Why small cap stocks valuations are rotting?

Erstwhile promoters of some of the companies which have changed management tell us - why.

MUDRA LIFE STYLE LTD was sold by the Indian Promoters to a Korean Company earlier this year. The company has now reported a loss of Rs 199.29 cr in Q2FY12 on a sale of Rs 44.90 Cr. The loss looks extraordinary by any standard. In fact they are. But if you read the notes below the tabulated result, the reason for the loss is write off/ down the values of inventories taken over by the new promoters at the time of acquisition. And one of the reasons for write off is NON EXISTING INVENTORY found during the course of stock audit conducted by the independent auditors. This not only a poor corporate governance but it is a FRAUD. This is similar to Satyam where the promoters had inflated cash and here Mudra Lifestyle inflated stocks. Erstwhile promoters have been inflating inventory and showing stocks which were not there to show not only higher profit but also to take loan from banks as well.

Somewhat similar issue is also there in case of ISPAT INDUATRIES LTD as well. Subsequent to the takeover by JSW, the company made a provision of over Rs 1180 Cr within 6 months of taking over the company by the new promoters under various heads. The point is, how come these amounts which were good till 6 months back, can become bad immediately on change of management. Simply, these were bad earlier also but shown to be good to keep balance sheet healthy. Else, how would someone explain for these provisions just because promoter shareholders have changed?

More recently, the new promoters of THE ANDHRA PAPER MILLS LTD also had to make provision of Rs 26.50 cr subsequent to taking over charge.

However, all small cap stocks cannot be bad. One is required to make proper research before making investment decision but sometime it is really difficult and for common investors, it is just impossible.

Jubilant Industries Ltd

Jubilant Industries Ltd (JIL) – Scheme of Arrangement a wealth creator or destroyer?

JIL has come out with a scheme of arrangement wherein its Agri & Consumer Division will be transferred to its wholly owned subsidiary company Jubilant Agri & Consumer Products Ltd (JACPL). There is nothing wrong with this as long as, aim is to give undivided management attention to this business. But what is really disturbing is merger of hugely loss making  Mall & Hypermarket business (Retail Business) of promoters closely held company Enpro Oil Pvt Ltd with JACPL.

Retail Business which is getting merged with JACPL has been making huge losses since inception, having made loss of over 300 cr since inception. During FY11 alone loss was in excess of 71 cr on a turnover of Rs 300 Cr. against JIL Profit before Tax of only Rs 40 cr during FY11. Thus loss of retail business exceeds the profit of JIL.

With the merger of Retail Business with JAPCL, profit of Agri & Consumer division which is getting transferred to JAPCL will be used to finance the losses of Retail Business.

Besides this loss making retail division, JAPCL is also taking over loan and net current liabilities of over Rs 238 cr from the promoters.

Now the question is what is the rationale of this merger? Is it that the management wants to share the so called bright prospect of retail business in India with the public shareholders, or it wants to fund the loss of a privately held company with the profit of a listed company at the cost of minority shareholders.

Given the finance of the retail business, certainly management is not sharing goodies with the minority shareholders, so ultimately, it is the loss which is getting transferred from closely held company to the listed entity. As usual, minority shareholders are taken for a ride.

Above all, this is coming to the shareholders of JIL at a cost of Rs 200 cr. (Present market value of 38.35 lac shares of JIL to be issued to the promoters in consideration of retail business and excess of liability over assets of Rs 123 cr to be taken over by JAPCL).

DFM Foods Ltd

Got a Brand or Product that sells ? – Your Balance Sheet will speak.

One does not often get the opportunity to come across Balance Sheet like DFM Foods Ltd, that too from a small cap sector. It is truly amazing for this Rs 120 crores company selling CRAX and NATHKATH brands packaged snack foods.

Consider some of these truly admirable figures in the Balance Sheet:

1. FY11 sales at 120 Cr but debtors just Rs 29000. Not even one day sale. That means products are in great demand or DFM knows how to sell. Customers and dealers are not required to be given any credit. If DFM can sell its entire products on cash basis, there is no denying that they have got a product or a brand or both.
2. Not only this, DFM inventory of Finished Stocks is just Rs 81 lacs. It is just 3 days sales. DFM dispatches every thing the moment it is produced. No need to stock. Meaning customers have lined up with cash to take the material  
3. So, no debtors, no finished stock then what next. What is even greater indicator? It is advances from customers. Yes sir, that is also there. DFM has advances from customers to the tune of Rs 5.20 crores. That is around your 15 days sales.
4. If you have these three extra ordinary indicators of your Brand, Products and sales ability, why sales during last 3 quarters are stagnating. Sir, plant running at 100% capacity.
5. Then what do you do? Expand. Doing Sir. New Plant is under construction at a cost of Rs 70 crores and will be ready by 3^rd Qtr of this year.
6.  How DFM using cash flow. Already bought land for new plant for Rs 9 crores. Given advance for capital goods of more than 4 crores. No additional loan till date. But will take when construction picks up.
7. Some concerns as well. Dispute is there with excise department regarding classification of the products.

Market is also quick to recognize these facts. Stock is quoting near to its all time high even during this uncertain time. Market cap is just at 1.5 times its sales.

Opto Circuits (India) Ltd

Value addition (manufacturing expenses) is a surprise.

For the first time, I went through the Annual Report of Opto Circuits (India) Ltd.

What looks great about the company is the margin in its medical devices business and also surprising is the value additions it does in its Indian operation.

1. Opto manufacture/assemble medical devices for 100% export.
2. It imports almost every thing (99%) what is required for manufacturing/ assembling
3. To manufacture medical devices whose sale value was 603 cr, labour charges was just over 1 crore, (thus operation is not a labour intensive), power & fuel was less than 1 crore (neither the operation is power intensive), other expenses including repairs and insurance etc do not add to even one crore (so other cost is also negligible).
4. One is made to think, what one can add value to imported raw material by spending not even one percentage of sales value and then sell it at a margin of over 35%. The products are sold in USA and Europe markets.
5. What Opto possesses which the manufacturers of these raw material do not have ? They loose huge margin if they sell final products instead of selling raw material to OPTO.
6. I thought, might be company may be making these raw materials in one of its overseas subsidiaries and final assembling is done in India. But these are not the products of any of its overseas subsidiaries as there is hardly transaction with them.
7. I thought India is a big medical market, but none of these equipments are sold in the country.
8. Company does not pay any taxes as its profit being profit from export.  but huge dividend payment is one thing which compel you to think.

What will Coal India do with its huge cash ?

Coal India Holds Cash of over 45000 cr as on 31^st March 2011. During last ten year, since 2001 when cash balance was around 1000 cr, every year cash balance has gone up to reach this level, even after spending for capex.

I can imagine if this trend continues, Coal India will be having more than 1 lac cr in cash in next 5 years. Even if we take into account all the expansions that Coal India proposes to undertake in next 5 years, it will not be able to use this mammoth cash and future its cash flows.

Co or the Govt. must find better use of this money rather than keeping the same in the bank. It is pity that when entire power and other  sectors in the country is starved of coal, Coal India  keeps on adding cash balance year after year. Can’t the company become more aggressive in opening more mines and help the country in developing infrastructure.

We blame shortage of funds for our poor infrastructure but when it is available there is no taker.

Compact Disc Ltd - Delisting cannot happen

Compact Disc Ltd is in the news since January 2011 for delisting. It is now almost over 6 months, but delisting has not happened. My view, it will never happen. Reason, delisting is a ploy of the management to manipulate the share price. There are several arguments in favour of my view.
1. The balance sheet is hugely manipulated. The company has no business and thus cash in the books to support the delisting.
2. Why the management will go for delisting ?. Normally the management of this size of companies, would like to keep shares delisted so that they can raise funds at will in future.
3. If the management feels that the share prices are low, they can make creeping acquision. but the management is not doing. The company can also go for buy back, if they have surplus fund.
4. Management holds around only 25% shares. To delist company would require 65% shares out of 75%. This is simply not possible in a listed company. The management understands this, thus this trick of delisting to raise share price.

Bartronics India Ltd - Another Satyam in making

 Bartronics India Ltd :   - Another Satyam in making ?

Company is supposed to be in RFID and Cards Business –

But  company’s sales is comprised of :
Sooftware Export – Value Added : Rs 127.87 Cr
Software Export – Self Developed : Rs 174.68 Cr
Manufacturing : Rs 29.11 Cr.
Trading in Software & Hardware : Rs 226.73 Cr

Against Software Export (Value added) of Rs 127.87 cr, company bought imported Software for Rs 112.97 Cr and after accounting for Opening/Closing, net software consumption was Rs 108.45 Cr – Thus Gross Margin earned Rs 19.42.  No manufacturing activity has taken place in the company for this item.

Against Software Export – Self Developed of Rs 174.68 Cr – company’s claim is that the same was developed in previous years by the company and no expenditure was done during the year. (During last year also company exported software worth Rs 100.08 Cr.).  Thus Gross Margin earned during the year is Rs 174.68 Cr.

Let us consider some of the points in respect of its income :

When the company is capable of developing its own software, why it is importing and what is this import. This could be to inflate the sales and book some Profit (Tax free).

Company claims to have sold software developed by it in the previous years. During last 2 years itself, company has sold software worth Rs 274.76 cr. It is common that to develop software, only raw material is manpower. During last 9 years amount spent by the company on salary & wages is only Rs 19.73 Cr. These salary expenses also includes, salary for other manufacturing activities undertaken by the Company.

Against the trading sales of Rs 226.73 cr, company has purchased (imported) software and hardware for Rs 192.03 Cr. It is difficult to understand the difference between trading sales of software and Software Exports (Value added). Both the sales have been against import only and there has been no value additions by the company.

Apart from above items of sales, company has booked revenue against services for Rs 21.70 Cr. Against this, the company has spent Rs 20.12 cr towards sub – contracting charges so no value added here also.

To highlight, the kind of manufacturing activities or value additions, the company does, let us see some (in fact all) of the expenses it has incurred during the year.

Salary & Wages : Rs 5.67 Cr

Factory Maintenance Rs 0.34 Cr

Power & Fuel Rs 0.46 Cr

Insurance : Rs 0.78 Cr

Printing & Stationary : Rs 0.23 Cr

Communication Expenses : Rs 0.37 Cr

Travelling & Conveyence : Rs 1.41 Cr

Repairs & Maint (others) Rs 0.57 Cr

These expenses has to be seen, considering the fixed assets base of Rs 71.23 cr in Plant & Machineries, Rs 104.65 Cr in Computers besides investment in building, electrical installation, vehicle etc. Thus there are hardly any manufacturing activities in the company.

Now consider Balance Sheet items:

Fixed Assets :
Company has added Rs 62.57 cr towards computers during the year. This is over and above the existing computers of Rs 45.35 cr.  Against this Salary & Wages expense of the company for the year is only Rs 5.67 cr that too has come down from Rs 6.39 cr. The activities within the company hardly justify huge additions of computers. Auditors have also qualified its report on fixed assets register.
The Company has made capital advance of Rs 183.22 Cr included in total capital WIP of Rs 206.54 Cr. – This seems to be next to impossible considering financial condition of the company as explained later in this note. The company has outstanding capital commitment of over Rs 267 cr as on 31/3/2010.
Fixed assets also include software for Rs 176 cr capitalised in the past.

Sundry Debtors :

Against total sales of Rs 581.58 cr, outstanding from customers are Rs 568.66 cr, which shows that the products sold by the company has no priority for the customers.

Sundry Debtors includes amount outstanding over 6 months Rs 270 Cr. Against total sales of Rs 587 Cr.

Loans & advances :

Company has given advances to its subsidiaries for Rs 317.61 Cr which is largely due from 2 of its subsidiaries as under :

Bartronics America Inc USD 48,752,556 (  Rs 219.38 Cr. @ 45/$).  This amount is bad because this subsidiary does not have any assets – Entire amount has been used in Goodwill Rs 150 Cr (at Rs 45/-$), Intangible assets Rs 77.35 Cr (at Rs 45/-$), and other assets which includes debtors, inter company receivable etc. The subsidiary has liability of Rs 32.26 cr as well.

Bartronics Asia Pte Ltd USD 21,097,042. (Rs 94.94 cr). – The company does not have any assets except Trade receivable running since last year. Probably very doubtful of recovery.

Sundry Creditors :

Against total purchases of Software/Hardware/Raw material of Rs 328 cr, amount due to the creditors is Rs 229 cr showing the truth behind it.

Secured Loans :

During the year the company raised additional loan of Rs 138.53 cr from banks taking its liability to Rs 395.57 cr.

Promoters Contributions :

Promoters raised through preference issue/ warrant Rs 103.68 Cr.

Now, Consider some of the points which shows that the company has no corporate governance, no liquidity (bankrupt) and the promoters are just manipulating the accounts.

The company is wilful defaulters of Income Tax and other taxes having not paid even undisputed income taxes for the years from 2007-08 to 2009-10 amounting to Rs 23.54 crores.

All other taxes like PF, ESI, Professional Taxes, FBT, Services Taxes etc have not been deposited in time.

Loan repayments have been delayed upto 6 months.

How can a company which has raised more than 100 cr from promoters, raised additional loan of Rs 138 cr from banks, and which has made capital advances of Rs 183.22 cr, default on admitted tax liabilities and does not pay its taxes in time. During the year debtors has gone up by Rs 350 cr..

To sum up, The company has no business model. Accounts are unrealistic and in all probability crooked up. Most of the assets it shows are not realisable. It is engaged in bogus software trading. Co is doing very small manufacturing activities of around Rs 20 cr or so. The company activities hardly require any managerial inputs. Quality of fixed assets is highly doubtful, advances for capital assets is uncalled for as these are not supported by any business plan. Some or most of the sundry debtors are never going to be realised if company stops making sales. Advances to subsidiaries are fully bad as subsidiaries have no assets to pay back. Bankers run the risk of loosing their loan money. Company has subsidiaries at USA and Singapore whereas 80% of exports are to Hongkong and UAE. Only 3% export is to USA.

Moreover, Rs 225 cr FCCB is due for conversion/ redemption  in 2013 at substantial premium to present market price. If redeemed company has no resources for that.