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Investing Basics

Investing Basics

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Investment Basics
http://investmentinfoline.blogspot.com/
makrand@gmail.com
1

Investing in stocks is like owning the company. What exactly does owning the company mean. We will take an example of a company called Arvind Mills. We will take a step by step approach to what Arvind Mills is all about and whether it is worth putting your money for buying Arvind Mills.

History:

If we look at the history of Arvind Mills, it was formed in 1931, was basically involved in spinning cloth out of raw cotton. The first phase of modernization was completed in late 80s along with the production of denim, and after a couple of mergers and acquisitions got listed. It also started venturing into the video cassette business and the readymade garments business. By 1994, it had three major operating units \u2013 Textiles, telecom and garments. The garments division started marketing Flying Machine and Newport jeans, and later introduced the Ruf n Tuf brand of jeans. It started floating all kinds of jeans brands \u2013 on its own and in parternship with the world leaders and by 1998 emerged as the third largest manufacturer of denim. It implemented the SAP R/3 system and launched the Arrow and Lee premium brands. It recorded a 280% growth in profits in 2003.

Source:
http://content.icicidirect.com/research/HistoryCompany.asp?icicicode=arvmil
Operating input and output break-up:
Now that we understand the business, let\u2019s look at what the company uses to make
what it makes:
As of March 2006, the raw materials used by the company along with some more
facts like quantity and value are given in the following table:
Product Name
Unit
Quantity
Value (Rs. Cr) % of Total
Cotton
Kg
75,800,000
393.69
63.51
Yarn
Kg
10,500,000
181.92
29.34
Grey Cloth
Mtr
1,500,000
14.09
2.27
Garments (cr)
No
200,000
5.66
0.9
Trunk Radio (cr)
No
348
0.58
0
Delta (cr)
Lin
6,880
0.57
0
Other
NA
NA
23.36
3.76
Source:
http://www.moneycontrol.com/india/stockpricequote/textilescottonblended/arvindmill
s/11/58/rawmaterials/marketprice/AM
A similar snapshot of the outputs (products of the company) and the installed vs used
capacity taken in Mar 2006 shows as:
Product Name
Production
Sales
Sales Value
% of
Total
Cloth
115,900,000
120,500,000
1252.07
77.13
EPBAX
100,000
100,000
1.82
0.11
Grey (Cr)
100,000
100,000
0.57
0.04
Grey Cloth
700,000
700,000
4.29
0.26
Jeans \u2013 Garments
6,300,000
6,400,000
180.50
11.12
Knitted Fabrics
1,300,000
32.98
2.03
Yarn
3,400,000
3,800,000
42.79
2.64
Misc + Utility
65.18
4.02
Investment Basics
http://investmentinfoline.blogspot.com/
makrand@gmail.com
2
Production Unit
Capacity
Installed capacity
Looms
3878
1042
Rotors
2748
7824
Spindles
222068
106776
Source:
http://www.indiainfoline.com/company/product.asp?ltnum=25&lmn=4&co_code=&f
dcd=&shcd=

After looking at the product, products and output break-up, the company\u2019s main operations can be classified as procuring cotton and yarn, using looms, rotors and spindles to produce cloth and jeans (garments). We can hence conclude that the expenditure will be hit by price of cotton and yarn. Cotton being the primary commodity with variable price in the market should have the most impact.

Raw Material Impact:
The
recent
demand
and
supply
figures
(Source:
http://www.commoditiescontrol.com/eagritrader/index.php?userid=&cid=3&varid=0
#

) of cotton indicate that domestic demand is a little more than the domestic supply and the same goes for the global market also. Yet, the cotton industry has some carry- forward stock which would useful as a cushion. Hence, we do not foresee a major shift in cotton prices, hence not hitting the bottom line of Arvind Mills.

However, India which was once a net exporter of cotton has now turned into a net importer of the same. This could result in a net increase in the cotton prices. However, we can peg the increase in cotton prices correlated to inflation and keep 6% as price increase in cotton over the year.

Cash Flow Analysis:
1. Operating cash flow

If we look at the cash flow, the Net Cash from Operating activities for year ending March 2006 (the cash generated out of producing cloth and garments) is +221.79 as compared to -37.06, +137.66, 222.35 and 230.64 for the previous years. This shows that the net cash from operating activities declined gradually till March 2005 and has had a drastic improvement in March 2006. We need to see a reason for this.

If we look at the break up given for operating activities cash flow break-up, the Net profit before Tax and Extraordinary items has remained almost constant through the years. Same is the case with Depreciation and Interest (Net). Hence, Operating profit before working capital changes has either remained constant or increased, which is a good sign.

If we look at the Trade and Other receivables row, we see a drastic reduction and this is one factor as to why the Mar\u201905 values are out of the trend. Also, the inventories row shows a trend from negative to positive which means that the inventories have increased in Mar\u201906 as compared to Mar\u201905. Also, the trend in inventories of drastic changes in values shows inefficient inventory management by Arvind Mills.

2. Investing activities cash flow:
Investment Basics
http://investmentinfoline.blogspot.com/
makrand@gmail.com
3

Cash flow break-up of investing activities shows that lot of money was poured into purchase of fixed assets in Mar\u201905 column while that sum is halved in Mar\u201906, though a lot of fixed assets were sold in Mar\u201906. The cash flow into purchase of investments has increased ten-fold and shows management focus on investing and not putting the earned money in Mar\u201905 into operations. A heavy change of value from -143.52 in March\u201905 to -345.74 in March\u201906 is shown owing to above.

3. Finance activities cash flow:

The cash flow from financing activities shows other long term borrowings column being used after Mar\u201904 after a major long term borrowing was paid off in Mar\u201903. This should have happened because of lower interest rate being charged on new loans and the management could have decided to pay off older higher interest debts to take new lower interest debt. This fact is also strengthened by the Interest (Net) paid column in the cash flow from operations area.

Looking at the overall cash flow:

1. The proceeds from the operating cash are being used to make new investments. We need to look at what kind of investments are being sought and made.

2. The company has shifted its loans from a higher interest rate to a lower
interest rate.
3. Inefficient inventory management.
Source:
http://www.indiainfoline.com/company/cashflow.asp?ltnum=24&lmn=4&co_code=&
fdcd=&shcd=
Free Cash Flow = 127.16 + 155.10 \u2013 (74.52 \u2013 30.88) + (39.63 \u2013 46.04) \u2013 24.75 =
207.46, Per share = 14.81
Price / Free cash flow = 3, which is a little lower when compared to other
manufacturing type companies which typically have ratio of 10-15.
Results watch:

Look at the sales, net sales, operating profit, net profit and EPS (Earnings per share) figures in the annual results of last 5 years for consistency. The figures should show a constant growth combined with the constant rate of growth.

Look at the latest quarterly results for the same as above. These figures are derived from the company operations and reflect the company strength and the management efficiency to drive the profits.

In particular:
1. Read the auditor\u2019s report on the profit/loss report and the cash flow report.
Arvind
mills
can
be
found
here
http://www.indiainfoline.com/company/auditreport.asp?ltnum=31&lmn=4&co
_code=&fdcd=&shcd=
2. Look at the footnotes of each of the results, its called reading the fine print.
3. Read the director\u2019s and chairman\u2019s report/speech for any forward looking
estimates, the business direction and the major decisions which the

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