The current section of the “Analysis” series covers India Nippon Electricals Ltd, a TVS group company, manufacturing electrical ignition systems for automobiles (two-wheelers, three-wheelers), and gensets (portable generators).
“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.
India Nippon Electricals Ltd Research Report by Reader
Dear Dr. Vijay,
Request you to look into my first analysis with the approach suggested under Peaceful Investing.
Kindly provide your expert views on this company.
About India Nippon Electricals Limited:
India Nippon Electricals Limited was incorporated in 1984 and converted into a joint venture in 1986 between Lucas Indian Service Limited, a wholly-owned subsidiary of Lucas-TVS Limited and MAHLE Electric Drives Japan Corporation, Japan – a company of MAHLE Group, Germany, to manufacture electronic ignition systems for two-wheelers, three-wheelers and portable engines. (Source: Company Website)
a) Sales growth: for 10 years = 13.42%
b) Operating Profit: Fluctuating from 9% to 14% in the past 10 Years. However, it seems to be stable at 14% since FY2017-18. There was a considerable dip in the profit in FY13-14. On analyzing the annual report of FY13-14, the reason was found to be high raw material cost and the inability of the company to pass on the cost increase to customers.
c) Net Profit margin fluctuating between 11% to 7%
d) Tax payout percentage = 29% Considered to be in line with corporate tax
e) Cumulative Free Cash flow = ₹175 Cr
f) FCF/CFO = 65%
A positive sign that the company is financially strong and can very well survive tough times.
g) Net Fixed Asset Turnover (NFAT) = 8.08. High NFAT is also a very good sign as it signifies that the company is able to utilize its assets with high operational efficiency.
h) Debt to Equity = 0 (Debt-free company)
P/E ratio = 12.47, almost equal to Govt. security bond rates.
Self-Sustainable Growth Rate (SSGR):
SSGR is 39%. SSGR is higher than sales growth. Hence, it provides a good margin of safety as well.
Business and Industry analysis:
Industry: Auto Ancillaries
a) Peer comparison: Sales Growth:
The sales growth rate of India Nippon Electricals Ltd is below average among its peers over a period of 10 years. However, an investor should take note that all peers (except WABCO) have taken a good amount of debt to fuel growth in sales. India Nippon Electricals Ltd is currently sitting on huge cash and the management should be able to manage any future capacity expansion without raising any debt.
Details of Clients:
Below is a concern for the company as around 88% of the company’s revenue is generated from two customers. The share of these two customers was 72% in the previous financial year. One of the customers is TVS Motor Company Limited, which is a relative of the ultimate parent company.
Total management remuneration is around ₹3.9 Crores, which is within the limit of 10% of PAT.
In the annual report of India Nippon Electricals Ltd for FY 2019 (Pg. 111), under related party transactions, it is disclosed that the company has done investments in two related companies namely Synergy Shakthi Renewable Energy Private Limited and Lucas TVS Limited
It is not clear how these investments in related parties will help retail investors like us. Moreover, through these investments, the company seems to be passing on the benefits to its related companies.
Requesting you to point out if some of the aspects are missed out while analyzing. Also, provide your expert views on this company.
Dr Vijay Malik’s Response
Thanks for sharing the analysis of India Nippon Electricals Ltd with us! We appreciate the time & effort put in by you in the analysis.
While analyzing the past financial performance data of India Nippon Electricals Ltd, an investor would notice that the company has one subsidiary company (99.97% stake), PT Automotive Systems Indonesia (PTA) and one associate company (40% stake), Synergy Shakthi Renewable Energy Pvt. Ltd. (SSREPL). As a result, India Nippon Electricals Ltd provides both standalone financials as well as consolidated financials in its annual reports.
Ideally, we believe that while analysing any company, an investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire group. Consolidated financials of any company present such a picture. Therefore, we prefer to analyse consolidated financials of companies.
Further advised reading: Standalone vs Consolidated Financials: A Complete Guide
Nevertheless, in the case of India Nippon Electricals Ltd, an investor notices that the subsidiary company in Indonesia, PTA, does not have any business operations. This subsidiary company was established in Indonesia when its group company and its largest customer, TVS Motors Ltd started operations in Indonesia. India Nippon Electricals Ltd purchased land in Indonesia to put up a manufacturing plant. However, the sales volumes of TVS in Indonesia did not reach a level that could justify the creation of a manufacturing plant by India Nippon Electricals Ltd in Indonesia. As a result, it supplies TVS Indonesia from its Indian plants and the Indonesia land parcel remains unused. Therefore, the Indonesian subsidiary of the company, PT Automotive Systems Indonesia (PTA) is without any operation and contains only a land parcel as an asset.
The associate company, Synergy Shakthi Renewable Energy Pvt. Ltd. (SSREPL), was established by India Nippon Electricals Ltd to generate energy from biomass. The plant started operations in FY2010. However, currently, due to adverse conditions, the plant is non-functional for the last many years.
As a result, if an investor wishes to analyse only the operating performance and efficiency of the manufacturing operations of India Nippon Electricals Ltd, then she may analyse standalone financials of the company. However, as mentioned above, we prefer to analyse the overall financial standing of the company including the investment position of the company. Therefore, we have analysed the consolidated financials of the company.
Let us analyse the financial and business performance of the company over the last 10 years:
Financial and Business Analysis of India Nippon Electricals Ltd:
While analyzing the financials of India Nippon Electricals Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 10%-15% year on year. Sales of the company increased from ₹169 cr. in FY2010 to ₹525 cr in FY2019. In the last 10 years (FY2010-2019), the sale growth of the company has been nearly consistent barring a few periods. The company witnessed a decline in its sales in FY2014. Moreover, the sales have declined to ₹516 cr in the 12 months ending Sept. 2019 (i.e. Oct. 2018-Sept. 2019).
While analysing the profitability of the company, an investor would notice that the operating profit margin (OPM) of India Nippon Electricals Ltd has been very fluctuating over the years. The OPM of the company was 14% in FY2012 and it declined sharply to 9% in FY2014. Thereafter, the OPM has witnessed steady recovery to 14% in FY2019, though in the 12 months ending Sept. 2019 (i.e. Oct. 2018-Sept. 2019), the OPM has declined marginally to 13%.
Periods of a sharp decline in the profit margins indicate cyclicity in the business model of the company. In order to understand these performance patterns better, when an investor analyses the business performance of India Nippon Electricals Ltd for the previous decade (FY2001-2010), then she notices that in those 10 years, the sales of the company had declined for 4 years (FY2005-2009) and the net profits of the company had declined for 5 years (FY2004-2009).
FY2010 annual report, page 4:
Therefore, if an investor extends her time horizon to almost 20 years (FY2001-2019), then she notices that India Nippon Electricals Ltd witnessed growth during FY2001-2004, and then it witnessed a decline for 4-5 years until FY2009. Later on, the business performance of the company started improving since FY2010. The improvement continued for the next 3-4 years, and then the company witnessed a decline in sales and profit margins in FY2013-2014. After this, the business of the company again improved over FY2015-2019. Recently, the business of the company has again witnessed a decline as shown by the decline in sales and profit margins of the company for the 12 months ending Sept. 2019 (i.e. Oct. 2018-Sept. 2019).
In order to understand the reasons for such fluctuating, cyclical performance an investor needs to identify the underlying factors affecting the business of the company.
While analysing India Nippon Electricals Ltd, an investor notices that the company operates in the auto-ancillary industry, which is highly dependent on the automobile industry. An investor would also appreciate that the automobile industry is a cyclical business, which witnesses its growth associated with the growth phases of the overall economy.
Because of the cyclical nature of its customer industry (automobiles), the auto-ancillary business also witnesses cyclical phases in their business. This is because the automobile manufacturers are very large corporations when compared to their vendors/suppliers (auto-ancillary players).
Automobile manufacturers have higher negotiating power over suppliers and as a result, they are able to push tough contractual terms on their suppliers. Automobile manufacturers operate on “just in time” inventory principles and do not wish to keep inventory with them. Therefore, a decline in their business is immediately transferred to the decline in the production of their suppliers. In addition, due to higher negotiating power, they put continuous pressure on the prices the suppliers are able to get from automobile manufacturers. Such cyclical characteristic of the business of auto-ancillary companies along with weak negotiating position usually reflects in the nature of fluctuating profit margins.
Investors would be able to recollect the fluctuating profit margins in the case of Gandhi Special Tubes Ltd, which is an auto-ancillary player, which supplies steel tubes including fuel injection tubes to the automobile manufacturers.
Further advised reading: Analysis: Gandhi Special Tubes Ltd
India Nippon Electricals Ltd has provided annual reports since FY2012 on its website. In addition, an investor can download the annual reports of the company for FY2010 and FY2011 from the Bombay Stock Exchange website (BSE). While reading of these annual reports for the last 10 years (FY2010-2019), an investor comes across multiple disclosures by the company, which clarify the direct dependence of the company on automobile manufacturers and its weak position on the negotiating table.
First, while analysing the profile of customers of the company, an investor notices that almost 98% of the sales of the company in FY2019 is to the three customers:
- TVS Motors: 63%,
- Hero Motocorp: 25% and
- Crompton Greaves: 10%
Such kind of customer profile indicates that the company is highly dependent on the limited number of customers. Moreover, 88% of the sales are direct to the two major automobile manufacturers.
In such a situation, any negative development at the end of any of these customers can have a significant impact on the business of the company.
An investor notices that in recent history, the decline in sales and profitability of the company in FY2013-FY2014 was due to similar factors.
In FY2013, the company intimated its shareholders that the company has lost significant business in the scooters segment from one of its large customers because of the models where its product was used have undergone changes.
FY2013 annual report, page 12:
Your Company had a negative growth in scooter segment however, due to changes in the models of one of the major customers where the product of your Company was used and thus the business volume dropping sharply.
Moreover, as the customers did not increase the prices in line with the increase in production costs of the company, its profit margins declined.
FY2013 annual report, page 11:
Profit before tax and exceptional items, as a percentage of sales, dropped by around 1.70% over the previous year mainly, due to increase in material and conversion costs given to suppliers not recouped, in full by the customers.
FY2013 annual report, page 12:
Although metal prices are softening, costlier imports due to weak rupee as well as increase in power cost are pushing up the cost of production which is not adequately compensated by customers.
The next year, the company had to fight back by cutting prices aggressively in order to gain market share. As a result, in FY2014, both, the company’s sales and its profits declined further.
FY2014 annual report, page 3:
Your Company went for an aggressive price strategy to get enhanced market share particularly for fly wheel magneto which coupled with the loss of business of profitable electronic component due to changes in the model of one of the major customers impacted the bottom line significantly.
The profit margins of the company are always at the discretion of the large automobile manufacturers. The automobile manufacturers enjoy the benefits of multiple suppliers for each product creating intense competition among the suppliers.
As a result, the company always finds it difficult to pass on the increase in production costs like cost of raw material, wage etc. to the customers. As an alternative, the company has to work on finding new low-cost suppliers and continuous internal efforts to reduce costs.
FY2010 annual report, page 9:
Likewise, prices of steel and products made of steel went up. To recoup the cost increases fully from the customers is becoming increasingly difficult due to competitive pressures. As a counter measure, your Company is exploring sourcing from more competitive vendors.
An investor may believe that the above competitive landscape of the industry may represent an old picture of FY2010, which marked the end of a difficult business period for the company (FY2005-2009). However, reading the later annual reports also indicates the similar business position of India Nippon Electricals Ltd where it finds it difficult to pass on the full extent of the increase in raw material costs to the customers due to intense competition.
FY2015 annual report, page 7:
While on one hand the input costs are going up, the intensifying competition for the range of products manufactured by the company on the other hand creates pressure on customer pricing. These pose challenges to maintain the profitability, as customers may not fully offset the cost escalations.
In FY2019, the global trade war and the entry of startups have further intensified the competition for the company. As a result, the company has intimated its customers that it finds difficult to maintain profit margins.
FY2019 annual report, page 18:
Risks and concerns: Protectionist measures adopted by few countries, global trade war and entry of start ups in providing efficient engineering solutions continue to haunt the industry. Similarly, rising trend in raw material prices in steel, copper and petroleum products result in increasing product costs. Minimum wages policy pushes the cost of operation up. It poses challenge to maintain the profitability as customers may not fully offset the cost escalations. Frequent changes in emission norms make the customer postpone their purchases and makes few existing products obsolete.
Your Company is focussing on development of newer range of products which offer customers good value propositions, improving productivity and cost reduction in every possible area of operation to protect the bottom line.
Further advised reading: Understanding the Annual Report of a Company
The business of the company is highly interlinked with the performance of its key customers. When its customers gain market share, the sales of the company grow. However, even in the phases of such business growth, the company is not able to increase its prices at its will. On the contrary, it faces a continuous pressure from its customers to reduce its prices. As a result, even after many years since the FY2010 disclosure above, the company still has to rely on alternate sourcing to maintain its profit margins.
FY2019 annual report, page 17:
Your company had a sales growth of around 16% in sales against two-wheeler industry growth of 6%, mainly due to increase in market share of our customers pan India, robust growth in sales of higher value of BS VI products and higher value of business from three-wheeler segment. Persistent pricing pressures from customers was managed through alternate sourcing and value-added solutions.
Because of the intense competition, many times, the company finds that the only way to increase market share is to reduce prices aggressively as it did in FY2013-2014. However, it affects profit margins.
FY2014 annual report, page 4:
The cost increases on account of costlier imports and other cost increases like diesel price increases, power cost etc. have not been adequately compensated by customers. On the other hand the competitive intensity of the market is forcing lower selling prices to gain new business.
The extent of intense competition is not unique to India Nippon Electricals Ltd. In fact, almost all the auto-ancillary companies face such tough business situations of multiple suppliers competing to get the business from limited large automobile manufacturers who have very high negotiating power. In order to understand the business dynamics of auto-ancillary sector better, it is advised that an investor may read the analysis of the following companies operating in this sector:
- Analysis: Gandhi Special Tubes Ltd
- Analysis: Sharda Motor Industries Ltd
- Analysis: Machino Plastics Limited
- Analysis: Fiem Industries Limited
While analysing the tax payout of India Nippon Electricals Ltd over the years, an investor would notice that in most of the years, the tax payout ratio has been lower than the standard corporate tax rate prevalent in India.
While reading the past annual reports, an investor notices that the manufacturing units of the company enjoy tax benefits. When the tax payout ratio in FY2014 increased to 24% from 19% in FY2013, then the company mentioned that this increase is due to the completion of tax holiday by one unit of the company.
FY2014 annual report, page 3:
The tax incidence on the profit earned was more than the previous year due to completion of the tax holiday period by one of the units of the Company.
Similarly, when an investor analyses the tax-payout reconciliation table of the latest annual reports prepared in line with the new Indian Accounting Standards (IndAS), then she notices that the difference in the standard tax rate and the actual tax payout by India Nippon Electricals Ltd is primarily due to three factors:
- Income that is exempt from taxation, which may be due to the tax holidays enjoyed by other manufacturing units
- Different tax rates for long term capital gains and
- Concessions on Research and Development expenses
FY2019 annual report, page 159:
Operating Efficiency Analysis of India Nippon Electricals Ltd:
a) Net fixed asset turnover (NFAT) of India Nippon Electricals Ltd:
When an investor analyses the net fixed asset turnover (NFAT) of India Nippon Electricals Ltd in the past years (FY2010-19), then she notices that the NFAT of the company has been consistently very high over the years. The NFAT has been in the range of 6 to 8 over the years.
An investor would notice that in the normal course of business, manufacturing companies usually have an NFAT in the range of 1-4. An NFAT of 6-8 indicates that the business of India Nippon Electricals Ltd needs very low investment in plant and machinery.
The low investment requirements in the business have benefits as well as challenges for the company.
The benefit is that the company can work on the business with lower profit margins. As a result, it can bear the competitive pressures as well as pricing pressure from its customers and still manage to report profits. Low capital requirements in the business help India Nippon Electricals Ltd in maintaining financial strength despite low negotiating power with the customers.
The challenges of a business with low capital requirements are multifold.
First, the competing suppliers to the automobile manufacturers also enjoy low capital needs and in turn, are able to provide intense competition at lower prices. As a result, an investor would notice that the competitive landscape for India Nippon Electricals Ltd has not changed even in decades. It is still as competitive as it used to be in the last decade.
Moreover, an investor would appreciate that due to low capital requirements; any person/entity with a small amount of effort can raise the capital, start the business, and increase the competition to India Nippon Electricals Ltd.
An investor may believe that starting the plant may be easy; however, getting the approvals from automobile manufacturers may be difficult. However, investors need to appreciate that in the automobile sector, there is a large aftermarket segment, where approvals from original automobile manufacturers may not play a role. In the aftermarket segment, the unorganized sector may provide competition for the company.
To learn more about cases where high net fixed asset turnover/low capital requirements have produced intense competition for established companies, an investor may read the analysis of Ion Exchange (India) Ltd, a company operating in the water treatment industry.
b) Inventory turnover ratio of India Nippon Electricals Ltd:
An investor would note that over the years (FY2010-2019), the inventory turnover ratios (ITR) of the India Nippon Electricals Ltd has been ranging from 15-18.
Such a trend of ITR indicates that the company has kept its inventory management under control and as a result, not allowed money to be unnecessarily stuck in working capital.
c) Analysis of receivables days of India Nippon Electricals Ltd:
An investor would notice that over the years (FY2010-2019), receivables days of India Nippon Electricals Ltd have been increased from 53 days in FY2010 to 69 days in FY2019.
Receivables days initially deteriorated from 53 days in FY2010 to 76 days in FY2014. However, since then the company could improve its receivables days gradually to 64 days in FY2018. In FY2019, the receivables days have increased to 69 days.
From the above discussion, an investor would note that 98% of the sales of the company are to large customers like TVS Motors (63%), Hero Motocorp (25%) and Crompton Greaves (10%). While reading the annual reports of India Nippon Electricals Ltd, an investor notices that the company ideally gives these customers a credit period of 45 days. However, due to the lower negotiating power, India Nippon Electricals Ltd is not able to enforce these credit terms strictly and therefore, ends up getting the money late at 60-70 days.
FY2019 annual report, page 152:
The average credit period on sale of goods is 45 days. No interest is charged on overdue trade receivables.
The Group’s receivables are predominantly from its related parties and large Original Equipment Manufacturers. The Group has never experienced doubtful debts in earlier years, therefore, there is no credit risk and thus no allowance for expected credit losses have been made.
However, the company has highlighted that over the years, it has never had an incidence of doubtful debt (i.e. non-recovery of receivables). Therefore, the company has mentioned that it does not face any credit risk. However, while analysing the past annual reports, an investor notices that in the FY2010 annual report, which is the oldest publicly available annual report, the company had made provisions for doubtful debts.
FY2010 annual report, page 64:
Further advised reading: Understanding the Annual Report of a Company
In FY2012, the company realized that it will not be able to recover these doubtful receivables ever and therefore, it wrote them off.
FY2012 annual report, page 45:
The deterioration of receivables days over the years from 53 days in FY2010 to 69 days in FY2019 has led to money being stuck in its working capital. The company used to have outstanding receivables of ₹28 cr in FY2010, which increased to ₹104 cr in FY2019. As a result, over FY2010-2019, an additional ₹76 cr was stuck in trade receivables.
An investor observes the same while comparing the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of the company for FY2010-19.
Over FY2010-19, India Nippon Electricals Ltd Limited reported a total cumulative net profit after tax (cPAT) of ₹309 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹269 cr. A lower cCFO than cPAT indicates that parts of its profits were stuck in working capital and as a result, were not available as cash flow from operations to the company.
It is advised that investors should read the article on CFO calculation mentioned below, which would help them understand the situations in which companies tend to have the CFO lower than their PAT and the situations when the companies tend to have CFO higher than their PAT.
Further advised reading: Understanding Cash Flow from Operations (CFO)
Margin of Safety in the Business of India Nippon Electricals Ltd:
a) Self-Sustainable Growth Rate (SSGR):
Further advised reading: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company
Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.
Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.
An investor would notice that India Nippon Electricals Ltd has witnessed an SSGR of about 20%-35% over the years.
While studying the formula for calculation of SSGR, an investor would understand that the SSGR directly depends on the net fixed asset turnover (NFAT) of a company.
SSGR = NFAT * NPM * (1-DPR) – Dep
- SSGR = Self Sustainable Growth Rate in %
- Dep = Depreciation rate as a % of net fixed assets
- NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
- NPM = Net profit margin as % of sales
- DPR = Dividend paid as % of net profit after tax
(For systematic algebraic calculation of SSGR formula: Click Here)
An investor would remember from the above discussion that India Nippon Electricals Ltd has a high NFAT in the range of 6-8 over the years, which has contributed significantly to the high SSGR of the company.
The sales growth achieved by the company over the years is about 15%, which is lower than its SSGR of 20%-35%. Therefore, investors would expect that the company would be able to fund its growth requirements from its business profits without requirements of any additional capital from debt or equity.
Therefore, it does not come as a surprise to the investor when she notices that India Nippon Electricals Ltd has been able to grow its sales from ₹169 cr in FY2010 to ₹525 cr in FY2019 and has managed to stay debt-free for this entire period.
An investor is able to observe this aspect of the company’s business when she analyses the cumulative cash flow position including free cash flow for the company over the last 10 years (FY2010-19).
b) Free Cash Flow Analysis of India Nippon Electricals Ltd:
While looking at the cash flow performance of India Nippon Electricals Ltd, an investor notices that during FY2010-19, the company had a cumulative cash flow from operations of ₹269 cr. During this period it did a capital expenditure (capex) of ₹94 cr. As a result, it had a free cash flow of ₹175 cr. (269-94).
Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF
While analysing the past annual reports of India Nippon Electricals Ltd, an investor would notice that the company has used this FCF to pay a dividend of about ₹106 cr. (excluding dividend distribution tax) to the shareholders. The rest of the money has been invested by the company in equity shares of group companies/associates and financial investments like mutual funds, venture capital funds, fixed deposits etc.
Free cash flow (FCF) is one of the main pillars of assessing the margin of safety in the business model of any company.
Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing
Additional aspects of India Nippon Electricals Ltd:
On analysing India Nippon Electricals Ltd, an investor comes across certain other aspects of the company:
1) Management Succession of India Nippon Electricals Ltd:
While reading about the company, an investor notices that India Nippon Electricals Ltd is a part of the TVS group of companies. Mr. T. K. Balaji (aged 71 years) is the Chairman of the company. Mr. T. K. Balaji is brother-in-law of Mr. Venu Srinivasan (grandson of TVS Group’s founder, T. V. Sundaram Iyengar).
In FY2013, Mr. Arvind Balaji (current age 45 years), son of Mr. T.K. Balaji joined the company as a whole-time director.
An investor may read the following article to understand the familial linkages: Will members of the fourth generation of TVS Group take more risks? (Economic Times)
Arvind Balaji, Son of TK Balaji, chairman & MD, Lucas-TVS. TK Balaji is married to Sheela (Venu Srinivasan’s sister)
In FY2015, Mr. Arvind Balaji was appointed the Managing Director of India Nippon Electricals Ltd.
Such transition of leadership indicates that the company has put in place a management succession plan in which the new generation of the promoter family is being groomed in business while the senior members of the promoter family are still playing an active part in the day-to-day activities.
The presence of a well thought out management succession plan is essential in the case of promoter run businesses as it provides for a smooth transition of leadership over the generations and provides continuity in the business operations of any company.
Further advised reading: Steps to Assess Management Quality before Buying Stocks
2) Project execution by India Nippon Electricals Ltd:
While reading the past annual reports of the company, an investor notices that India Nippon Electricals Ltd has been able to increase the manufacturing capacity of its existing units as well as start new manufacturing unit at regular intervals as per the need of its customers.
FY2011 annual report, page 9:
During the year under review, your Company faced capacity constraints, which has been addressed. The enhanced capacity will meet the requirement for 2011-12.
FY2012 annual report, page 9:
Additional capacities were created in two of the manufacturing units during the year under review and capacity expansion has been planned in the third unit during the year 2012-13.
FY2015 annual report, page 5:
Your company also increased production capacity in Rewari to meet the higher demand from the customers.
FY2015 annual report, page 6:
An assembly plant located in MIDC, Kolhapur in the State of Maharashtra is in the final stages of commissioning, primarily to service the requirements of customers based in Maharashtra.
FY2017 annual report, page 7:
Your company also increased production capacity in Pondy to take care of the higher demand from the customers.
FY2018 annual report, page 15:
company also increased production capacity in Pondy and Hosur units to meet out the higher demand from the customers
An investor would notice that such instances of regular capacity additions to meet the increased demand from customers indicate good project execution skills by the company.
Further advised reading: Steps to Assess Management Quality before Buying Stocks
From the earlier discussion, an investor would remember that the company has very concentrated customer profile where 98% of the sales are to only three customers. As a result, the fate of the company is very closely tied with these customers and in many cases, the company has to follow its customers whenever they enter new markets or create manufacturing plants at new locations.
The company had to create a subsidiary in Indonesia when its largest customer, TVS Motors, started its production facility in Indonesia. However, the production volumes of TVS in Indonesia did not reach sufficient numbers. As a result, India Nippon Electricals Ltd did not start to create any plant in Indonesia and instead, it supplied products to TVS Indonesia from its Indian manufacturing units. Currently, the company only has the land parcel in Indonesia that it had purchased to create the plant there.
FY2013 annual report, page 13:
Your company acquired land in Indonesia through its subsidiary company, PT Automotive Systems Indonesia, with a view to establish manufacturing operations to support TVS Motors. However, as the volumes have not reached our expectations, we cannot proceed with the same.
The investment by the company in Indonesia did not yield any results, as TVS Indonesia does not have required production volumes. Moreover, local automobile manufacturers have their own supplier networks. As a result, India Nippon Electricals Ltd has decided to liquidate the subsidiary company.
FY2017 annual report, page 10:
However, as mentioned in the previous report, the manufacturers of two wheelers in that country have their own sources for the products in the subsidiary’s range of manufacture and it has been decided to take necessary steps to liquidate the subsidiary
On similar lines, India Nippon Electricals Ltd purchased land in Uttarakhand in the last decade when one of its customers planned to open up a manufacturing plant there. However, in FY2010, the company intimated its shareholders that it had to defer the plans to start manufacturing in Uttarakhand due to change in the customer’s plans.
FY2010 annual report, page 9:
Your Company has deferred commencement of manufacturing at Uttarakhand due to changes in the customers’ plans. Manufacturing will commence at an appropriate time depending on volumes. Meanwhile, your Company is meeting customers’ requirements from its unit at Rewari.
Therefore, an investor would notice that many times, India Nippon Electricals Ltd has to make investments in locations where later on it could not manufacture products because either the customer changed its plans or the customer could not do well.
These aspects of the business of India Nippon Electricals Ltd indicate the strong linkage and dependence of the company on its key customers and as a result, the low negotiating power held by the company with its customers.
3) Utilizing company resources to help group companies:
From the above discussion, an investor would notice that India Nippon Electricals Ltd has been able to generate surplus cash (free cash flow) from its operations. Over the years, there have been incidences when the company has used this cash to help group companies.
i) Equity investments in group companies:
Over the years, India Nippon Electricals Ltd has bought an equity stake in one of the group companies, Lucas TVS Ltd.
- Until 2009, the company used to own 14,850 shares at an investment of ₹3.42 cr.
- In FY2010, the company purchased additional 82,501 shares of Lucas TVS Ltd at ₹24.81 cr and as a result, at the end of FY2010, the company had 97,351 shares of Lucas TVS Ltd for an investment of ₹28.24 cr.
FY2010 annual report, page 32:
In case these shares were issued as new shares by Lucas TVS Ltd, then it represents a case where the money of India Nippon Electricals Ltd to benefit Lucas TVS Ltd. However, if India Nippon Electricals Ltd bought these shares of Lucas TVS Ltd from some other entity, then it represents a case where the money of the company was used to benefit the seller of these shares.
Further advised reading: How Promoters benefit themselves using Related Party Transactions
Nevertheless, if an investor goes by the valuation of the shares of Lucas TVS Ltd provided by the company in its FY2019 annual report, then the 97,351 shares held by the company are valued at ₹91.8 cr, which is at a significant gain from the investment value of ₹28.24 cr.
FY2019 annual report, page 93:
However, an investor may note that first; Lucas TVS Ltd is not a listed company. Therefore, its shares do not trade on any stock exchange. As a result, the valuation provided in the annual report may be very different if India Nippon Electricals Ltd goes out in the market to sell these shares.
Second, Lucas TVS Ltd is a TVS group company and India Nippon Electricals Ltd may never get an opportunity to sell these shares. As a result, it may have forever lost the access to the ₹28.24 cr invested by the company in Lucas TVS Ltd.
The company has highlighted its intention not to sell these shares but to hold them for the long term in the FY2019 annual report, page 113:
The investments in equity instruments are not held for trading. Instead, they are held for medium or long-term strategic purpose.
To understand the steps used by companies to take money from one company and then use it to benefit other group companies, in more detail, it is advised that an investor may read the following analysis of National Peroxide Ltd, a Wadia group company. In the case of National Peroxide Ltd, the promoters have used multiple ways to provide benefits to group companies from the money of National Peroxide Ltd.
ii) Loans/intercorporate deposits to group companies:
An investor also finds instances where India Nippon Electricals Ltd had to help its group companies by providing loans/intercorporate deposits to them out of its resources.
FY2014 annual report, page 48:
The company has been providing intercorporate deposits even in FY2009 when it was facing a continuous streak of declining business performance since FY2004-2005.
FY2010 annual report, page 36:
Further advised reading: How Promoters benefit themselves using Related Party Transactions
4) Investment in Synergy Shakthi Renewable Energy Private Limited (SSREPL):
In the FY2010 annual report, India Nippon Electricals Ltd intimated its shareholders that it had invested ₹6 cr in SSREPL for a 40% stake in the company and that the project of SSREPL has started operations.
FY2010 annual report, page 11:
Synergy Shakthi Renewable Energy Ltd., in which your Company has invested Rs.6 crores, being 40% of its share capital, has commenced commercial production during the year.
While searching for additional details about the project of SSREPL, an investor find from online sources that it had created a power project for ₹49 cr out of which ₹15 cr was equity contribution and remaining ₹34 cr was debt. (Source: http://power.industry-report.net/synergy-shakti-renewable-energy-pvt-ltd/)
SSREL is a part of Lucas TVS group. Pursuant to obtaining clearance from Government of Tamil Nadu to put up a 10 MW biomass based power plant, SSREL started construction at Ollaipatti Village, Krishnagiri District, Tamil Nadu (TN) in 2007. The total project cost was around Rs 49 crore, of which promoters contributed Rs. 15 crore as equity. The construction of plant has been completed and its commissioning was done in Feb 2010.
From the above description, it looks that out of the ₹15 cr equity contribution, ₹6 cr (40%) was contributed by India Nippon Electricals Ltd whereas balance equity contribution of ₹9 cr (60%) was invested by Lucas TVS.
Over time, the biomass power project faced severe troubles. First, the company faced challenges in procuring raw material, biomass, for producing power.
FY2011 annual report, page 12:
SSREL is, however, facing acute shortage of biomass availability. As a result of overall economic growth, a number of industries are competing to procure biomass not only for power generation but also for other industrial purposes.
Later on, in the FY2016 annual report, India Nippon Electricals Ltd intimated its shareholders that since June 2015, the SSREPL project is non-operational because of adverse conditions. The state electricity utility, Tamil Nadu Electricity Board (TNEB) is not providing it remunerative tariffs for the power. Moreover, as per regulations, SSREPL cannot sell power to any other third party.
FY2016 annual report, page 16:
Synergy Shakthi Renewable Energy Private Limited (SSREPL) was not in operation since June 2015 due to restrictions on sale of power to third parties, unviable tariff offered by TNEB and adverse changes in regulatory policies. As a result, the associate company incurred a loss of ₹389.46 lakhs as against a profit of ₹70.52 lakhs during the previous year.
As of FY2019, the SSREPL plant remains closed and is continuously incurring losses.
FY2019 annual report, page 18-19:
Synergy Shakthi Renewable Energy Private Limited (SSREPL) was not in operation from 2017-18 onwards due to unviable tariff and adverse regulatory policies. SSREPL had made many attempts to liaise and represent Government and various authorities to make changes in regulations but the efforts had not yielded favourable results. SSREPL has incurred loss of Rs 257.34 lacs during the year against Rs 98.45 lacs in previous year.
SSREPL seems a case of suboptimal capital allocation where the project started facing troubles in procuring the most important input of raw material soon after it became functional. Moreover, even if the company was not finding it viable to supply power to TNEB contracted prices, it was a very strict regulatory condition not to have the authority to sell power to third parties. It seems that the project assessment leaves a lot of scope for improvement.
While reading the FY2017 annual report, when the SSREPL project was closed for some time, an investor notices that India Nippon Electricals Ltd put in additional money of ₹12 cr in the project.
FY2017 annual report, page 10:
to enable SSREPL restart its operations on a viable mode, SSREPL has come up ‘rights issue’ in the ratio of 2 shares for every one share held by its existing shareholders at the face value of ₹ 10/- each to revive the company repay the borrowings from banks and also to meet the working capital requirements. Your Company subscribed ₹12 Crores for the ‘rights issue’ proportionate to its existing holding of ₹ 6 Crores.
Putting additional money in a failed project may represent throwing good money after bad money.
Further advised reading: How to Identify if Management is Misallocating Capital
In FY2019, the value of total investment of ₹18 cr done by India Nippon Electricals Ltd is currently valued at ₹3.62 cr, which represents a significant amount of value erosion.
FY2019 annual report, page 150:
Moreover, investors would notice that this is not the first instance when India Nippon Electricals Ltd has faced erosion of the value of its investment. Previously in FY2009, the company provided for ₹2.76 cr as impairment of its investments indicating value erosion.
FY2010 annual report, page 29:
5) Investment in the venture capital funds seemingly promoted by TVS group companies:
While analysing the financials of India Nippon Electricals Ltd over the years, an investor notices that the company has invested in a few venture capital schemes.
FY2019 annual report, page 93:
Venture capital funds are investment vehicles, which invest in upcoming/startups/very small size companies in different sectors. An investor feels that the company should ideally use the money in its own business activities. In case, it is not able to find attractive opportunities in its business, then it should return the money to shareholders by way of dividends or share buybacks.
Investing money in avenues like venture capital funds indicates that first, the management of the company is not able to find attractive opportunities in its business and second, it is not willing to return this money to the shareholders.
Additionally, if an investor looks at the names of the venture capital funds, then it also looks like an attempt by the company to support the investment management business of other TVS group companies. The company has also disclosed the venture fund investments under related party transactions in the FY2019 annual report, page 166.
From the above discussions, an investor would acknowledge that India Nippon Electricals Ltd has been able to generate surplus funds (free cash flows) from its operations. However, the management of the company has used parts of these funds to benefit TVS group companies by way of equity investments, intercorporate deposits, investments in venture capital funds etc.
Further advised reading: How Promoters benefit themselves using Related Party Transactions
6) Multiple instances of errors in the regulatory disclosures India Nippon Electricals Ltd:
While analysing the annual reports and other stock exchange filings done by India Nippon Electricals Ltd, an investor comes across many instances where the company made a mistake. In many cases, the company had to resubmit the regulatory disclosure after correcting the mistake.
In FY2018 annual report, in the related party transactions disclosure at page 144, the company made a mistake and repeated the value of the investment in LTVS (Lucas TVS Ltd, a relative of the parent company) in the section for Synergy Shakthi Renewable Energy Pvt Ltd (an associate) as well.
The company made a mistake in the e-voting results for FY2018-19 when it erroneously stated that the promoters are not an interested party to the resolution whereas, in fact, the promoter was an interested party. On August 19, 2019, India Nippon Electricals Ltd submitted the rectified e-voting results to the stock exchanges.
August 19, 2019, BSE corporate announcement by the company:
Sub: Corrigendum to the filing of e-Voting Results 2019-reg
This has reference to the filing of e-Voting results for the year 2018-19 (through .pdf and under XBRL mode) on 1t h August, 2019 wherein we mentioned ‘No’ inadvertently under the column, ‘Whether promoter/ promoter group are interested in the agenda/resolution?’, against Resolution no.3. We have now corrected it as ‘Yes’ and are attaching the e-Voting Results for your information and record. We confirm that there are no other corrections made in the voting results and the correction made as mentioned above does not have any impact on the voting results.
The company made errors in the related party transactions for March 31, 2019, filed with stock exchanges. On July 30, 2019, the company submitted a repeated copy by rectifying the mistakes done in the previous disclosures.
July 30, 2019, BSE corporate announcement by the company:
Please refer to our letter dated 26 th June 2019 wherein we have filed the details of related party transactions on a consolidated basis for the half year ended 31st March 2019 and balances as on 31st March, 2019 along with the list of related parties pursuant to Regulation 23 (9) of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. We noticed that certain details were inadvertently mentioned incorrectly in the filing made with Stock Exchanges and had made the changes as detailed in the table below in the enclosed revised filing under Regulation 23 (9):
The company made some errors while submitting the Q4-FY2019 results to the stock exchanges and thereafter, on June 8, 2019, submitted the rectification to stock exchanges.
June 8, 2019, BSE corporate announcement by the company:
We noticed a typographical error in the first para of the covering letter wherein instead of mentioning 31st March 2019, 31st May 2019 was mentioned. The same is corrected and is re-submitted. There is no other change in the submission. We request you to take this on record.
It seems that all these errors may be insignificant mistakes, which an investor can easily find while reading without affecting her interpretations. However, repeated instances of such mistakes might indicate that processes at the company, maker-checker approval mechanisms may require strengthening.
Margin of Safety in the market price of India Nippon Electricals Ltd:
Currently (January 8, 2020), India Nippon Electricals Ltd is available at a price to earnings (PE) ratio of about 12.9 based on the last four quarters consolidated earnings from Oct. 2018 to Sept 2019. The PE ratio of 12.9 provides a small 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, even 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.
- Further advised reading: 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- Read: How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Further advised reading: Hidden Risk of Investing in High P/E Stocks
Overall, India Nippon Electricals Ltd seems a company that has been able to grow its business at a rate of 10-15% year on year for the last 10 years (FY2010-2019). However, the business performance of the company over this period has been cyclical. The company witnessed its operating profit margins (OPM) decline from 14% to 9% and then increase to 14% over the period of the last 10 years. Such fluctuating performance indicates that the company operates a cyclical industry.
The key reason for the cyclicity in the business performance of India Nippon Electricals Ltd is its strong linkage with the prospects of the automobile industry, which in turn, is dependent on the general economic condition of the country. About 88% of its sales are to two large automobile manufacturers. As a result, the business performance of the company is highly dependent on the performance of the automobile industry and in particular of its key customers.
The company is dependent on a few large customers and therefore, has a very low negotiating power over them. Any loss of business from any customer can hit its business significantly. Moreover, the auto-ancillary industry has intense competition, which often results in players undercutting prices to gain new business. As a result, the company faces challenges in maintaining its profit margins because it is not able to pass on the cost increases to its customers. The company has to find alternative methods to reduce cost like finding low-cost suppliers and creating low-cost designs & process improvements.
The company has to follow its customers in new geographies and markets when they plan production in their new manufacturing plants. However, many times, these expansion decisions may not provide good returns on the investment. The subsidiary formed by the company in Indonesia is still non-operational despite more than a decade. In the past, the company had to defer its plans to start manufacturing in Uttarakhand after its customer changed its plans.
However, despite challenging business conditions, the company has been able to generate free cash flow, as the business of the company requires low capital investments. Because of low capital requirements in the expansion plans, the company is able to keep its financial position under control despite continuous delays in collecting payments from its customers. The company has witnessed money being stuck in working capital over the years. However, still, a low capital requirement for capital expansion has helped the company remain debt-free and report surplus cash.
The company has used the surplus cash to pay dividends to shareholders. However, alongside, there have been many occasions where the company has used its cash to help its group companies by way of investments in equity shares, intercorporate deposits, investments in their venture capital schemes and power plants etc. We have seen that promoter groups with a large number of companies usually shift money from one group company to another as they deem fit e.g. National Peroxide Ltd (Wadia group). Investors should keep a close watch whether the company provides benefits to the group companies in terms of investments, loans, intercorporate deposits etc.
One benefit for companies from promoter groups is that usually, there is a well-defined success plan in place. In the case of India Nippon Electricals Ltd, in FY2013, Mr. Arvind Balaji, the son of Mr. T. K. Balaji, joined the company. Currently, Mr. Arvind Balaji has taken over the active day-to-day management of the company as the Managing Director.
In the recent past, there have been many instances where the company has made a few mistakes in the regulatory filings, which may seem a trivial matter. However, it may also indicate that the approval processes, maker-checker arrangements etc. need strengthening.
Going ahead, an investor should monitor the profit margins of the company along with receivables days. The investor should check whether the company provides its money to group companies and whether it is able to recover its investments put in Indonesia and the biomass power plant.
Further advised reading: How to Monitor Stocks in your Portfolio
These are our views on India Nippon Electricals Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.
You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”
I hope it helps!
Dr Vijay Malik
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Registration Status with SEBI:
I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013
Details of Financial Interest in the Subject Company:
Currently, I do not own stocks of the companies mentioned above in my portfolio.