Welspun India causes more damage than it appears

Few investors trust Welspun India’s management after what the company did to one of its biggest clients. Welspun’s management tried to clarify the reason behind Target Corp deciding to end its relationship with the Indian company, but very few are taking their word for it.

Welspun India has hit the lower circuit for the second consecutive day losing 40% of its value in the past two days. Nearly 2.5 crore shares sellers have queued up to sell their shares as the stock has hit the maximum level it can fall in a day. From the number of sellers in the market it seems that Welspun India has a long way to go before it stabilises.

More than the impact the company will be taking on its books, the hit it takes on its reputation is what matters more. An analyst from Elara Capital has pointed out that the move by Target, its second largest client, would result in its earnings falling by 22%. Welspun has lost a marquee client which contributed around 10% to its topline. But it’s the perception, which is reflected by the price-to-earnings ratio (PE) that matters the most.

Welspun has been accused by Target for selling phony Egyptian cotton sheets. The retailer pointed out that they discovered last month that 750,000 sheets and pillowcases labelled as Egyptian cotton were actually made with another type of cotton. Clarifying their stance, Welspun India’s management said they will appoint an auditor to probe the charge. The company said that the issue mainly related to provenance/origin of the cotton and not the quality as the product has been highly rated by customers. Selling the product as a superior brand but using inferior cotton is hardly a justification.

But the damage had already been done. After Target, the world’s largest retailer Wal-Mart Inc has said that they are reviewing Welspun’s cotton certification record. Wal-Mart is the third largest client for Welspun.

Relationship and reputation is very important for an established retailer like Target. The products supplied by Welspun, which is one of the many vendors for Target, are a very small portion of its revenue. Even for Welspun, sales to Target accounted for 10 per cent of its revenue but the sheets accounted for only around 3-6 per cent. One can imagine how small the contribution of these products would have been for Target which has a revenue of around $74 billion. With quality of product and trust in mind Target Corp decided to stop buying all products from Welspun.

Target, in fact, has announced that they will be refunding the money to its customers who have bought the inferior products provided by Welspun.

For Welspun, the damage is not only losing one of its biggest client who contributed 10% per cent to its top line, but the potential of losing others too and fighting a perception battle. Welspun derives roughly 60% of its revenue from the US and will have to get into the fire-fighting mode to protect its territory. There are no talks of legal actions yet, but if Target decides to sue the company, the impact could be huge.

If guilty of deliberately selling a wrong product, the government of India should also pull up Welspun India for tarnishing its image, especially at a time when the country is seeking investment for its ‘Make in India’ bid.

Impact of Welspun’s wrongdoing is already visible on companies that are providing similar products. Indo Count, a company in the similar space is trading 11% lower as investors fear that all Indian companies might be subjected to similar audits as Target has done for Welspun.