03 – CURRENT TEMPTATION, FUTURE FRUSTRATION

Posted on October 4, 2020 by Jimit Zaveri under Current temptation, future frustration

The third part of Series “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 series with one of the company which is engaged in manufactures industrial speciality oil, ink oil, residue oil, Jal pentane mixture and lubricants, has a 52 weeks low price of Rs.48 and LTP is Rs.139. This company has rewarded ~2.90x of return in a year.

Let’s start looking at the numbers.

We can see that the company generating profits. But the company do not have major other expense means the company do not have major fixed assets or borrowings.

When we look at the balance sheet then it seems that the company does not have any issue except debt. But when we look at the receivables then we come to know that the company has 68% of receivable of total sales in FY20 but do not have major inventories. Is this a manufacturing company or an IT company? So that though the company make profits but cannot able to convert it into cash flow.

But there are more cockroaches available.

Journal entry of Deferred expenditures

Deferred expenses Dr

To Cash

So that here expenses directly get settled into the balance sheet and do not comes to an income statement. If this charges debited to income statement then the company is into the losses, not in profits.

Journal entry of Deferred Income

Cash Dr

To Deferred Income

When have to give effect to income statement then

Deferred Income Dr

To Revenue

Again, a direct balance sheet effect rather passes through the income statement. This income can be used for future drought period.

The company has contingent liabilities ~23% of revenue and ~11.71x of net profit.

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

Disclosure – Companies mentioned in the article are just for an example & educational purpose. 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

02 – CURRENT TEMPTATION, FUTURE FRUSTRATION

Posted on September 20, 2020 by Jimit Zaveri under Current temptation, future frustration

The second part of Series “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 series with one of the company which is engaged in manufacturers of Wind Turbine Generators (WTGs) in India, has a 52 weeks low price of Rs.16 and LTP is Rs.48.15. This company has rewarded ~3.01x of return in a year.

Let’s start looking at the numbers.

We can see that the company has a declining trend of revenue, operating & PAT level also incurring losses. But the company has delivered a good return in a year so it might be possible that the company has a strong balance sheet.

When we look at the balance sheet then I got shocked. The company has trade payable, inventories and receivables are higher than sales. Also, the company is getting higher advances from its customer which is again higher than sales so that the company should have a monopoly and everyone wants its products only. But then why revenue keeps on declining?

Cash conversion cycle of the company is of 497 days in FY20 means its take almost 1+ years to convert to cash. Even the company has receivables, inventories and payables as a % of sales are 174%, 131% and 139% respectively.

When I have looked at the related party transaction then Rs.450 cr of sales in FY20 and Rs.648 cr of sales in FY19 done through related parties which are 59% of sales in FY20 and 45% in FY19.

Another part, when we look at the advances from customers then all are from related parties only. This trick is used by the company to show slightly better CFO. Also, receivable from related parties is 20.49% of total receivables in FY20 and 18.40% in FY19. And if we look at the receivable as a % of sales to related parties then it is 60.16% in FY20 and 46.31% in FY19. Now, I am curious that related parties have ~Rs.1100 cr of the fund to give as an advance but do not have Rs.270 cr to pay for receivables.

When we look at the exposure of the company to related parties then it is worth of Rs.865.46 cr in FY20 and Rs.708.10 cr in FY19 which is 16.35% in FY20 and 14.94% in FY19 of total balance sheet size. These related parties are making losses.

The company has Cumulative CFO < Cumulative PAT which shows difficulties to convert PAT into Cash Profit. Also, CFO is artificially boosting through advances from customers which is from the related parties.

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

Disclosure – Companies mentioned in the article are just for an example & educational purpose. 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

13 – ONCE A DARLING, NOW AN EVIL

Posted on September 6, 2020 by Jimit Zaveri under Once a darling, now an evil

The 13^th part of Series “Once a darling, now an evil”. This series is based on the companies which were once upon a time darling of the market and now, it has wiped out the majority of all those gains. I am trying to put some of the number-crunching facts by which we have identified ongoing issues in the companies and have saved our wealth.

I am starting this part with one of the company is in the business of manufacturing and trading of iron and steel products which has an all-time high price of ~Rs.443 in 2012 and now last traded price at Rs.1.59.

In the first instance this company having a huge sales growth. But PAT has huge volatility.

So, we go deeper ….

Here, we can see that debtor day and inventory days are growing rapidly and assets utilization & return ratio are falling.

I would like to go further detail of it.

Here, we can see that CFO is very volatile with cumulative CFO of FY09-12 is Rs.-20 cr whereas cumulative PAT is Rs.88 cr so that CCFO<CPAT which indicates that the company has a working capital issue which we have seen in debtor days and inventory days also.

The company shows good depreciation cover because of the capitalization of assets. One can improve depreciation cover either through improving EBIDTA or by reducing depreciation. If an asset is capitalized then it is not expensed in the same year the asset is purchased. So that here the company has selected to reduce a depreciation.

Actual Journal entry of depreciation

Depreciation A/C Dr

To Accumulated Depreciation or Fixed Assets A/C

Here, depreciation charge at income statement which will reduce the bottom-line of the company. And also added to the accumulated depreciation or directly reduces from the fixed assets so that value of fixed assets gets reduced.

But what happens when the company has decided to go for capitalization of depreciation

Fixed Assets A/C Dr

To Cash A/C

Here, the value of fixed assets gets increased rather than getting it reduced and cash will directly getting reduce with that amount. The income statement does not have any impact it which resulted in reduces depreciation expenses and improves bottom-line.

So that when the company is making a capitalization of depreciation then we have to look at the FCF rather than just check CFO. And when we go for FCF then it’s negative in all the periods. Capitalizing an expenditure enhances current profitability and increases reported cash flow from operations. Capitalization of depreciation will increase the value of assets which is not a part of CFO but it’s a part of CFI so that FCF will provide us a better picture.

Also, the company does not have any interest cover.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. 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

01 – Current temptation, future frustration

Posted on August 22, 2020 by Jimit Zaveri under Current temptation, future frustration

I have started with series “Once a darling, now an evil“ is based on the companies which were once upon a time darling of the market and now, it has wiped out the majority of all those gains. This series has received lots of love and recognition. Majority of readers of the series has demanded current darling which can have the potential to become evil. I cannot refuse the request of all loyal readers who keeps on encouraging me. So, on an auspicious day, I am going to start with this new series with all your love and wishes. 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 wish this series “Current temptation, Future frustration” also receive all your love and recognition.

I am starting this series with one of the company which is engaged in the business of high-end speciality chemicals, has a 52 weeks low price of Rs.0.95 and LTP is Rs.9.90. This company has rewarded ~10.42x of return in a year.

This company at least earns revenue. ? But revenue not growing and even going down year-on-year. Let’s look further because at the lowest price the company traded at Mcap/sales of ~0.15x.

It’s not time to get happy by just looking at the revenue. When we look at the balance sheet then we noticed that the company has higher receivables and inventories.

Receivable and inventory as a % of sales continuously growing with stable payable which will worsen cash flow from operating activities of the company.

Wow…. Let’s drive Volvo and Jaguar with the money of shareholders (the majority of shareholders are very busy and does not have time to look at this).