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What Went Wrong With Kitex Garments?

Kitex Garments (KGL) is a company that seems to never go out of the news, though you’ll be forgiven for never even hearing about the company. It’s run by Sabu Jacob, in Kerala. Why the interest in a company that makes cotton undergarments for kids, and sells them abroad, and managers to run a labour intensive company out of Kerala?

Answer: He generates awesome ROCE (Return on Capital Employed) in Kitex, with ludicrously high margins.

But recently, the company has been in the news for the wrong reasons. They have an excellent video that shows you how well they treat employees. And that’s needed for running a business in Kerala, where apparently the highest issues with trade unions occur. When the local politicians diverged and decided to cut their influence off, they even fought panchayat elections, and won!

What went wrong then? A number of things that have happened recently have spooked investors. (Note: the awesome Valuepickr thread on the company is a good source for much of the below)

The promoters own another concern called Kitex Childrenwear Limited (KCL) which is in the same facility as Kitex Garments. This is something that’s gray because that brings about issues with corporate governance: who’s making the most of the pie etc. But the real issue is: for years, management has been saying they will merge KCL and KGL. That hasn’t happened, and in the latest conference call, it seems it was mentioned that they will list KCL and then consider a merger. This is viewed as just bad faith.

The CFO abruptly resigned in January, with immediate effect. While this was palmed off as a “normal” thing by Mr. Jacob, the real problem is the abruptness of the departure and no apparent replacement in place (the portfolio is now with Mr. Jacob himself). It seems he announced his resignation a month back (source), but the company didn’t announce it then – which is again quite strange since it would have soothed the markets to know there was a smooth handover.

They have 200 cr. of cash on which they haven’t earned much interest. There were questions about where the cash was, and it turned out – in some discussion blogs online – that the money was in an EEFC account in dollars, waiting to be converted. Now EEFC cash has to be converted within a certain time under RBI regulations, and the non-conversion of it was a big concern – for a company that has a post tax profit of Rs. 100 cr., surely the extra 9% or so on 200 cr. would be attractive? Plus, they pay some 19 cr. as interest on their borrowings.

The company management said it was waiting for Rs. 67 to the dollar. This is a problem because firstly why wait, it’s the same thing to just convert at 62 and get 9% interest than to wait a year for 67, and secondly, are you making infant garments or are you doing forex scalping? These are pertinent questions. Yet, even this conference call (after the CFO resigned) the money was not fully converted – though now they have said they have paid back $10 million of loans and will convert the remaining cash and pay up the $9 million of the remaining.  (Source)

Oh, no big capex, and no big dividends. So this is like Infosys cash which is for decorative purposes.

And then, they’ve lost 50% of the business from Jockey, one of their larger customers. Jockey’s moving to synthetics and Kitex is only cotton.

And today, an independent director resigned.  (source)

The Chart…

…is not pretty.

Kitex

Where does it go?

We have no idea. Most people look at such charts and say: Should I buy?

Remember, that a stock that has fallen 90% is one that first fell 80% and then…fell by another half.

You can never catch the bottom, and it may be a good 50% further away from here. Yet, Kitex is the story of a passionate entrepreneur who built a huge labour intensive export business from a state you would just not expect, and that too with high ROCE and margins. This story, though, changes when you start looking the lack of deployment of idle cash, the corporate governance issues with promoters owning a competitor, the fear of sudden CFO and director resignations and the loss of business from a large customer.

Will it hurt to wait a quarter or two before one takes a further call? Possibly not, since the markets are kinda like that nowadays. But at this point, this isn’t looking all that great as an investment – this could just be silly news that will be overshadowed by great results later, or this may be a warning for the times to come. The true test of investing is in taking the plunge, or deciding not to – anything else is bullshit. So, we are not going in even at this price. But hey, this isn’t advise!

Disclosure: No positions with Analyst, family or company.