Company Background: A company in the business of exporting frozen fruits and vegetables was bought by a Reliance employee (son of a little known stock broker) in his early 30s. Continued losses meant the firm went kapoot in 1999 with Rs20cr+ debt piled on. The company was declared sick, the debt was restructured and the operations handed over to IFCI Ventures. It resumed operations in 2001 clocking Rs5cr in sales and dawdled along till 2005 with Rs8cr of sales, no profits. The year 2005 marked Vineet's second coming, he settled the outstanding dues with IFCI and bought their stake. Below is a snapshot of what happened after Vineet entered the fray for the second time.
Everfresh was bought from Chambal Fertilizers, a Birla company. Temptation also bid for HLL's marine foods business unsuccessfully and finally settled on three independent units. Subsequently, Vineet was caught in Kohinoor Foods imbroglio, when in Jun 2008, still left with some spare cash from QIP proceeds, TFL bought shares amounting to a 13.5% stake in Kohinoor for Rs40cr. Finally, after SEBI asked TFL to curtail its advances, TFL sold out the entire stake in FY10 for Rs30cr, a Rs10cr loss, accounted as extraordinary loss in PnL. After four years of breakneck growth, Temptation has paused to take rest this year and is expected to close the year with sales touching Rs1400cr and profits at Rs70cr. As the company sought much needed rest for consolidation, its chairman Vineet chose the Tihar cellar to escape his hectic routine.
So Far, So Good: Vineet was sent to Tihar for assisting a UK based firm Telecordia (telecom consulting and services) in seeking a security clearance from the Internal Affairs Ministry (apparently he paid the bureaucrat in cash and kind). Vineet's self-interest is not clear, maybe he was playing a role of a middle-man just making some quick bucks from Telecordia. Another cash-for-loan case is pending against him in which it is alleged that he paid a PNB DGM Rs20lacs for getting a Rs150cr loan sanctioned for Temptation.
None of the allegations are very serious in nature. Government banks taking favors for granting loans is a a pretty well known aspect in business circles. Even Standard Chartered adopted this for some time as a modus operandi for sanctioning loans. Bribes are usually sought for granting clearances, if not by bureaucrats, then by the politicians concerned.However, Temptation's nature of business operations raises some alarming questions:
Export Oriented (80%): As already specified, Temptation operates in frozen food (mainly for export market), and processed food (Karen, Everfresh). Two-thirds of its sales come from Marine food business, which is entirely export oriented. Amongst other businesses, one third of sales come from exports. In sum, Temptation's 80% sales are contributed by exports. It makes it very prone to any growth decelerations in USA, Europe, and exchange rate fluctuations. The Company bills its customer in Rupees for now, but in the face of reducing profits, its customers may not agree to favorable terms in future.
Customer Concentration (Very high): About 6-8 customers account for most of the exports from Temptation. In India, sales are concentrated to 20-25 customers.
Working Capital Cycle (105 days): Customers usually pay late, and the raw material payments cannot be deferred, as farmers and mandi-businessmen demand immediate payments. The accumulated cash gets sunk into ever-rising WC demands with growth. As per latest BS, 370cr are locked in working capital. If the full amount is to be financed by a working capital limit, it will knock off Rs44cr from the profits. Currently company is funding less than half of the WC with loan (Rs177cr) with the rest getting financed by internal accruals. The company's interest burden is still Rs20cr+ but a healthy EBIT of Rs96cr provides cushion from an immediate shock.
Business-Breakup: Temptation's frozen fruits and vegetables business has operating margins of up to 15%. However, Marine Foods only has operating margins of 4-6%. Since Marine unit is entirely export-dependent, any shock in global scenario can immediately turn the unit into a loss-making exercise. Marine Foods is the largest contributor to sales, so even a marginal drop in margins in this division can wipe out the profits of the rest of the divisions. It makes a seemingly manageable debt of Rs177cr look like mammoth. Company can head back to a sick bed under certain (however unlikely) turn of events.
Cash Burn: In its relentless pursuit for growth, Company has found ingenious ways to burn cash. After three acquisitions in a space of six months (Rs 60cr), it spent Rs 30cr in capital expenditure for consolidating operations. It pumped in the rest of QIP proceeds along with some funds raised through debt in Kohinoor's equity. It subsequently sold the entire stake in Kohinoor incurring a needless loss of Rs10cr. Promoters were planning to raise a further Rs1000cr so that their free-flowing growth is not hindered, but negative sentiments in the credit market post-2008 thwarted their ambitions. This year too, it has put in Rs 1.2cr in a West Bengal based Food Park and Rs 3cr for a stake in a Terminal Market.
Food Park: Food Park can be a considerable source of upside, as a major chunk of investment (Rs 50cr) is going to come from government as a subsidy. However, bills are often overstated to get full subsidy (capped at 50% of project cost), and this requires frequent cash dealings wherein company's interests (as distinct from the promoter's interests) may not remain safe. Besides the food park in West Bengal, company has also made an investment in a terminal market. Agri-infrastructure is a capital intensive business and this can be a source of further cash burn put paying to the hopes of the Company transforming into a positive cash flow company.
The Company's asset base is valued at close to Rs500cr in books, and if we take the Everfresh and Karen brands into consideration, company's asset base can be considered to have an implied value of Rs 700cr+. Adjusting for debt, company's equity can be valued at Rs 550cr+.
Environment Management: The Company has spread its wings in too many directions without stopping to make the operations cost effective and gain optimum benefits from what is under its inner wings. The current promoter is in the business for hardly five years (in his earlier stint, he hardly ran it), and has shown lack of intent in taking operational responsibilities, other than coming up with the sexiest annual reports (with assistance from Atherstone Investor Communications). His arrest in cash for loan and clearance allegations implies that he can get things done, but not without hiccups. The Company has only 165 employees, too small for a business of this kind. The limited Environment Management capabilities of the Company raise serious questions against its ability to transform itself into a winning proposition.
Owner a Financier than a Businessman: The owner does not have much feel for the business itself, he would rather drive in his Porsche and mingle in society parties rather than getting his hands dirty while attracting new customers or marketing his brands. He talks about assimilating a portfolio of brands (like a broker), rather than about a zeal for creating a unified Temptation in people. It is a cause for concern as good companies generally require dedicated and believer management teams.
Accounting for all these deficiencies, Temptation at current level is still too good a proposition. Consider this: a dividend of Rs 0.70 per share transforms into a nearly 4% dividend yield. If the company repeats this measly payout ratio (4%), the shareholders will still be beating dividend yields earned by their peers. Since the Company has landed itself in a soup, it is expected that fund raising plans will now be put on back-burner for a while and operational consolidation will be on for a couple of years. This can lead to rationalization and if the Company's performance continues to remain robust, 5x-6x returns are not unlikely in a two year time-frame.
However, serious corporate governance allegations have been raised against the Company, Corporate Governance is anyway deficient even in good companies. And any churn in its export customer lists can severely impact the profits. A small investment (possibly less than 1% of your portfolio size) can be undertaken to benefit from any potential upside, yet remaining largely unscathed from unexpected happenings.Yet, as there are substantial opportunities in Indian markets, a lottery stock like Temptation is best avoided.
Please read the articles by Gaurav and Mumbai Mirror to get a feel for the kind of allegations against Vineet. If you feel, he deserves a chance, you can well go ahead and invest in the firm.
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