La cort de Venus

The current article in this series provides responses related to:

 Queries on pledging of promoters’ shareholding

 Revaluation reserves and its impact on taxes & valuation

 Meeting with managements & share warrants

 Capitalization of investments in wholly owned subsidiaries

 Applicability of self-sustainable growth rate (SSGR) and free cash flow (FCF) metrics to banks/NBFC/financial institutions

 Usage of last 10 years of financial data for analysis of companies

Query

I have done a personal analysis of Cox and Kings and I am bullish on this stock due to strong financial parameters. But one thing that concerns me is that the company has some 45% of promoters total shareholding pledged. I know that pledge is dangerous and have seen the terrible consequences in the past. But is it also dangerous when the company has solid interest coverage ratio and very good free cash flow and future also looks pretty bright

A1: Ideally, any pledge of the shareholding of promoters' should be seen with caution. However, many times, banks stress on promoters of small companies to pledge their shares in favour of banks, in order to mitigate their risk and to increase the commitment of the promoters in repaying their loan. If the promoter is a small time entrepreneur, then he/she has no other option but to pledge the shares, however, promoters of large companies have many other competing financial institutions, which can give them loans. Therefore, if the shareholding of the promoter of a large company when pledged, should be seen with extreme caution and should be analysed further to know whether the promoters' shareholding is pledged for loans taken by the company or for loans taken by the promoter in its personal capacity. The annual report of the company contains required information to make this judgment. Therefore, any pledging of shareholding by promoters of large companies should be treated with caution.

Query

Read: Analysis: Indo Count Industries Limited. The notes on Revaluation Reserves is very interesting.

Please clarify, does the company also considers the same methodology in calculating net depreciation (after revaluation) for computation of corporate tax. If they do, what’s the advantage as there will be more tax outgo in initial years? Please correct me if I miss anything. Please also suggest me some company Annual Reports you find it more interesting and knowledgeable.

A2: The company has been showing lesser tax in cash flow statement than the tax expense in profit &

loss statement. Even though the company has shown net tax paid (adjusting for refunds, if any), still, the difference of the tax between P&L and CF statement is significant. Looking at the amount of difference in tax between two statements for FY2016 ( 73 cr), it looks highly likely that there would be many other₹ factors other than the treatment of revaluation reserve, which has led to this difference. One reason might be that the revaluation reserve, which is adjusted from depreciation in P&L might not be adjusted in IT return filing, which can be one of the reasons leading to the higher tax payout in P&L. It needs to be confirmed by any tax consultant or from the company. The higher tax payout as per P&L might not be a very undesirable thing for promoters as even after payment of 33% tax on it, the balance 67% gets reflected in PAT, which in turn increases the EPS and thereby increases the share price, which in majority of cases is based on a P/E ratio. Therefore, as the EPS increases, the market sentiment towards the stock changes and this, in turn, expands the P/E ratio as well, which in turn creates wealth. A similar case

was seen in Emami Limited. You may read its annual report as well as the analysis of Emami Limited present on drvijaymalik.com

Query Two questions:

1) How Important is meeting the management as companies typically do not disclose all the details in annual reports and most of the information is not available online regarding the company. What is your approach regarding this?

2) Since reading the Indo count analysis - I had a different thought, given that management has increased stake in the company, definitely, they expect stocks to give them a better return. Wouldn't it be in fact be likely for us to invest some portion and track the progress? As we can see in the case of Indo count itself, it has a good return. I am sure management would not risk their equity valuation going down.

What would be your take on this?

A3:

1) I do not believe that meeting the management is necessary for making an investment decision. On the contrary, meeting the management might introduce biases in the investor's analysis. I believe that the major stress should be given on analysis of publically available information about the company, management's decisions and their outcomes to create an opinion about the competence and shareholder friendliness of the management. An investor may attend analyst conference calls or meet investor relations/company management to understand the business of the company, however, one should not get influenced and misinterpret the management vision as a sign of competence.The investor should have her own independent opinion about the management quality based on the data evidence.

2) The interpretation of the events like warrants allotment & their usage for personal benefits is dependent on the investor. A market is a place where different people interpret same information differently and then take opposite sides of the trade (buy & sell). I believe that an investor should choose an investing approach, which she feels comfortable about. In case, an investor believes that the warrants subscription by the promoters is a sign that share price is going to rise, then she may take an appropriate investing decision. On the contrary, if an investor believes that such a step is like taking advantage of minority shareholders, which most of the times, cannot influence such decisions, then she may refrain from investing in such stocks.

Query

What are your views on capitalizing the WOS (Wholly Owned Subsidiaries) by Quick Heal Technologies Limited?

A4: Looking at the disclosure, it seems that the company has made investments in its subsidiaries by subscribing to shares of the subsidiaries. This is normal practice and such investments are reflected in the non-current investments section of the balance sheet under equity investments. On the face of it, it seems like a normal business transaction. The details of the treatment of the same in the FY2017 annual report might throw some more light on the transaction.

Query

I had attended your 2nd peaceful investing workshop at Mumbai and this article was a great revision of sorts. However, could you explain how the SSGR as formulated by you and the requirement to have FCF can be used while studying financial institutions like NBFCs? Does the concept remain same?

A5: SSGR & FCF are highly relevant for companies, which have to rely on assets for generating new business. This is because SSGR relies heavily on the net fixed asset turnover (NFAT) and FCF is a result of capital expenditure (capex). For companies like financial institutions/NBFC/IT companies, which are mainly service industries and new business does not depend a lot on the amount of fixed assets, SSGR &

FCF do not retain same importance.

Query

As I know your analytical approaches that we should watch at least past 10 years track record of the company, but sir, if we take back 10 years back then I think the script which able to become multibagger already became multibagger I mean already went up so much , how are u justify this sir, please explain.

thanks doc

A6: There are different investors in the market, who specialize in investing in companies at different stages of their life cycle. There are some investors who believe in investing in newly formed business: like seed funding, angel investors, venture capitalists. There are other investors, which invest in businesses that have seen the light of the day and have a history of operations of a few years like private equity funds. Then, there are investors who invest only in large established companies and prefer dividends and safety of capital. It is, therefore, advised that an investor should find out her own preferred area of investing and search for companies accordingly. In case, an investor believes that a company with 10 years of good performance would have already become a multibagger, then she should focus on companies, which have a shorter period of good performance.