Garnet International Ltd Management Discussions.

India Economy: FY18 Review and FY19 Outlook

The year 2017-18 was an interesting period for the Indian economy with a varied economic performance highlighting the progress made and the challenges the economy faced over the last twelve months. The Indian economy grew at its fastest pace in the last seven quarters in Jan-Mar18 (Q4FY18), overcoming a sluggish first half of 2017-18 that saw the impact of demonetisation settling down and then the introduction of Goods and Services Tax (GST) which brought some temporary uncertainties. The 7.7% YoY growth in Q4FY18 took Indias annual real GDP growth for FY2018 to 6.7% YoY, that was lower than the 7.1% YoY in FY2017. The slowdown in growth was a conscious decision to improve other macro-economic factors such as inflation and fiscal deficit.

Inflation as measured by the Consumer Price Index (CPI) was 3.6% for the year 2017-18, cooling off from 4.5% registered in the previous fiscal as the government and the RBI worked in tandem to keep rising prices within control despite rising crude prices.

Crude prices have been on the boil since the last one year growing more than 45% from $50-$55 / bbl at the start of 2017-18 to $75 / bbl by the end of the year. Supply shocks are arising because of the US sanctions on Iranian oil exports, controlled OPEC production and crisis in Venezuela. These changes would be partially absorbed by increased supply from the U.S. The higher crude prices will have an impact on the trade and current account deficit (CAD) apart from increasing inflationary pressures in the economy as logistics cost and the prices of key inputs for several industries go up.

The FY18 targeted fiscal deficit-GDP ratio was 3.2%. As per the revised estimates, using the second advance estimates of GDP, it has turned out to be 3.6%. In FY18, already there has been a slippage on the fiscal consolidation path. CAD as a percentage of GDP reached (-) 2.0% in 3QFY18 from (-) 1.2% in 2QFY18

After two muted years of GDP growth punctuated by demonetization in fiscal 2017 and introduction of GST in fiscal 2018, India seems to be on the recovery path and is expected to post a healthy 7.4-7.5% real GDP growth for FY 2018-19, emerging as the fastest growing large economy in the world.

The major growth factors are domestic in nature with any upturn in global growth providing tailwinds to the India growth story.

The asset quality issues plaguing the public-sector banks have reached such gargantuan proportions – with gross non-performing assets (GNPAs) touching in excess of 10.5% - that no meaningful and sustainable economic recovery is plausible without, at least, beginning of a resolution process. The transparent and time-bound process driven by National Company Law Tribunal (NCLT) offers hope and the recent resolution of Bhushan Steel and Electrosteel is a start in the right direction. The government focus on demand and job creation through spending on rural and labour-intensive infrastructure space is likely to support growth next fiscal, and push demand in the consumer sectors. Key government reforms like GST as well as RERA or Ujwal Discom Assurance Yojana (UDAY) will have minimal impact in the short run but have a larger impact in the long term.

There are dark clouds looming on the horizon that may derail the growth engine, with high crude prices being the largest of them. Sustained crude prices in excess of $80-85 per barrel will push up inflation and lead to rate hikes by the Reserve Bank of India. The government may resort to tax cuts to keep fuel prices under control which may hurt government spending on infrastructure or welfare schemes and lower growth in FY 2018-19.

India Capital Markets: FY18 Review and Outlook

The Indian capital markets saw mixed fortunes with the key domestic indices across market caps increasing in the range of 8-10% but lagging most of the emerging market as well as developed market indices in 2017-18.

(All indices indexed to 100 as on April 01, 2017)

The 2018 Union Budget proposed a tax of 10% on Long Term Capital Gains with exemption on gains up to January 31, 2018, thereby removing the exemption on capital gains for listed shares. This dampened investor sentiment and along with rising bond yields globally and higher crude oil prices, led to end of the multiple expansion story in small and mid-caps and sparked off a correction phase. The reclassification of fund schemes by SEBI also lent a hand. This sell-off along with lower liquidity in small caps led to several stocks ending the year more than 50-60% lower than their all-time highs within a short span of time.

The investors will be keeping an eye on various factors that will lend volatility in 2018-19 like

• International Crude Oil Prices

• State and General elections and the expectation of a stable and progressive government

• Monetary policy action by RBI to tackle rising global bond yields and any inflationary pressures

• Trade deficit

• Corporate earnings that are expected to be sober in 2018-19 as compared to 2017-18

With growth expected to taper off, we expect the focus in the investment management space to shift from growth investing to value investing.

Indian Textile Industry

The Indian textile industry is one of the largest in the world with a large raw material base and manufacturing strength across the value chain. The uniqueness of the industry lies in its strength in the hand woven as well as the capital-intensive mill sector. The mill sector with 3,400 textile mills having an installed capacity of 50 million spindles and 8,42,000 rotors, is the second largest in the world.

• Indias textiles industry contributes 10 per cent to the manufacturing production of India.

• It contributes 2 per cent to the GDP of India and employs more than 45 million people.

• ?The sector contributes 15 per cent to the export earnings of India.

• ?With production of 6,106 million kg, India was the largest producer of cotton in 2016-17.

It is ‘Advantage India with respect to textiles sector because of

• Robust Domestic Demand

• Strong Government Support

• Sourcing Advantage for Cotton

Exports have been a core feature of Indias textile and apparel sector. Exports in textile and apparel sector stood at US$ 36.63 billion in FY17. Exports of textiles from India reached US$ 27.85 billion during April – December 2017.

The seamless garments market in India that ranges from innerwear to shapewear and sportswear is expected to grow exponentially in the coming years. The key growth drivers for this segment will be increasing demand due to comfort factor, availability of cheaper technology, increasing awareness about fitness and sports and rise in domestic production. From the current market share of less than 1% in the lingerie segment, seamless garments can grow to corner 30% of the market in the next five years aided by new launches made possible by advancement in technology.

Companys Business Overview:

Shares and Securities:

With more than three decades of experience in the Indian capital markets, Garnet International (GIL) possess a long and successful heritage of investing in shares and securities and working with businesses to help them create value.

GIL specializes in exploring new businesses and identifying companies, with leadership positions in niche areas, having a long term competitive advantage and huge headroom to grow profitably. The objective is to seek long term appreciation by investing capital and expertise in high quality companies with robust management. The investment philosophy is sector agnostic.

The company formed a wholly owned subsidiary, Garnet Valorem Capital Ventures Pvt. Ltd. during the financial year 2017-18 to focus on alternative investment strategies not limited to quant based investing and private equity.

Textiles:

Nestled in Ludhiana in the state of Punjab, the companys subsidiary, Sukartik Clothing marks the groups foray into the vibrant textiles & garments landscape of India. Over the past few years, it has established itself as one of Indias key players in the manufacturing of seamless garments and knitted fabrics. The company manufactures seamless sportswear, lounge wear, inner wear & compression wear along with knitted fabrics. Today, the company has emerged as the partner of choice for some of Indias leading retail brands like Raymond, Pantaloons, ColorPlus, Clovia, Rupa and Proline. Sukartik Clothings modern manufacturing facility is vertically integrated with all key processes – seamless knitting, garment dyeing, stitching and boarding, all under one roof. The plant set up over 35,000 sq. ft. is fitted with best in class imported machines and is ISO certified 9001:2008 and 14001:2004.

The company is poised to ride the wave of rapid growth in the seamless garments segment.

Financial Performance of Garnet International Ltd

During the financial year 2017-18, the consolidated revenue from operations of Garnet International Limited grew by 530% from 55.11 crores to 347.36 crores due to higher turnover in the shares and securities segment that increased by 722%. The revenues from the textiles segment (part of subsidiary, Sukartik Clothing Pvt. Ltd.) decreased by 20.6% on account of weaker demand for the companys products in the export markets.

The Profit After Tax (PAT) registered a growth of 17.8% boosted by income-tax gains where MAT credit related to previous years amounting to 1.94 crores was recognized during the financial year. The company recorded its highest ever consolidated PAT of 11.42 crores, up from 9.70 crores last year.

The companys operating performance was affected by the steep fall in the mid and small cap equities during Q4 FY 18.

The segment-wise performance for the year 2017-18 is as follows:

Shares & Securities Textiles
Revenues 336.0 11.3
% to Total 96.7 3.3
% Growth 723.0 -20.7
EBIT 10.0 -0.1
% to Total 100.8 -0.8
% Growth -10.9 -105.8

The profitability for the Shares and Securities business was affected by weak capital market performance in Jan-Mar18. The textiles segment saw 21% de-growth in sales on account of low demand for the companys products in domestic and export markets. The operating profit of the textiles segment was also hit by higher depreciation (up 63%) on account of capital expenditure to improve production capacity and technology at the Ludhiana plant.

Commentary on key financials:

• Shareholders Equity – During the year, the company allotted 3,20,000 convertible warrants to Ms. Anita Chainrai (Non- Promoter) at the rate of Rs. 820 per share. As of March 31, 2018, the companys net worth was 88.11 crores, an increase of 67% over the previous year. This helped to increase the size of company operations in the Shares and Securities segment. Further, the company also came up with a bonus issue of 2:1 i.e. two shares for every one share held during Q4FY18.

• Investments – The total book value of investments in shares and securities including shares and securities held as stock in trade as on March 31, 2018 was 116.2 crores, higher by 74.1 crores as compared to previous financial year. This increase in investments was largely funded by short term borrowings (up by 46.6 crores) and issue of preferential allotment ( 24.1 crores)

• Borrowings – The total long term and short-term borrowings of the company as on balance sheet date was 47.4 crores, up from 0.9 crores as on March 31, 2017. Consequently, the finance cost for the year 2017-18 jumped nearly 12 times to 91.6 lacs from 7.7 lacs in 2016-17.

• Taxes – The company has outstanding MAT credit of 6.21 crores because of erstwhile tax exemption on Long Term Capital Gains. The company recognized 1.94 crores of MAT Credit related to previous financial year during the current financial year, impacting PAT.

Risk Management

The companys operations are subject to various risks – market risk, liquidity risk, interest rate risk and credit risk. However, risk management is an integral part of operations of Garnet International Ltd and cannot be separated from the main activities or other processes within the organisation.

Internal control systems and their adequacy

Our internal control procedures are adequate to ensure compliance with various policies, practices and statutes in keeping with the organisations pace of growth.

We have in place systems and processes commensurate with our size and nature of business and we maintain a system of internal controls designed to provide reasonable assurance regarding the following:

• Effectiveness and efficiency of operations

• Adequacy of safeguards for assets

• Prevention and detection of frauds and errors

• Accuracy and completeness of the accounting records

• Timely preparation of reliable financial information

Human Resources

People are the single biggest competitive advantage a company can have. The Company realises this and is hence aiming to deliver higher performance from its employees by taking initiative to develop its talent pool. During the year under review, the Company has enjoyed cordial professional relations with employees at all levels.