Five companies that suffered a quality dip

Before investing in a company, we typically assess several factors. One such factor is its quality.

Quality is one of the most crucial aspects to evaluate when investing in a stock . The better a company's metrics, the better its quality and vice-versa.

Using our newly introduced Stock Ratings tool, we decided to find companies that were once considered gems but witnessed a deterioration in their quality in recent years.

How were the quality scores calculated?
Broadly, two parameters were considered while assigning quality scores to the companies - business efficiency and balance sheet quality. While business efficiency looks at a firm's profitability and past returns (based on metrics such as ROE, ROCE, operating profit margins and debtor to sales), balance sheet quality assesses companies on their historical performance and how well they sustained themselves during lean periods (using the debt-to-equity ratio, contingent liabilities and working capital).

Based on the above criteria, we found five such companies:

• Anjani Portland Cement
  
• Bodal Chemicals
  
• Rupa & Company
  
• Shilpa Medicare
  
• Zee Entertainment

These firms had a quality rating of 8 or higher in FY18 but fell to 2 or below as of January 2024. All, except one, reported negative returns over a six-year period, as shown in the table below.

Let's delve into the reasons for the slump in the quality scores of these companies.

Anjani Portland Cement

Anjani Portland Cement operates in a cyclical industry and faces stiff competition from its peers. Though it has grown moderately since FY18, things took an ugly turn in FY22, when the company acquired Bhavya Cements for more than Rs 600 crore. This resulted in its debt magnifying from Rs 3 crore in FY21 to Rs 440 crore as of September 2023.

The company's financials were further affected when its PAT (profit after tax) fell by 51 per cent in FY22, primarily due to the rise in financing costs, power and fuel expenses and raw material prices. This led to a loss of Rs 59 crore in FY23. Moreover, its revenue decreased by around 17 per cent in FY23 owing to lower realisations (decline in the per unit price).

Bodal Chemicals

Bodal Chemicals is one of the major producers and exporters of dye intermediates, dyestuff and basic chemicals, globally.

The last few years have seen the business struggle in a challenging business environment, mainly due to fluctuating raw material costs and reduced demand. This affected its revenue growth, which increased by just 7 per cent since FY18. Subsequently, its ROCE (return on capital employed) and ROE (return on equity) plummeted to 5 and 4 per cent, respectively, in FY23, compared to 28 and 24 per cent in FY18.

Despite the setbacks, Bodal Chemicals has aggressively approached growth and launched various capacity expansion initiatives. Consequently, its debt levels ballooned from Rs 181 crore in FY18 (debt-to-equity ratio of 0.3 times) to Rs 769 crore as of September 2023 (debt-to-equity ratio of 0.7 times). This further pushed financing costs up, in turn lowering the company's profits.

Rupa & Company

Rupa & Company is an inner, thermal and casual wear company that operates in a highly competitive industry. In a bid to increase its profit margins, the company tried to enter the premium innerwear segment by acquiring the licence to launch global brands like 'FCUK' and 'Fruit of the Loom' through its wholly-owned subsidiary, Oban Fashions .

However, the subsidiary incurred losses which impacted the profitability of Rupa & Company on a consolidated basis. Coupled with the effects of COVID-19, the company's PAT growth fluctuated widely over the last few years (FY18-22).

Moreover, in FY23, the company struggled with highly unpredictable raw material costs, which led to a destocking of inventory at the distributor level. Ultimately, its financials were affected, as the revenue and PAT fell by 23 and 72 per cent, respectively, in FY23. This also had a significant impact on its ROCE and ROE, which declined from 25 and 24 per cent, respectively, in FY22 to 8 and 6 per cent in FY23.

Shilpa Medicare

Shilpa Medicare specialises in manufacturing active pharmaceutical ingredients and formulations. Owing to price erosion, the business has experienced volatile growth rates over the last few years.

An unstable macroeconomic environment coupled with increased costs also affected Shilpa Medicare's operations, causing a decline in its PAT by 59 per cent in FY22 and a loss of Rs 31 crore in FY23.

The company's financial performance further worsened when continuous capacity additions and new product launches led to a rise in its debt levels from Rs 390 crore in FY20 (debt-to-equity ratio of 0.3 times) to Rs 865 crore (debt-to-equity ratio of 0.5 times) as of September 2023.

Zee Entertainment

With more than 30 years in the media space, Zee Entertainment has maintained a dominant position in television broadcasting, OTT (over-the-top), music and others. However, the brand has been struggling of late as its advertising revenue declined from Rs 5,037 crore in FY19 to Rs 4,059 crore in FY23. The management has blamed poor macroeconomic conditions for the declining revenues. On top of that, revenues from subscriptions and selling media content grew only by 9.1 per cent per annum during FY18-23.

While its digital platform, ZEE5, has been doing well, continuous investment has increased its costs and impacted its overall profitability. As a result, its PAT declined by around 30 per cent annually in the last five years. Further, the company has been plagued by corporate governance issues, a reduction in promoter stake, high share pledging and defaulting by SITI Networks (Zee's related party) on its debts, leading to its downfall.

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