My humble suggestion is before you form your conviction on a stock ask yourself as to how well this company is equipped to survive the economic downturn or a bad business environment (which is as inevitable as bull run that we are seeing now). By now you would already be looking at profit numbers, sales growth ROE, ROCE, valuation metrics etc to inform your stock picks. You should also pay attention to if they have the right discipline to manage cash to survive the downturn/bad business environment and if they can start generating lots of cash when the market cycle turns.
So if I were you I’d look at things like company’s debt position, working capital management, capital allocation and cash flow situation. There are several ways to do it. One is to read credit rating reports from agencies such Crisil or Care. These reports describe a company’s working capital practices (inventory, cash conversion cycles etc) over the last few years. These reports also mention the company’s lenders. If the lenders are likes of Kotak’s or HDFC’s then I will worry less as these bankers are extremely good at underwriting and they do a very good due diligence on a company’s business before giving them loan. However if company’s bankers consist of 2nd grade PSU banks I will be careful.
Second is I will look at cash conversion metrics such as working capital management. This data is easily available on screener. I might also check company’s return on assets to get an idea whether the next plant they have built or machinery they have bought is generating enough returns.
For example Shilpa Med’s cash conversion cycle is some 270 days. Which means if they sold their goods on 1st January they won’t get see any cash before the Q4 of year. But in the meantime they need to pay salaries and bills. So to do that they will draw on debt which they will hope to repay with the profits at the end of the year. But Shilpa Med hasn’t generated any profits in the last two years which means they need to keep taking on new debt which is what you see in their balance sheet.
But more debt also means more interest payment which will impact profits. Company is also doing some heavy Capex year on year but return on asset is just not there. In the meantime, high depreciation expense, on these assets, along with high interest payment, will continue to eat into their profit margin from both the sides.
So I see a big fuse lit on this company.
Now if their management on a con-call said something like selling off their assets, pruning their debt, tightening their working capital and improving operational efficiencies, this might become an interesting stock.
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