PDS Limited (PDSL) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the PDS Limited Q1 FY '24 Earnings Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Iqbal Khan from Nuvama. Thank you, and over to you, sir.

Hello. Good afternoon, everyone. On behalf of Nuvama, I welcome you all to PDS Limited Quarter 1 FY '24 Earnings Call. Today, we have with us Mr. Sanjay Jain, Group CEO; Mr. Rahul Ahuja, Group CFO; and Ms. Reenah Joseph, Head of Corporate Finance, M&A and Chief Investor Relations Officer. Before I hand over the floor to management, I would like to highlight that the safe harbor statements on the second slide of analyst presentation is assumed to be read and understood. With this, I now hand over the floor to Sanjay Jain for opening remarks. Sanjay, over to you.

Thank you, Iqbal. A very good morning, afternoon and good evening to all our stakeholders across the time zones and a warm welcome our Quarter 1 Earnings Call. There have been a bit of connectivity issues at this end. So for any logistics issues, the line drops from our end, just kindly stay put, we should be back in a few seconds. And I apologize if there's any inconvenience because of this. I would begin by saying that the performance for this first quarter should be seen in light of 3, 4 key aspects. Firstly, the macroeconomic uncertainties have impacted on the demand scenario as we have been mentioning it over the last 6 months that the first 2 quarters of financial year '23-'24 could be a bit choppy because of the market condition. Secondly, the quarter 1 in terms of seasonality usually is our leanest quarter. However, the quarter 1 FY '23 last year, on one hand I'm saying the quarter is leanest, the quarter 1 last year also benefited from the tailwinds of the pent-up demand in a post-COVID restriction scenario. So these are a couple of factors that one should look at. And one more thing is that the Bangladesh operations, usually, in the first quarter, there is one Eid break and then there is a second Eid break in the second quarter, but both the Eid breaks happened during the first quarter, that kind of increased the number of idle days for which the factories were shut. Our factories and also factories in general for production from about a little close to 9 days to about 16 days or so. And we, however, have cautiously navigated the last couple of months and anticipate to do so in a muted environment. But the good thing is that the signals that are coming in from our main markets where in we operate -- when U.K. and Europe are about 75% of the top line of the company, the signals that we are getting for a good anticipated recovery in the second half of the year have all started to [indiscernible]. It is also important that while on one hand, the reported top line which is largely coming in from the design-led sourcing business has shown a decline. The gross merchandise value that we have handled during this quarter, exactly increased 13% over the same period last year. And if you observe that the gross merchandise value that we have reported as part of our investor release is about INR 3,000 crores, whereas the top line of the company is about INR 2,100 crores. That means approximately INR 900 crores worth of business that we handled during the quarter actually is a contribution from the new initiative of sourcing as a service of the newly acquired Ted Baker business. So therefore, this makes us feel that with the passage of few months, while the design-led sourcing business should bounce back because of the signals that are coming in, there is already a good contribution setting in from the new initiatives that we have taken. And the interesting thing is, on one hand, while there is a demand disruption that is there, but it is also unfolding into newer opportunities for us. We have earlier shared with you that sourcing as a service was one opportunity. We also mentioned about complete sourcing solution contract that we got from one of our retail customers in Germany. So therefore, company is actually gradually migrating the journey of being a solution provider to our retail customers, and therefore, also building in businesses with higher margins. That's also one of the reasons that amongst others, that gross margin directly expanded close to 2.75% in the quarter as compared to the last year's same quarter. And of course, while we remain positive about the anticipated recovery, but we also have the lever in hand in terms of any cost optimization that we may have to do in the later part of the year. But at this stage, we remain very positive. During the quarter, we also successfully completed the acquisition of Ted Baker Design business, and we are currently in the process of integrating it. And if I take the first almost 2 weeks plus we completed the acquisition sometime in June month, and we already have achieved good financial performance. But before I come to the numbers from Ted Baker. The Ted Baker Design Group will serve as the global hub for the Ted Baker brand and will help us manage the global design and merchandising functions. Further, this entity will function as a core licensee and operating partner for Ted Baker having the wholesale business in the U.K. and Europe. So what I mean to say is, on one hand, there is a service fee that we are getting for handing the back end with respect to designing, merchandising and enabling sourcing. But at the same time having got the wholesale business, these are the 2 revenue streams that are coming in from this business, while we spent close to about INR 150 crores for which we actually got an equivalent amount of working capital in the business. We anticipate that the business we are gearing up, we are working towards annualized turnover of about INR 475 crores to INR 500 crores in that range broad range. And we believe this business has a potential of about 7% to 9% profit margin. So therefore, there is -- from an ROCE perspective, we are already foreseeing this business to be in the 30% plus range. And now that succumb to the first 15 days of the performance post our takeover, the business has reported INR 30 crore top line with approximately 9% bottom line in the 2 weeks post our takeover. And another interesting aspect is that the Ted Baker acquisition is actually leading to many more such opportunities now before us. So if I rewind the clock from a Hanes sourcing as a service business, we actually saw as a sourcing as a service business coming our way. And the most similar such contracts and got $1 billion worth of orders. And you saw a contribution of INR 900 crores coming in from such businesses in terms of GMV on top of our top line of INR 2,100 crores that we handle. And now the Ted Baker opportunity, the first step unfolding well in a silo in terms of its own viability but also leading to unfolding of many such opportunities. So therefore, in these turbulent times, while we anticipate the main design-led sourcing business to bounce back. The new initiatives are beginning to contribute a lot to what we are doing. Now if I come to the manufacturing capabilities, we feel as a very responsible -- PDS on the fall in terms of ESG compliances, we've gone to make sure that our own 2 factories in Bangladesh keep embracing the highest trend of ESG governance standards. So we saw the installation of solar power panels in our Bangladesh factory, Green Smart Shirts, and this would enable us not only on one hand, [ boding ] further the path of cleaner power, but also would lead to cost savings of annualized approximately INR 70 to INR 80 lakh per annum. And about 12 to 18 months back, we had brought in a change in the leadership team of our factory, Progress, that actually has resulted into Progress factory making money. We believe there was a need to also augment the leadership team of Green Smart factory, wherein we've actually brought in a new team of CEO and a Chief Operating Officer, who spent close to 20 plus years in the industry of manufacturing and selling garments to global retailers. So therefore, having achieved the turnaround, we want to make sure that there is permanency in terms of making profits and then gradually taking up the curve. But as I said earlier, the manufacturing operations this quarter does have an impact of longer Eid break and also on the whole there has been a muted demand or so. So with this, I would hand it over to our, CFO, Rahul Ahuja, and who will take you through the financial performance of the quarter -- for the quarter.

Thank you, Sanjay. Good afternoon, and good evening to everyone. On the commentary for our financials for the first quarter, we concluded the FY '23 on an optimistic note but you are aware of the headwinds in the coming quarters. For the quarter ended June '23, we reported a top line of INR 2,115 crores with a gross margin of 18.17%. Quarter 1 is usually a new quarter in our industry. However, Q1 FY '23 was exceptional as we benefited from the pent-up demand and reopening of economies post COVID time in lockdowns. Other than coming off a high base of last year Q1 FY '24 experienced a slowdown due to the global economic headwinds impacting spending power and demand, leading to an inventory buildup with large retailers and brands. We believe that this trend will continue with some spillover in Q2 and have a positive view for the latter half of this year. The muted demand enabled us to capture better margins -- gross margins have improved by 279 basis points from 59 -- from 15.9% to 18.7% quarter-over-quarter. We reported EBITDA for the quarter of INR 67 crores with an EBITDA margin of 3.2%. The EBIT for the year stood at INR 51 crores with a margin of 2.4%. Profitability, however, was impacted by interest costs mainly attributable to the increase in the base rate, average SOFR increased from 0.7% same time in the same quarter last year to about 4.9% for Q1 FY '24, approximately a 7x increase in the interest rates. Tax outflows were primarily attributable to the profitability of companies, including Ted Baker in the UK. jurisdiction attracting a higher tax rate. As a result, in spite of operating profit being at similar levels as that of last year. Our profit after tax witnessed a decline with a profit of INR 23 crore. Revenue from our Sourcing segment stood at INR 2,031 crores with an EBIT of INR 45 crores and a return on capital employed of 38% for the quarter. Our Manufacturing segment reported a revenue of INR 117 crores and an EBIT of INR 4 crores. As Sanjay mentioned, given the Eid holidays, where in both the Eids were in the same quarter this year. During the month of April and June 2 of our factories were shutdown for the holiday period impacting our production base. Roughly the number of holidays were more as compared to the same quarter last year by about 7 to 8 days. Moving on to our balance sheet. Net debt stood at INR 26 crores versus INR 115 crores reported in June 2022. The reduction in our cash balances compared to our position in March '23, was mainly attributable to the acquisition of Ted Baker business that we did in June. We operated on a net working capital of 2 days. The company delivered 31% (sic) [ 37% ] return on capital employed and a return on equity of 27% for the quarter ended June 2023. The company maintains a stable financial position with a net debt-to-EBITDA ratio of [ 0.06 ]. We would continue on our growth journey by being prudent on operating costs and maintaining our balance sheet size to achieve higher returns for all our stakeholders. We will now open the line for any questions that you might have.

[Operator Instructions] The first question is from the line [ Akshat Sam ] from SAM Capital.

So this is more of a broad-based question on our business models. So we have over 100 subsidiaries now and adding more every year because of our unique partnership model. But we also have a lot of multiple subsidiaries operating in the same geography and basically a lot of them may be are competing against themselves to win businesses the question is...

[Technical Difficulty]. Sorry, to interrupt sir, but we seem to have lost the line for the management. It seems to have disconnected. Please stay with us. We will just reconnect with the management. Ladies and gentlemen, we have reconnected with the management. Akshat, I would request you to please repeat your question so that the management can hear the entire question.

Hello. Can you hear me?

Yes, Akshat. Sorry, apologies for that...

So there's a couple of questions on my end. So the first question is more about our partnership -- unique partnership model. So we have over 100 subsidiaries, and we are adding more every year because of our unique model as I said. But also, there are a lot of multiple subsidiaries operating in the same geography. And they are like competing against themselves to win businesses also haven't we better served by consolidating some of the subsidiaries as I say, operating in the same geographies, I mean, which will lead to more cost savings and other synergies and it will also help with management bandwidth where you'll have better oversight and then a smaller number of subsidiaries in say a particular geography. So yes, that was the first question.

Yes. Let me take the question then on one by one. So on the subsidiaries, I think this is an inherent part of our business model wherein a normal company, one will take an employee on board and then kind of incentivize employees, wherein we actually take an entrepreneur on board in view of an employee and the entrepreneur actually has a share of profits. And this is very clearly identifiable in the hands of a prospective entrepreneur when he or she has a shareholding in that legal entity. So therefore, this is very much an inherent part of what we do and how we operate. And this is likely going to be in a similar manner as we take along because we were in a given geography, for example, I would say, in Hong Kong, I have a simple approach business, primarily catering to customer Primark in U.K. but there it's a design-led sourcing business. I have a business led by a gentleman called Eric Leddel in the name of [indiscernible] in Hong Kong that focus on home category. And there's a third business led by [indiscernible] focused on Walmart. So that's the reason entities are existing. What is important for us as a management team is to ensure that the governance continues to be strong and keep going higher and up. That is where, as we learn from our investors, we are increasing constantly our disclosures in the top 10 verticals and so on, plus the strong board that came at the listed company level. We're also institutionalizing the growth culture to the next level in terms of 10 largest verticals as well. Auditors are largely [ EY SBT ] across the various subsidiaries. So I guess, of course, in our company in due course of time, there are some redundancies that we can address by optimizing some legal entities. But I think this is core to what our business is. But last point, we are very sensitive to the cost aspect that you mentioned. And at this stage, the central team that manages this entire close to $1.5 billion top line and $2.5 billion GMV is about 1% of sales at present and we are making sure that we don't allow it to go up. And in fact, all the CFOs that we wanted to hire in the central team is all done in using more of technology to take it ahead. So a long answer to your short question, but I think it's important to kindly understand this is an inherent part of our structure through which we operate.

Sir, my second question is, we are trying to position ourself as more of a solution provider to a lot of these companies. So what other business segments within the holding value chain are we looking to get into or expand the total addressable market? For example we started sourcing as a service 3 years back and also we recently got into a logistics company in Bangladesh. So is that a segment we are looking to expand into and what other segments within the value chain we will look to expand into -- going into the future. Yes, that's it from me.

I think one more point, which is a little bit reflecting on the first point that you raised. Even our customers require a new entity to be put in place, for example, when Hanes signed up an annual sourcing of a service $400 million business contract, they wanted it to be done as a separate entity. In fact, the CEO there has actually a joined reporting relationship to Hanes as well as to PDS, so wherein the Hanes is actually able to see it's cost for the business. So that's also a bit of reflection on the first question you mentioned. Now on yes, sourcing as a service, we believe from a concept stage 18 months back it is now institutionalized. Our management team across the various verticals has got very much tuned to up to speed on sourcing as a service. So across all the relationships this is being offered and let me remind you that this is not something that I'm pushing. This is also the need of the customer as well, wherein the retail customers are actually wanting to focus on their core offerings. And they were searching for credible counterparties like us. So therefore, to that extent, it has become institutionalized. It is a constant that we will keep increasing now in terms of our offering. We went a step beyond, while sourcing as a service for Hanes was actually procuring from 1 geography of Bangladesh for them. But then for Gerry Weber in Germany, it is not the entire global sourcing. So that's going up the value chain and now brand management in Ted Baker. So therefore, if I got your question right, we would keep endeavoring on a customer's pain is actually gain. So they want somebody to take care of the entire back end. So for example, Authentic Brands Group in U.S., they do -- they own a lot of brands like Reebok, Ted Baker, Forever 21. The annual revenue that we generate from these brands is about $25 billion. So when they are now acquiring brands, they're actually looking forward to an operating partner who works alongside with them, while they derive royalty, they want the operating partner to manage the brand for them as well. So therefore, PDS is actually foreseeing a lot of such opportunities unfolding. So our core business of design-led sourcing will keep remaining intact, but the opportunity of value-added services plus new categories. In fact, about 1 year back -- 12 to 18 months back, we have mentioned to our stakeholders that we've got into home as a category. And with our existing customers, we want to do such businesses. ASKA, one of our large U.K. base customers, on one hand, this was a customer on design-led sourcing. We've got a $400 million plus of sourcing as a service contract, and we've got a $250 million of agency contract for home business. Agency is the beginning of the journey. So that's the answer that, yes, we believe there is humongous potential now to engage more with the customers and win the largest wallet of share.

The next question is from the line of Sarvesh Gupta from Maximal Capital.

Sir, you said that this business is seasonal and hence explains the Q1 fall. But how do you see the full year FY '24 growth trends as they are as of now? And if you can break it up between H2 and H1.

I think as we have mentioned earlier that we were kind of anticipating a single-digit growth throughout the year for -- because as we said, the first 6 months would be muted and the next 6 months you see the recovery. So therefore, that's fair answer to your question, kind of single-digit growth for the entire year. And I think we are gearing towards making sure that somewhere profit should improve closer to 15% to 25% for the entire year. That's the target with which we are working in the year-end. In terms of split in the H1 and H2, as we had said earlier, H1 actually should is anticipated for a decline over the last year, but then H2 should see a strong recovery. So therefore H2 quarter should be significantly better than H1.

So you are seeing 15% to 25% in terms of profit growth for the full year?

I think I would say optimistically, it may go in that range of closer to 20% plus or so. But I think if the demand doesn't improve, then the profits could be about 10% or so in terms of -- I think there's nothing like an absolute number that we're working towards. We anticipate that range that in a tough scenario about 10%-ish or so, but if there is potential then you can actually go better than that as well as the recovery happens in the second half of the year. But at this juncture, when we are talking to you today, all the signals are very good. Customers are taking a little bit of extra time to close the orders. But the engagement level with our customer is very intense and the signals are all very positive.

And the margin improvement trajectory that you have been guiding for of 50 basis point per year sort of that holds for even no?

Yes. I think while not withstanding closer to 2.75% improvement, I think a maintainable gross margin improvement year-over-year is yes, 50 basis points. There is seasonality, while every effort is there to add more value-added businesses. But to -- 1 line answer to your question, yes, we are geared up for 50 basis point improvement year-over-year.

Understood. And sir, on your finance cost, sir, there are 2 questions. First of all, in your business, when you're saying net working capital days is only 2 days but if I look at your working capital debt, it almost comes to like 25 days. So what is the -- why is there a difference between the two and why -- in a sourcing sort of a business, why should you carry working capital debt at all in your balance sheet? So if you can explain this discrepancy between these 2 figures of 2 days versus 25 days.

So as far as our working capital is concerned, these are largely post-shipment route. And so we will always need once we manufacture the goods to finance our receivables. So largely, our working capital comes from there. As far as our number of working capital days is concerned. If we were to let off our cash position, the cash margin that we carry or the cash that we carry in our balance sheet. If we net them off from our working capital, that 2 days. If you were to calculate just the working capital, that is the number which comes more like 22, 23 days.

I think just to add to Rahul downside I would say this is not a discrepancy. This is an opportunity that operating working capital days length, yes, it is 2 days of working capital, inventory receivable and minus stable days. And you rightly observed from a borrowing perspective, the number of days are much higher. We have not calculated, but I hear you, they are higher. So why the discrepancy or where is the opportunity then? The opportunity is that there is always cash in the system on one hand and then there is [ borrowing ]. And when we report net debt, we net off cash. But Rahul, our CFO, is close to about 27 years in the industry, and the first half of it was as a banker for GE and Standard Charted and other leading banks. And I think few of the areas that he has identified that our cash margins on the lines are much higher than what they should be. So therefore, few -- over the next 2 quarters, we anticipate that the cash margins that is there should get released. And therefore, the real debt utilization will actually come down. So therefore, what you observe as a discrepancy allow us to work towards as an opportunity to make sure that the debt itself is down rather than cash knocked off against the debt and then we'll talk about net debt. So I think I agree with the observation. We would gear towards bringing it down in terms of the real utilization of debt.

And these are not the LCs that you are opening for your vendors. So are you taking any risk on their default on your balance sheet?

I think our LCs are a very small portion of our procurement from the vendors. If I have to say circa approximately [ 25% ] or so as we posted during the call, Rahul, can get the number. But that's the broad number of LCs being issued. I don't think there is any kind of default risk because every factory that we bring on board is taken on board with our comprehensive receiving 6 to 12 months of vendor onboarding process. And therefore, we are in constant touch. We have a strong team of 800-plus merchandisers on ground. For example, in Bangladesh I pickup has 1 location where maximum number of factories are located that we deal with. So therefore, through our teams on ground through our factory onboarding process, we believe the exposure is low. And I think it is also well spread across. That's also important thing that do I have a concentration risk on our given factory, and therefore, there is any theoretically a default risk. That risk is also -- if at all, we say there is a risk, low risk, that is also mitigated and spread across close to 600 vendors that we deal across the globe as well. So therefore, to summarize careful onboarding process, being in touch through the on-ground teams. It is not that my designer team is sitting in U.K. and therefore they ask for a remote control managing the factory. There is a set of people on ground and well spread across. So the risk is well managed proactively and the probability of it hitting us is extremely low.

So 20%, 25% of the entire sourcing is via LCs, right?

On a given point of time, that could be the peak situation that might be there, wherein we facilitate the factory in terms of fabric procurement, print procurement, et cetera, in the value chain. But then I think the important thing is that on the front end as well, the customer profile is also carefully looked into and saying in short customer track record. So therefore, one should not look in a silo in terms of the fact that I'm taking an exposure on the factory. The exposure is coming because at the first step, there is an order that is emanated from a reputable customer with a track record. So that's how I need to request you and encourage you to look at the entire picture.

The next question is from the line of Karan Premchand Gupta from CAVI Capital.

I'll just take over from the last question and just delve a little bit deeper on when you're factoring your accounts receivable, are those on a recourse or nonrecourse basis to PDS?

Any given vertical? Sorry, go ahead please. You finish your question.

So what I was trying to ask is in case the customer defaults, then whoever is doing the factoring, can they come back to you for restitution?

So our factoring is of 2 kinds. We largely do insurance-backed factoring wherein the risk is taken by the bank. So the day goods are dispatched we get our money and the risk then lies with the bank because they have taken a back-to-back insurance. Largely, this is -- the facilities we have from our banks as far as post shipment is concerned.

In fact, I would give the answer that the cost to us is 0. It's under no eventuality that once the receivable is factored that they can come to us.

Fair enough. And then next, I just wanted to get a little bit more understanding about this acquisition of the Ted Baker business in the U.K. Now given my understanding is that the total acquisition cost was about INR 150 crores, and you mentioned that this was all related to working capital. Now it's a very sizable number given that you generally don't carry any working capital. So is there a plan or a time line by which you will be able to bring this amount in line with the overall consolidated level and thereby free up that capital? Or how do you think of this?

Yes. I think it's an interesting observation. Yes, we have upfront written a check of about INR 150 crores, and there is a corresponding working capital to that. And as -- firstly, if were not average wherein basis, we mentioned about the anticipated turnover that we think this business could generate somewhere between INR 450 crores to INR 550 crores with about a 9%, circa 7% to 10% range profitability. So we anticipate that this business in year 1 should give us 30% on our capital employed on a INR 150 crore check that we've written. But the upside is that we are working towards factoring these receivables on a nonrecourse basis. So therefore, it may take us about 3 to 6 months because the whole process of getting the insurance in place, getting the factoring lines activated. It takes time to get all these operational things on ground up and running. So as these things on ground takes about 3 to 6 months, there is a big chunk, for example, of receivables of approximately $16 million to $17 million which we got in our hands on day 1. So if I talk about approximately 60%, 70% of that getting factored which is about $10 million to $11 million. That means about INR 80 crores to INR 90 crores worth of cash would actually come back to us. 50% of cash, there's a potential basis the existing factors through which we do our business of nonrecourse factoring. So that's the answer to your question. In about 6 months' time, we are working towards trying to recoup this back to a nonrecourse factoring program. Then that should, touchwood hopefully, even further increase return on capital into our other business as well.

Okay. So when you say INR 150 crores in working capital, is that all in receivables? Or is [indiscernible] inventory? Or what else is there in that working capital?

It's actually, for example, on a gross asset basis, there was about $40 million of assets, wherein the inventory was about 50%, about $20 million or so. There was about $16 million to $17 million of receivables, about $1.5 million of cash, that's about $40 million. And there were current liabilities of about $20 million or so. That's give me about $19 million, $20 million of net working capital. That's giving an answer to your question as to what is the breakup and the inventory in hand largely belongs to the wholesale business that we have also got a license to do as a franchisee. So therefore this inventory would get rotated. And then we have taken the inventory on hand, we have taken due care in terms of diligence and in terms of provisioning prior to we getting it into our balance sheet. So therefore, this inventory comes into our hands with a careful process. But I've answered the question in terms of breakup, $20 million on receivables, $17 million on inventory, $20 of payables and only of wholesale business for which we are the licensee and we will keep rotating it in the normal course of business.

No, that's very heartening to hear and also thank you for discussing the inventory, how you went about looking at the inventory because I was going to ask about that. So I appreciate it. Finally, like are there any other similar transactions in the pipeline that you can talk about? Or if you were to come across something like this. Do you think you would like to take similar transaction forward and what is your appetite for those, both in terms of number of transactions and size of transactions? That's it from my side.