This Managing Director Failed to Change. He's Trapped and Not Even Aware of It!

May 11, 2018

Kunal Thanvi, Research analyst

We are in middle of May.

It is that time of the year when companies declare their annual results.

They also host conference calls and analyst meets to discuss the year gone by and their plans for the future.

This is called the 'earnings season'. We are super busy during the earnings season.

This is the time when we can log on to these calls and ask the management of these companies some tough questions.

Last Tuesday, I logged on to a conference call with the management of a small-cap company.

It's in the business of exporting granite to US and Europe.

Historically, it was one of the market leaders in its industry - granite kitchen countertops.

However, in last five years, there has been a structural change.

Granite has been replaced in American and European kitchens by a new material - Quartz.

Quartz has better qualities, an aesthetic feel, and lasts longer than granite.

As of March 2018, of the total kitchen counter top sales in the US, the share of quartz has gone up to 80%. Granite was the material of choice for decades.

Mind you, this trend is now being seen across the globe, including India.

The management completely failed to understand this. They're hoping for a turnaround in the traditional granite business.

When You're Trapped Like Umbrella is Just a Hope!

Here's what the Manging Director (MD) said...

  • The US market has seen a structural change with Quartz taking over Granite.
  • We have struggled to get GST refunds and that has led to working capital issues.
  • Many of our suppliers (quarry owners) need to shut down their quarries due to environmental problems.
  • The new E-way bill has made us uncompetitive in sourcing raw material as transportation costs have increased.
  • We believe, the granite business will revive in coming years.

Yes, this MD is trapped. But he is not aware of it.

He believes, the company will turnaround.

Consider my conversation with him on the conference call...

    Kunal: You mentioned that the trend in the US would reverse i.e. from Quartz to Granite again. However, if you look at global players like IKEA, they have already tied up with best quartz players in the world and believe that is the future.

    MD: Well, we believe, it is not a permanent change. It is a fashion, quartz is not a natural stone and it is currently preferred because of the bright colour combinations it offers. There is no big difference between a granite and quartz. It is just a fashion which we believe, is set to reverse.

He is wrong. It isn't just a fashion.

The truth is, Quartz has several characteristics - durability, stain resistance, aesthetic feel, colour composition - that make it better than granite.

The management has not only missed this change, they're preparing for a new level of problems.

They're planning to set up a new granite plant.

Just think about that...

Here is a company caught on the wrong side of the trend.

Instead of accepting this, it is expanding capacity for the product which is getting replaced by a better one.

What are the chances this company will do well?

Let me just say, I won't take that chance.

I'll not recommend this company.

At Smart Money Secrets, I always look out for management quality. By management quality I don't mean only ethical behaviour and good corporate governance.

These three points are equally crucial...

  • Their ability to allocate capital i.e. what are the returns they generate from their investments?
  • Their capacity to adapt in today's fast changing business environment.
  • Their capacity to disrupt their own ideas.

These characteristics are generally found when owners run their business themselves. Just two weeks ago, I recommended a company where the management changed recently. The new managing director ticks all the right boxes.

I believe, the upside in this stock is about 60%.

Chart of the Day

E-commerce has bought the biggest structural change in the way we shop.

Yes. I am talking about the Walmart-Flipkart deal.

India's biggest online retailer is being acquired by world's biggest offline retailer.

Walmart is acquiring 77% stake in Flipkart at Rs 1,056 billion (US$ 16 billion).

Well, if we do some basic math Walmart is valuing Flipkart at Rs 1,350 billion.

This is equal to total market cap of India's largest offline retail players.

Has Walmart Made a Big Mistake Acquiring Flipkart?

Shocking, isn't it?

The valuation of Flipkart is equal to the combined valuation of India's largest retail companies.

And Flipkart has never made any profits. It reported an operating loss of Rs 45.8 billion in FY17 and is expected to report an operating loss of Rs 91.1 billion in FY20.

If Flipkart would have been a listed company, it would have never passed through the Smart Money Score. A company with no operating profits and just a hope of future profitably should be valued very strictly.

I believe, the valuation at which Walmart is acquiring Flipkart is insane.

With no operating profits and a strong competitor like Amazon, Walmart's shareholders are expecting a rough experience.

In fact, post the announcement of the deal, Walmart's share price declined by around 3%, which is around half of its Flipkart investment on day one itself.

Kunal Thanvi
Kunal Thanvi (Research Analyst)
Editor, Smart Money Secrets

PS: Do you sometimes wonder how the best investors in India select stocks? Wonder no more! Just let them do the work for you. Kunal Thanvi, editor of Smart Money Secrets can show you how. Click here to find out...

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