Summary: Filatex’s shares have gained pretty decently in the last few weeks, and much more than the market. Upon analyzing, one can find that it had got more to do with the regular ups and downs of the market and little else. The company is a very risky proposition for a lay investor to enter, unless the buying decision is based on a deep understanding of the fiber industry. Personally, I have small gains on the scrip. I am iluting my holdings and getting out, believing that I have just got lucky.

My Holdings

My Present Holdings
Avg. Purchase Price	Holding period	Highest Purchase Price	Lowest Purchase Price	Unrealized Profit/Loss
43.7	3-6 months	43.7	43.7	5.6%

 

About FILATEX

The company makes manmade fibres. Essentially it makes fibres that can be used in textiles, plastic products etc. The company was incorporated as public limited in 1990.

FILATEX’s Ecosystem

Filatex is to the Indian textile industry what Precision Wires is to the motor winding industry. It supplies yarn to the textile industry. Apart from this it makes fibres for each and every use one can think of, from ropes to toothbrush bristles. Needless to say, the ecosystem involves manufacturers buying fibres from players like Filatex, and then selling the end product to the eventual end customers. The chain of command is pretty straight forward. Due to intense competition in the industry, the price pressure on the fiber makers is very high. The differentiator for the manufacturers is design and utility  of their products (textiles/tooth brshes or e.g.)and not the quality of fiber used.

FILATEX’s position in its ecosystem:

If we rank the manufacturers of synthetic textiles in a decreasing order of their average size of the past 3 years, we see that Filatex is not among the top 10 in India. It is ranked 12^th. That is not great.

 

Company Name	Last 3 FY Average Gross Sales
Grasim Industries Ltd.	8698.6
Indo Rama Synthetics (India) Ltd.	2750.5
Garden Silk Mills Ltd.	2572.3
S R F Ltd.	2305.2
Bombay Dyeing & Mfg. Co. Ltd.	1877.2
Century Enka Ltd.	1364.1
Sutlej Textiles & Inds. Ltd.	1227.7
Nakoda Ltd.	1056.5
Banswara Syntex Ltd.	681.3
Modern Syntex (India) Ltd.	593.8
Sumeet Industries Ltd.	480.8
Filatex India Ltd.	450.2
Indian Acrylics Ltd.	420.1
Welspun Syntex Ltd.	414.5
Supreme Tex Mart Ltd.	414.4
Pasupati Acrylon Ltd.	384.1

When we observe the table, we not only see that the company is not among the key players in the industry, but also that it is significantly smaller than the largest player. Given that the company is in existence for about 21 years, it is not a great statistic. Also, we see that some of the key textile manufacturers (like Grasim) are also players in this industry. These companies are textile manufacturers and in that industry more margins are now dependent on how you market/design instead of fibers. Despite that the fact that these companies persist in textile manufacturing tells us that fiber making is not a high tech precision work anymore and is more of a commoditized endeavor. That implies that margins should be under extreme pressure and the only key to success is to have razor tight operations and high financial prudence.

With respect to Filatex, since it is a small player in the industry we need to judge the company on its financial prudence and the quality of its finances. For a small company in a tough industry it will take years to recover after one small misstep. In terms of fit vs. Flab, I can say I don’t know if the copany is fit yet, but it cannot afford any flab.

Reported Financial Performance:

The in the last FY2010-11, the company’s total revenue and PAT increased on a YoY basis. The % increase in revenue was more than % increase in PAT in this FY, but it was the opposite 2 years ago. That tells us that the finances of the company fluctuates

Below is a high level view of the company’s finances as reported in its annual report

FY	2008-09	2009-10	2010-11
Net Sales (Rs. Cr)	359.07	399.76	486.43
Reported pat (Rs. Cr)	6.58	17.19	19.01
Average Net Worth (Rs. Cr)	64.58	83.95	106.67

 

Free Cash Flows to Equity Owners:

Along with the above finances, one can look at the below measures from the company’s annual financial statements.

FY	2008-09	2009-10	2010-11
Cap Ex	4.31	7.81	45.26
Dep + Amortization	7.92	8.53	9.22
Absolute change in Non-Cash W/C	10.29	-25.33	-24.7
Total Increase in Debt	0.24	-9.57	46.9
Total Increase in Deferred Tax Liability	8.53	2.51	-0.59

 

One can see that the company has undertaken a big capital expenditure project. This is for capacity building on Yarn production. One cannot fault the logic of the company for doing so because in its industry, bigger players tend to be more resilient. It, however, has financed entire project from debt as the increase in debt in the latest FY is the same as the increase in Capex work.

The impact of debt and capex will appear in financials of subsequent years. Normally when we have sporadic increases in debt and capex, we look at what happened in previous years and normalize that impact in present year’s financials. For this company, the situation is slightly tricky. The debt and capex have increased in this FY and it is trickier for us to normalize them as we don’t know if this is what the company intended to undertake or if there will be another set of expenditures in the coming year.

We still normalize debt and capex, but we need to accept the results with come caution. Most probably, the nos. we get will be more optimistic than reality.

Also, for the company, the working capital changes are sometimes positive and sometimes negative. This impacts the financial condition of the company. Assuming that this is a recurring trend, I normalize this working capital over a period of 6 years.

Convertible Shares and New Preferential shares

When the company announced its annual results, it mentioned that it had 40,00,000 shares that could come into existence after convertible warrants were converted to shares. Normally, that conversion cases dilution in the profit distribution to share holders. Since the results were announced the company has actually converted these warrants into shares and for the analysis below I have taken these additional shares and calculated nos. on a per share basis.

Also, in the month of July, the company also allocated over 28,00,000 shares on preferential basis to non-promoters, there by raising a capital of over 14.3 Cr. This was not disclosed at the time of annual results. For the purpose  of calculating free cash flows, in the absence of a better parameter, I have considered these preferenial allocations to be a part of FY 11 financials.

To understand why preferential shares are important, pls read my article on free cash flows.

Post normalization results

When I normalized the above factors and calculated the FCFE and included preferential allocation made in July, I get the following data (all amounts in Rs. Cr.):

Average last 3 FY Sales	415.09
Net Profit (latest)	19.01
Cash Value	7.86
Latest FCFE after Normalization of Debt and Capex	-14.79
Latest FCFE before Normalization of Debt and Capex	-8.81 (+5.5 if no preference shares)
Average FCFE after normalization for the past 3 years	2.42
Average FCFE before normalization for the past 3 years	6.73

 

Clearly for FILATEX, one can see that its irrespective of whether we normalize the debt and capex or not, the free cash flows in FY 2011 have been negative. That was expected as the company borrowed debt and invested in this year. But we also see that if the company had not made those preferential allotments normalized free cash flows would have been positive.

The way I see it, that is not a great thing to do. The common shareholders seem to have got a raw deal.

 

Fit vs Flab:

With a good amount of debt taken, the company will have more interest to pay in the coming years. It’s last FYs interst coverage was at a healthy 8.5 but when we look at above nos we know that the full brunt of interest has not arrived yet and that the profits for the last 2 FY have been relatively higher. It looks a sort of honeymoon period to me. Unless the company is able to repeat the financial performance with the increased capacity, the company will have a tough future.

Also, for the company the current assets are higher than the current liabilities but lower than total libilities. For a manufacturing company this is a sign that in a liquidation scenario, the recouping the money won’t be easy. However, the company is nowhere coming to the brink of liquidation. It is making profit, but the goodness of its finances are questionable.

Based on above data on positive (and slightly inflated) profit, negative this year’s cash flows , very low average cash flows and  increased debt, I believe Filatex is in a territory where it its future is darker than its immediate past. It is not fit, does not have flab but is anemic.

 

Ownership Structure:

52.58% of the company is in the hands of its promoters. This is not ideal under normal conditions; as if the company performs poorly then it will be difficult for someone else to buy it. Having said that, one behavior that is prevalent in a company that has high promoter holding is that such companies prefers to pay handsome dividends (as dividends are tax free in India). Hence, if the company is making money consistently and over a long time and is paying dividends continuously, then it can be said that its ownership should not be an issue.

In this regards, we see that Filatex is not making consistent Money (very low 3 years free cash flows). At the same time the company is averse to paying dividends. In the last few years, the only time the company paid any dividend was in 2009 and in 2011 and that too at a very anemic 10% (1 Rs per share). It has been in the business for a long time (since 1990). This behavior is BAD.

Based on this, I can say that the fact that the company is owned more than 52% by its promoters is not such a great thing for lay investors like me.

 

Return on Net Worth: 

The PBIT/Avg. Net Worth for FILATEX was 2% 6 years ago. It has increased to 28.8% in the last FY. In this time, the highest value was 39% in 2 years. That this improvement has happene shows us that operations wise the company knows how to run its operations profitably. The company has done better since height of financial turmoil in 2008 than before that.

Based on this statistic alone, one can say that the company knows how to run operations profitably. If there are any doubts one has on the finances, those are because of the financial decisions taken by the company.

Value Judgment:

The company has a small amount of Cash in hand. This is OK as a manufacturing company need not be cash heavy. I remove this cash amount from the share price of today, and compare the free cash flows to the share price. By doing so, we get the following nos:

Company	Filatex
Latest BSE closing Price	46.15
P/E Reported	5.8
P/FCFE Updated (After Normalization – Latest)	-204.2
P/FCFE Updated (Before Normalization – Latest)	18.8
P/FCFE Updated (After Normalization – Last 3 FY Avg)	14.3
P/FCFE Updated (Before Normalization – Last 3 FY Avg)	8.9
P/Trailing 4 Qtr Earnings	5.4
P/Bv	1.04
Current Assets > Current Liabilities	True
Interest Coverage	8.5

 

The company is trading at 14.5 times its last 3 years average free cash flows (which is on the higher side) and is trading at 1.04 times its book value (which is on the lower side). As per the analysis earlier in the article, there are no issues with the operations of the company with regards to their profitability but the financial decisions of the company (like issuing preferential shares and paying no dividends) are questionable.   The company is trading at only 5.7 times its trailing 4 quarter’s reported net profit, but those nos. do not incorporate the preferential shares issued in July (which I included in FCFE) and so that this multiple is incorrectly implying a cheap proposition.

On the basis of this, in terms of its stock price I can say that there is no margin of safety in Filatex as of now. The financial future is less rosy and in that list the present stock value need not show any appreciation.

 

Verdict:

Investing in Filatex is risky at present levels. Unless an investor knows the business of selling fibers better than me (my understanding of their business is more academic) and has an insight that is deeper than mine, I would suggest avoiding this scrip.

Personally, I have un-booked profit s on the company and I attribute that more to the vagaries of the market movements than the fact that I picked a great company to invest. Simply put, I got lucky. I am going to liquidate my holdings in this company immediately as that is not the sort of luck I want to hang on to in my future investments.

Personal Note on FILATEX:

I the past one year, I started by investing in Auto Ancillaries and then moved on to other industries. I preferred only those industries whose business I thought I understood. Textiles was NOT one of them. I invested in a few textile companies on the basis of their reported profits and the analysis I did on the basis of that. Filatex seemed good at that time. I just picked the time when the price was at a temporary low and bought a small no. of shares, just to keep an eye on the stock.

I have gained since the last time but in the mean time I have realized that the company has allotted preferential shares and that its finances were not as good as I thought. Nevertheless, the prices went up. In the past 2-3 weeks alone it has given one of the best returns among textile firms. I personally think that has got to be the shortsightedness that arose due to good trailing 4 quarter profits, and nothing more.  Alternatively, it could be that I invested at such a low prices that I have undeservedly gained due to reglar ups and downs of the market.

 

Lessons learnt:

• Financial decisions of a firm can make or break the interest of a common minority lay investor.
• A company with risky prospects can also give some gains. That has got nothing to do with the quality of investment.