Analysis: Bharat Rasayan Limited

This article provides an in-depth fundamental analysis of Bharat Rasayan Ltd, an Indian player in the crop protection industry dealing in the entire range of products ranging from technical pesticides, formulations and its packaging material.

In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

Bharat Rasayan Ltd Research Report by Reader

Hi Dr. Vijay,

I have done research on Bharat Rasayan Ltd using the approach that I learned from the many articles I read on your blog.

Please provide your valuable inputs on my analysis given below.

Regards,

Pratik Biyani

Financial Analysis of Bharat Rasayan Ltd:

Net Sales:

• Bharat Rasayan Ltd has been growing its sales at a fast pace of 20-40% between 2012 and 2017 barring 2016
• The two consecutive years of FY15 & FY16 has suffered poor monsoons which lead to a slump in pesticide sales
• However, FY17 turned out to be a good monsoon year after two consecutive years of below-normal south-west monsoon (June-September) rainfall
• This can be seen in the growth of the cos sales in 2015 and 2016. In 2016, the company’s sales grew by only 3.8%. This shows the impact of seasonality or bad monsoon can have on the cos business
• The year 2017 saw good monsoons in India which can also be seen in the cos numbers. Sales grew by 36.3% in 2017
• In the next two-three years, we may put in Rs 200 crore in the area of intermediates for manufacturing new products, said Mr. Gupta
• When I did a peer analysis of the sales growth of the co, the co. in tough times of 2015 and 2016 (due to poor monsoon) was amongst the cos with a growth
• In addition, during good times like 2017, the co. clocked the highest growth YoY

Peer Comparison:

Many companies in India couldn’t perform as expected in 2014-15 due to unfavourable monsoon. This was not the case with Bharat Group who achieved 25- 30% growth to $165 million in sales The co figured in the list of Top 20 Indian Agrochemical Companies in the 2014 ranking released by AgroPagesThe co attributes this growth to their consistent pursuit of quality and business ethics “BRSN could outperform the competition mainly on the strength of its working systems and professionalism,” said Mr. GuptaThe co’s S&OP (sales and operating planning) facilitates advance planning and seamless working of supply chain and manufacturing functions Through substantial investment in machinery and plant automation, BRSN plants had a near zero down time, considerably reduced manufacturing losses and improved operational efficiency. All the above initiatives coupled with agility in decision making enabled BRSN to offer right price at right time in a short active selling seasonAlso, BRL is always committed to add new products in its pipeline. In the 2014-15 season, addition of new molecules like diafenthiuron and fipronil also contributed to growth in company’s turnover

(Source: http://news.agropages.com/News/NewsDetail—17003.htm)

Profitability:

• A look at the profitability trend of Bharat Rasayan would indicate that both the operating profit margin (OPM) and net profit margins (NPM) have been growing considerably over the years. The last 4 years have been averaging 18% OPM and a below par 7.3% NPM however, the NPM has grown from 5.1% in 2013 to 8.8% in 2017
• However, the OPM and the NPM have not been moving closely (as seen in the graph above). This is mainly due to an increase in the interest and depreciation cost of the company
• Depreciation increased from INR 1.5 cr to INR 7 cr to INR 18 cr in FY12/13/14
• Capex increased to INR 46 cr, INR 77 cr, and INR 25 cr in FY12/13/14 thus the increase in the cost of depreciation
• At the same time, the cos interest cost also significantly rose from INR 1 cr in 2012 to INR 16 cr in 2014
• It is visible in the Debt to Equity ratio of the company, which increased, from 0.2 in 2011 to 2.1 in 2013 and 1.7 in 2014
• Thus, the company had taken debt to finance their capital expenditures
• Therefore, need to note is that Bharat Rasayan Ltd has been under various capex investments in the past, and thus the NPM has fluctuated, (due to depreciation and interest changing)
• However, over the last few years, the organization has managed to keep a constant depreciation and interest expenses

Tax Payout:

The tax payout ratio of Bharat Rasayan Ltd, over the years, had been around the standard corporate tax rate prevalent in India.

Operating Efficiency of Bharat Rasayan Ltd:

Asset Turnover:

• While assessing the Net Fixed Asset Turnover of the company, the NFAT of the co has been consistently increasing from 2.5 in 2013 to 4.7 in 2017. The NFAT had declined from 18 in 2010 to 7.6 in 2011 and then 2.5 in 2013 due to an increase in the cos capex
• It is reasonable to ascertain that the NFAT would decline in the initial phases of commissioning any new plant because the utilization of the plant to optimal levels would take some time when the NFAT would gradually improve, as in the case of NOCIL Ltd
• Another modern and larger plant, spread over 11 hectares (105,000 sq. m.) in the Chemical Approved Economic Zone at Dahej in Gujarat was set up to manufacture tech grade pesticides, intermediates, and bulk formulations. The Plant (Unit 2) worth $30 mn was set up in 2012

Inventory Turnover:

• Looking at the inventory turnover ratio of BRSL, it is noticeable that the co has been able to improve its inventory turnover ratio consistently since FY 2015. The ITR has increased from 7.0 in FY 2013 to 8.8 in FY 2017. This reflects good inventory management by the company over the years
• The co keeps stressing about the importance of inventory management due to the seasonality of its business and yet, it has been able to improve its inventory turnover over the years

“BRSN could outperform the competition mainly on the strength of its working systems and professionalism,” Mr. Gupta says proudly And through substantial investment in machinery and plant automation, BRSN plants had a near zero down time, considerably reduced manufacturing losses and improved operational efficiency. All the above initiatives coupled with agility in decision making enabled BRSN to offer right price at right time in a short active selling season.

(Source: http://news.agropages.com/News/NewsDetail—17003.htm)

• Compare this to Insecticides India whose ITR has been only between 2 and 3
• For Bayer Crop Science, the ITR has decreased from 6.2 in 2014 to 3.9 in 2017
• For Excel Crop care, the ITR has decreased from 4.9 in 2014 to 4.2 in 2017

The pesticide industry is working capital intensive. Due to seasonal nature of the business and the uncertainties related to timing and coverage of monsoon, level of pest infestation etc, the level of inventories the companies need to stock is large. Further, the industry needs to offer long credit periods to farmers due to intense competition and low offtake.

(Source: CARE Ratings: Rating Methodology for Pesticide Companies)

Receivables Days:

• Receivables risk is one of the biggest risks for the company
• The industry has to extend long credit period due to intense competition amongst the players.

As, pesticides are the last input in the agricultural operation, after having invested in seeds and fertilizers, farmers have little surplus money left for purchasing pesticides and therefore, providing long credit is necessary to stimulate the demand

(Source: Credit Rating Rationale, CARE Ratings)

• While analysing the receivable days, the co has been able to decrease its receivable days from 73 in 2013 to 61 in 2017. It reached to 67 in 2016 due to weak monsoon and thus an extension of credit to its customers
• However, there is no stable trend visible and much of the reason is due to the seasonality of its business
• In addition, due to intense competition, the co must have given a credit period to retain customers

Let us do a peer comparison:

Peer Comparison:

All the cos peers hover around the same range.

CFO vs PAT of Bharat Rasayan Ltd:

• When we compare the cos cumulative CFO to its cumulative PAT, we see that the cos CFO is a little lesser than its PAT
• This can be attributed to the seasonality of the cos business due to which it has to keep greater levels of inventory and give longer credit period to its consumers
• Thus, it is important to keep a watch on the operating efficiency parameters especially inventory utilization going ahead to ascertain whether the company is able to improve its working capital utilization going ahead
• However, when seen on a year-to-year basis, CFO has been greater than the cos PAT most of the years. However, there was a sharp decrease in the CFO in 2017 due to an increase in the cos receivables and inventory in 2017

Free Cash Flow of Bharat Rasayan Ltd:

• The co had a negative FCF in 2012 and 2013 due to a new plant that was set up in Dahej in Gujarat
• Since then, the co was able to generate positive FCF and then again, in 2017, the cos FCF deteriorated in 2017
• As previously noted, the cos negative CFO in FY17 was due to a higher receivable and inventory- This can be attributed to the seasonality of the cos business due to which it has to keep greater levels of inventory and give longer credit period to its consumers

Market Capitalization of Bharat Rasayan Ltd:

It seems that the market has appreciated that BRSL has been able to demonstrate a strong Cash Flow position, better margins, and better future outlook and as a result, its market capitalization has increased from Rs. 53.28 in FY 2013 to Rs. 1272 in FY2017, a CAGR of 121%

Leverage analysis of Bharat Rasayan Ltd:

Debt to Equity Ratio:

• The co has managed to decrease its Debt to Equity ratio from 2.1 in 2013 to 0.6 in 2017
• The co had carried out a major capex in 212 and 2013 for which it had taken debt which increased the cos Debt to Equity ratio to 2.1
• In addition, the interest coverage of the firm has increased from 2.5 in FY2013 to 8.2 in FY2017

Management Analysis of Bharat Rasayan Ltd:

Remuneration of Directors and Key Managerial Personnel:

• According to the Companies act 2013, the remuneration payable to anyone managing director or whole-time director or manager shall not exceed five per cent. of the net profits of the company.
• Mr. Rajendra Prasad Gupta, Whole-time Director, got paid INR 6.4 crores remuneration in 2017 which is 11.8% of its Net Profits in that year (INR 54.4 crores)
• Mr. Mahabir Prasad Gupta, Whole-time Director, got paid INR 2.3 crores remuneration in 2017 which is 4.2% of its Net Profits in that year

Thus, the total remuneration of the directors is INR 8.7 crores which is 16% of the cos Profits in 2017

Investable PE Ratio of Bharat Rasayan Ltd:

Self-Sustainable Growth Rate: 

Self-Sustainable Growth Rate (SSGR) is a measure of the growth potential inherent in the business model of a company, which it can achieve using resources generated through its current profits without relying on external sources of funds like debt or equity dilution.

SSGR = [(1-Dep) +NFAT*NPM*(1-DPR)] – 1

Where,

• Dep = Depreciation Rate
• NFAT = Net Fixed Asset Turnover
• NPM = Net Profit Margin
• DPR = Dividend Payout Ratio

If the SSGR is higher than the current sales growth rate, it means that the company’s business features (NPM, NFAT & DPR) allow it to grow its sales at a higher rate than the current growth rate.

Co.’s SSGR has decreased from 60% in 2011 to 6% in 2015 but is now on an increasing trajectory to 8% in 2016 to 16% in 2017

Let us delve deeper into this:

• Co has been able to increase its SSGR in 2016 and 2017 due to an increase in the NPM and NFAT, two key pointers
• In the earlier years of high SSGR, co had a high NFAT (due to less or no capex)

FCF as a percentage of CFO:

Co does not deserve any premium in this aspect in terms of PE ratio.

Dr Vijay Malik’s Response

Hi Pratik,

Thanks for sharing the analysis of Bharat Rasayan Ltd with us! We appreciate the time & effort put in by you in the analysis.

Let us first try to analyse the financial performance of Bharat Rasayan Ltd over the last 10 years.

Financial Analysis of Bharat Rasayan:

Bharat Rasayan Ltd has been growing its sales at a very fast pace of 25-30% year on year for the last 10 years (FY2008-17). Its sales have increased last year from ₹67 cr. in FY2008 to ₹621 cr. in FY2017.

An investor would notice that the company had muted sales growth until FY2011 when it increased up to about ₹100 cr. However, the sales started increasing sharply from FY2012 onwards and have become six times since then from about ₹100 cr. to current sales of ₹621 cr. This sudden increase in sales coincides with the commencement of the second manufacturing plant of the company at Dahej, Gujarat.

The sharp increase in sales from the start of the new plant indicates that the company has been able to find customers for the new capacity and in turn that the company has an untapped market, where it can supply its products.

Upon analysis, an investor would find that the sales of the company’s products are dependent upon many factors like the performance of monsoon, commodity cycles, general economic scenario etc. CARE Ratings in its credit rating report for the company for January 5, 2018, states that:

“Highly dependent upon monsoon and climatic conditions:The pesticide industry derives its sales from the agriculture sector which is highly dependent upon monsoons as well as incidence of fungal/pest attack on crops.”

Further advised reading: 7 Important Reasons Why Every Stock Investor Should Read Credit Rating Reports

However, upon understanding the past performance of Bharat Rasayan Ltd, an investor would notice that the company has been able to increase its sales even in those years when the industry faced the above-mentioned challenges.

In FY2013, the country faced a tough year from the perspective of monsoon performance. However, the company could increase its sales by 32% from ₹142 cr. in FY2012 to ₹188 cr. in FY2013. (Annual report for FY2013, page: 14)

Financial Year 2012-13 was a tough year for Indian agriculture and agro chemical industry. Serious challenges were posed by the delayed and not-so-well distributed monsoon in the key agriculturally important geographies of the country. However despite these challenges, your Company has managed to overcome obstacles and achieved a reasonable growth through introduction of new products, increased production and broadened customers’ base.

– Gross Sales increased by 32.66% to ₹ 20,127.38 Lacs from ₹15,172.19 Lacs in the previous year;

Similarly, in FY2014, the company could almost double its sales from ₹188 cr. in FY2013 to ₹361 cr. in FY2014 despite the challenges of slow growth scenario prevalent in the economy. (Annual report for FY2014, page: 22)

During the year, Indian economy witnessed various issues such as slower growth, high inflation, uncertain political environment and strong forex volatility. Despite such an environment, Company’s Total Revenue stood at ₹36234.90 Lacs as compared to ₹18816.47 Lacs during the previous year thereby registering a growth of 92.57%

Further advised reading: Understanding the Annual Report of a Company

The above incidences will indicate to an investor that the company operates in a market, which is very under-penetrated indicating that many potential customers do not have access to the products. As a result, in the periods of general economic slowdown and poor monsoon, when its existing customers are not able to maintain their purchases of the company’s products, the company is able to find new customers who were not using its products in the past and thereby generate higher sales.

Such a scenario indicates that the market segment of the company products (crop protection: insecticides, pesticides, herbicides etc.) is still untapped by the manufacturers. As a result, the company could sell the output of its new manufacturing plant at Dahej despite tough economic situations.

The company has highlighted this aspect of the crop protection industry in its FY2017 annual report (page 45) in the management discussion and analysis section:

The growth of agrochemical industry is directly proportional to the growth of the agriculture sector. Any improved situation like increased purchasing power with the farmers to buy more of agro-chemicals is a further to the industry. The scope of the agro-chemical industry in India is quite wide given the fact that there is still a considerable part of the country not touched by the modern technology and irrigation facilities.

Further advised reading: How to do Business Analysis of Agrochemical (Pesticide) Companies

The company has not disclosed the current capacity utilization of the plants (Rohtak, Haryana and Dahej, Gujarat) in its communications. An investor may contact the company directly to understand the current utilization levels to estimate the ability of the company to generate future growth from existing capacity or the requirement of increasing capacity in near future.

Upon analysing the profitability of the company, an investor would notice that the sales growth achieved by Bharat Rasayan Ltd has been associated with a significant increase in the operating profit margins (OPM). OPM has increased from 6-7% until FY2011 to 18% in recent years. The improvement in the OPM is significant and deserves deeper analysis by the investors.

For arriving at the factors leading to the improvement in OPM, investors should do a comparative assessment of the expenses of the company for FY2011 when OPM was 7% and FY2017 when OPM has increased to 18%.

Further advised reading: How to do Business Analysis of Chemical Companies

Upon the comparison, the investors would notice that the raw material cost of the company, as a proportion of sales, has remained almost constant at 65-66% over the years. The stable raw material cost over the years indicates that the company has the ability to pass on increases in the costs to its end customers and thereby protect its profitability margins.

The stable raw material costs though highlight the pricing power enjoyed by the company but do not explain the significant improvement of the operating profit margins.

For finding out the reasons for the improvement of the margins, an investor would have to look at other components of the company’s expenses. When the investor compares these expenses over FY2011 and FY2017, then she notices that Bharat Rasayan Ltd has achieved a significant reduction in its sales & administration costs and other expenses. She notices that these two heads have led to an improvement of about 9% (sales & admin costs = 4% and other expenses = 5%) out of the total 11% improvement of the operating profit margin of the company from 7% in FY2011 to 18% in FY2017.

Improvement of sales, general administration, and other expenses indicate that the company has been able to increase the efficiency of its resources. The company has been able to generate higher sales revenue from the Dahej plant. However, it could avoid a proportionate increase in associated expenses like administration staff, additional dealers, purchase costs etc.

Upon reading the past annual reports for the above-mentioned period, an investor would find that the company has communicated the steps that it has taken to save on costs in its FY2014 annual report (page 28) in the management discussion & analysis section like the centralized purchase of raw material and other cost control measures:

The centralized purchase of the major raw-materials and the centralized fund raising exercise at Head Office level has indeed proved beneficial to the Company as both these areas are fairly sensitive keeping in view the peculiar nature of Company’s operations. As an ongoing exercise continuous planning by senior personnel based at Head Office in Delhi with respect to crucial operational matters goes a long way in exercising strict cost controls eventually resulting into profit maximization.

The operating profit margin has been stable at about 18% for the last few years. An investor should monitor closely whether going ahead the company is able to achieve any improvement in the OPM.

An investor would notice that the net profit margin (NPM) of Bharat Rasayan Ltd has not been able to show the same level of improvement as its OPM. It seems that the higher interest cost due to the debt taken to complete the Dahej plant has had an impact on the NPM. As a result, the improvement in the NPM is less than the OPM of the company over the years.

The tax payout ratio of Bharat Rasayan Ltd, over the years, had been around the standard corporate tax rate prevalent in India.

Further advised reading: How to do Financial Analysis of a Company

Operating Efficiency Analysis of Bharat Rasayan:

While assessing the net fixed asset turnover (NFAT) for Bharat Rasayan Ltd, an investor would notice that the NFAT of the company witnessed a reduction over FY2010-13 when it constructed the Dahej plant. From FY2014 onwards, the NFAT is improving consistently due to improved utilization (i.e. higher sales) of the Dahej plant as well as reducing fixed asset base due to depreciation.

Looking at the inventory turnover ratio (ITR) of Bharat Rasayan Ltd, an investor would notice that the ITR of the company has been fluctuating from 6.9 to 10 over the years. Similarly, the receivables days of the company have been fluctuating from 53 to 73 days over the years.

Such fluctuating working capital performance levels indicate that the company faces a tough working capital planning situation where it has to keep the significant level of inventory in the distribution channel and give a higher credit period to customers.

Further advised reading: How to Analyse Operating Performance of Companies

Such business situations make the operations working capital intensive as highlighted by CARE Ltd in its credit rating rationale for the company in January 2018 (page 2):

Working capital intensive nature of operations: The commoditised nature of the products and seasonality factor (high demand during crop sowing seasons) makes the operations of the group highly working capital intensive. The group is required to stack up variety of products as inventory in advance of the season resulting in high inventory holding period which is a common phenomenon across pesticide industry. Further, since pesticides are the last link in the agricultural operation, after having invested in seeds, fertilizers, etc., the farmers have little surplus money for purchasing pesticides. Therefore, providing credit is necessary to stimulate demand. Thus, due to such intrinsic nature of business, the group’s working capital requirement continues to remain high.

An investor would notice that the over last 10 years, the company has witnessed a significant amount of money being stuck in the working capital. Approximately, ₹72 cr. has been stuck in the additional inventory and ₹104 cr. has been stuck in the receivables from the customers.

As a result, it does not surprise an investor when she notices that Bharat Rasayan Ltd is not able to convert its profits over the last 10 years into cash flow from operations. The company has reported a cumulative cash flow from operations (cCFO) of ₹169 cr over the last 10 years (FY2008-17) against cumulative net profit after tax (cPAT) of ₹181 cr.

Further advised reading: Understanding calculation of Cash Flow from Operations (CFO)

Margin of Safety in the Business of Bharat Rasayan:

i) Self-Sustainable Growth Rate (SSGR):

An investor would notice that Bharat Rasayan Ltd has witnessed an SSGR ranging from 6-17% over the years. SSGR was at the higher levels in the past as the company had high NFAT before the capex on the Dahej plant. However, once the Dahej plant started production, the SSGR has been in the range of 6-17%.

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 is attempting to grow its sales at a rate higher than its SSGR and additionally, it is not able to convert its profits into cash flow from operations, 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 the SSGR of Bharat Rasayan Ltd is about 6-17% whereas it has been growing at a rate of about 25-30% over the years. As a result, the investor would appreciate that the company required outside funds to meet its growth requirements.

The company has been able to increase its sales from ₹67 cr. in FY2008 to ₹621 cr. in FY2017 by doing a capex of ₹208 cr. Over the same period, it had to raise additional debt of ₹107 cr. as its total debt has increased from ₹8 cr. in FY2008 to ₹115 cr. in FY2017.

ii) Free Cash Flow Analysis:

If an investor analyses the total cumulative financial performance of Bharat Rasayan Ltd over the last 10 years (FY2008-17), then she would notice that the company has a total cumulative CFO of ₹169 cr. whereas it had to meet a capex of ₹208 cr. and the interest expense of about ₹68 cr. indicating a total expenditure of about ₹276 cr. (208+68).

Bharat Rasayan Ltd could meet the cash flow gap of ₹107 cr. (276-169) by raising additional debt of ₹107 cr. as discussed above.

Free cash flow (FCF) and SSGR are 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 and annual report analysis of Bharat Rasayan:

While studying Bharat Rasayan Ltd, an investor comes across certain other aspects, which are important for analysis and subsequent final investment decision by investors:

1) Promoter/Management remuneration:

While reading the FY2017 annual report, page 36, an investor would notice that the promoters/management of the company has drawn the maximum possible remuneration permitted by the Companies Act 2013:

The maximum remuneration as per the Companies Act in FY2017 is ₹929.98 lac and the promoters have taken home the maximum salary permitted.

Moreover, a look at the remuneration levels of the promoters/management for the previous year (FY2016 annual report, page 29, indicates that in FY2016 also, the promoters have taken home the maximum remuneration allowed by the Companies Act:

The promoters/management took home ₹572.84 lac as remuneration against the limit of ₹572.85 lac.

When an investor extends her analysis to FY2015, then she finds the same behaviour of the promoters/management where they took home a total remuneration of ₹533.53 lac against a limit of ₹534.05 lac.

From the above analysis, an investor would appreciate that the only factor, which is limiting the remunerations of promoters/management is the ceiling put by the Companies Act.

Additionally, the remunerations being usually at the maximum limit stipulated by the Companies Act might also indicate that the company arrives at a remuneration increase for the promoters/management in any year after it knows the upper limit of remuneration for the year to ensure that no part of the maximum limit goes unutilized. There seems to be little correlation between the remuneration increase of the promoters/management and other employees.

When an investor analyses the FY2017 annual report, then at page 44, she notices the data for the comparison of promoters/management remuneration and other employees of the company:

The investor would notice that the on average the employees of the company received an increase in remuneration of about 10%, whereas one of the promoters, who draws a salary, which is more than 25,000 times the median salary of the employees received an increase in remuneration of more than 70% during the year. It is pertinent to note that the said 70% increase in remuneration is at an already high salary level.

Further advised reading: How to identify Promoters extracting Money via High Salaries

2) Loans and advances from promoters/related parties:

While analysing Bharat Rasayan Ltd, an investor would notice that the company has taken a significant amount of loans from related parties. As per the FY2017 annual report, page 89, the total loans outstanding from related parties is about ₹80 cr.

Upon analysing the past reports for the company, an investor would notice that the loans and advances from related parties started increasing significantly from FY2013 onwards. In FY2014, the loans from related parties increased to about ₹34 cr. from ₹5 cr. in FY2013. Annual report FY2014, page 64:

An investor would notice that during the period from FY2013 to FY2017, the loans from related parties have increased from about ₹5 cr. to about ₹80 cr. whereas during the same period the overall debt of the company has witnessed a net decline from ₹131 cr. to ₹115 cr.

The comparative analysis of total debt of Bharat Rasayan Ltd with its break-up into the related and outsider (banks etc.) parties shows the following picture:

An investor would recollect that FY2013 is the period when the company completed its capex of about ₹125-150 cr. on the Dahej plant and it became operational. After FY2013, the company started its phase of high sales growth (₹98 cr. in FY2013 to ₹621 cr. in FY2017) and significant improvement in the operating profit margin (OPM).

The analysis of the breakup of the debt among the related parties and outside parties indicates that since the start of the Dahej plant, the promoters have been infusing more and more capital into the company in the form of debt/loans and are replacing the outside lenders.

Related parties currently own 70% of the debt of the company in FY2017 up from 4% in FY2013.

An investor can assign two interpretations to such a development:

a)

The first interpretation can be that the company is facing liquidity stress, as it might not be making sufficient cash from its business to meet the requirements of its operations and the debt repayments to outside lenders. As a result, the related parties have to infuse money into the company to support its operations and debt repayments to outside lenders. Related parties have infused about ₹75 cr. in the company during FY2013-2017.

This interpretation would lead an investor to believe that if the related parties do not infuse the money in the company, then the company would find it difficult to run its operations and it might default to the outside lenders.

Additionally, this interpretation will question the credit rating of AA- assigned by CARE Ltd to the company. The credit rating of AA- indicates a strong financial position with a very low probability of default.

CARE Ltd on its part has safeguarded itself by using the methodology, which takes the combined view of Bharat group including Bharat Rasayan Ltd, Bharat Insecticides Ltd, and BR Agrotech Ltd to arrive at the rating of AA- for Bharat Rasayan Ltd.

While arriving at the ratings of Bharat Rasayan Limited, CARE has taken a combined view of Bharat Rasayan Limited, B.R Agrotech Limited and Bharat Insecticides Limited due to integrated and interlinked business under the same management. These entities are hereinafter collectively referred to as Bharat group.

An investor would appreciate that the methodology used by CARE Ltd to assign the credit rating of AA- to Bharat Rasayan Ltd by combining the strength of all the entities of the group might not do justice with indicating the credit strength of standalone entity Bharat Rasayan Ltd.

An investor would also appreciate that the other entities: Bharat Insecticides Ltd and BR Agrotech Ltd are not the subsidiaries of Bharat Rasayan Ltd. Therefore, the minority shareholders do not have any control/legal right over these entities.

These companies are controlled by the same promoters & management and the promoters have been using these entities to infuse money into Bharat Rasayan Ltd to support its operations and debt repayments. The promoters are taking these steps today but in future, the promoters might not follow the same steps and then the company might face difficulties in its business.

Therefore, the first interpretation to the infusion of funds by related parties in Bharat Rasayan Ltd might indicate that the company on its own does not have the business strength as perceived by the market and it might be standing on the crutches of related parties.

b) 

The second interpretation to the infusion of funds by related parties to replace outside lenders of Bharat Rasayan Ltd can be that the promoters/related parties are flush with funds and are not finding opportunities to deploy those funds anywhere else at attractive rates of return. Therefore, they are replacing the outside lenders of Bharat Rasayan Ltd and in turn ensuring that they get interest income from Bharat Rasayan Ltd, which is higher than the interest income available to them outside.

While analysing the FY2017 annual report of the company, pages 88 & 89, an investor would notice that the company has disclosed the amount of the interest paid by it to all the related parties on the loans given by them to the company. An investor can use this data to find out the interest rate that related parties are charging to the company.

The following table shows the calculation of interest rate paid to four of the largest lenders from the related parties:

An investor would notice that the related parties are getting an interest rate of about 9.6% to 10.2% on their loans to Bharat Rasayan Ltd.

The interest rate available for deposits in the banking system currently ranges from 5.25% to 6.25% (January 12, 2018) (Source: SBI Website)

The second interpretation to the infusion of funds by related parties might indicate that the related parties are getting an interest rate of about 10% from the money put in by them into Bharat Rasayan Ltd against the interest rate of about 6%, which they might get when they put money as deposits in the banks.

Therefore, an investor would notice that the act of related parties to infuse ₹75 cr. as loans into Bharat Rasayan Ltd to replace the outside lenders might indicate a situation where the company is facing cash flow constraints to run operations and repay outside lenders. On the other hand, if Bharat Rasayan Ltd has a strong cash flow position to run its operations smoothly and has the ability to repay all its outside debt on its own, then the loans from related parties might indicate an attempt by them to get higher interest rates on their money than the deposit rates from banks.

We would suggest that the readers/investors should do further analysis and arrive at their own conclusion regarding it.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

3) Sales and purchase of material from related entities:

The FY2017 annual report, page 88, indicates that Bharat Rasayan Ltd enters into sale and purchase transactions with the related entities:

An investor would notice that the promoters of Bharat group have primarily divided their business operations across the value chain of insecticides into the following segments:

• Technical grade pesticides (equivalent to active ingredient): in Bharat Rasayan Ltd
• Formulations (active ingredient mixed with inert substances/excipients): in Bharat Insecticides Ltd and
• Packaging material to sell the final product: BR Agrotech Ltd

As all these companies play a role in different steps to manufacture and sell the pesticide/insecticide in the market, therefore, each of these companies buys the product of another company as its raw material and then processes it to sell it further. As a result, there are many sale and purchase transactions between them.

This business inter-relationship along with the loans given by these entities to Bharat Rasayan Ltd might have led CARE Ltd to use the combined methodology of using all the three entities of the Bharat group to arrive at the credit rating.

However, as the other entities: Bharat Insecticides Ltd and BR Agrotech Ltd are not subsidiaries of Bharat Rasayan Ltd, therefore, it becomes essential for the minority investors to assess whether the sales and purchase transactions between Bharat Rasayan Ltd and other group entities are at market prices. This is because if these transactions are not at market prices e.g. if sales from Bharat Rasayan Ltd are at lower prices and purchases by Bharat Rasayan Ltd are at higher prices, then these transactions might lead to the shifting of economic benefits from Bharat Rasayan Ltd to other group entities.

Moreover, these group entities may invest this money back in Bharat Rasayan Ltd at interest rates higher than bank deposit rates would make it a vicious cycle. The investor can apply the same interpretation to the management personnel getting a high salary from the company and then giving the same as a loan to the company at a higher interest rate than bank deposit rates.

Further advised reading: How Promoters benefit themselves using Related Party Transactions

4) Dividends funded out of debt:

An investor would notice that Bharat Rasayan Ltd has a negative free cash flow (FCF) position where it has to raise debt to meet its operational and capital expenditure requirements. In such cases, where companies do not make sufficient cash flow from operations and raise debt to meet the capex, the investor would notice that the companies meet their fund requirements for dividends out of the debt proceeds.

Further advised reading: Steps to Assess Management Quality before Buying Stocks (Part 2)

Margin of Safety in the market price of Bharat Rasayan:

Currently (January 11, 2018), Bharat Rasayan Ltd is available at a price to earnings (P/E) ratio of about 31 based on trailing 12 months earnings, which does not offer any 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, taking 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

Analysis Summary

Overall, Bharat Rasayan Ltd seems to be a company, which has shifted gears in terms of sales growth and profitability since it completed its manufacturing plant in Dahej. The company seems to have the pricing power to pass on the changes in the raw material costs to end customers. This ability along with the steps taken by the company to improve resources efficiency/cut costs have ensured that its growth over the last few years has been associated with a significant increase in operating profit margins.

The company operates in a very competitive environment where it has to ensure that a sufficient amount of inventory is always available in the distribution network despite facing the challenges of seasonal variations of demand. Additionally, the company needs to provide a long credit period to its customers to generate demand. As a result, the business of the company is working capital intensive resulting into the cumulative cash flow from operations of the company being less than cumulative profit after tax over the last 10 years.

The cash flow from operations of the company has not been sufficient to meet its capex requirements for sales growth. As a result, the company has to raise debt to fund its growth.

Over the last few years, the company has been raising more debt from related parties and using it to meet its operational requirements and repay outside lenders. In FY2017, almost 70% of the debt is from outside lenders. The investors should do further analysis and try to interpret whether the loans from related parties are to help the company in its liquidity constraints or these loans are an attempt by related parties to earn higher interest rates than the bank deposit rates.

Investors should keep a close watch on the profitability levels, working capital management including inventory and receivables, loans from related parties and the cash flow position of the company to monitor the business position of the company in future.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views about Bharat Rasayan Ltd. However, investors should do their own analysis before making any investment-related decision 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”

Hope it helps!

Regards,

Dr Vijay Malik

P.S.

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Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.