Why small cap stocks valuations are rotting?

Erstwhile promoters of some of the companies which have changed management tell us - why.

MUDRA LIFE STYLE LTD was sold by the Indian Promoters to a Korean Company earlier this year. The company has now reported a loss of Rs 199.29 cr in Q2FY12 on a sale of Rs 44.90 Cr. The loss looks extraordinary by any standard. In fact they are. But if you read the notes below the tabulated result, the reason for the loss is write off/ down the values of inventories taken over by the new promoters at the time of acquisition. And one of the reasons for write off is NON EXISTING INVENTORY found during the course of stock audit conducted by the independent auditors. This not only a poor corporate governance but it is a FRAUD. This is similar to Satyam where the promoters had inflated cash and here Mudra Lifestyle inflated stocks. Erstwhile promoters have been inflating inventory and showing stocks which were not there to show not only higher profit but also to take loan from banks as well.

Somewhat similar issue is also there in case of ISPAT INDUATRIES LTD as well. Subsequent to the takeover by JSW, the company made a provision of over Rs 1180 Cr within 6 months of taking over the company by the new promoters under various heads. The point is, how come these amounts which were good till 6 months back, can become bad immediately on change of management. Simply, these were bad earlier also but shown to be good to keep balance sheet healthy. Else, how would someone explain for these provisions just because promoter shareholders have changed?

More recently, the new promoters of THE ANDHRA PAPER MILLS LTD also had to make provision of Rs 26.50 cr subsequent to taking over charge.

However, all small cap stocks cannot be bad. One is required to make proper research before making investment decision but sometime it is really difficult and for common investors, it is just impossible.

Jubilant Industries Ltd

Jubilant Industries Ltd (JIL) – Scheme of Arrangement a wealth creator or destroyer?

JIL has come out with a scheme of arrangement wherein its Agri & Consumer Division will be transferred to its wholly owned subsidiary company Jubilant Agri & Consumer Products Ltd (JACPL). There is nothing wrong with this as long as, aim is to give undivided management attention to this business. But what is really disturbing is merger of hugely loss making  Mall & Hypermarket business (Retail Business) of promoters closely held company Enpro Oil Pvt Ltd with JACPL.

Retail Business which is getting merged with JACPL has been making huge losses since inception, having made loss of over 300 cr since inception. During FY11 alone loss was in excess of 71 cr on a turnover of Rs 300 Cr. against JIL Profit before Tax of only Rs 40 cr during FY11. Thus loss of retail business exceeds the profit of JIL.

With the merger of Retail Business with JAPCL, profit of Agri & Consumer division which is getting transferred to JAPCL will be used to finance the losses of Retail Business.

Besides this loss making retail division, JAPCL is also taking over loan and net current liabilities of over Rs 238 cr from the promoters.

Now the question is what is the rationale of this merger? Is it that the management wants to share the so called bright prospect of retail business in India with the public shareholders, or it wants to fund the loss of a privately held company with the profit of a listed company at the cost of minority shareholders.

Given the finance of the retail business, certainly management is not sharing goodies with the minority shareholders, so ultimately, it is the loss which is getting transferred from closely held company to the listed entity. As usual, minority shareholders are taken for a ride.

Above all, this is coming to the shareholders of JIL at a cost of Rs 200 cr. (Present market value of 38.35 lac shares of JIL to be issued to the promoters in consideration of retail business and excess of liability over assets of Rs 123 cr to be taken over by JAPCL).