Thursday, July 5, 2012

Titan Industries -Short- Show us the Cash


Cmp /LTP 233. Market cap 20,700 crores
"Revenue is vanity ,margin is sanity & cash is reality" & Titan `s cash reality is definitely not looking good.
 Just gone through FY 2011-2012 annual report of TITAN INDUSTRIES. 
While going through the consolidated financials ,found some strange numbers so thought of posting it.
Summary - I believe Titan is due for a 8% to 10% correction at least  i.e Target 1 of 210-215.Target 2 of 30% correction i.e retesting of Dec 2011 lows of 170. Reasons ( see below)
(1) Fundamentals - deteriorating earnings quality
  • For FY12,Ratio of Profit After tax (PAT) / Cash flow from Operating activities ( CFO) is 541% vs 7 year average of 86%.
  • For FY12 Net Income / Profit After Tax ( PAT) has grown by +40% but Cash flow from Operating activities ( CFO) is down by (-85%)
  • I.e PE is 34x but P/CFO is 186x vs 7 year average of 27x
(2) Technically - is not that weak. In fact ,its in upstrend as above 200 DMA of 213 and just 7% below its all time / lifetime high of 251.(even though CFO is at 6 year lows). But current levels is also at 1 year resistance zone of 230-251.Stock has meet resistance in this zone at least 10 times in past 1 year.
Its up 41x in past 7 years i.e +70% p.a returns CAGR.But in last year up just +8%.
(3) Valuations -P/CFO at 186x vs 7 year average of 27x.
(4) Macro - We are in 4th year of growth & a slowdown seems to be around the corner. In 2008 slowdown -FY09 saw PE multiple derating from 34x to 21x and 31% price correction.Details below
Of above 4 reasons , I would rate Earnings quality as key. Sole valuations - are never good reason to buy/sell.But key trigger for price action would be the no. (4) if it starts posting weak results.

Time frame for the short & stop loss
  • Timeframe - such `fundamental` -earnings quality based shorts can take time to work - weeks,even months. Reasons are 
    • (1) In India, cash flow statement is reported only once in a year vs every quarter for developed markets. i.e information lag ( all the more reason for Emerging markets to trade at discount vs developed markets )
    • (2) Thus most investors / analysts look only at simplistic PE ratios instead of going through details.
    • (3) Result is emerging markets like India are more inefficient & hence react late to fundamental based information.
    • So ideally fundamental based  shorts are not recommended for everyone. Any short works best when the key index /indices such as NIFTY & SENSEX are in down trends  / weak trends.(Beta factor).But NIFTY seems to be in a good upstrend - above 200 DMA & above 5200.Its up +11% in past 1 month & also outperforming developed markets after long time.
  • Stop losses - From charts, 233-251 is resistance zone & if  one takes a fakeout of 5% then from its all time high of 250, a stop loss of 260 should be good.Else one can use their own pain levels to decide SL
Key points of Titan Industries
  • Titan is no. 1 market leader in watches segment - 70% market share. Watch Brands :- Fastrack,Sonata,Helios,Raga,Xylys.Also owns key jewellery brands :- Tanishq,GoldPlus.Eyewear :-TitanEye
  • In past 7 years, Titan revenue & profits after tax has grown by 10x times.
  • And market cap has grown by 41x or 70% p.a (CAGR). This also shows most of share price appreciation is by PE multiple rerating ( PE ratio of from 7x in 2004 to 35x now.)
  • But last 1 year , Titan stock is up by just +8%. (I.e law of diminishing returns ?)
  • Thus its a typical growth stock where high premium is given to growth. Downside of such growth stocks is that a slowdown in growth / decline is growth quality can lead to sharp de-rating of PE ratios. And it seems such a risk has arisen now.
Some points to note :-
  1. All numbers in Rs. Crores. ( 1 crore = 10 Million)
  2. PAT - Profit after tax
  3. CFO -Cash flow from Operating activities
  4. As per India GAAP, Interest cost is under CFF ( Financing activities) . So to be in line with E - Earnings/ PAT have reduced reported CFO by cash interest paid & called is at adjusted CFO.
  5. Consolidated financial data is taken from Titan Annual reports ( till FY07). Link here  .Analyst meet ppt here ( data for FY03 to FY07 taken from moneycontrol )
  6. I have used this PAT/CFO ratio approach to judge earnings quality & have elaborated on some known reasons for the difference between reported profits in P&L vs cash flows. Done for NIFTY stocks in last year  
  7. On basis on this approach , one cannot jump to conclusion that management or earnings is fraud.There are many other checks for earnings manipulation and I`ve used just one of many ratios.
  8. In India cash flow statement is declared annually. Same for Consolidated P&L. So regular / quarterly reporting will help investors arrive at a more timely decision. E.g best way to resolve this issue is for Titan management to start reporting cash flows every quarter instead of after every 12 months.(As based on current policies,we`ll get to know the next cash flow only next year)
  9. I dont own Titan but had I held this stock, I would definitely sell some / all (as I give high importance to earnings quality.)
Now detailed rationale for the short thesis
1) Fundamentals - deteriorating earnings quality and seems to be at least a 8 year low
  • FY12 PAT has grown by +40% but CFO down by (-85%). i.e Ratio of PAT/ CFO is at 541% vs 7 year average of 86%. This alarmingly resembles Satyam`s (India `s Enron scam) financials.
  • FY 12 CFO is similar to FY 06 cash flows when sales were 80% lower . 
  • "Revenue is vanity ,margin is sanity & cash is reality" & Titan `s cash reality is definitely not looking good and seems to be at a multi year low.
Table below - Click to zoom
In charts..

With detailed calculations below.

Promoter has also sold 0.4% in past 1 quarter. Might seem low but at cmp market cap the stake sold is worth 85 crores. Shareholding pattern in past 1 year below. FII`s have increased stake,DII have reduced.

2) Technicals - from chart below. 230 -251 is the 1 year resistance zone.
  • Titan is up +13% in past 1 month. 
  • YTD up +37%. In past 1 year up +9%.
  • 213 is the 200 DMA that could be a initial target ( 9% below cmp).
Cash CFO is at 5 year low but stock just 7% below all time highs of 250. So this anomaly can only be resolved either by (1) Slowing earnings in next year FY13 i.e mean reversion of reporting high results in FY11/FY12 (2) Sharp rise in cash flows or falling share price / reduction in premium valuation multiples.
Interactive chart here

3) Valuations  -P/CFO ratio is 186x vs 7 year average of 27x. Thus some derating should follow.

4) Macro -We are in 4th year of growth & a slowdown seems to be around the corner.India Retailers fear inventory build-up, begin discounted sales 2-3 weeks early. News here

In 2008 slowdown ( see FY09 results in table given earlier), Titan posted results of just 11% PAT growth,Stock saw a correction of 31% with PE valuation multiples derating from 34x to 21x.Similar derating will lead to price correction of 39% i.e target of 140 vs cmp of Rs 233 per share.

In recent interview to CNBC TV 18 / moneycontrol ( 29 June 2012),management has already signaled of a tough quarter - Q1 FY13 (April-June 2012). See Bhaskar Bhat,MD reply to second last question "We have had a difficult first quarter because of all round sluggishness in retail. May was not good. April was good. June is  so-so (comme ci comme ca) and we do hope - we are not changing anything but its going to be a tough year".  So don't say management didn't warn you. Interview link here

Disclosure :- I have an initial` SHORT position in Titan futures.Might add more to existing or even square off in case stop losses are hit.