LEEL Electricals: A company that gave its investors & Porinju Veliyath lots of losses and learnings

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It is often said that hindsight is the best sight. In contrast, life as well as investing is all about the future that takes into account the key learnings from hindsight, which paves the way for a better tomorrow. Smart investors are always in the learning mode and in that context 2018 definitely made a lot of small and midcap investors wiser, may not be richer, as they realised their set of mistakes and failures.

One such company that turned out to be a nightmare for its shareholders was LEEL Electricals. The company has been in the news off late as Porinju Veliyath, the renowned micro and smallcap investor, in his latest letter to shareholders admitted to the investment failure with regards to the big bet he took in 2017. Keeping that in focus, we discuss the key learnings from the sequence of events that unfolded in the last 12-18 months, which ultimately led to the significant wealth erosion of over 70 percent for minority shareholders.

In February 2017, Lloyd Electrical & Engineering and Fedders Lloyd Corporation announced sale of the Lloyd brand and the consumer durable business to Havells. The consumer business of Lloyd is engaged in sourcing, assembling, marketing and distribution of consumer durables including air conditioners, TVs, washing machines and other household appliances.

LEEL’s market capitalisation (m-cap) touched Rs 1,200-1,300 crore ahead of the deal announcement as the transaction was valued at nearly Rs 1,600 crore. The company caught the attention of value buyers as the remaining entity, with an established track record of manufacturing, was available at near zero valuations, taking into account 30 percent tax deductions on the gross sale amount.

The company recorded an exceptional gain of Rs 946 crore in the September 2017 quarter to account for profit on the stake sale, which translated to a post-tax earnings per share of Rs 164. However, one-third of these gains (around Rs 310 crore) were reversed in the subsequent March quarter as the new management assumed charge after the demise of Brij Raj Punj (Chairman & Managing Director) in December 2017. The company attributed the associated cost/expenses for the change in stance.

Financials also started to deteriorate after the closure of this transaction. The company reported an operating profit of just Rs 70 crore over the next five quarters. Operating profit has further declined by an aggregate exceptional loss of nearly Rs 47 crore with regards to its two overseas subsidiaries.

The balance sheet at the end of March 2018 showed a sum of Rs 313 crore against capital expenditure in a number of promoter group entities with unrelated business interests -- Himalayan Mineral Waters Pvt (Rs 120 crore) and Fedders IT Technology Pvt (Rs 59 crore). However, as per the latest balance sheet, no progress was been made on these investments over a six-month period.

The Havells deal was a key trigger for value investors. However, the events did not turn out as anticipated and it turned out to be a typical value trap as cash proceeds for the company did not translate into actual returns for minority shareholders.

The first and most important learning from this case study is that the management remains the single most important variable that drives all business activity. Although this has been reiterated umpteen times, investors (as minority shareholders) should give utmost importance to the people at the helm and changes in key management personnel needs to be monitored closely.

A deeper look in the financials and accounting policies of a company can reveal much more about the company and its future intentions. In case of LEEL, reversal of gains was a presage of deteriorating corporate governance standards and should not have been ignored in first place. The events that followed were rather unfortunate and resulted in significant destruction in shareholders wealth.

Also, following the footsteps of large well-known investors can turn out to be hazardous as an individual can easily replicate a portfolio position, but their conviction and risk appetite are often difficult to replicate.

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