This article provides in-depth fundamental analysis of IST Ltd, an Indian auto ancillary player, which is primarily earning its profits by being the parent company of the landowner of a Unitech Infospace.
IST Ltd Research Report by Reader (Ashish Malhotra)
Hello Dr Malik
It was indeed pleasant meeting you during your seminar in Delhi.
Following your principles for investing I have come across this company IST Ltd. that I have tried to analyse however after careful review there are certain matters that are making me hesitant and concerned and would appreciate your review.
IST Ltd. is a company listed in Auto component manufacturing category; however, it seems strange in terms of structure. While it is an OEM supplier of parts to various automotive companies, however, its sales is only 17% of the total revenue and less than 10% of the profits.
IST Ltd has a hundred percent owned subsidiary Gurgaon Infospace Ltd which is into the development of Infrastructure for IT/ITES Sector. It has leased a prime office complex in Gurgaon as per code sharing agreement 28% of the revenue earlier with Unitech Group who have built and maintained the complex (perhaps this has been taken over by a new foreign partner which I am not too sure about). 90% of the profit in IST are from this entity. Besides, there is a 3rd associate company where they have 30.8% holding i.e. IST Steel & Power Ltd and this gives less than 1% of the profit to the parent company that too last financial year. Before it was a loss making associate.
Following is the business performance of the company. There are certain key findings that I would like to share with you to save your valuable time.
- Promoter holdings is 74.994%, perhaps more by way of certain shell companies.
- No financial institutions, FIIs holding in it. Your ideal setup.
- No dividends till date, negative since they are not sharing the fruits with the investors and therefore have still not unlocked the value in the company. Perhaps this explains why the market capitalization is less than the retained earnings of last many years. Major concern.
- Promoter revenue is only 11.11 lakhs, perhaps they are hiding their remuneration behind the subsidiary and associate company. This too is less than last year perhaps because the auto component business in itself is a loss making business for them.
- A little over 10cr revenue of the auto business is by way of interest, rent, and sale of noncurrent investments, which gives the auto company a respectable profit as against a loss. However, these investments are in tax free bonds and loans to associate companies and family. Perhaps another concern as these can easily be written off from the balance sheet.
- 5 crore capital advance is given to a certain entities which are related to the promoter. Also, a loan of Rs 4.06 cr is given to owner entity which just gets an interest of 8.23%. Again a cause of concern.
- Trade receivables of the auto company in the standalone statement of accounts show a 100% rise from 2.13cr to 5.15cr and is not clearly specified as to why and is hidden in other unsecured trade receivables considered good. While the figure is small as compared to the size of the operations.
- The profits of the company are very high and seems growing. These are by way of noncurrent investments. Just last year, they have sub leased two commercial properties in Noida value approx. 66cr. This will surely generate higher profits in the future for the company. Besides all the capital is invested in tax free bonds, debentures, and its associate’s preference shares. Again stating the complexity of the operations and raises questions about the transparency of these arrangements.
- The management does not seem to have any negative publicity however, the owner promoter has been a close relative of some minister of corporate affairs in previous governments.
- With all the positive and negative points highlighted it is surely available for fraction of the value of the company and being a value investor cannot seem to pass this opportunity.
Would appreciate a great deal if you could share your views on this strange company. Thanks.
Dr Vijay Malik’s Response
It was a pleasure to have you at the “Peaceful Investing” Workshop held in Delhi. I am happy to know that you found the workshop useful and value adding to your stock analysis skills.
Many thanks for sharing your analysis of IST Ltd with the readers and the author. I appreciate the in-depth analysis of IST Ltd done by you and the time & effort that has gone into it.
Let us try to analyse the IST Ltd on consolidated basis:
Financial Analysis of IST Ltd:
As rightly pointed out by you, according to the FY2016 consolidated annual accounts disclosed by the IST Ltd, its major net worth as well as profits are comprised of:
- IST Ltd, which is into high precision auto ancillary business
- Gurgaon Infospace Ltd, which has jointly developed the “Unitech Infospace Sector 21” project with Unitech group. Gurgaon Infospace Ltd is entitled to 28% of the revenue share generated by this project.
- IST Steel & Power Ltd
Let us first try to see IST Ltd segment by segment:
1) IST Steel & Power Ltd:
We notice that IST Steel & Power Ltd constitutes only 0.7% of the profits and has about 2% of the net worth tied up in it. The profits, which IST Ltd generates from IST Steel & Power Ltd is meagre ₹61 lac, whereas, as per the annual report, IST Ltd has invested close to ₹23.8 cr. into this company.
The company has been making investments in IST Steel & Power Ltd at least since FY2009, which is visible from the investments section of the FY2010 annual report, which is the earliest available annual report present at BSE India website.
Analysis of past annual reports indicates that IST Ltd incrementally invested ₹15 cr in IST Steel & Power Ltd in FY2012 by preferred shares and further invested ₹2.6 cr. in FY2013 by investing in equity shares.
The investment of ₹23.8 cr. done in IST Steel & Power Ltd does not seem to have given any reasonable returns to shareholders of IST Ltd over last 7 years (FY2009-16). It is good that IST Ltd has stopped putting in additional money in IST Steel & Power Ltd since FY2013.
As there are no details available about the operations or the assets held by IST Steel & Power Ltd, it is difficult to make any reasonable assumption whether IST Ltd’s investment in IST Steel & Power Ltd would be able to give any significant return to IST Ltd. An investor should contact the company to understand the purpose of these investments and their current fate.
At March 31, 2016, the disclosure of contribution of IST Steel & Power Ltd to the net worth of IST Ltd (shown above) being ₹9.5 cr. gives an indication that the investment done in IST Steel & Power Ltd has been eroded by possibly the accumulated losses in IST Steel & Power Ltd.
Further advised reading: How to Identify if Management is Misallocating Capital
Looking at the scale of operations of IST Steel & Power Ltd by the relative profit contribution and the asset size as compared to IST Ltd, we believe that an investor can safely ignore this segment from consolidated assessment. i.e. assign it nil value.
An investor should keep a continuous check on the investments being done by IST Ltd in IST Steel & Power Ltd and if in future the company puts in further money into IST Steel & Power Ltd without any justifications or further details, then the investor should take it very cautiously.
2) IST Ltd:
IST Ltd is into manufacturing of high precision auto components. However, as rightly pointed out by you, this business seems to be making operating losses. Initial level assessment indicates that almost all the profits of ₹6.6 cr. in FY2016 (standalone) can be attributed to the other income of ₹10.4 cr. The situation was no different in FY2015 when the entire profits of ₹2.5 cr. could be attributed to the other income of ₹5.6 cr.
An investor would notice that the other income (standalone) primarily consists of interest income from tax free bonds, profit on sale of noncurrent assets and the rental income. All of these avenues of income are unrelated to the auto ancillary business, which is core to the operations housed in IST Ltd, leading to a safe conclusion that the operating segment of auto ancillaries in IST Ltd is not making profits.
Moreover, the management has also been upfront in acknowledging the fact of operating losses in the FY2016 annual report, when they left nil expenditure on CSR at page no. 38:
Moreover, as part of the management discussion & analysis section of the FY2016 annual report, page 7, the management has been described about the challenges faced by the auto ancillary business, where it acknowledges that the buyers (OEMs) have so much power in this industry that the vendors are not able to pass on the increase in raw material costs to the customers (OEMs), even at the cost of having operating losses.
The Auto Component Industry in India is highly price sensitive. The Original Equipment Manufacturers do not grant price increase though the input costs have increased. This has impacted profits of the Company.
Almost all the auto ancillary vendors to OEMs face such a situation and it is very difficult for these companies to generate good operating profitability margins unless they supply their products in the after-market segment. However, even in the after-market segment, there is competition from un-organised sector. No wonder, the auto-ancillary sector is a tough sector to operate for the players.
Therefore, in light of the miniscule contribution of profits from IST Steel & Power Ltd and the operating losses of the auto ancillary business in IST Ltd, it becomes clear that almost all the profitability and future cash generation for IST Ltd is dependent upon the fate of its wholly owned subsidiary Gurgaon Infospace Ltd and other investments made by it.
Therefore, it becomes paramount that the investor should analyse the business of Gurgaon Infospace Ltd and other investments of IST Ltd to understand the probability for future value generating ability of IST Ltd. The FY2016 annual report of IST Ltd in the noncurrent investments section of the consolidated financials provides a gist of the investments made by the IST group apart from the wholly owned subsidiary (Gurgaon Infospace Ltd).
However, the biggest challenge that an investor faces here is that Gurgaon Infospace Ltd is an unlisted entity and the IST Ltd’s annual report provides very minimal information about it. Furthermore, the details of other investment entities Vinayak Infra Developers Private Ltd, IST Softech Private Ltd, Subham Infradevelopers (P) Ltd and the commercial properties in NOIDA are not available for assessment.
Gurgaon Infospace Ltd
FY2016 annual report of IST Ltd, provides the following information about Gurgaon Infospace Ltd at page 39:
The above data indicates that the Gurgaon Infospace Ltd has very high margin business with a net profitability margin of about 85% (PAT of ₹63 cr. /Sales of ₹74 cr). This is evident from the details of the business of Gurgaon Infospace Ltd available as part of schedules in the consolidated financials in FY2016 annual report, page 80:
The Company is nearing completion of development Special Economic Zone alongwith the Unitech Developers and Projects Limited in terms of Co-Development Agreement dated 17-09-2007 in terms of which receipts shall be shared between the parties in 28(GIL): 72(UDPL) ratio. The SEZ is being developed and operated in terms of the SEZ Act, 2005 and the rules framed thereunder.
It indicates that Gurgaon Infospace Ltd has the right to receive 28% of the revenue from the project “Unitech Infospace Sector 21”. Further, searching the public sources indicates that this project is fully complete and functional. Further, Unitech has sold its 72% stake in this project to Brookfield (Livemint)
“In addition, in respect of the InfoSpace Gurgaon G2-IST (”G2”) Project, a third party, Gurgaon InfoSpace Ltd (’’GIL’’) holds the title to the land and through a joint development agreement is entitled to 28% of the revenue arising from that project with Candor and the third party in their capacity as shareholders in the G2 Project being entitled to the remaining 72%.”
The fact that the building is complete and Gurgaon Infospace Ltd is entitled to revenue share for its contribution of land in the project, means that the expenses, if any, in the project are to be borne by the other joint development partner (earlier Unitech and now Brookefield) from their share. Such an arrangement creates a situation where the property becomes a cash cow for the landowner (Gurgaon Infospace Ltd in this case) as it has to only collect revenue with minimal expenses. No wonder Gurgaon Infospace Ltd has been able to enjoy net profitability margin of 85%. Such a business situation leads to rapid generation and accumulation of cash in the balance sheet.
From the summary of financials of Gurgaon Infospace Ltd shared above, an investor would notice that Gurgaon Infospace Ltd has accumulated a lot of cash and has made investments of ₹125 cr. It becomes paramount to analyse the avenues where the cash has been invested as it would indicate whether the management has been using the cash conservatively or is splurging it at the cost of minority shareholders of the parent entity.
An investor can find out the avenues of these investments by comparing the details of non-current investments of IST Ltd in consolidated financials (shared above, which includes the investments done by Gurgaon Infospace Ltd) and the non-current investments of IST Ltd in standalone financials (given below, which exclude the investments done by Gurgaon Infospace Ltd). This assessment becomes essential to understand the manner in which the promoters have utilized the cash available with the company.
By comparing the two sections of noncurrent investments (i.e. by deducting standalone investments from consolidated investments), it can be estimated that Gurgaon Infospace Ltd has made its investments in primarily the following avenues:
- Tax free bonds of HUDCO, NTPC, IRFC, and NHAI about ₹85 cr.
- IFCI debentures: ₹10 cr
- SBI Premier Liquid Fund: ₹2.6 cr
- Sublease of commercial property in NOIDA: ₹19.8 cr
- Related parties: Vinayakinfra Developers Private Ltd and IST Softech Private Ltd: ₹8 cr.
- Total: about ₹125 cr.
It indicates that primarily the money has been invested in debt instruments (bonds/debentures/mutual funds) etc. However, the management has also given about ₹8 cr. of cash to related parties, which is a concern as despite being cash rich, the management has not been paying dividends to shareholders.
From the assessment until now it would be clear to an investor that the only key operating and profit generating asset owned by IST group is the IT/ITeS SEZ property (Unitech Infospace Sector 21) in Gurgaon, which is currently being managed by Brookfield. The property is in one of the good location in Gurgaon at Old Delhi Road and enjoys good marketability.
The revenue share of IST Group from the property (through Gurgaon Infospace Ltd) is ₹74.5 cr. As per the general commercial real estate industry standards, the commercial lease transactions include escalation of rentals by about 12-15% every 3 years. In a property with multiple tenants, it might lead to about 4-5% rental escalation every year. Therefore, it can be assumed that in case Brookfield is able to maintain the property in a good condition and the marketability of the property remains intact, then the rental income from the SEZ building would be able to increase by 4-5% every year.
Moreover, from valuation point of view, the commercial properties usually sell between 8-10% of rental yields. Assuming 9% rental yield, the 28% stake of Gurgaon Infospace Ltd in the SEZ project “Unitech Infospace Sector 21” which leads to annual rental income of ₹74.5 cr., can be assessed at about ₹827 cr. (74.5 / 0.09). If realized, then the tax aspect on this valuation would differ according to the manner in which the transaction is structured. With the tax experts’ advise, the transaction (property sale/shares sale) might be structured with minimal tax impact.
Overall Net Asset Valuation of IST Ltd
An investor may arrive at an overall valuation of IST Ltd by cumulating its different investments (consolidated view):
- 28% stake in Unitech Infospace Sector 21: ₹827 cr.
- Tax free bonds, debentures, liquid mutual funds: ₹140 cr.
- Commercial properties bought in FY2016: ₹66 cr.
Total Assets: ₹1,033 cr.
Other pertinent points from asset valuation perspective:
- Debt outstanding of ₹12.6 cr.
- Security deposits to be repaid: ₹36.9 cr. (Note 6 of consolidated financials FY2016)
- Assigning “Nil” value to the investments done in associates (IST Steel & Power Ltd), related parties (Vinayak and IST Softech), others (Shubham Infradevelopers) etc.
- Assuming current liabilities of ₹4 cr. would be easily covered by cash of ₹4 cr. and rest of current assets of about ₹36 cr.
Total deductible: about ₹50 cr.
Therefore, it might seem that from gross level analysis of assets, IST Ltd should have a valuation of about ₹983 cr. (1,033 – 50)
However, an investor must not forget that there is a very big factor, which stands between the investor and the fruits of the business of the company. This factor is “management” of the company. We have seen in multiple cases where the retail investors in the fundamentally sound businesses could not get any benefit as the management siphoned off all the past, present and future gains of the business from the company and the interest of retail shareholders were not kept in mind.
One such example of the management taking away the gains of business away from retail shareholders in case of Gujarat Automotive Gears Ltd has been discussed in detail in the following article:
Therefore, looking at the data analysis until now, it seems certain that the net assets & investments owned by IST Ltd are valued more than the current market capitalization of the company. However, it remains to be seen whether the current management is the right agent, which would ensure that the value of the assets of IST Ltd, can ultimately flow to the shareholders.
Out of the three segments of the businesses of IST Ltd: auto-ancillary, steel & power and real estate, the only segment that is making some money for the company is real estate. Auto ancillary business is making operating losses and the steel & power business has declined in its net worth and is barely profitable now (PAT ₹61 lac).
The real estate business of Gurgaon Infospace Ltd is also a venture in which the company owned a piece of land and entered into a development agreement with Unitech group in which the Unitech group seems to have built the property, marketed it as “Unitech Infospace Sector 21” and leased it. In lieu of the contribution of land, the IST group is getting 28% of the revenue of the project.
It remains to be seen whether IST group could have constructed the property on its own, marketed and leased it without being associated with other large real estate developer groups like Unitech.
Currently, in FY2016, IST group has invested in/purchased sublease of two commercial properties at NOIDA. It remains to be seen whether these properties are barren land taken directly on sublease from NOIDA, which are yet to be developed or these are completely build & functional/nearing completion buildings.
If these newly bought properties are at land stage, then it remains to be seen, whether the management would be able to find another partner who could develop these properties. However, if these newly bought properties are nearing completion/completed buildings, then it remains to be seen whether the IST group would be able to find lessees/buyers for the commercial spaces in these buildings.
An investor may see a sample of the marketing attempts of a lease transaction by the IST group by visiting the website of the IST group.
Following the above “For Lease” link leads an investor to know that IST group is out in the market to lease out 66,443 sq. ft. space in IST House in Sector 44, Gurgaon. It is not clear since how many days the group has been out in the market looking for the leasing of this property as it could not be ascertained since how many days this link has been live. However, if I see this link and the pdf document attached at the link as an attempt to market a space in a good locality in Gurgaon, then I find a lot of scope of improvement in the marketing effort by the IST group.
Additional aspects and annual report analysis of IST Ltd:
On assessment of the IST group apart from its business segments, an investor would notice quite a few other pertinent points:
1) The group has invested ₹23.8 cr. in IST Steel & Power Ltd since at least last 7 years, however, the investment is yet to create any significant return to investors.
2) The group has invested funds (₹8 cr) in related parties: Vinayakinfra Developers Private Ltd and IST Softech Private Ltd. There is no information in the annual report or in the public domain, which can lead any investor to assess whether these companies have any operating business and if the money can be safely returned. Moreover, as per the related party section of FY2016 annual report, these investments are earning an interest of about ₹63 lac, which amounts to 7.75% of return.
The rate of interest of 7.75% being charged from related parties is low because as per FY2016 annual report IST Ltd has taken a loan of ₹12.5 cr. from an NBFC at 9.50%.
It is tantamount to borrowing at a higher rate of interest from the market at the cost of shareholders of IST Ltd and then giving benefit to related parties by passing on the loan to them at a lower cost.
Further advised reading: How Promoters benefit themselves using Related Party Transactions
3) The group has done investments in another entity Subham Infradevelopers P. Ltd. (₹11.5 cr.) since FY2013. There is no information in the annual report or in the public domain, which can lead any investor to assess whether Subham Infradevelopers P. Ltd. is an operating company, which can give the money back when asked and also how this investment is beneficial for the minority shareholders.
4) IST Ltd is the only company that I have come across until now in which the company secretary is the highest paid person in the company, even higher than the executive director.
5) While analysing past annual reports, in FY2013 annual report, I am not able to reconcile the cash flow from the balance sheet.
The cash outflow of ₹26.2 cr. shown in the CFO calculations under other current liabilities, could not be ascertained from the analysis of the balance sheet for FY2013
6) Moreover, there is a typo error in the above cash flow statement for FY2013, where the net cash from operating activities, which is shown as negative ₹10 cr. is actually coming out to be positive ₹10 cr. i.e. an inflow of ₹10 cr.
Without doubt, the company is currently earning a lot of cash by way of rental revenue from the “Unitech Infospace Sector 21” project, however, it is not paying out dividends to the shareholders. Instead, the company is investing the money in related party entities, other seemingly real estate entities like Subham Infradevelopers P. Ltd. etc.
Moreover, despite being cash rich, the company has taken loan from NBFC at a higher rate than the rate at which it has given loans to related parties.
From overall operating performance perspective, none of the operating segments in which the company is in charge of the activities is making good money. The only source of money the company is earning is where it owned land and gave it to a developer to construct a building and in return, it is earning a steady income. This is just like what a lot of landowners/farmers did at the peak of real estate boom in Gurgaon when they gave their land parcels to large real estate developers to construct building and in turn assured steady income for them.
Therefore, overall the management efficiency leaves a lot to be desired in terms of business operations management. It remains to be seen how the investment in two NOIDA properties turns out in future.
Margin of Safety in the market price of IST Ltd:
IST Ltd is currently available at a P/E ratio of 6.69, which does provide a margin of safety in the purchase price 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
However, I personally feel a lot of uncertainties while assessing the management of IST Ltd and as has been discussed in multiple articles on this website, the management is the key factor that determines whether the fruits of the business would flow to the minority shareholders.
Similarly in case of IST Ltd also, it remains to be seen, whether the value of the net assets on its books, which is higher than the current market capitalization, would flow to the shareholders.
These are my views about IST Ltd. However, you should do your own analysis before taking any investment related decision about IST 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
Hope it helps!
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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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- Currently, I do not own stocks of the companies mentioned above in my portfolio.