the sale of a significant stake by promoters in H1-FY2021.

Advised reading: How to know if Promoters are Losing Commitment to the Company

iii) Sale of shares shortly after the conversion of optionally convertible preference shares (OCPS) by promoters:

While analysing the corporate announcements filed by the company to Bombay Stock Exchange (BSE), an investor comes across a disclosure filed by one of the promoters of the company, Jaya Chandrakant Gogri, on October 13, 2020 (click here). This disclosure contains details of the shares acquired by Jaya Chandrakant Gogri and other promoters by way of conversion of OCPS and the number of shares sold by the promoters during this period.

When an investor analyses the above-mentioned corporate announcement, then she notices that Jaya Chandrakant Gogri and other promoters had acquired a 7.53% stake in the company by way of conversion of OCPS. At the same time, the promoters sold a 5.37% stake in the company (652,300 shares).

Valiant Organics Ltd Conversion Of OCPS And Sale Of Shares

As per the above disclosure, these transactions took place on October 11, 2020. As per the BSE website, the closing share price of Valiant Organics Ltd 2020 (without considering the impact of 1:1 bonus share of December 2020) on October 09, 2020 (Friday) was ₹3,364.15 and on October 12, 2020 (Monday) was ₹3,619.65.

Considering the closing price of October 09, 2020 (Friday) of ₹3,364.15 for the sale of 5.37% (652,300 shares) by the promoters, an investor may note that the promoters withdrew ₹219.44 cr (=3,364.15 * 652,300) from their investments in Valiant Organics Ltd.

For any further clarifications, an investor may contact the company directly about the conversion of OCPS by the promoters and the subsequent sale of shares by them.

iv) Dividends funded by debt:

When an investor analyses the cash flow position of Valiant Organics Ltd year on year, then she notices that in recent years, the company has paid increasingly higher amounts of dividend even when it could not meet its capital expenditure requirements from its cash flow from operations (CFO).

For example, in FY2020, Valiant Organics Ltd reported a CFO of ₹161 cr; however, it spent ₹205 cr in capital expenditure. As a result, it had a cash flow shortfall of (₹44) cr. The company raised debt to meet the cash-flow deficit and its debt increased from ₹77 cr in FY2019 to ₹124 cr in FY2020. However, an investor notices that in FY2020, Valiant Organics Ltd declared a dividend of ₹13 cr, which was almost double of the dividend of ₹7 cr declared by it in FY2019.

Similarly, in FY2021, Valiant Organics Ltd reported a CFO of ₹113 cr; however, it spent ₹159 cr in capital expenditure. As a result, it had a cash flow shortfall of (₹46) cr. The company raised debt to meet the cash-flow deficit and its debt increased from ₹124 cr in FY2020 to ₹186 cr in FY2021. However, an investor notices that even in FY2021, Valiant Organics Ltd increased its dividend to ₹14 cr, as compared to the dividend of ₹3 cr in FY2020.

An investor would appreciate that a company should pay dividends from the surplus/free cash flow generated by it after meeting capital expenditure requirements for future growth. If a company has a negative free cash flow, then it indicates that all the cash generated by the company is being invested back into the business. In such a case, any dividend payments are effectively debt funds being used to pay out money to equity shareholders. This is because money is a fungible commodity.

An investor would note that promoters being the largest shareholders in the company are usually, the highest beneficiaries of such dividends, which are funded by debt.

Going ahead, an investor should keep a close watch on the cash flow position of the company and monitor whether it is able to generate a free cash flow or whether it continues to pay dividends, which are effectively funded by debt.

Advised reading: How to know if Promoters are Losing Commitment to the Company

5) Weak internal controls and processes at Valiant Organics Ltd:

While analysing Valiant Organics Ltd, an investor comes across many instances, which indicate that the internal controls and processes at the company have room for improvement.

i) Managing Director acting as Chief Financial Officer of the company:

Until August 28, 2020, the Managing Director (MD) of Valiant Organics Ltd, Mr Arvind Chheda, also used to have responsibilities of Chief Financial Officer (CFO) of the company. The secretarial auditor of the company highlighted this non-compliance with the law in the annual report of the company in FY2020.

FY2020 annual report, page 39:

Wholetime Director re-designated and appointed as the Managing Director of the Company effective from April 20, 2019 has been continued as the Chief Financial Officer of the Company which in, my opinion, is not in due compliance of Section 203 of the Act.

After pointing out by the secretarial auditor, the MD, Mr Arvind Chheda, resigned from the post of CFO and from August 29, 2020, Valiant Organics Ltd appointed Mr Piyush Lakhani as CFO.

ii) Not registering the logo/trademark:

In the DRHP of the company in 2016, Valiant Organics Ltd highlighted to potential investors that it has not registered its trademark/logo and as a result, it runs the risk of others launching duplicate products with similar logo/trademark.

DRHP, page 10:

We have not applied for our registered trademark or logo and therefore, we do not enjoy the statutory protection accorded with the registered trademark.

DRHP, page 13:

Since our trademark is not registered, it can allow any person to use a deceptively similar mark and market its product which could be similar to the products offered by us. Such infringement will hamper our business as prospective clients may go to such user of mark and our revenues may decrease.

An investor may expect that a company would have its logo/trademark registered. Nevertheless, an investor may contact the company directly to understand whether it has now registered its logo/trademark or it is still running the above-highlighted risk after 5 years of IPO.

iii) Not keeping safe custody of important documents:

While reading the DRHP of the company before its IPO in 2016, an investor comes across disclosure by the company that it has lost many important documents like registration certificate and it does not have the copies of the same as well.

DRHP, page 10:

we have misplaced certain original documents/approvals/permissions and the same cannot be found, neither do we have a copy of the same, including inter-alia our original Certificate of Registration under Maharashtra State Tax on Professions, Trades, Callings and Employments Act, 1975.

iv) Delays in meeting statutory deadlines:

In FY2020, Valiant Organics Ltd did not meet statutory deadlines for many activities. The secretarial auditor highlighted all these non-compliances in its report dated September 2, 2020, in the FY2020 annual report, page 39:

  • Listing of the shares and OCPS issued to shareholders of Amarjyot Chemicals Ltd was done after 111 days from the order of the National Company Law Tribunal (NCLT) instead of the required period within 60 days from the order.
  • Form IEPF – 2 for the Statements for unclaimed and unpaid dividend amounts as of March 31, 2019, which was to be filed within sixty days after the holding of AGM has not yet been filed after a delay of more than one year.
  • Board resolution passed for appointment of Internal Auditor on May 27, 2019, was yet to be filed with Ministry of Corporate Affairs (MCA) even after more than one year.
  • The required details of the Nodal Officer (s) were not filed with IEPF Authority within the stipulated time. Moreover, it did not display the name of the Nodal Officer and his e-mail ID on its website.

Such delays in meeting statutory deadlines in FY2020 was not the first such instance. Previously, in FY2018, Valiant Organics Ltd did not file the board resolution passed on May 10, 2017, for variation of terms of remuneration of the Managing and Executive Directors, with MCA on time.

The secretarial auditor highlighted these non-compliances in its report dated August 8, 2018, in the FY2018 annual report, page 32:

Company has complied with the provisions of the Act, Rules, Regulations, Guidelines, etc. mentioned above except that board resolution passed on 10.05.2017 for variation of terms of remuneration of the Managing and Executive Directors is pending to be filed with MCA

Advised reading: Understanding the Annual Report of a Company

v) No technical support service contract with any competent party:

In the DRHP in 2016, Valiant Organics Ltd highlighted to the potential investors that it has not entered into any support service contract for the equipment and machines, which it uses in production. The company highlighted that it has entered into an annual maintenance contract (AMC) for some of the laboratory and electronic equipment. However, the disclosure by the company seemed to indicate that the company does not have a proper maintenance system for many of its equipment and machines.

DRHP, page 16:

Our manufacturing operations involve daily use of technical equipment and machineries. They require periodic maintenance checks and technical support in an event of technical breakdown or malfunctioning. Our company has not entered into any technical support service contract with any competent third party. However, we have entered into an annual maintenance contract for few laboratory / electronic equipment.

An investor may contact the company directly to understand whether it has now entered into any technical support service contract for its equipment and machines or it is still managing the maintenance of its equipment on an ad hoc basis.

6) Related party transactions of Valiant Organics Ltd:

An investor would appreciate that Valiant Organics Ltd is a part of the Aarti group of Companies. As per the company disclosures in the DRHP before IPO, it was involved in various transactions like the sale of products, purchase of goods and services from other Aarti group companies like Aarti Industries Ltd, Aarti Drugs Ltd and DRL Cargo Carriers Ltd.

DRHP, page 13:

Valiant Organics Ltd Related Party Transactions In DRHP

Similarly, Amarjyot Chemicals Ltd (ACL), which was merged by Valiant Organics Ltd with itself, also had significant related party transactions like purchase of raw material and job-work with Aarti group companies.

The credit rating agency, CRISIL, highlighted these transactions between Amarjyot Chemicals Ltd (ACL) and Aarti group companies in its credit rating report for ACL in October 2017.

Amarjyot has a long-standing business relationship with Aarti Industries. The company procures a large part of its raw material requirement from Aarti Industries and also derives a substantial portion of its job work revenues. Additionally, the promoters of Aarti Industries, members of Gogri family hold ~30.68% stake in Amarjyot in their personal capacity along with Aarti Corporate Services Limited (100% subsidiary of Aarti Industries).

Therefore, an investor would appreciate that both Valiant Organics Ltd, as well as Amarjyot Chemicals Ltd (ACL), used to have business transactions with Aarti group companies.

However, when an investor reads the publicly available annual reports of Valiant Organics Ltd, then she notices that the company has stopped mentioning Aarti group companies especially Aarti Industries Ltd and Aarti Drugs Ltd as related parties.

As per the FY2020 annual report of Valiant Organics Ltd, page 80, the two entities shown under significant influence of the management are Novel Spent Acid Management and Shanti Intermediates Pvt. Ltd.

An investor may contact the company directly to understand the details of its current level of transactions with key Aarti group companies like Aarti Industries Ltd, Aarti Drugs Ltd and its logistics companies. If Valiant Organics Ltd still has business dealings with these Aarti group companies, then she may ask the company about the reasons why they are no longer shown under related parties in the annual report and why business transactions with them are not disclosed.

Advised reading: How Promoters benefit from Related Party Transactions

7) Information in the annual reports of Amarjyot Chemicals Ltd:

While analysing the merger of Valiant Organics Ltd and Amarjyot Chemicals Ltd (ACL) when an investor analyses the past annual reports of ACL, provided by Valiant Organics Ltd on its website, then she notices a few interesting disclosures.

An investor notices that in the FY2015 annual report, Amarjyot Chemicals Ltd (ACL) has disclosed that it is 100% owned by public shareholders and the promoter shareholding in the company is NIL.

Financial statements document (download), page 137:

Amarjyot Chemicals Ltd FY2015 Fully Public Owned

When an investor checks the name of the statutory auditor of ACL in FY2015, then she notices that the company was audited by Madan Dedhia & Associates (as per the above mentioned financial statements document, page 144). An investor should note that Madan Dedhia & Associates was the statutory auditor of Valiant Organics Ltd until FY2018 (as per FY2018 annual report, page 35).

An investor may contact the company directly to understand why in the FY2015 annual report of ACL, the promoter shareholding was shown as NIL and the public shareholders were shown to own 100% of the company.

An investor may appreciate that if the above disclosure about the shareholding by ACL is incorrect, then the investor may be very cautious while reading the information provided by ACL in its annual reports.

The Margin of Safety in the market price of Valiant Organics Ltd:

Currently (July 13, 2021), Valiant Organics Ltd is available at a price to earnings (PE) ratio of about 35 based on consolidated earnings of FY2021. An investor would appreciate that a PE ratio of 35 does not offer any margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

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.

Analysis Summary

Overall, Valiant Organics Ltd seems a company, which is growing at a very fast pace in the last 10-years using both organic as well as inorganic methods i.e. by expanding the manufacturing capacity of its plants as well as acquiring other companies. In recent years, Valiant Organics Ltd has been involved in a couple of mergers where it took over the business of a few companies of the Aarti group.

Until now, Valiant Organics Ltd has faced low competition in its business, which is also helped by the tough environmental and safety regulations for the Chinese chemical industry. As a result, the company has been able to get good pricing for its products from its customers and report good profitability. However, it seems that Valiant Organics Ltd does not enter into long-term agreements with either its customers or its raw material suppliers. As a result, the company faces the risk of losing its customers at short or no notice. The customers can take away their business without any consequences.

In the past, in FY2017, the company faced a tough situation due to delays in import shipments of its raw material. As a result of dealing with very few suppliers with no long-term supply agreements, the company had to buy raw material from local suppliers in the spot market at very high prices, which affected its profit margins as its OPM declined to 25% from 30% in FY2016.

In recent years, Valiant Organics Ltd has merged two Aarti group companies with itself namely, Abhilasha Tex Chem Ltd (ATCL) and Amarjyot Chemicals Ltd (ACL). Valiant Organics Ltd issued shares to the shareholders of both these companies in the merger. When an investor analyses the valuation paid by Valiant Organics Ltd for ATCL and ACL, then she realizes that the company seems to have paid a very rich valuation both from the perspectives of PE ratio as well as PB ratio. We believe that an investor should do a deeper analysis of the valuation paid by Valiant Organics Ltd to ATCL and ACL shareholders in the merger.

An investor comes across many instances where the promoters of Valiant Organics Ltd have withdrawn their investment from the company in the form of an offer for sale in the IPO or by selling shares in FY2021 when the stock price of Valiant Organics Ltd increased. Also, the company had paid out a higher dividend even when the company had a cash shortfall in recent years and had to raise debt to meet its capital expenditure requirements. An investor would note that promoters being the largest shareholders benefit the most when a company payout out dividends, which are funded by debt.

An investor comes across many instances that indicate weak internal processes and controls in Valiant Organics Ltd. Until recent times, the company’s MD used to hold the charge of CFO as well. It seems that the company had not registered its logo/trademark. It has lost many important registration documents and does not have a copy of them. It is not able to meet statutory deadlines for filing many statutory obligations. An investor also notes that Valiant Organics Ltd does not seem to have any technical support contract for maintenance of machinery with any competent counterparty.

We believe that going ahead; an investor should focus on the competitive intensity in the industry of Valiant Organics Ltd. She should monitor the profit margins in the future. She should keep a close watch on the operating efficiency ratios like net fixed asset turnover and inventory turnover, which have declined in recent years. She should keep a track of the generation of free cash flow by Valiant Organics Ltd and also notice whether the company continues to pay a high dividend by raising debt even if it faces a cash shortfall.

The investor should monitor the transactions of Valiant Organics Ltd with its promoter group including any further mergers, sale and purchase of goods and services. She should also keep a close watch on the promoters’ shareholding to see if the promoters are focusing on taking the profits away from their investments in the company, which might indicate a declining commitment of the promoters towards Valiant Organics Ltd.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Valiant Organics 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.

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.

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10 thoughts on “Analysis: Valiant Organics Ltd

  1. Very detailed research and analysis. I appreciate how you put every single detail in an elaborate and easy to understand way. I would like to thank you for this article and all the other content that you have put on this website.

  2. Hi Sir,
    It is a very comprehensive analysis as always. This is very useful in the current environment when all chemical stocks are making lifetime highs. Analyses like these are important to know what can go wrong for a business in the absence of long term contracts. The mergers were not minority shareholders friendly. I am referring to one para: “Therefore, if an investor assesses the predominant value received by the shareholders of ACL upon its merger with Valiant Organics Ltd, then it amounts to 8,315,955 equity shares (= 6,482,868 shares + 1,833,087 OCPS) on May 4, 2019.” Here the number of shares is 6,284,868 I guess and it looks like there is a small typographical error.
    Thanks,
    Omkar Ranjan Sharma

    • Great analysis, Sir. Just one doubt on NFAT, while calculating for half a year, shouldn’t we annualise? Income from operations for the half-year ending Sept. 2016 for Abhilasha Tex Chem Ltd was at 17.09 crore and the fixed assets were 11.32. NFAT=(17.09*2)/11.32=3.02, which is almost equal to last year’s value of 3.08.

      • Dear Tej,
        Thanks for writing to us and point out the error. You are right about the calculation of NFAT from part of the year data. We have rectified the same for Abhilasha Tex Chem Ltd as well as for Amarjyot Chemicals Ltd in the article.
        Regards,
        Dr Vijay Malik

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