This article provides in-depth fundamental analysis of Rexnord Electronics & Controls Ltd, an Indian manufacturer of coolant fans and shaded pole motors mainly used in computer hardware equipments, power supply equipments, textile machines, refrigeration industry, injection molding machines, photocopying machines etc.
Rexnord Electronics & Controls Ltd Research Report by Reader
Q: Dear Dr. Vijay Malik,
I have posted my second analysis of Rexnord Electronics & Controls Ltd on your website. Kindly provide your views and also guide how we can better the analysis format:
- Promoter holding increased from 46.6% to 51.5% from 2014 to 2015.
Financial analysis of Rexnord Electronics & Controls Ltd:
- Sales growth: Look for high and sustainable growth >15% per year. Growth rate of >50% are unsustainable.
- 10 Years: 21.6%
- 5 Years: 20.25%
- 3 Years: 24.77%
- Profitability: Look for high and sustainable OPM and NPM. I prefer companies with NPM of >8%.
- Tax rate of Rexnord Electronics & Controls Ltd is consistently above >30%
- Interest coverage:
- Interest coverage ratio of Rexnord Electronics & Controls Ltd = 3.17
- Debt to Equity ratio:
- D/E ratio= 0.59
- Current ratio: Look for companies with CR >1.25
- Cash flow: Positive CFO is necessary. It’s great if CFO meets the outflow for CFI and CFF.
- Cumulative PAT vs CFO: Look for companies where cumulative PAT and CFO are similar for last 10 years.
- cPAT: ₹8.79 cr vs. cCFO: ₹19.68 cr
Valuation analysis of Rexnord Electronics & Controls Ltd:
- Price to Earnings ratio (P/E ratio):
- Rexnord Electronics & Controls Ltd = 24.36
- Industry P/E = 38.71 (moneycontrol)
- P/E to Growth ratio (PEG ratio): should be <1.
- Rexnord Electronics & Controls Ltd = 0.48
- Earnings Yield (EY): should be greater than long term government bond yields or bank fixed deposit interest rates.
- Rexnord Electronics & Controls Ltd = 8.11%
- Price to Book value ratio (P/B ratio):
- Rexnord Electronics & Controls Ltd = 3.34
- Price to Sales ratio (P/S ratio): buy if P/S ratio is < 1.5 and sell if >3.
- Rexnord Electronics & Controls Ltd = 1.11
- Dividend Yield (DY): Higher the better. DY of >5% is very attractive. However, I do not focus a lot on DY for companies in fast growth phase.
- Rexnord Electronics & Controls Ltd = 0.00%
- EV/EBITDA: It is a valuation parameter for entire stakeholders and removes the impact of sources of funds (i.e. capital structure or debt to equity ratio).
- Rexnord Electronics & Controls Ltd = 9.93
Business and Industry analysis of Rexnord Electronics & Controls Ltd:
- Comparison with industry peers: The Company must show sales growth higher than peers. If its sales growth is similar to peers, then there is no Moat.
- 10years sales growth rate:
- Rexnord Electronics & Controls Ltd: 19.24%
- Havells India Ltd: 18.66%
- Crompton Greaves Ltd: 13%
- The above comparison shows Rexnord Electronics & Controls Ltd has an advantage over its peers from the industrial fan sector.
- 10years sales growth rate:
- Conversion of sales growth into profits: A Moat would result in increasing profits with increasing sales. Otherwise, sales growth is only a result of unnecessary expansion or aggressive marketing push, which would erode value in long term.
- 10 years sales growth rate: 19.24%
- 10 years profit growth rate: 35.48%
- Conversion of profits into cash: Increasing profits due to Moat must be collected as cash. Otherwise, either the profits are fictitious or the company is selling to any John Doe for higher sales without having the ability to collect money from them.
- cPAT: ₹8.79 cr vs. cCFO: ₹19.68 cr
- Creation of value for shareholders from the profits retained by the company: The Company with Moat will create significantly higher market value for its shareholders for every INR of profits retained by it. If a company were destroying value of shareholders money, it would never have a Moat, however fast it may show its sales to be growing.
- Total retained profits of last 6 years (A): ₹8.79 cr
- Total increase in market capitalization in 10 years (B): ₹55.54 cr
- Value created per INR of retained profits (B/A): ₹6.31 cr
Dr Vijay Malik’s Response
Thanks for writing to me! I appreciate the time & effort put in by you in analyzing Rexnord Electronics & Controls Ltd and sharing your analysis for the benefit of author and readers of www.drvijaymalik.com. Let us first analyse the financial performance of Rexnord Electronics & Controls Ltd over last 10 years.
Financial Analysis of Rexnord Electronics & Controls Ltd:
Rexnord Electronics & Controls Ltd has been growing its sales consistently at an excellent pace of 20-30% year on year since last 10 years (FY2006-15). However, a look at the profitability trend of Rexnord Electronics & Controls Ltd would indicate that both the operating profitability margin (OPM) and net profit margin (NPM) have been fluctuating widely in a cyclical manner during last 10 years (FY2006-15).
Operating profit margins (OPM) have been varying from 14% to 6% to again 14% to now 12%. Similarly, net profit margins (NPM) have been fluctuating from 1.4% to 2.5% to 1.5% and now to 4.8% over the years.
Such fluctuating margins are characteristic of companies, which have low bargaining power with their customers. In such businesses, companies find it difficult to pass on the increase in raw material costs to their customers quickly and thus take a hit on their profitability margins
Also Read: How to do Financial Analysis of a Company
Rexnord Electronics & Controls Ltd has been paying taxes at more than 30% rate over last 10 years, which is in line with the standard corporate tax rate in India. This is a good sign.
Operating Efficiency Analysis of Rexnord Electronics & Controls Ltd:
Over the years, Rexnord Electronics & Controls Ltd has been reflecting improved operating efficiency even though the Net fixed assets turnover (NFAT) has been varying over the years from 2.79 in FY2007 to 6.04 in FY2011 and to 3.43 currently.
Inventory turnover ratio of Rexnord Electronics & Controls Ltd has improved from 3.4 in FY2007 to 5.8 in FY2015. Receivables days of Rexnord Electronics & Controls Ltd have improved from 98 days in FY2007 to 36 days in FY2015. Improvement in receivables days indicates that the company has been able to collect the money from its customers faster, indicating its growing influence in the market. Improved collection practices lead to lower working capital finance requirements and thereby lower interest costs and improved profitability.
Improving inventory turnover and receivables days indicate that Rexnord Electronics & Controls Ltd is able to manage its working capital more efficiently and able to free up funds, which were earlier locked up in the day to day operations of the company.
Rexnord Electronics & Controls Ltd has PAT for last 10 years (FY2006-15) of ₹9 cr. whereas the CFO over the similar period is ₹20 cr. cCFO has been much higher than cPAT over last 10 years mainly on account of better working capital management leading to freeing up of funds, as discussed above.
Margin of Safety in the Business of Rexnord Electronics & Controls Ltd:
i) Self-Sustainable Growth Rate (SSGR):
Self-Sustainable Growth Rate (SSGR) of Rexnord Electronics & Controls Ltd is about 5-6%. As mentioned in the article on Self-Sustainable Growth Rate, SSGR does not factor in working capital changes. However, we can estimate whether funds are being tied up in working capital by comparing cPAT with cCFO.
Analysis of SSGR indicates that Rexnord Electronics & Controls Ltd can sustain a growth rate of only 5-6% from its core operations without getting under debt burden. However, an investor would notice that Rexnord Electronics & Controls Ltd has been growing at a pace of 20-30% over last 10 years.
The growth beyond SSGR has been funded from the cash freed up by better working capital management, as discussed above, and by raising additional debt. The debt levels of Rexnord Electronics & Controls Ltd have increased from ₹3 cr in FY2006 to ₹8 cr in FY2015.
The company has also raised equity capital by issuing additional equity in form of granting warrants to promoters on preferential basis and converting them into equity shares. However, the conversion of warrants, which have been allotted at a steep discount to ongoing market price raises other concerns about the management, which we would discuss later in the article.
ii) Free Cash Flow Analysis of Rexnord Electronics & Controls Ltd:
These findings of SSGR get re-affirmed when an investor analyses the cash flow from operations (CFO) of Rexnord Electronics & Controls Ltd with its capital expenditure (Capex) requirements over last 10 years (FY2006-15). During FY2006-15, Rexnord Electronics & Controls Ltd realized total CFO of ₹20 cr. and out of it Rexnord Electronics & Controls Ltd had to spend ₹19 cr. into capital expenditure, thereby releasing free cash flow (FCF) of only ₹1 cr. as surplus for shareholders.
It is important to note that the major portion of CFO of ₹20 cr. has come from the funds released from working capital. Had the management not been able to achieve this improvement in working capital efficiency, then the debt levels would have been much higher than ₹9 cr at March 31, 2015.
In light of the above findings, it does not seem illogical that the company has not declared any dividend in last 10 years.
Susheel, your approach to analysis of Rexnord Electronics & Controls Ltd, though methodical, misses out on the analysis of managerial aspect of the company.
The easiest way to analyse the management is to read the annual report of the company in details with due attention to each section of the annual report.
When an investor reads the annual report for Rexnord Electronics & Controls Ltd, then she comes across certain developments, which raise further questions about the management of Rexnord Electronics & Controls Ltd. Let us deal with them one by one:
Additional aspects and annual report analysis of Rexnord Electronics & Controls Ltd:
A. Grant of warrants on preferential basis at a steep discount to market price:
Rexnord Electronics & Controls Ltd sought permission of shareholders’ in the AGM of the company in August 2014. The resolution in FY2014 annual report, page 2, mentioned that:
“The Board be and is hereby authorized in its absolute discretion to offer, issue and allot, on preferential basis upto 34,78,800 (Thirty Four Lacs Seventy Eight Thousand Eight Hundred Only) Warrants carrying an entitlement to subscribe to an equivalent number of equity shares of face value of ₹10/- each at a price being not lower than the minimum price calculated in accordance with the Regulations for Preferential Issue contained in Chapter VII of the Securities and Exchange Board of India (Issue of Captial and Disclosure Requirements) Regulations, 2009 (hereinafter referred to as “SEBI (ICDR) Regulations”) as amended, to the allottees mentioned below on a preferential basis.”
Shareholders’ approved this resolution in the AGM on August 30, 2014. The company, without much delay, allotted the warrants to the promoters at September 23, 2014 as per the following BSE filing on the same date:
“Rexnord Electronics & Controls Ltd has informed BSE that the Board of Directors of the Company at its meeting held on September 23, 2014 allotted 34,78,800 Warrants carrying an entitlement to subscribe to an equivalent number of equity shares of face value of Rs. 10/- each at a price of Rs. 13.40/- on preferential basis in accordance with SEBI (ICDR) Regulations, 2009 to the Promoters & Non-Promoters, as approved by the members of the Company in the Annual General Meeting held on August 30, 2014.”
However, what seems interesting is the price at which the warrants were offered: ₹13.40/- whereas the closing market price on September 23, 2014 was ₹23.34/-. A discount of 43% (₹9.94) to the then market price.
This amounted to handing over of ₹3.36 cr to promoters on a platter (₹9.94 * 34,78,800).
No wonder the promoters exercised their option and converted 10,98,300 warrants into equity shares on December 13, 2014 at the fixed price of ₹13.40/- as per the BSE filing of the same day:
“Rexnord Electronics & Controls Ltd has informed BSE that the Board of Directors of the Company at its meeting held on December 13, 2014, has allotted 10,98,300 Equity Shares of Rs. 10/- each at a premium of Rs. 3.40/- each to promoters and non-promoters on conversion of 10,98,300 Warrants issued on preferential basis, pursuant to approval of Shareholding of the Company accorded on August 30, 2014 in the Annual General Meeting.”
The closing market price of shares of Rexnord Electronics & Controls Ltd at December 12, 2014 was ₹22.85/-
B. Gaining majority shareholding control over the company by backdoor channel:
In FY2015, the promoters of Rexnord Electronics & Controls Ltd increased their shareholding from 46.47% at March 31, 2014 to 51.46% at March 31, 2015 by an increase in their shares by 888,300, which has entirely come from conversion of warrants in to equity shares by promoters.
As discussed above promoters attained the majority stake by getting shares at steep discount to the ongoing share price (₹13.40/- vs ₹22.85/-). If the promoters would have bought these shares in the open market to increase their stake beyond 50%, the share market would not have given them these shares at this discount.
C. Contractual agreement with son-in-law of the promoter:
Rexnord Electronics & Controls Ltd has sought shareholders’ approval to enter into contractual agreement for sale, purchase, payment of commission and reimbursement of expenses with M/s Excelum Enterprises, which is the firm owned by son-in-law of the promoter.
As per FY2015 annual report of the company:
“The Company has entered into a Contractual Agreement with M/s. Excelum Enterprises for Sale & Purchase, payment of Commission on Sales (including Overseas Sales) and reimbursement of expenses for an amount not exceeding of ₹2 Crores on annual basis, on such terms and conditions as may be agreed to by the Board.
M/s. Excelum Enterprises is a proprietary firm of Mr. Kunal Tanna being a relative of Mr. Kishore Chand Talwar and Mrs. Nainy K. Tanna, Directors of the Company, this transaction will require approval of the shareholders of the Company. Pursuant to the Section 188 of the Companies Act, 2013 and rules made thereunder, the approval of transactions is required by passing a Special Resolution at the General Meeting for appointment of any agent for purchase or sale of goods, materials or services or property where the amount exceeds 10% of the Turnover of the Company or ₹100 Crores, whichever is lower OR exceeds 10% of the net worth of the Company or ₹100 Crores whichever is lower.”
Mr. Kunal Tanna is son-in-law of promoter Mr. Kishore Chand Talwar as established by the following section of annual report for FY2015 (page 15):
The transactions with M/s. Excelum Enterprises started in FY2015 as witnessed by the related party disclosures on page 40 of FY2015 annual report.
The dealings with the firm of promoter’s son-in-law, which started in FY2015, are proposed to be expanded in a major way by taking shareholders’ permission going forward.
It remains to be seen whether the dealings within the family of the promoters would be beneficial to the public shareholders of Rexnord Electronics & Controls Ltd.
Further advised reading: How Promoters benefit themselves using Related Party Transactions
D. No professional director on the remuneration committee of the board:
Rexnord Electronics & Controls Ltd does not have its Nomination and Remuneration Committee in compliance with the Companies Act, 2013. This issue has been highlighted by both independent auditor as well as the secretarial auditor:
Secretarial Audit report FY2015 annual report, page 16:
“The Board of Directors of the Company is duly constituted with proper balance of Executive Directors and Independent Directors. There were no changes in the composition of the Board of Directors that took place during the year. The composition of Nomination and Remuneration Committee is not in conformity with the provisions of Section 178 of the Companies Act, 2013.”
Independent Auditor’s report FY2015 annual report, page: 26:
“We draw attention to note no 41 to the financial statements which describes the non compliance to the provisions of section 178 of the Companies Act, 2013 with regard to composition of the Nomination and Remuneration Committee of the Company.”
Also in the note 41 to the financial statements at page 42 of FY2015 annual report:
“The Company is in process of appointing professional directors to compose the Nomination and Remuneration Committee in conformity with the provisions of the Section 178 of the Companies Act, 2013.”
This observation by the auditors is continuing repeatedly from past years, however, the management does not seem to be doing any thing about it. It raises questions about the corporate governance standards being followed by Rexnord Electronics & Controls Ltd.
An ill-constituted Nomination and Remuneration Committee might be the reason that the promoters could get warrants at a deep discount to market price at the cost of public shareholders.
E. Resignation of Company Secretary in July 2015:
It is the responsibility of the company secretary to ensure that the company is in compliance to various statutes/laws that it is required to follow. However, as detailed above, Rexnord Electronics & Controls Ltd is not in compliance with the provisions of Companies Act, 2013. This non-compliance to the proper composition of Nomination and Remuneration Committee is continuing since past years and has been repeatedly highlighted by external auditors.
This might be one of the reasons that the company secretary Mr. Debabrata Guha Chaudhury resigned from the company from June 01, 2015. The company informed about this development to BSE at July 02, 2015 in a corporate filing:
“Rexnord Electronics & Controls Ltd has informed BSE that Mr. Debabrata Guha Chaudhury, Company Secretary of the Company has resigned from the position with effect from June 01, 2015.”
An investor would notice that the instances discussed above raise questions about the management of Rexnord Electronics & Controls Ltd. An investor who wishes to invest her hard earned money in Rexnord Electronics & Controls Ltd, should analyse these issues deeper and convince herself with the explanations to above issues before making investments in the shares of the company.
Margin of Safety in the market price of Rexnord Electronics & Controls Ltd:
Rexnord Electronics & Controls Ltd is currently available at a P/E ratio of about 20, which does not offer any margin of safety as described by Benjamin Graham in his book The Intelligent Investor.
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
Overall, Rexnord Electronics & Controls Ltd appears to be a company growing at a fast pace, with cyclically fluctuating profitability margins with improving working capital management. It has been able to meet its capex requirements from its cash flow from operations mainly due to improved working capital efficiency.
It remains to be seen whether Rexnord Electronics & Controls Ltd would be able to keep improving its working capital consistently in future. Otherwise, there is high probability that Rexnord Electronics & Controls Ltd might see higher debt levels as its SSGR of 5-6% does not support its current growth rate of 20-30%.
An investor should analyse the management aspect of Rexnord Electronics & Controls Ltd in detail before taking any investment decision about the company.
These are my views about Rexnord Electronics & Controls Ltd. However, any investor should do her own analysis before taking any investment related decision about Rexnord Electronics & Controls Ltd.
You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company“
Additionally, the investor should keep track of the future performance of the company for signs of improvement or worsening as part of their monitoring exercise. She may use the steps explained in the following article for monitoring stocks in her portfolio.
Also Read: How to Monitor Stocks in your Portfolio
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- The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
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