Kitex Garments

In the 80’s getting a new dress is an ordeal task. You go to the store and buy a piece of cloth for shirt and a matching cloth for pant. This piece of cloth is called as a fabric which is obtained by weaving a fibre like cotton. Then you take this fabric to a tailor who stitches it according to your measurement. This stitched fabric is called as a garment that we wear as a new dress. The entire process took a month in the 80’s.

Things are very different today. I take my kids to Kohl’s and buy them ready made garments. The entire process takes less than one hour and I buy it at a very low price. This drastic improvement happened because of better technology, mass production, and specialization. The infant garments that Kohl’s sells are supplied by Kitex Garments which is the topic of this post.

1. Business

Kitex Garments is in the business of manufacturing and exporting infant wear garments. It was incorporated in the year 1992 and it runs its operations from Kochi, Kerala. The company generates 80% of its revenue from exports and the remaining 20% comes from domestic sales. Majority of its customers are in the US. Its customers include Babies-R-us, Carter, Kohl’s, The Children Place, and Walmart. It sells both fabric and garments to its customers. Around 70% of its sales and 100% of profits comes from selling garments. Kitex is the 3rd largest infant wear supplier in the world with a capacity of producing 5.5 lakh pieces every day. The management is confident that they will become the leading manufacturer in the world before the end of 2015.

Textile industry is a highly fragmented, competitive, and a commodity business. You have to fight tooth and nail with domestic players and also with other low cost producing countries like Bangladesh, China, Pakistan, Sri Lanka, and Vietnam. In 2014, the domestic textile industry as a whole cranked out 14% return on capital employed. Compared to this, Kitex generated 38% return on capital employed. How did Kitex manage to achieve superior returns against the low base rate returns of the industry? In order to answer this question we need to know (1) what assets are needed to produce a garment (2) how much profits the company keeps in its coffers by selling these garments. For answering the first question let us look at the balance sheet.

From the table given below we can see that Kitex employs around 75% of its capital in fixed assets and the remaining 25% in working capital. It’s fixed assets include land, building, and machinery. The company has its own processing plant in a single location which enables it to produce better quality garments at a very low price due to scale advantages. Its working capital assets includes (1) inventories; mostly cotton (2) majority of its customers are big retailers and it has around 12% of sales as accounts receivable (3) accounts payable; payments that it needs to make to its suppliers.

kitex-capital-employedFrom the income statement, I extracted sales and pre-tax operating income for the last eight years. Looking at the table few questions came to my mind (1) in 2009 the world went into a great recession. But Kitex’s sales did not go down during that period. Why? (2) in the last eight years the company compounded its sales at 14.25%. But its pretax operating profit compounded at 46.05%. How can operating profit grow faster than sales? (3) sales grew at double digits only in 4 out of 7 periods. Why?
Kitex-sales Before answering these questions, let us look at its return on capital employed (ROCE). In the last eight years, Kitex improved its ROCE from 5% to 60%. These are phenomenal returns and it achieved this by improving both its asset turn over and operating margins. It improved its asset turn over by better fixed and working capital management. From the chart given below, you can see that its investment in fixed capital has gone down over the years for producing Rs 1 in sales.



Its operating margins improved because of its investment in better machinery and technology which increased efficiency, reduced wastage, and man power. In the latest conference call, the management told that its technological investments resulted in increasing the number of stitches per minute from 6,000 to 9,000. Also low cotton prices helped its margins. Around 80% of its cost goes towards raw materials and labor. From the chart given below you can see that the company was able to drastically reduce both these expenses.


Now it’s time to answer some of the questions that I asked earlier. Even during 2009 recession its sales did not go down. This shows that infant wear products are recession proof. Parents will cut down their own expenses in order to provide food, clothing, and shelter for their infants. So sales not dipping during recession should not surprise anyone.

Whenever you find operating profits growing faster than sales you should look for operating leverage. This measures the sensitivity of operating income to changes in sales. In order to understand this concept you need to know about two kinds of costs (1) fixed cost; these costs don’t change as sales change. Some examples are depreciation, administrative expenses, and some percentage of labor costs (2) variable cost; these costs change as sales change. Some examples are material costs and large percentage of labor costs.

Take a look at the table given below. Sales grew by 100% but profits went up by 140%. This is because of the existence of operating leverage of 1.4. The calculations of how I arrived at 1.4 is given below. Operating leverage is a powerful force which magnifies profits (up and down). Mr. Market sometimes does not account for this and misprices the stock. If you keep your eyes open for operating leverage then you can find some multi baggers.


Contribution Margin is the difference between sales and variable costs.
This is the amount that is left over to cover fixed costs and provides profits.

Contribution Margin = (Sales - Variable costs)
Contribution Margin2013 = (100 - 30)
Contribution Margin2013 = 70

Operating Leverage2013 = Contribution Margin2013 / Profit2013
Operating Leverage2013 = 70 / 50
Operating Leverage2013 = 1.4

%Change in profit2014 = Operating Leverage * %Change in sales2013 to 2014
%Change in profit2014 = 1.4 * 100%
%Change in profit2014 = 140% [ Profit increase from 50 to 120 is 140% ]

By looking at the income statement of Kitex, we can’t differentiate between fixed and variable costs. But that doesn’t preclude us from seeing the presence of operating leverage. All you need to do is divide the percent change in operating profits by percent change in sales. The chart given below show the existence of operating leverage.


Kitex sales grew in double digits in 4 out of 7 periods. Few reasons that lead to the sales growth are (1) increase in 2010 could be because of the world coming out of recession (2) increase in 2011 can be attributed to rupee depreciating against the dollar (3) increase in the last couple of years can be attributed the tragic incident that happened in Dhaka, Bangladesh in 2013. This made Western retailers to seek quality sources like Kitex.


2. Moats

Kitex has two sources of competitive advantage (1) low cost producer due to scale advantages (2) high switching costs for its customers. Professor Bakshi wrote about this already and you can find the excerpts given below.

It’s fully compliant, large scale operation (the company can manufacture about 250,000 pieces of infant-wear every day), its fair treatment of employees, its focus on automation, and other factors gives it a low-cost advantage over its competitors which is hard to replicate. For example, given its large business volume, the per-unit cost of social compliance for Kitex is much smaller than that of thousands of sweatshops, most of whom simply can’t afford to comply. Kitex will continue to gain market share from them because— thanks to its low cost advantage — it can charge the same price for its products than it’s non-compliant competitors and yet earn healthy profit margins. Another source of Kitex’s competitive advantage is high switching costs for its customers. Large buyers of garments spend significant amount of time and resources in selecting and approving vendors. Once a vendor has been selected and approved, then so long as it’s compliant with quality, safety, and social compliance standards, its very difficult and costly to switch to another vendor just to save some money. – Professor Bakshi

In the latest conference call, the management told that its pricing power with its customers improved a lot. By looking at the gross margins we cannot conclude if that’s the case as majority of margin improvements came from better technology. And sales increase came mostly from volume growth. So I looked at its accounts receivable days. From the chart given below we can conclude that the company is doing a good job in collecting cash from its customers. It doesn’t prove the presence of pricing power. But it shows that its customers want its products and paying cash sooner than later.


Big retail customers look for three things from the suppliers of infant wear products. They are (1) low cost (2) high quality (3) timely execution of orders. Even though this industry is extremely competitive, Kitex is the only company possessing all three qualities. This will enable the company to maintain the durability of its moat for a very long time.

The big business houses in the USA and Europe manufacturing and dealing in textiles and garments depend upon India, China and the neighboring countries, due to availability of the raw materials and skilled labour at lower prices in these countries, to get the required output at the lowest possible cost. However we perceive threats by way of competition from the neighboring countries like China, Pakistan and Sri Lanka. Although the competition is hectic we have an edge over others with our quality and timely execution of orders. – 2014 annual report

3. Management

In 2008, Kitex’s total capital employed in its operations was around Rs 130 crores. In the next six years it added another Rs 112 crores as capital expenditure. Adding this together we get a total of Rs 242 crores. On this capital it produced a total pretax operating profit of around Rs 410 crores from 2009 to 2015. Every rupee invested in the business produced Rs 1.69. These are fantastic returns and it tells that the management is very efficient in capital allocation. It achieved these returns without taking any additional risks (leverage) as indicated by the reduction in debt-to-equity ratio. In the latest conference call, the management told that they will take additional orders only when they are confident about delivering it on time. This shows that the management is conservative in nature.

Sabu M. Jacob is the managing director of Kitex. From 2011 to 2014 his compensation increased from Rs 1.64 crores to Rs 4.64 crores. On average his compensation represents 4.5% of pre-tax operating profit. This is definitely on the higher side. He is a type two owner operator.


This is an owner-operator who is passionate about running the business but is in between the two extremes of being completely stakeholder oriented and operating the business for his or her own personal benefit. These managers typically receive higher compensation packages than OO1 managers. – The Investment Checklist

The company has a lot of related party transactions with enterprises owned or controlled by its directors. This is definitely a concern. But there is some good news. Kitex already appointed Ernst and Young to merge Kitex Childrenswear with Kitex Garments.


4. Valuation

In FY2015, Kitex generated a pretax operating income of Rs 147 crores. At 10% cost-of-capital its operating assets should be worth Rs 1,470 crores. Clearly the economic value of its operating assets is much higher than its accounting value of Rs 243 crores. After paying down all its debt it will still have Rs 62 crores of cash left in its bank account.

No growth valuation of Kitex will be Rs 1,532 crores. As of this writing its market capitalization is Rs 3,159 crores. At this price the market expects the company to grow its residual operating earnings at 5.25%. If you consider Kitex stock as your savings account then at the current price you are getting a pretax yield of 4.75%. Is this high or low? In order to answer this question, we need to know the market size of infant wear.

The global infant wear market size is around $20 billion and India represents a very low single digit market share. Of this low single digit market share, Kitex controls 70% share. Kitex’s management expects to grow its top line between 20 to 25%. If we assume its top line to grow at 20% for the next ten years then in 2025, Kitex will generate a revenue of around Rs 3,164 crores (~ 527 million).

This will give Kitex around 3% global market share in 2025, which is very low for the world’s largest producer of infant ware. The company seems to have an earning power to generate pre-tax operating margins of around 25%. After paying taxes at the rate of 34% its profit after tax will be Rs 514 crores. At 20 times earnings the company will be worth Rs 10,280 crores in 2025. From the current market price the CAGR comes to 12.5%.

The company is currently having a lot of tailwind going in its favor. Some of them are (1) quality issues in Bangladesh and delayed orders in China (2) low cotton prices (3) investment in technology helped to improve efficiency and reduce wastage (4) by the end of this year it will introduce its own brands in the US. If this works out then it’s an icing on the cake and this will result in further margin improvements. If the movie unfolds as expected then odds of Kitex stock exceeding the CAGR of 12.5% is very high. As of this writing I do not own any shares of Kitex Garments.

45 thoughts on “Kitex Garments

  1. Hi Jana,

    Once again a very good article. The quality of your write-ups keep improving with time. Guess your blogging has made you a better investor and vice versa.

    One question, in the valuation portion ” In FY2015, Kitex generated a pretax operating income of Rs 147 crores. At 10% cost-of-capital its operating assets should be worth Rs 1,470 crores.”

    How did you arrive at the 10% cost of capital. Is this for the Company or is it a standard metric you use for this kind of industries.

    Many Thanks

    • Aman,

      Thanks. Risk free fixed deposit rate is between 8 and 9%. So I keep my opportunity cost at 10%


  2. Hi Jana,

    Thanks for another very insightful piece.

    One question:
    “In FY2015, Kitex generated a pretax operating income of Rs 147 crores. At 10% cost-of-capital its operating assets should be worth Rs 1,470 crores.”
    To build in further margin of safety, should the operating income be normalized while valuing operating assets instead of using the latest figure?


    • Rohit,

      You have a valid point. In the last couple of quarters pretax operating income was at 35-37%. Also in the conference call the company is confident on acheiving this in the long term. So I took 25% as a reasonable figure.


  3. Hi Jana,

    You have given a pre tax earnings of 5.25% based on current market value of 3159 jas it been calculated based on the current profit before taxes . At 4.75% and at current market the earnings come to 150 crs which is close to the no . at 5.25% its 165 crores ?.

    Also I did a current valution based on the company worth of 10250 cr in 2025 that is coming to 3950 using 10% doscount rate . This doesnt include the owner earning during the 10 years ? Am I corrent on this assessment

    • Srinivas,

      The valuation of Rs 10,250 crores is an after tax figure and it also includes deprecation. So yes you can take this as owners earnings.


  4. Hi Janav
    enjoy reading your posts…. you are turning into a really good value investor i must say ( being student of Prof Bakshi )…
    It would be interesting to see Kitex valuation done with another framework that Stephen Penman uses with discounted residual earnings + discounted continuing value.
    Working out valuations with different frameworks might make us see what really works for the Indian market

  5. Very good analysis Jana.

    The owner operator is one of the risk factors as the growth owes a lot to the skills of the CEO it seems. Also I am eagerly awaiting how the merger with related entities will be done.

    Your valuations seem to be very conservative. Perhaps prudently so. Sometimes we run the risk of being too conservative forecasting the ‘fast growth period’ as well as the ‘ growth rate during fast growth period’ to arrive at a fair value, only to see the company surprises us on both counts. I have made this mistake several times and missed a few great opportunities thinking that they were wildly over priced. . Page industries being one example. I would not have dared assume 50% growth rate for the next decade back in 2005..:) Prof Bakshi’s notes on ‘paying up for quality’ comes to mind (the corner where Buffett operates)

    Discl. I am investor in Kitex since 2013. Back them Debt levels used to worry me a lot causing me to start the position very small. Been paying up a little bit since that concern is easing off.

  6. A really good write up , Jana..It shows that there is decent upside left in Kitex even after the tremendous run up over the past year…Really succint , the way you explained it

  7. Hi Jana,

    Really enjoyed reading your article !! May i know where you obtained this information “The global infant wear market size is around $20 billion” ?


  8. Hi Jana,

    Thanks again for the excellent blog on how to generate and value a business. Very detailed analysis using kitex.

    Question on this: In 2014, the domestic textile industry as a whole cranked out 14% return on capital employed. — where do we get this data?


  9. Great post. I do not know much about this company but clearly looks outlier. Does rupee depreciation play any role in Kitex performance? If yes then how should one remove it from long term earning calculation or one should assume the same trend continues?

    • Atul,

      The company definitely has currency risk. But unfortunately I don’t know how to handle it. The only way I can think of is margin of safety i.e. how much you pay for the stock.


      • Thanks Jana for the reply. I was more looking in the past. Let me ask the question another way what is the revenue growth at constant currency in the past say five years?

      • Atul,

        In all my calculations, I removed other income which had foreign exchange gains. But I am not sure if that takes care of currency gains completely. If there is another way do let me know.


  10. Janav,
    How did you arrive the market expects the company to grow its residual operating earnings at 5.25%? I really didn’t get that part.

    • Mani,

      147 crores / (0.1 – 0.0525) will give you around 3095 crores. To this add the cash of Rs 62 crores and you will get the market cap as of my writing.

      The stock ran up another 20% yesterday and you need to adjust the calculations for this.


  11. Jana,

    I was referring to Hawkins case study in your article no 2 on valuation , sorry to bother but can you do the similar analysis of kitex and post it as addendum to this article .

    Thanks in advance

    • Jana,

      Repeated the same process as done for Hawkins and came out with intrinsic value of 434 with zero growth rate and at the current market price the market is assuming a 5% terminal growth rate . The current year residual earnings growth rate is 45% which looks like a too high number to sustain in the future


  12. Hi Jana,
    Great Post.

    I have a hypothetical question (may seem simplistic) – Say we have three companies which are expected to grow at similar rates (with similar risk profiles) but have differing RoCE’s (assume RoCE’s are sustainable). Cost of Capital is same for all.

    Company A: RoCE 36%. Cost of Capital 10%. Terminal growth rate 5.25%. Op Profit Rs 147 cr
    Company B: RoCE 26%. Cost of Capital 10%. Terminal growth rate 5.25%. Op Profit Rs 147 cr
    Company C: RoCE 10%. Cost of Capital 10%. Terminal growth rate 5.25%. Op Profit Rs 147 cr

    If we use the standard formula [147/(10%-5.25%)] we arrive at the same value for all three companies. How does one incorporate the excess returns that A & B will earn into the valuation methodology?


    • Yash,

      That is a very good question. Remember in Kitex I already showed that the economic value of assets is more than its book value as its ROCE is high. Had it been low at say 10% then I would have eliminated the business.

      If you want to see through the formula then you have to break it out as shown below

      Company A
      Net Operating Assets = (147 / 0.36) => 408.33 crores
      It should be worth = 408.33 + [ (408.33 * (0.36 – 0.1)) / 0.1 ] => 1470 crores [The math is the same if we do 147 / 0.1]

      Company C
      Net Operating Assets = (147 / 0.1) => 1470 crores
      Since the asset earns only at the cost of capital it should be worth its book value.


    • PK,

      Thanks for the comments. Sure. I am came across some and also if time permits.


  13. Want o know how do you zero down on businesses. I mean out of the huge universe of companies how do you zero down on companies worth looking at deeply? Whats your screening technique? And what sites etc. do you use to funnel them?

    • I don’t use any screens. I study companies which are owned by those who are better than me.


      • Thanks for your reply Jana. But in that case don’t you miss the gain as most holding’s are disclosed after they’ve gone up substantially. For example, Mr. Bakshi wrote about Kitex when it was around Rs. 400. But he wrote that he invested in it when it was Rs. 167 for example. So today when one tends to look at Kitex its already approaching Rs. 800 so how do you deal with something like that.

        I am just interested in your approach in zeroing down on companies. And how you look at the possible gains that might arise from your selections.

      • You’re right and we will not be able to buy the stock at the same price paid by the expert investors.

        I have been doing this an year and have studied around 10 companies and once in a while I am presented with an opportunity to buy. And I am ok with this.


  14. Hello Jana ,
    It would be really helpful if you could explain how you got the Following in detail :

    1. How you determined residual operating earnings at 5.25%.
    2. No growth valuation of Kitex will be Rs 1,532 crores.
    3. . If you consider Kitex stock as your savings account then at the current price you are getting a pretax yield of 4.75%.

  15. Hi Jana,

    Thanks for the analysis and insights!

    I am writing this to understand the concept of cost of capital better. So what if this company has debt borrowed at 12.5% than would the cost of capital be different from 10% assumed in your analysis which is the risk free rate.

    Does cost of capital be different for growing company from that of mature company?


    Manish Kansal

    • Manish,

      I tend to simplify cost-of-capital concept by using

      (1) standard rate of 10% for all companies. If a company is risky then I don’t invest.

      (2) by using operating earnings before interest. Also I avoid companies with a lot of debt.


  16. Hi Jana, very good post….can you look at a company called MPS which seems to have similar triggers like Kitex though in publishing services…

  17. Hi Jana,

    As part of your analysis of Kitex Garments, did you see any credible competitor emerging from India on this line of business. Thank you

    • Karthik,

      I didn’t look at emerging players from India. Kitex is the 3rd largest player in the world and the details of the top 3 players are given below.

      Wingloo (China) : 7.5 Lakh pieces per day
      Gimmell (Singapore): 6.5 Lakh pieces per day
      Kitex (India): 5.5 Lakh pieces per day


  18. This is a pretty detailed write up. Thanks for it. Regarding the moats: It seems to me more of niche area where others haven’t stepped in yet. With a capex of around 80Cr-120Cr, we can’t say that setup cost is moat. Regarding low cost production – This would truly have been a moat if it was B2C (like Relaxo), but here it is a B2B with a few large clients. In the latest call, the management says that top line growth is not an issue at all. Says that there is enough of demand that even an one single existing client can absorb the entire 100% growth it projects (although, thats not what the management plans to do.). Given that, I don’t think low cost production is a moat here (So if some other vendor manages to be complaint and keeping switching cost as a separate moat – so not counting that here, one or two clients will do to give volume to the new vendor). I’m not sure of the switching cost as moat, did you check the AR of the clients – to see if we can glean something from there on it? I’d assume another moat, is the labor intensive nature. You’ve got to get and train people. It is this part that has been the bottleneck for kitex. From Prof Bakshi’s writeup, it appears that laborers come from far and are trained and stay in campus. But with this kind of margins, say someone sets up shop at Tiruppur, skilled labor may come by too.

    The management has been very ballpark earlier on projections. So we can not attach as much credence to their projections on figure, But it is good that they have concrete plans. The current plan of the management is to show 100% growth in sales by FY18 (25% in FY16, 35% in FY17 and 40% in FY18). more importantly: This extra 100% will be sold LDP (using private label and own brand) not FOB. So much higher margins. Using that I’d value the company thus:

    Assuming Margin for new sales (i.e., Inlicense +own brand): 45%
    FY16 FY17 FY18
    Revenue Growth 25% 35% 40%

    Revenue 638.88 817.76 1022.2Cr

    %Revenue at new margin 20 37.5 50 (i.e., how much % of sales is LDP).

    Operating Margin 35.41 37.51 39.01 (Assuming LDP + FOB appropriately).

    Operating Income 226.24 306.74 398.74

    So FY18 (E):
    %increase in Operating Income from FY15: 236.3% (398.74 is 236% from FY15 eps).
    EPS FY18 (E): 49.01 (assuming same 236% increase as in operating income)

    FY18 exit PE: 18 25 50
    exit Price 882.16 1225.22 2450.45 (assuming exit at above PEs).

    At the current price of Rs 1041/- , it seems over priced to me.
    (Note: The above is assuming the Management is able to breeze through as planned, without even considering the impact of merger of Kitex Childrenswear which has not as good margins.)

    What do you think?

  19. Hi Jana,
    Just a question on Operating Leverage…
    OL for Kitex is 4.35 according to the change in profit% to change in sales% from 2014 to 2015. But if you multiply 4.35 with the operating earning of 2014 ie. roughly at 85 odd crores, you get 375 crores. If this is subtracted from Sales figure of 442 crores, you get Variable cost of just 65 odd crores. Is it feasible…. you have raw material costing roughly 50% of the sales……………

  20. Can someone explain the free fall in Kitex apart from the flat nos. Is it true that there are irregularities in the books of accounts and what has happened to the 200 cr cash lying idle. why is it not being used?

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