Weighs less on the trust front hence better left alone
Investors have often been lured to penny stocks trading at low multiples in hope of making a quick buck. Attention towards such companies is at peak when they are able to raise capital, especially from foreign markets. Over the past one year, retail investors who have been tricked into putting their money in such companies have found their entire capital erode with passage of time. Actually the shares issued in foreign markets in form of GDRs are bought by operators in collusion with promoters. A GDR issues generates ample interest in the domestic market. However, these GDRs are gradually converted into shares and sold to retail investors in India.
On 22 September 2011, market regulator SEBI had found 7 companies involved in such malpractices and banned such these companies from raising capital/money from the market.
AVON CORP was amongst the 7 companies banned by SEBI from raising money from the public. However some of our clients had been approached by the company to invest in their fixed deposit. Hence the note.
Rather than going into financial jugglery we thought it would be better if we could chronicle how our opinion on the company was formed.
About the company:
Avon Corp, a manufacturer of personal & industrial weighing scales, was brought to our attention in mid 2010 by one of our clients who was somewhat familiar with the company management and considered them hardworking and trustworthy.
A company managed by known and assumingly trustworthy people, trading a low PE of around 2-3x and growing over 50% was an ideal mutlibagger candidate.
The client asked us to go through the stock and provide our opinion. While initially lured by the strong financial, we soon discovered an increasing cash hole in the company and hence rated the stock an AVOID. Our reply, dated 19 Sept 2010, was as follows:
Finally got hold of Avon Corp Annual Report this weekend. Just trying to document my thoughts on the company so i don’t loose thread at later date:
- The company is trading at PBV of ~0.5x (80cr, Rs13 per share).
- It has net cash of 14 cr as against market cap of 36 cr.
- Net Current assets- Debt=90-22=68. Another mouthwatering proposition.
- Impressed by growth over last 5 years…..5x sales and 10x revenues.
- Also impressed with future prospects due to its strong and cost effective product line………expecting ballpark sales to reach Rs400 cr by 2015, at current net margin of 10% that gives 40cr profit.
But i guess you know all this and the reason i am writing at almost midnight is the following:
Constant dilution in equity: While pat increase from 1 cr to 11 over last 5 years, EPS halved largely due to increase in equity base, raising doubts on management’s intentions.
While profits surged the company’s operating CF has always been negative, not a sign of viable business
Also the management issued GDRS (4.8cr shares, pre GDR it was 1.65cr) at Rs.10 effective cappig the upside over the medium term. Now without the GDR the company would have at EPS of ~6. Not sure why the issue was at such low valuation, PE of less than 2.
So either business is not in such good shape as PNL points and the promoters need cash to hide the operational efficiencies. The alternative is a sinister one, the promoters are issuing shares to themselves thru proxies at throwaway prices and taking minority shareholders for the ride.
As luck would have it the company’s price rose more than 50% after our AVOID rating, but we kept our faith. Soon, the so called “foreign investors” started converting their GDRs into shares and offloading them in Indian markets. The share price tanked from 52 week high of 11 to 4 by August end prompting us to issue the following note on 24 August 2011:
Was going through the shareholding pattern of Avon Corp. Relating to the GDR issue of last year, it seems all have been converted into shares and sold to retail investors. This further raises my apprehensions on the company’s management. I believe the company had not received cash from the GDR issue. Most likely the promoters had issued GDR to themselves which they sold to public making a clean gain of nearly Rs50Cr.
Not considering it an investment worthy stock anymore.
This time fortune favoured and SEBI banned Avon Corp and its promoters from accessing capital market on 22 September 2011 largely for the same reasons that raised our doubts on the company.
However to our surprise, some of our clients have informed that they have been approached by Avon Corp for making investment in their fixed deposit. Given our analysis, the company’s past track record and SEBI’s ban we believe it would be prudent and pragmatic to stay away from making any investment in the company.