Thursday, May 14, 2009

Karuturi Global - Caution advised, Conservative players should Avoid / Exit KGL

Karuturi Global needs no introduction. I am sure many of you would be betting on KGL as a super multibagger and even more of you would have this in your portfolio. Karuturi, often termed as the Global leader in cut rose production is one of the hottest stocks due to 2 reasons. One is the expansion in Cut rose production (1 billion stems that they wise to produce and target for FY 10) and the other is their foray into the agri business with a mammoth land allocation.

For the ones who are not aware of Karuturi, Karuturi is termed as the World's largest cut rose producer with a current capacity of 650 million stems and most of their production comes from Ethiopia and Kenya, due to factors like good climate, support from government, closer proximity to the European markets, tax advantage given to these countries and availability of land and cheap labor. All these reasons do look very logical. Total sales rose by 9 times between FY 06 (43 crore) and FY 08 (397 crore) and they reported a total sales of 440 crore and a net profit of 125 crore in FY 09. Massive Expansion Currently they have 250 hectares (1 ha is approx 2.5 acres) under cut rose cultivation - 174 in Kenya, 70 in Ethiopia and 10 in India. 450 hectare of land has been allotted to KGL in Ethiopia and they are planning to bring them under cultivation in the next 2 to 3 years. For their Agri foray, the lease deed has been executed for 3 parcels of land - 11,700ha, 108,300 ha and 191,700ha. This totals to 311,700 ha which is roughly around 775,000 acres of land. When i say this size, i would also like to mention that this is almost 7 times the size of Mumbai. Why do i say this? Just because all papers have mentioned this and i am not willing to be left out :) With the above kind of expansion plans, all kinds of sales and price targets are flying over. Even the company has mentioned that they would expect agri business to constitute more than the cut rose business in 2 years. This would give a rough sales target of around 2500 crore in revenues by FY 2011(considering that the company implements just 50% of their cut rose target in the next 2 years) Fine, let me come to the topic. We are recommending a high degree of caution for the conservative investor and i personally, would not advise this counter to anybody for the next 2 years. Check out the following 1) There are 2 ways by which a company can move in the growth trajectory - by making the business better OR by making it bigger. KGL has opted for the latter, which is not right kind of growth for the

company. Why should KGL foray into agri business, when their existing cut rose business is doing very well with a net profit margins of around 28%? The company is currently operating in only 250 ha for cut rose business and why should not they expand their current business instead of leasing out 311,700 ha of land for agri business? This doesn't make any sense. The only reason which i can think of is to give mind blowing numbers like 7 times size of Mumbai, 750,000 acres and create a fancy around the stock. 2) The company is termed as the Global leader in cut rose production and i seriously doubt it. The Floriculture industry is valued at 80 billion USD out of which cut rose industry is valued at 64 billion USD. How can a company with 400 crore of revenues for the year FY 09 be a leader in a space that is valued at 275,000 crore? :) I wonder who really termed them as the World's largest cut rose producer. 3) Since KGL is an asset oriented company, it is very important to look at ROA. The one reason why ROA could go wrong is for a company which has trademarks, patents, huge brand image like in the case of Coke or Boeing, since these invisible strengths are not taken into assets. However, KGL doesn't have any of these and it is safe to use ROA. The ROA for the company is on a constant decline - The ROA has declined from 33% in FY 06 to 12% in FY08. A constant decline in ROA for a growth company which is asset driven is a clear sign of trouble around the corner. 4) From the share holding pattern filed by the company in Mar 2009, it is evident that the Promoters hold only 23.84 % in the company. It should be noted that out of this holding, around 80% of their stake has already been pledged as securities for the loans availed. I really wonder how the expansion plans would be funded. Though the company has reported that the lands have already been acquired on lease, how would the business run going forward? To develop and to cultivate the lands for both agri and cut rose expansion, they need huge amounts of money and the share holding pattern does not seem to be giving any clues as to how further funding would be done. The total share holdings of the promoters have been on decline from 50% to 23.84% in around 2 years time. Also, few FIIs like Quantum fund and Morgan Stanley have been offloading their stakes (this should be taken with lesser importance) The write -up on KGL will be continued tomorrow. Till then have a re look at the facts and mail me for clarifications / suggestions.

Saturday, May 16, 2009

Continued - Karuturi Global - Caution advised, Conservative players should Avoid / Exit KGL

5) The growth in Total receivables for the company is not under control. The growth has been the same as the sales growth. Though this may be acceptable to some quarters, when you look at the size of the receivables, it sounds caution. The company has reported a Total receivables of 189 crore for FY 08, when the sales and the profits for FY 08 were 395 crore and 102

crore respectively. Yes, the total receivable for the company at the end of the financial year has been much higher than the net profits that the company had reported. This essentially means that the company could be boosting sales by giving more credit and hence more receivables. The company is booking the sale and announcing it but it is not collecting money. 6) The company bought Sher Agencies of Kenya almost by Sep 2007 for a total amount of around 330 crore. The price was equivalent to almost one time the then sale of Sher Agencies. However, the company has written a Goodwill of around 117 crore in to the balance sheet for the year FY 08. The Goodwill at 117 crore seems to be on a higher end. 7) The income tax and the interest numbers reported in the balance sheet seems ........ Consider this - The company reported a total debt of 311 crore in the balance sheet of FY 08 and reported an interest expense of 5 crore for the same year. All the debt has been reported as Long term debt and though we are not sure if all the debt is through Zero coupon FCCBs, the interest of 5 crore makes me only suspective. Also, the company has reported that the Income tax was just 60 lacs on a taxable income of 125 crore. I guess paying tax only on the Indian operations alone should be much higher than this. 8) There are only two ways by which a stock price can go up. 1) The Premium or the PE that an investor is willing to pay for the company should increase 2) The company should report more earnings and the earning per share should increase. The promoters have been constantly diluting the equity such that the EPS has fallen from Rs. 35.70 in FY 08 to Rs.3.41 in FY 09. I have just considered only the basic EPS and the diluted EPS would be much lower. Though one of the reasons could be the stock split in FY 08, the promoters have been diluting their stake as well. With such a huge number of outstanding shares and the business growth slowing down due to the expansion plans, believe me, the EPS of KGL will grow only at a conservative level for the next 2 years. That would be reflected in the stock price as well. 9) Cash from operating activities is very low compared to the net income. for ex - operating cash flow for FY 08 was just 23 crore when compared to the net income of 104 crore. This is due to the total receivables outweighing total payable by a large proportion. By the balance sheet of FY 08, the total receivables was 189 crore while the total payable was only 47 crore. Clearly the receivables are very high and their growth sounds caution. Basically, the points that were mentioned in the article were only few of the things that we were not comfortable with, when doing a research on the company for our recommendation. Clearly, as i had scripted the title, conservative investors should stay out of the company. Even the risk takers who believe that the company will succeed should wait for a year seeing how the agri foray turns out and how the financial statements shape up. To contact the equity analyst on this story: Arun Gopalan in Chennai atArun@hbjcapital.com