Sanjoy Bhattacharyya & Prof Sanjay Bakshi Load Up On “Hidden Gem” Quoting At “Compelling Valuations”

Dreams of being “next Page Industries” go awry amidst fears of being “next Satyam”

At one time in the not-so-distant past, leading experts recommended a buy of Kitex Garments on the basis that it had the credentials to be the “next Page Industries” and of creating untold wealth for its shareholders.

This proposition was endorsed by Prof Sanjay Bakshi, the authority on value investing. The Prof wrote a detailed teaching note titled “The Importance of Unconventionality” in which he heaped lavish praise on Kitex Garments. He said:

“As gigantic customers like Carter’s, Toys “R” Us, Gerber, and The Children’s Place divert more of their sourcing requirements to Kitex, I expect the company’s revenues and earnings to grow manifold over the next decade.

Despite its tiny size, the company enjoys significant power over its much larger customers which is reflected in improvement in its profitability and working capital situation. EBITDA margins have improved from 16% in 2008 to 24% in FY14. Working capital turns have improved from 4x to 11x over the same period. In FY14, Kitex delivered a 60% pre-tax return on equity with no net debt.”

The Prof also made it clear that he has invested in Kitex Garments:

“As I write this, the current market price is Rs 492 per share. I have no target sell price, and I haven’t sold a single share. Moreover, I feel good that I invested in this pro-social, and yet highly profitable business – a combination I absolutely love.”

Unfortunately, for reasons that are not entirely clear, the stock lost favour amongst the cognoscenti. The experts at the valuepickr forum expressed concern that the affairs of the Company looked “too good to be true” and that there appeared to be “funny math” going on.

The fears centered on a whopping sum of Rs. 200 crore which the Company claimed to have deposited in a foreign EEFC account for an inordinately long time at zero interest. The experts argued that this decision defied logic because the sum would earn huge interest if deployed in India and also be spared of adverse foreign currency fluctuations.

It was also suspected that the receivables looked disproportionate in comparison to the growth in sales.

Receivables up 53.2% for #KitexGarments in a yr when sales up 6.7%; debt has been pared a bit but the 'infamous' cash now gone up to 249cr.

— Alokesh Phukan (@greyfool) April 4, 2016

The allegation that the Company could be the “next Satyam” has spooked investors to such an extent that the stock is still down 47% on a YoY basis and 4% over 24 months.

The extent of the underperformance of the stock has to be gauged in the light of the fact that we are presently in a raging bull market where even junkyard stocks are soaring to new heights.

Prof Sanjay Bakshi rubbishes concerns by buying truckload for ValueQuest

The Prof has so far maintained a studied silence on the issue of Kitex Garments. He has not issued any clarification on whether he still stands by what he said in his teaching note or not.

However, actions speak louder than words.

The Prof has sent a clear message that he regards all concerns and allegations about Kitex Garments as being baseless by getting Value Quest India Moat Fund Limited, his PMS Fund, to buy a massive truckload of 7,86,097 shares of the Company as of 30th September 2016. The investment is worth Rs. 34 crore at the CMP of Rs. 436.

It is notable that as of 1st April 2016, the Fund held 279,319 shares and that 506,778 shares have been added in the period from April to September 2016.

It is also notable that this is the second major investment by Value Quest India Moat Fund. We saw a few days ago that the Fund has invested a similar amount in Wonderla Holidays.

Sanjoy Bhattacharyya endorses Prof Sanjay Bakshi’s choice

Sanjoy Bhattacharyya, the doyen amongst value investors, has come out with all guns blazing in favour of Kitex Garments. His fund, the Ocean Dial Gateway To India Fund, has invested an undisclosed amount in Kitex Garments.

Ocean Dial has also issued a detailed note in which it has explained all the virtues of Kitex Garments. The salient points made in the note can be summarized as follows:

(i) Scorching track record of growth over the past ten years with 35% operating margins and 25% ROCE and net cash;

(ii) Business model has strong pricing power and deters competition with high barriers and high switching costs;

(iii) Infant wear business is recession proof as doting parents are not cost conscious;

(iv) High quality production and safety standards;

(v) Good employee relationships and productivity;

(vi) Revenue has grown at a CAGR of 17% in the past 10 years. Management is confident of growth at 20% CAGR due to expansion of client base and increase of market share in USA and Europe;

(vii) Risks of high client concentration are being addressed;

(viii) Risk of conflict with family owned concern is addressed by ensuring full transparency and appointing Ernst & Young as consultants.

“Hidden Gem” quoting at “compelling valuations” with likely “re-rating”

At the end of the detailed analysis, Ocean Dial has opined that Kitex Garments is a “hidden gem” owing to its operations on a global scale, a marquee client base and sufficient barriers to entry to maintain pricing.

It is also claimed that the present valuations of 13xFY18 PE are “compelling” and that re-rating in the valuation is likely, subsequent to the merger of the family business with the listed entity.

Ashish Kacholia defects to camp of arch rival S. P. Apparels Ltd

In an earlier piece, I pointed out that Ashish Kacholia, who held 475,000 shares of Kitex Garments, had dumped his holding in a hurry. He was probably spooked by the numerous allegations made with respect to the affairs of the Company.

The latest news is that Ashish Kacholia has shifted his allegiance to S. P. Apparels. As of 30th September 2016, Kacholia holds 6,11,856 shares of S. P. Apparels which is worth Rs. 20 crore at the CMP of Rs. 322.

SP Apparels is an arch rival of Kitex Garments. It also manufactures infant wear and targets the same customers as Kitex does.

Prima facie, SP Apparels also appears to be a powerhouse stock. It reported blockbuster Q1FY17 results with the net profit surging to Rs 16.4 crore from Rs 6.7 crore in Q1FY16. The revenue grew 17.8 percent to Rs 149.8 crore from Rs 127.2 crore earlier. The Earnings before interest, taxes, depreciation and amortisation (EBITDA) increased 79.4 percent to Rs 32.3 crore, while EBITDA margin expanded 670 basis points to 19.9 percent from 13.2 percent.

SP Apparels sells products under the well-known “Crocodile” brand and plans to open 70 exclusive outlets in India.

Rana Plaza collapse tragedy a boon in disguise for Indian apparel manufacturers

Bangladesh has a stranglehold over the garments industry thanks to its rock bottom pricing. However, the collapse of the Rana Plaza in which several poor contract workers manufacturing for well known brands lost their lives has caused revulsion amongst Western buyers and they are looking for alternate sources of supply.

Experts have opined that a lot of business will shift from Bangladesh to companies like Kitex Garments and SP Apparels which have in place excellent labour oriented policies and high safety standards.

In fact, a report in ET points out that Tirruper, a small town in South India, will overtake Bangladesh, Vietnam and even China for leadership in the global apparel industry. It is stated that India’s $17 billion exports of apparel were about half as much as Bangladesh’s last year and its 3.7 percent global market share lagged behind Vietnam’s 5.1 percent. However, the gap is being closed on a rapid basis, the report says.

Conclusion

Novice investors like you and me have so far kept distance from Kitex Garments owing to the fears outlined above. However, the vote of confidence given by eminent experts like Prof Sanjay Bakshi and Sanjoy Bhattacharyya means that we may need to calm our fears and give the stock a closer look. If the stock is indeed a “hidden gem” and is quoting at “compelling valuations” then there is no reason why we should pass over the multibagger gains waiting for us in the stock!