14 – Current temptation, future frustration

The 14th part of the Series is “Current Temptation, future frustration”. This series is based on the companies which are currently darling of the market and many trying to catch such opportunities but it has a probability to become a reason for future frustration. It can wipe out the majority of gains in wealth. I am trying to put some of the number-crunching facts by which we can identify ongoing issues in the companies and can save our wealth.

I am starting this article with one of the company which is engaged in the business of Solar consulting & EPC have a 52 weeks low price of Rs.296, 52 weeks high price of Rs.1,990, and LTP is Rs.1,133. This company has rewarded ~283% of return in a year with LTP, and 572% of return in a year with 52 week high.

Let’s start looking at the numbers.

We can see that the company has a decent promoter holding which gives confidence to many people but with it, promoters of the company have ~30.93% of their holding pledged.

We can see the all-time high sale of the company with Operating profit. Even if we look at the CAGR of sales as well as profit then it is also on the higher side.

When we look at the balance sheet then we can see that the company has continuously raised its share capital, now need to check that either through fundraising or through corporate actions. The borrowing of the company is also growing rapidly. If we look at it in detail then the company has raised funds in FY20 and announced a bonus in FY22.

If we look at the numbers with connections then we can come to know that share capital is growing in line with sales growth. But borrowings and working capital are growing at a rapid pace compared to sales growth, which indicates that the company requires a higher working capital as well as borrowings to fund its growth. The reserves of the company are also growing rapidly which is a good sign to fund the growth of the company.

When we look at the cash flow statement then Cash from Operating Activity is -ve in some of the years. The cumulative CFO of FY17-22 is Rs.-19 cr with FCF of Rs.-79 cr so the company needs outside funding for supporting the growth. If we look at the cumulative operating profit and net profit then it is Rs.47.72 cr and Rs.29.65 cr for the same period. This indicates that the company cannot able to convert accounting profit to cash profit.

If we look at the receivables and inventories as a % of sales then it is 60% of sales whereas payable is just 8% of sales so the company needs a higher working capital to fund growth. The Cash Conversion Cycle is continuously worsening mainly due to higher inventory days. The company takes almost 8.5 months to convert its spending into cash.

We can see that the company keeps on diversifying from its original business, even though the company has not properly captured its original business. The existing business is still struggling to strengthen its financial performance and venturing toward new business can be harmful to the business going forward.

This entire series is based on past available data and ignored the future development of companies and the stock market always looks at the future.

Disclosure – Companies mentioned in the article are just for example & educational purposes. It is not a buy/sell/ hold recommendation.

This series contains learning from books –

Financial Shenanigans

Quality of Earnings

The Financial Numbers Game

Creative Cash Flow Reporting