June 17, 2013

Self torture

I wrote about two companies in January – Deccan chronicles and Zylog systems (read here).
In case of deccan chronicles, the stock had  dropped more than 90% from its peak and a debt default and other allegations were already in the newspapers.
In case of zylog, my impression from reading the annual reports was summarized as follows
  • poor operating performance resulting in cash flow problems (in addition to commoditization of the core business)
  • Cash flow problems resulting in higher debt which was taken to fund the growth
  • higher debt resulting in promoter pledges to get the funds
  • Point a. causing the stock to drop, resulting in margin calls and forced sale of the pledged stock.
  • The forced sale, causing further steep drop in the stock price
As part of the disclosure, I indicated in the post that I had a very small speculative position in the stock and in the comments section provided the following rationale for it


i am testing a hypothesis that the management will fix cash flow problems and the business is worth more than the current mcap.however it is a speculative position with a large probability of loss. it is also a very tiny, insignificant position

hi anil 
i would not call such postions a mistake. i do such things actively - on very tiny amounts

these position have a large learning value which is worth more than the money lost. one could get the same by just watching it, but when you put real money, the experience is very very different. it helps one in avoiding such mistakes in the larger serious position.
A new update
On June 14th, SEBI barred the promoters (read here) from buying or selling any securities in the stock market
The key points in the news article seem to be the following
Sebi had, suo moto, carried out an examination in the scrip of Zylog Systems in view of surveillance alerts regarding variation in price. Sebi during examination of the scrip prima-facie observed that the company provided misleading information to the stock exchanges wherein it stated that its promoters have been buying and increasing their stake while actually the promoters were net sellers and their shareholding declined due to invocation of pledge by financiers. Similar misleading clarification was also given by the promoter of Zylog Systems, Sudarshan, to the media.

Sebi order said that Zylog Systems disclosed incorrect and false information in the quarterly shareholding pattern for the four quarters in the year 2012 to the stock exchanges by overstating the holding of the promoters and understating the quantum of shares pledged by the promoters.
Sebi also observed various instances of non-adherences to accounting standards and listing agreement in the annual report by Zylog Systems.
In addition to the above, the latest results show that the promoters have pledged close to 95% of their holding in the company (up from 75% in the previous quarter)

What next
As I indicated in the earlier post, I created a small tracking position to follow the company and confirm my thesis that the debt/ cash flow problems are temporary and should get solved.

I am not sure if the thesis will turn out to be correct or not, but the SEBI order changes the whole picture. I am fine with poorly performing businesses and will hold the stock for the long term if the management is competent and working on fixing the issues. However, if there are coporate governance issues, then all bets are off.
Although the position was small, a loss always pinches. In this case, I walked into it with open eyes – a case of self torture :)
Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.


Tirath Muchhala said...

Such Graham-ian positions are worth the torture. The real question is: Are the Canadian and American business real? If yes, could they be bought by some entity? Furthermore, barely any shares have changed hands post the SEBI order. Will the lenders invoke the pledge and initiate a sale of businesses? Good questions to ask methinks.

Rohit Chauhan said...

true ..good questions. at the same time, will you consider investing or staying invested if you dont trust the management now ?


Ravi said...


For fun sake let us assume that zylog systems turned out to be a great bet what would your feeling be?
Would you have sulked that you did not allocate a major percentage or you would have thought its okay this was just for fun sake and meant to be a learning?
Reason I ask is, most of the time when we invest in stocks we do not invest to lose money. We invest only because we think there is a fair enough chance to make money. Only conviction levels differ. We tend to make unnecessary bets just because there is no real good opportunities and we find something that looks like a okay bet (low conviction levels) and tend to justify that investment with whatever rationalization we can make. AS I see it is purely the case of pascal saying " All men's miseries derive from not being able to sit in a quiet room alone"
Actually even I am bored with market..it neither goes up so we can sell and take out the money nor does it go down to provide very good bargains. This is the worst period for value investors who feel they need to do something always. Probably true test of value investors who can wait long enough for a fat pitch that may take too long to come.


Tirath Muchhala said...

Ha :)
The equity is worth 90 Cr now. If they indeed raised USD 24 Mn via the GDRs less than 2 months ago, only if they stole the money is this company worth near nothing. Even Satyam's Raju couldn't steal 100% of the assets - So, yes; staying invested seems to give good odds. Wait and watch. Burning is part of the game isn't it? :P

Rohit Chauhan said...

hi ravi
i would have been happy if the bet had worked. i am like every other guy out there ...i am happy when my bet works and feel bad when it fails. nothing unique with that.

In case of zylog, it was a clear gamble for me, but i did not bet with an aim to loose money. it allocated .03% of my portfolio to it. an allocation of this size is not meaningful any day.

let me disclose something - i have small side portfolio of all such bets. there are companies like zylog, infinite, bhel etc with miniscule size in that portfolio. if i make money well and good , if not it is still ok. you can say that i am doing it to keep myself busy :)

at the same time, there are other bets where my conviction is high and i have been adding meaningful amounts to those stocks in last 6 months. so bets like zylog are not because i am not finding anything else to do.

i am tesing a hypothesis of investing in stocks where it has been beaten down by 80% and i think there is value there. some picks in that basket of stocks will fail - i expect that. lets see how it works out in aggregate. till then i will sulk if it does not work or beat my chest when i make money :)

Rohit Chauhan said...

hi tirath
yes, quantitavely speaking the value is there. but at the same time i have an idiosynchratic way of investing. if i loose faith in the management, i will exit the stock.
is it irrational ? maybe ...but i dont like to stick with companies where i feel cheated.


Tirath Muchhala said...

Ravi - well said indeed.

What'sUp Prahalad said...

Rohit Chauhan ji:

have you looked at Jayant Agro Organics.
1. India produces 80% of world wide castor seed production and castor oil and its derivatives are in high demand because
a. castor oil replaces crude oil in the chemical industry
b. castor oil and its derivatives are established "green chemicals"
c. EU regulations like REACH (Registration, Evaluation, Authorisation and Restriction of Chemical substances) which are forcing industry to move to greener alternatives..
d. Ford starting 2012 has decided that all its car dashboards are going to be made of "castor oil derived foam" (due to stringent eu,us,japan regulations)
e. NIKE during olympics released lightest ever football shoes made from castor oil derivatives

Jayant has been growing consistently

5 yrs 500% growth in Net Profits and 400% growth in Sales..
Consolidated Sales/NP numbers.
March 2007 Sales 462.49Cr Net Profit: 6.76Cr
March 2008 Sales 605.96Cr Net Profit: 9.51Cr
March 2009 Sales 875.86Cr Net Profit 7.49Cr
March 2010 Sales 904.01Cr Net Profit: 12.47Cr
March 2011 Sales 1,175.26Cr Net Profit: 24.92Cr
March 2012 Sales 1,832.26Cr Net Profit: 31.35Cr
March 2013: Sales 1,621cr Net Profit: 36.24cr
MCap: 133cr only 5258 shareholders..
dec2012-March2013 HNI(High networth investors) increased from 26 to 56
Promoters have increased holding to 64.7% by creeping acquisition (not more than 4.9% each year as per SEBI rules)

recently Arkema largest consumer of castor oil and its derivatives signed a JV and agreed to buy 24% stake in Jayant Agro Subsidiary.
Arkema is french speciality chemical giant.. and wanted to secure availability of castor oil for its specialty chemicals business

ITOH Oil of Japan a castor oil based specialty chemical company..also has a 40% stake in subsidiary of Jayant (Ihsedu ITOH Green chemical marketing company - yet to start operations)

Jayant Agro has recently started producing higher valued added castor oil derivative "sebacic acid" in India.. Jayant promoters hold US patent for efficient production of sebacic acid

Jayant is the largest processor of castor seeds from india as per SEA (Solvent Extractors Association) of India since 2004 till date..
Jayant has backward integrated by buying Guj govt owned castor seed crushing plant in Banaskantha) Banaskantha is the largest castor growing district in Gujarat and gujarat produces 70% of India's production of castor seeds..
company is a govt recognized "Star Trading House" and govt recognized research organization
in 2012 promoters bought 4.9% from open market at avg price of 120/share
castor oil derivatives are used to produce "High performance plastic(used in deep sea drilling/Auto parts/cell phones/electronic items/electronic adhesives), corrosion resistant marine paints, eco friendly paints (Zero VOC advertisement of nerolac), food grade plastics,Pharmaceuticals-parentals, ink, chocolates, icecreams, fabric, paper, deodrants, shaving cream, soaps,crayons, solar panels.. the list is endless.. castor oil derivatives can replace crude oil in chemical industry and end products are green sourced and have higher performance characteristics..
Exports are mainly to US, Europe, Japan and China..

A real indian company which is positioned to take advantage of the fact that India is the largest producer of castor seeds.. and has backward integrated to castor seed crushing..

=happy investing

Manish Dhawan said...

nope don't agree mate. u don't have 2 pee on an electric fence to know that its fatal. Vicarious experience teaches u a lot if u r a keen learner.

'Cockroach theory' works beautifully especially in Indian equity where corporate governance is questionable and SEBI is spineless.

As soon as u smell foul, be assured shit is out in the open and it will only spread.


Rohit Chauhan said...

how do you define cockroach theory ? how do you know when the governance is questionable ? from the annual report or from the other channels ?

how about cases, where neither the annual report or the other channels dont have any clear info - like satyam ?

i think you are missing the point of the post. how do you avoid companies before you come to know of the first cockroach ..not after the first cockroach is seen ..like india cements

if something grey is a reason to reject a company, you will find a very small handful of companies which are really clean. then again i doubt that ...can u have a clean company in a corrupt system ?