Professional Documents
Culture Documents
Agrochemical (Pesticides)
Agrochemical (Pesticides)
(Pesticide) Companies
Published: 16-Aug-22
Modified: 21-Aug-22
1. Similarities with Pharmaceutical Industry
2. Key factors influencing the business performance of agrochemical (pesticide)
companies
3. Summary
The current article aims to highlight the key aspects of the business of
agrochemical (pesticide) companies. After reading this article, an investor would
understand the factors that impact the business of pesticide companies and the
characteristics that differentiate a fundamentally strong pesticide company from a
weak one.
In fact, China produces more than 90% of the world’s technical production and
has a very large overcapacity.
Just like pharmaceuticals, pesticides also affect human health because from the
crops they enter the food chain and human body; therefore, companies need to
conduct many studies/trials to ascertain their safety before the products are
approved for commercial use.
As a result, it takes a long period from the identification of any new pesticide to
its commercial use on the farms, which is usually about 10 years.
All these studies take a significant investment of money and other resources.
Therefore, countries grant patents to companies investing in research &
development (R&D) of pesticides, which gives them a period of exclusivity for
selling that particular pesticide to recover their investment in R&D and earn a
profit.
After the patent protection of any successful pesticide is over, then just like in the
pharmaceutical industry, many other companies start producing that pesticide,
which is called a generic version. However, even the generic companies need to
establish the safety of their product by conducting safety trials, which also takes
significant time. As a result, it may take generics companies about 5 years to
register their product.
Being a regulated industry, it takes almost 10 years for an entity to bring a new
molecule into the market and almost five years to get a generic product
registered.
Moreover, patented pesticides sell at a higher price and at good profit margins
due to limited competition during the exclusivity period. The prices decline
sharply when numerous generic companies enter the market. As a result, generic
pesticides have lower profit margins. An investor may notice the same dynamics
in the pharmaceutical industry.
Further advised reading: How to do Business Analysis of a Company
Just like the pharmaceutical industry, every pesticide needs to be registered with
govt. authorities before it can be sold in any country. Registrations are country-
specific and a company needs to register its product in every target country.
Just like the pharmaceutical industry, the registrations take time and money. In
the pesticide industry, the registration process of a product in developed markets
like the USA/EU may take about 3-5 years and a cost of about USD 10-15 mn
whereas a registration in India may take about 1-3 years and a relatively lower
cost. The requirement of registrations and the time & cost involved in the same
may act as an entry barrier for new players.
Ramprakash Bubna: in Germany the things are very difficult. Our rate of success
of registrations in Germany is very, very low.
In addition to the low success rate, the registration processes are also very costly
because apparently nowadays, the govt. authorities have started to look at them
as a profit-generating activity.
In the pharmaceutical industry, the demand for drugs in India or in any country is
primarily driven by the local factors/diseases prevalent in that area and may not
be influenced by global factors. Similarly, in the case of agrochemicals as well,
the demand is influenced by local factors and not global dynamics.
An investor may read the following article to understand more about the business
analysis of pharmaceutical companies: How to do business analysis of
pharmaceutical companies
Let us now understand the key characteristics of the business of agrochemical
(pesticide) companies and understand the major factors impacting them, so that
we may understand, which pesticide companies have a stronger business model
than others.
Even within the season, the demand for pesticides fluctuates widely depending
upon factors like rainfall (monsoon), pest attacks, pest resistance etc. Therefore,
a company may be ready with full inventory; however, there might be a rain
deficit leading to lower acreage of crops and less demand for pesticides.
Demand may also get affected if a particular pest attack may not happen in any
year or the pest becomes resistant to the existing pesticide.
Therefore, it is very difficult for agrochemical companies to decide the exact
demand for their products in any year. However, they need to keep sufficient
stock of pesticides so that they do not run out of the product when the demand
comes.
In India, most of the pesticide players are formulators who import technical
pesticides from China and then produce formulations in India. This business
model does not require a large investment in manufacturing plants etc. because
producing formulations is low capital intensive whereas producing technical
products is highly capital intensive.
The key consumer of the pesticide industry in India, the farmer community is not
very rich and has to manage with limited resources. As a result, they are very
price conscious in their pesticide purchase decisions and are unwilling to pay a
high price for any specific brand.
the market for pesticides is low brand conscious and highly price sensitive. Due
to dominance of generic products, there are several ‘me too’ and spurious
products available in the market.
Most of the raw materials used as inputs for the production of technical products
and subsequently formulations are derivatives of crude oil. As a result, the raw
material costs of agrochemical companies witness a lot of fluctuation as the
crude oil prices are very volatile.
First, over time, the pests develop resistance to existing pesticides that stop
working. As a result, newer pesticides need to be developed, which requires a
significant investment of money and time in R&D.
Entities with strong R&D capabilities and high budgetary allocation for R&D work
will be better placed in terms of tapping the opportunity arising from patent
expirations.
Unfortunately, most Indian agrochemical companies have a small R&D budget
and spend only 1%-2% of their revenue on R&D in comparison to multinational
companies (MNCs), which spend about 11%-12% of revenue on R&D.
Therefore, an investor should analyse the R&D spending by the company along
with its tie-ups with innovator MNCs to assess whether the company would be
able to counter product portfolio obsolescence.
However, the long credit period hurts the agrochemical companies because in
the case of bad harvest, poor monsoon etc. the farmer is unable to pay the
money.
This risk is especially high for companies who have most of their products under
the red label (extremely toxic) and yellow label (highly toxic) instead of products
under the blue label (moderately toxic) and green label (slightly toxic).
entities which are highly dependent on red and yellow triangle pesticides run the
risk of losing their source of revenue from products falling under banned
category.
In addition, diversified companies, which are usually large in size also have
advantages because they have higher bargaining power over their suppliers as
well as customers and distributors.
While the formulations business is not capital and technically intensive, the
profitability of the entities depends on their ability to develop a strong brand and
distribution network, which may entail significant time and cost and act as key
competitive strengths.
Moreover, if they are integrated players i.e. produce technical products as well as
formulations, then they are able to capture a higher share of the value chain and
earn a high-profit margin in addition to better control of the supply and quality of
raw material.
Organic farming promotes growing food without the use of agrochemicals like
pesticides, fertilizers etc. However, in the absence of these additive factors, the
production yield of organic crops is low, which results in a high market price for
organic products.
If going ahead, improvement in technology and processes leads to an
improvement in the production yields of organic farming, then a resultant decline
in the price of organic products may lead to a large section of the population
shifting to consuming organic foods. It may lead to a decline in the demand for
agrochemicals like pesticides.
Summary
Overall, the agrochemical (pesticide) industry seems an essential segment of the
economy like the pharmaceutical industry, which is essential to prevent damage
to food crops due to pests. Developing newer pesticides is a very resource-
intensive exercise due to multiple safety trials because pesticides enter the food
chain and affect human health. This also makes it a heavily regulated industry.
Companies with higher R&D spending are at an advantage because they are
able to get an exclusive period to see their products at a profitable price to
recover their R&D expenses. However, once the patent period ends, then many
generics players enter the market and bring down the prices as well as
profitability.
Most of the agrochemical companies in India are generic formulation players that
produce commoditised products, which is not a capital-intensive process. As a
result, the industry is highly fragmented and intensely competitive where many
players compete on the price to gain customers. Moreover, the customers are
also highly price conscious with low brand loyalty. All this leaves a very low
pricing power in the hands of generic agrochemical players.
Demand for pesticides is seasonal and uncertain due to weather changes and
pest resistance. As a result, companies need to keep a large inventory to meet
the seasonal increase in demand. In addition, companies need to update their
product portfolio to meet regulatory and market demands for newer and safer
pesticides.
Agrochemical operations are working capital intensive due to large inventory and
trade receivables requirements. Farmers use pesticides at the end of crop
sowing operations when they have consumed almost all their resources.
Therefore, they need a credit period to pay after the harvest is over. If the crop is
bad, then they are not able to pay leading to bad debt for companies.
As a result, large agrochemical companies with a significant R&D budget and a
diversified product portfolio and extensive distribution are at a competitive
advantage. These companies can develop new products, enter into an exclusive
alliance with innovator MNCs, sell in different geographies, educate customers
about their products as well as generate resources for working capital needs.
Effectively, in the agrochemical industry, big players have a ready stage to
become bigger.
The agrochemical industry is facing threats from the growing use of GM seeds,
preference for organic food as well as the growing presence of fake/spurious
products in the market, which may affect the business of agrochemical
companies going ahead.
As ready examples, an investor may read our detailed analysis of the following
companies operating in the agrochemical sector.
Dr Vijay Malik
Below are 2 notable examples of agrochemical
companies along with their analysis(Sharda Cropchem
and Bharat Rasayan)
3. Analysis Summary
The current section of the “Analysis” series covers Sharda Cropchem Ltd, a
trading company focusing on agrochemicals, conveyor belts etc. that has taken
registrations for selling agrochemicals in many countries.
“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.
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.
I am a big fan of your blog and I have learned a lot from your analysis. I have
analyzed Sharda Cropchem Ltd. Please review and provide feedback. Thank
you,
Abhijit Dutta
Financial Analysis:
Valuation Analysis:
P/E ratio – 20
PEG ratio – 2.68
Earnings yield (EY) – 5%
P/B ratio – 3.73
Price to sales ratio (P/S) – 1.90
Dividend yield (DY) – 0.75%
Management Analysis:
Abhijit Dutta
Thanks for sharing the analysis of Sharda Cropchem Ltd with us! We appreciate
the time & effort put into the analysis.
While analysing the history of Sharda Cropchem Ltd, an investor notices that
over the years, the company had many subsidiaries both in India and overseas to
conduct its business. As per the Q4-FY2022 results announcement, pages 3-4,
on March 31, 2022, Sharda Cropchem Ltd had 41 subsidiaries.
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 company including its subsidiaries, joint ventures etc.
The consolidated financials of a company present such a picture.
Further advised reading: Standalone vs Consolidated Financials: A Complete
Guide
Therefore, in the case of Sharda Cropchem Ltd, we have analysed the
consolidated financials of the company.
Sales of Sharda Cropchem Ltd have grown at a pace of 18% year on year from
₹778 cr in FY2013 to ₹3,580 cr in FY2022. Moreover, sales have increased
every year since FY2013.
The operating profit margin (OPM) of the company has fluctuated within the
range of 17% to 23% during this period with periods of declining OPM like
FY2015 when the OPM decreased to 17% from 20% in FY2014 and FY2018-
FY2020 when the OPM declined to 17% in FY2020 gradually from 23% in
FY2017. During the same period, the net profit margin (NPM) of Sharda
Cropchem Ltd decreased from 14% in FY2017 to 8% in FY2020.
Due to the market dominance of MNCs, Sharda Cropchem Ltd has to sell its
products at a discount to MNC products. The company does not have the power
to price its products higher or equal to the prices of MNC products because then
the customers would simply buy the products of MNCs.
Conference call, July 2018, page 6:
Rohan Gupta:…we have been able to pass on to the end customer or not?
Ramprakash V. Bubna: Not in all the cases…Because we are to follow the
footsteps of the multinationals and multinationals are also very conscious of not
losing their market share and they do not pass and they do not increase
During FY2018-FY2022, Sharda Cropchem Ltd suffered a lot of pressure on its
profit margins because despite increasing costs, the MNCs instead of increasing
their prices, decided to decrease them to maintain their market share.
In fact, at times, the MNCs buy active ingredients (AI) for their final products from
the company at a cheaper price and then give Sharda Cropchem Ltd strong
competition in its target markets.
Ramprakash Bubna: The AIs have increased in the last year or before last year
mainly because of the demand from many multinational companies who were not
able to secure the AIs on their own and we were able to supply them at
competitive prices
Therefore, the pricing and business strategy of Sharda Cropchem Ltd is highly
dependent on the large MNC competitors.
The market situation faced by Sharda Cropchem Ltd is such that the large
distributors do not encourage generic players. This is because the MNCs provide
them with many financial incentives, which makes it difficult for smaller generic
players like Sharda Cropchem Ltd to convince them to stock their products.
Ramprakash V. Bubna: The MNCs are not very keen and they do not press the
customers for the payments and are very liberal, they give very liberal
extensions and on the contrary, smaller companies like us, we are having
pressure on cash flow so we put the pressure on them to make the payments
Moreover, Sharda Cropchem Ltd also realized that it could not match the MNCs
in terms of very long credit periods to distributors even if it wants to. This is
because Sharda Cropchem Ltd being an Indian company is not allowed to give
very long credit periods.
R.V. Bubna: No, we cannot match with them because they are in a different
atmosphere, we have lot of regulations and we have to comply with our
regulations in India. So we cannot give very long credit even if we feel that the
customer is safe.
Therefore, Sharda Cropchem Ltd is caught in a difficult situation where it is not
able to get a large opportunity with big distributors as the MNCs have created
strong barriers due to their existing relationships with them.
An investor may estimate the restrictions faced by Sharda Cropchem Ltd in the
business environment when she gets to know that in the USA, the big 4
distributors hold about 75% of the market share. The generics companies are
only fighting for the remaining 25% share.
China is the world’s largest agrochemical producer and supplies about 75% of
the world’s demand for agrochemicals.
R.V. Bubna: No, we don’t enter into any supply agreement, we negotiate them
with them from order to order basis because this is to our advantage.
The company avoids long-term supply agreements with its suppliers because it
thinks that in a long-term agreement it would have to accept delivery of products
even if its customers’ demand declines due to poor weather etc. The company
fears that in such a situation, it would be stuck with unsold inventory.
Gautam Arora: Also I would be put at a disadvantage if I enter into long term
supply arrangements with supplier because the products that we deal in are very
sensitive to weather conditions across the globe so in case I have any kind of
a tie up for specific volumes to be picked up from my supplier and the weather
turns bad in a particular region then I will be tied down with this inventory and
with nowhere to go.
However, such a strategy relies on everything being normal in the entire supply
chain. During FY2018-FY2020, when the Chinese govt. came down heavily on
polluting industries, which disturbed entire Chinese production, then this strategy
of only doing spot buying hurt Sharda Cropchem Ltd. This was because it had to
accumulate excess inventory that too at higher prices and it had no other
alternative.
R V. Bubna: If Sharda wants to import the product from any other country, it is
being prohibited by the registration law. As per the registration rules, we have
to source the products only from the registered source, which is declared in our
registration application or registration document and this is applicable to every
supplier in USA.
In addition, once a source country is finalized in the registration, then it becomes
difficult to change it later on because, at times, it may involve repeating the entire
trial. Moreover, in almost all cases, changing/adding a new supplier is a time-
consuming process.
Sharda Cropchem Ltd does almost its entire business in overseas locations
where it sources most of its material from China and sells it primarily in Europe,
North and Latin America and a bit in the rest of the world.
Almost all of its purchases from China are in US Dollars (USD) whereas the
majority of its sales are from Europe, which is in Euro (EUR). Therefore, Sharda
Cropchem Ltd is highly vulnerable to the movement of the Euro and USD relative
to each other.
The dependence of Sharda Cropchem Ltd on the EUR/USD is such that during
FY2015 when the Eurozone was under crisis and the value of the Euro declined
significantly, then its profit margins were impacted significantly. The OPM of
Sharda Cropchem Ltd declined from 20% in FY2014 to 17% in FY2015.
Conference call, June 2015, page 3:
Ramprakash V. Bubna: Sir not only LATAM, all the countries where the
currencies have devaluated even in say Canada, Mexico, South Africa we have
to take the price reduction.
As a result, the volatility of cross currency pairs is one of the key risks highlighted
by the company to its investors.
The agrochemicals sold by Sharda Cropchem Ltd are relevant for specific
crops/pests etc.; therefore, their demand peaks up during the season when a
particular crop is grown. As a result, the business performance of Sharda
Cropchem Ltd is seasonal. The Jan-March (Q4) is usually the best quarter for the
company followed by April-June (Q1) and July-Sept (Q2). The Oct-Dec (Q3)
quarter is the weakest quarter in its business performance.
R. V. Bubna: See our business is a seasonal business, and this has been the
practice for the last 8 to 10 years. But the Q4 is the best quarter for our
business, Q1 is the second best, Q2 is the third best and Q3 is the weakest
One problem in a highly seasonal business is that if the company is left with an
unsold inventory of any chemical, then it has to wait for almost 8-9 months for the
next season before it can sell it. Therefore, if there is any problem in inventory
sourcing/logistics and the products arrive late in the season, then the company is
stuck with inventory for a long time.
Conference call, May 2017, pages 16-17:
Ramprakash V. Bubna: Mr. Resham, last year has been a little bit of an
aberration because of very difficult situation in China and late deliveries by the
suppliers. So by the time we shift the goods and landed in the various regions, it
was bit late for that season. So we are left with the lot of unsold inventories.
When a company has unsold inventories from the previous season, then it
carries the risk of inventory losses because of the volatility in the product prices.
Agrochemicals are known to enter the food chain and affect all consumers.
Therefore, there are continuous studies to assess the harmful impacts of
agrochemicals on humans, other animals and the environment. This leads to a
frequent ban on various agrochemicals, which has become a routine practice in
the industry.
In May 2022, Sharda Cropchem Ltd also intimated to its shareholders that a ban
on the products is a very normal occurrence in the agrochemicals industry and
investors should not be surprised by it.
Overall, Sharda Cropchem Ltd seems to be highly dependent on MNCs for its
pricing and China for its sourcing. It does not seem to have any pricing power
over its counterparties. The business is exposed to seasonality, cyclicity,
vagaries of nature/weather as well as the movement of foreign exchange. An
investor must assess all these aspects in her analysis of Sharda Cropchem Ltd.
Over the years, the tax payout ratio of Sharda Cropchem Ltd has been in the
range of standard corporate tax rate except in a few instances where the payout
ratio was low because of the business conducted by the Dubai subsidiary, which
is in a tax-free zone.
Ramprakash V Bubna: The effective tax rate, the only thing that we can off
hand guess is that may be last year the volume on our subsidiary in Dubai that
have been higher where there is no tax liability
Sharda Cropchem Ltd reported a low tax payout ratio of 11% in FY2020, which
was primarily due to choosing the new corporate tax rate for its deferred
tax liabilities.
FY2020 annual report, page 185:
Company has applied the lower income tax rates on the deferred tax assets /
liabilities to the extent these are expected to be realised or settled in the future
period when the Company may be subjected to lower tax rate and accordingly
reversed net deferred tax liability of INR 3,522.84 lakhs.
As per the company, it may continue with the old tax rate regime for a few more
years until it exhausts its minimum alternate tax (MAT) credit entitlements.
R.V. Bubna: Not for the next two years because we have a lot of minimum
alternative tax (MAT)to be recovered for which we have credit entitlement. So,
we will not adopt the new tax regime atleast for the next one or two years.
Sharda Cropchem Ltd follows a very asset-light business model where it focuses
only on getting the registrations/approvals to sell agrochemicals in different
countries. The company has completely avoided investing in any manufacturing
or R&D facility. Its business model involves taking registrations for off-patent
agrochemicals and then sourcing them from outside third parties in countries like
China and then selling them into its target markets.
The inventory turnover ratio (ITR) of Sharda Cropchem Ltd has declined from 9.1
in FY2013 to 5.0 in FY2022. A declining ITR indicates that the inventory
utilization efficiency of the company is declining over the years.
The ITR witnessed a sharp decline over FY2017-FY2018 when it reduced to 4.2
in FY2018 from 8.2 in FY2016. The company increased its inventory in FY2017
in anticipation of high sales as it had received new registrations in the USA.
Within a year, Sharda Cropchem Ltd faced the risks of excess inventory and
suffered a drop in its profit margins as it had accumulated inventory at high prices
whereas now the prices had come down.
The effect of inventory buildup was also seen in FY2020 when players were
trying to get rid of the inventory even at lower prices.
R.V. Bubna: I would say an element of frustration on the part of many players
who want just to get rid of their stocks at beaten down the prices.
In FY2020 as well, the company had to write down some of its inventory.
Nevertheless, the business model of Sharda Cropchem Ltd is such that it has to
keep a lot of inventory as it has obtained many registrations, which it claims to
supply. As a result, to meet customers’ expectations of immediate delivery, the
company ends up maintaining an inventory of a large number of products.
Otherwise, it would lose its customers.
The company intimated to its shareholders that in LATAM and Mexico, the credit
period for collection is about 240 days.
Conference call, August 2015, page 19:
Gautam Arora: So Europe is roughly about 135 days, US is close to about 90-
100 days, NAFTA and LATAM is close to about 240-odd days
As per the credit rating agency, CRISIL, outstanding receivables in LATAM
countries make its business model working capital intensive.
R. V. Bubna: See this is only because we don’t have any borrowings in the
company. So, this is only to meet the temporary requirement of working
capital which has been inflated due to inventories and receivables…the funds
have come from the promoters, which came in at a notice of one or two days.
The working capital requirements of the company increased so much that in
FY2019, the company reduced its investments in filing registrations so that it
could spare money to fund its working capital.
Ashok Vashisht: The major focus earlier was on Europe. Now we have been
putting equal focus on NAFTA and Latin America regions as well.
Going ahead, an investor should keep a close watch on delays in receivables
beyond 6-months and the write-off of bad debt to assess whether Sharda
Cropchem Ltd is able to collect its money on time.
Over FY2013-22, Sharda Cropchem Ltd reported a total net profit after tax
(cPAT) of ₹1,794 cr. During the same period, it reported cumulative cash flow
from operations (cCFO) of ₹1,813 cr.
It is advised that investors should read the article on CFO calculation, which
would help them understand the situations in which companies tend to have the
CFO lower than their PAT. In addition, the investors would also understand the
situations when the companies would have their CFO higher than the PAT.
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 may calculate the SSGR using the following formula:
While looking at the cash flow performance of Sharda Cropchem Ltd, an investor
notices that during FY2013-FY2022, it generated cash flow from operations of
₹1,813 cr. During the same period, it did a capital expenditure of about ₹1,517
cr.
Therefore, during this period (FY2013-FY2022), Sharda Cropchem Ltd had a free
cash flow (FCF) of ₹296 cr (=1,813 – 1,517).
In addition, during this period, the company had a non-operating income of ₹122
cr and an interest expense of ₹105 cr. As a result, the company had a total free
cash flow of ₹313 cr (= 296 + 122 – 105). Please note that any capitalized
interest is already factored in as a part of the capex deducted earlier.
Sharda Cropchem Ltd has used this money primarily to pay dividends to its
shareholders.
Going ahead, an investor should keep a close watch on the free cash flow
generation by Sharda Cropchem Ltd to understand whether the company
continues to generate surplus cash from its operations.
On analysing Sharda Cropchem Ltd and after reading annual reports, RHP, its
credit rating reports and other public documents, an investor comes across
certain other aspects of the company, which are important for any investor to
know while making an investment decision.
1) Registration requirements prove to be a strong entry barrier for companies:
Sharda Cropchem Ltd has stated in multiple disclosures that its key business
strength is its registrations/approvals in different countries. As per the company,
getting registration is a costly and time-consuming process where the outcome is
very uncertain.
Even if a company invests a lot of money to gain registrations, then it may not get
an appropriate value if it decides to exit the business by selling the registrations.
Therefore, to save on time, the generics companies purchase the data from the
data-owners and use it in their registration application. In return, the generics
companies pay data compensation charges to the data owners. However,
gaining access to the data is not a simple and quick negotiation. At times, these
negotiations with the data owners can take even up to 12 years.
Tushar Sarda: What steps are we taking to address the reason for decline in the
ROCE and ROE?
Ramprakash Bubna: The reasons are increase in the capex and surge in the
cost of registrations.
As a result, registrations become a critical entry barrier for new companies.
In fact, the difficulty in obtaining registrations becomes a benchmark for the profit
margins earned by the agrochemical companies in different geographies.
Ramprakash V. Bubna: See in the financial year 2022 the gross margins
in Europe is 35.7%, NAFTA 29%, LATAM 15.4% and rest of the world 22.6%.
In fact, when different countries in Latin America and the Rest of the world
relaxed their registration requirements, then the increased competition made
these markets non-attractive for Sharda Cropchem Ltd. As a result, the company
reduced its focus on these markets.
Ramprakash V. Bubna: You see the rest of the world is getting slowly and
slowly less important for us because the registrations barriers are not so
strong and the margins are less and it requires an equal amount of efforts so it
is receiving lesser attention from us.
Conference call, July 2017, page 4:
As per the company, outsourcing entire manufacturing saves it from being tied to
any particular product. The company wants to keep its business highly flexible
and does not want to be in a situation where it has to manufacture a product
even if there is no demand for the same. In case, the demand for any one
product declines or is banned altogether, then Sharda Cropchem Ltd wants to
quickly move over to other products, which have a strong demand instead of
being stuck with a plant manufacturing a product that no one wants to buy.
As per the company, the manufacturing process is the least value-adding step in
the entire agrochemical value chain. Most of the value in the entire supply chain
is enjoyed by the marketing entities.
2) Not all registrations are profitable investments for Sharda Cropchem Ltd:
From the above discussion, an investor would feel that getting registrations is
difficult; therefore, getting as many of them as possible should be a great
strategy. However, the case of Sharda Cropchem Ltd indicates that a lot of its
investment in the registrations did not bear fruit. Instead, a significant amount of
money spent by it on registrations was written off when it did not provide requisite
returns. In fact, many of the registrations were written off even during the process
of pendency of a grant of the registration i.e. in the capital work in progress
(CWIP) stage.
Ashish Lodha: Profit after tax declined by 7.6% from Rs.191 Crores to Rs.176
Crores in FY2019. This was mainly on account of CWIP write off of Rs.42.2
Crores in FY2019.
FY2020 annual report, page 32:
PAT declined by 6.61% from last year due to Intangible Assets & Intangible
Assets under Development write off & higher depreciation
Sharda Cropchem Ltd has mentioned that going ahead; every year, it may have
to keep writing off about ₹30-50 cr of its investments in registrations.
Himanshu Binani: …intangible write offs which has been now a constant
feature…So, going forward how one may look at this number?
Ramprakash V. Bubna:…it will be in the same range of Rs. 30 to 50 Crores.
Sometimes, the government authorities ban some registrations while we have
already made the investments.
Such a substantial write-off of the investment done in registration indicates that
the due diligence done by Sharda Cropchem Ltd for its product selection leaves
scope for improvement. The company highlighted that while selecting products
for registration, it primarily relies on the feedback of the market participants.
We also noted that when regulators increased the registration fees to generate
profits from the registration process, then the return on equity of Sharda
Cropchem Ltd declined.
Sharda Cropchem Ltd mentioned that it did not own the original registration for
Quizalofop-Ethyl. Instead, one of its competitors owned a registration for it.
Luckily, for a brief period, to ensure easy availability of Quizalofop-Ethyl, the
regulators allowed other companies to get registrations for Quizalofop-Ethyl at a
very low cost even if they do not own the original registration.
Therefore, any investor should always be aware of the significant impact that
regulators can have on the business of any agrochemical company like Sharda
Cropchem Ltd (“stroke of a pen” risk).
Sharda Cropchem Ltd faced two different instances where it faced litigations
when it was alleged that its products damaged crops and trees. In July 2013, it
settled a case in South Africa where it was claimed that its product damaged
trees and crops.
a claim filed by Plaaskem Pty Limited, South Africa…in respect of the generic
active ingredients supplied by Hockley International Ltd. (“Hockley”) alleging that
the said formulation caused damage to the trees and crops of its end users. The
generic active ingredients used by Plaaskem to formulate the formulations
were supplied to Hockley by the Company….this matter was settled in July 2013
Another case against the company’s subsidiary in Europe claiming damage to
plants from its products was pending at the time of IPO.
Societa Agricola Allasia Plant s.s. (“SAAP”) has filed a case…in relation
to damage caused to its plants cultivated, by the use of Dessicash 200 SL (the
“Product”) provided by Sharda Europe…This matter is pending.
An investor may contact the company directly to know the status of this case.
Going ahead, an investor should keep in mind the risk of failing to meet
regulations as well as changing regulations while she assesses Sharda
Cropchem Ltd. This is because even if the company is able to successfully
defend a case against it, it still consumes a lot of resources of the company in
terms of money, management’s time and brand value.
Sharda Cropchem Ltd was affected by high import duties in FY2020 during the
US-China trade war when under the leadership of President Donald Trump; the
USA imposed high duties on imports from China including agrochemicals. At that
time, the customers of Sharda Cropchem Ltd refused to absorb the impact of
these high duties and as a result, the company had to take a hit on its margins.
Recently in USA, higher import duties were imposed on goods originated from
China. Since SCL imports about 97% of the goods from China, the gross
margins were impacted by 200 basis points
Advised Reading: Credit Rating Reports: A Complete Guide for Stock
Investors
Therefore, the entire strength of the business model of Sharda Cropchem Ltd
comes from the cumbersome and time-consuming registration process, which
dissuades many competitors from entering this field. The business strength is not
due to any proprietary technology or any difficult-to-manufacture product, which
no one else can produce.
Sharda Cropchem Ltd is a part of the Bubna family and currently, the founder-
promoter couple, Mr Ramprakash V. Bubna, CMD. (aged 75 years) and Mrs
Sharda R. Bubna, WTD, (aged 69 years) along with their sons, Mr Ashish R.
Bubna, WTD, (aged 49 years) and Mr Manish R. Bubna, WTD, (aged 47 years)
are present on the board of directors.
The presence of younger family members at executive positions within the group,
while the senior members are still handling responsibilities, looks like a good
succession plan. This is because the young members can learn about the fine
nuances of the business under the guidance of senior members until the seniors
decide to take retirement.
Going ahead, an investor may keep a close watch on the relationships among
the sons of the founder-promoters to understand whether any ownership issues
arise between them.
Until now, the promoters have managed the equations between the two brothers;
Mr Ashish R. Bubna and Mr Manish R. Bubna, by making them draw an exactly
equal salary from the company every year.
In FY2016, both the brothers took home a salary of ₹22,995,405
each (FY2016 annual report, page 60)
In FY2017, both the brothers took home a salary of ₹30,043,982
each (FY2017 annual report, page 55)
In FY2018, both the brothers took home a salary of ₹31,414,273
each (FY2018 annual report, page 61)
In FY2019, both the brothers took home a salary of ₹34,302,081
each (FY2019 annual report, page 61)
In FY2020, both the brothers took home a salary of ₹32,504,953
each (FY2020 annual report, page 58)
In FY2021, both the brothers took home a salary of ₹32,895,142
each (FY2021 annual report, page 63)
An investor may contact the company directly for any clarifications about any
ownership issues between the promoter-family members.
Sharda Cropchem Ltd disclosed in the RHP in September 2014 that it has not
registered its brands in the foreign countries and as a result, there is a risk that
some competitors may launch products under the same brand name. The
company only believed that the regulators would not grand registration to any
competitor under the same brand name.
In the RHP, Sharda Cropchem Ltd also intimated that it has taken registrations in
the names of its distributors, consultants and other third parties. The company
has done all the spending for these registrations and it derives economic benefits
from them; therefore, it sells its products under the licenses received in the
names of consultants and distributors. However, the company does not have any
binding agreement with such third parties.
In the past, there have been many instances where Sharda Cropchem Ltd has
been found lacking in its internal controls and processes.
As per the RHP, September 2014, pages 27-28, the company failed to make
necessary filings with RBI when it received foreign investment. At the same time,
it also failed to comply with FEMA regulations while incorporating subsidiaries
and making investments outside India.
In 2011, Sharda Cropchem Ltd was penalized by customs officials for wrongfully
taking the duty-free clearances of imported goods.
In 2015, the company did not timely disclose to the stock exchanges that in its
board meeting, it would also consider a declaration of dividend.
The report of Board of Directors for the financial year ended 31st March 2017 did
not contain the explanation or comments by the Board in respect of the
qualification made by the company secretary
In addition, the company did not furnish a required declaration needed as a part
of the audited financial result and therefore, the stock exchanges issued notices
to the company.
There was a delay of 1 day in submission of copy of the Annual report to the
stock exchanges
During FY2010, FY2012 and FY2013, the company had delayed the deposit of
undisputed statutory dues to the govt. authorities (RHP, September 2014, pages
31-32).
An investor may contact the company directly for clarifications about the steps
taken by the company to reduce such instances of noncompliance.
Another instance of weakness comes across when an investor visits the website
of Sharda Cropchem Ltd. The website of the company does not have a security
certificate. It is opened via an “HTTP” connection instead of an “HTTPS”
connection. As a result, it is labelled “Not secure” by the web browsers. The cost
of a security certificate for a website to make it secure is about ₹1,000/- per year,
though various open-source free alternatives also exist.
Going ahead, an investor should keep a close watch on the signs indicating
weaknesses in the internal controls and processes of Sharda Cropchem Ltd.
Sharda Cropchem Ltd has modelled its business around obtaining more and
more registrations to sell agrochemicals in many countries and has completely
avoided owning any manufacturing facility. It is a pure trading company, which
sources all of its products from third parties, mainly from China. The business
strength in relying only on registrations comes from the cumbersome and time-
consuming registration process, which acts as an entry barrier for generics
agrochemical companies.
Generics agrochemical players including Sharda Cropchem Ltd do not have any
pricing power over their customers. They only follow the pricing strategy of large
MNCs that own 75% of the market share. When MNCs refuse to increase prices
even when costs are going up, in order to maintain their market share, then
Sharda Cropchem Ltd suffers significantly on its profit margins. The MNCs
pamper large distributors with incentives and rewards and as a result, they do not
entertain generics players; therefore, companies like Sharda Cropchem Ltd have
to primarily rely on smaller distributors limiting their market reach.
Sharda Cropchem Ltd is stuck with suppliers in China for its products because
there is no alternative. Even if it wants to switch to a new supplier, the
registration regulations do not allow an easy switch. Therefore, it is like either
supply from China or do not supply. As a result, when Chinese agrochemical
production came under stress in FY2018-FY2020, then Sharda Cropchem Ltd
had to buy an excess inventory at high prices to ensure that it does not lose its
customers. In the end, the company suffered due to excessive unsold inventory
when prices declined later on.
Sharda Cropchem Ltd has a high receivables days due to twin factors of MNCs
giving very long credit period to distributors, which puts pressure on Sharda
Cropchem Ltd as well to match and secondly, due to long-stuck receivables in
Latin America where many economies and their currencies are performing
poorly.
The company has a succession plan where the sons of the promoter are playing
an active role in the company; however, it remains to be seen whether the two
brothers would keep on collaborating.
3. Analysis Summary
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.
Regards,
Pratik Biyani
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:
Tax Payout:
The tax payout ratio of Bharat Rasayan Ltd, over the years, had been around the
standard corporate tax rate prevalent in India.
Inventory Turnover:
Receivables Days:
Peer Comparison:
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
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%
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
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
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)
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.
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.
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:
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.
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.
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.
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)
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%.
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.
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
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:
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.
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.
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.
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.
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.
b)
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 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:
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.
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)
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 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.