And worst of all, patient

The Company: THE INDIAN CARD CLOTHING CO. LTD (ICC)

The Business: The company pioneers in the manufacture of card clothing for the over the last three decades. It manufactures flexible and metallic card clothing and raising fillets and sheets and saw tooth wire. (Source: MyIris )

Market Capitalization: ~ Rs. 127 Crores
Latest Quote: Rs. 277.70

Trailing P/E : 9.07
Price/(three-year average earnings) : 13.07
Debt-Equity Ratio: 0.02
EPS CAGR (5-yr) : 23%
Price/Book Ratio: ~1.7

The Impression:

• very low debt-equity ratio
• 3-yr P/E is fair
• undervalued by current P/E
• Increasing profit margins ( 9.77 (2001) --> 12.38 (2005) )
• Good ROCE
• High EPS CAGR
  

The Wrinkles:

• Volatile Earnings (EPS-2002 : 9.65, EPS-2003: 6.75, EPS-2004: 20.29)
• Flat Sales till 2004 (Sales-2001: 37.96Cr, Sales-2004: 36.87Cr)
• Sales Spike in 2005 (Sales-2005: 46.94Cr)

The Question:

How can ICC increase EPS while sales are more or less flat?

A Closer Look at the Profit and Loss Statement:

The net sales as of March 2001 was Rs.37.96 Cr and the corresponding EPS was Rs. 7.80. In 2004, the net sales was Rs. 36.87 Cr and the corresponding EPS was Rs.20.29. That's a three-fold increase in EPS for the same number of shares AND net sales.

From the profit and loss statement, the income under the heading "Other Income" is steadily increasing. In 2001, Other Income was Rs. 3.34 Cr (~10% of net sales). By 2004, Other Income was Rs.7.64 (~20%). This company is getting 1/5th of its income from a source other than its main business.

What Other Income?

In 2004, the sources of other income based on the annual report (in Lacs) are :

• Dividend and Interest -199.98
• Profit on Sale of Investments - 359.73
• Rent Received - 80.24
• Others - 123.96

I won't even bother to comment on the relative size of 'Others' within"Other Income'. Overall, it looks like ICC is selling a LOT of its investments. The income under these heads, except for rent, would not add to expenses. Any income received in this manner would get directly added to the bottom line and result in, would you believe it, an increase in profit margins.

When this income is discounted, the 2004 picture is:

• Total Income: Rs. 36.87Cr
  
• Total Expenses: Rs 30.67Cr
• PBDIT: Rs 6.2 Cr.

In 2003, almost all of the EPS can be traced to the other income. The Operating income was Rs. 0.33Cr on sales of Rs.33.56Cr. That's a 1% margin for the year with sale of investments.

There are always two sides to anything

One view can be that this company is in serious trouble. Obviously, ICC cannot maintain its EPS at this level forever, for soon, there would be nothing left to sell. Then, the crash will be inevitable. The other viewpoint is that the company is undergoing drastic changes to improve profitability. After a bad 2003, the company's costs came down from Rs. 33Cr to Rs.30Cr even as sales increased from Rs. 33.56Cr to Rs. 36.87Cr. Most of this came from, it seems, cutting Employee Cost by ~ Rs.2Cr. Another positive is that the net sales for increased by 1/3rd from 2004 to 2005.

My view

This company has had recent growth in sales but the margins are very small. Given that most of ICC's reported EPS comes from 'Other Income', I'm not comfortable with its long-term prospects, i.e once all the money's gone. To me, the company is selling pieces of itself just to report a profit and pay dividends, which seems to be a rather underhanded way to manipulate the P&L numbers.