Thank you for subscribing to InvestKaroIndia.
This blog has now moved to a new domain and service called TheWrap🌯

TheWrap🌯 is designed to be the most efficient way for a working class investor to keep up with the markets.

Its cheap, its in depth and it solves all pain points involved in active investing.

Check our sample report below.

Sample TheWrap Report

There is so much available in TheWrap🌯 that you will never be able to use it all.
Dont believe us? Believe our users⤵️

A typical subscription like this costs INR 15,000 per year.

TheWrap🌯 only costs INR 3000 per year!!

Yes, you read that right - we are 80% cheaper than anything else available in the market today.

Try TheWrap🌯 for a month at the below link and decide for yourself.

TheWrap🌯

Here is a quick walkthrough of our entire website.

Thank you for reading and supporting.

TheWrap🌯

Thank you for being a subscriber to TheWrap🌯 and InvestKaroIndia.

In the last six months, as TheWrap has evolved, we have added several services in addition to the weekly newsletter.

So far, a user had to navigate to various portals to access these services. This wasn’t an ideal set up and led to a lot of friction along with a bad user experience.

To fix the above, we have now consolidated all of services within the TheWrap🌯 subscription to a single portal.

In the above portal, you can access everything that TheWrap has to offer - from weekly reports to data tools to weekend meet recordings, courses and even a community.

If you’re an existing Wrap subscriber, your account is already migrated and set up. To login, please reset your password using the forgot password option at the portal.

Below is a quick video walkthrough of the entire portal.

In the coming week, we will turn off the existing portals and completely migrate to the new portal. So please ensure to login to the new portal at the earliest convenience.

Answering some FAQs related to this migration.

Q. Can I sign up on a trial basis?
A. Yes, you can sign up for a one month trial on the new portal.

Q. I am a monthly subscriber, will I continue to be automatically charged?
A. No, we have already paused billing via substack and have migrated your account to the new portal. Upon expiry of your current month validity, you will have option to pay for yearly or 3 year plans.

Q. What will happen to Discord community?
A. At this point we are keeping the community alive and will try to integrate it within the new portal in addition to the already existing community on the portal.

Q. Can I ignore and remove old links and only bookmark the new portal?
A. Yes, the new portal is already active and has all parts of the wrap available.

Q. When will you turn off the old links?
A. The old links will be turned off starting 26th April 2024.

Q. Can I change my email address?
A. Please reach out to us at help@investkaroindia.in

Q. Can I upgrade my plan to 3 year plan?
A. You can buy additional 3 year plan. At the payment page in new portal, please choose the start date of the plan as the date when your current plan expires.

Q. Will I continue to get weekly emails?
A. Yes, all existing processes remain as is. The email will come from the new portal instead of here on substack.

Q. I have friends who want to sign up, whats the payment page?
A. Its available on the new portal itself, please direct them to it.

Q. I have more questions, how do I reach out?
A. Please write to us at help@investkaroindia or WhatsApp us at +91-8297756798

Q. What will happen to this substack?
A. This substack will remain free going forward and will publish a monthly in-depth company analysis.

I hope you will enjoy the new portal and it will make navigating Wrap and its various parts much easier.

As always we will continue to improve the service and bring to you the finest financial content.

Thank you
Tar

Hi 👋! It's Sunday, and thank you for signing up.
The about page for TheWrap is here.

Macro jitters, IT index takes a beating, Earnings continue to roll in

Click here to read about how to understand and interpret the above grid.

The top focus for the market this past week was the war in Middle East. Amid the chaos, Indian markets performed relatively well and showcased resilience.

Most of the market indices ended the week in positive, with minor losses on the others. IT Index however took a beating and ended the week with a negative return of 4.36%. Soft commentary from Infosys and weak topline growth in line with results of TCS from last week were the culprit. The pain for IT service companies will last a couple more quarters as demand in the North American market remains weak.

Now, compare this to performance by US market. All major indices of the mother market were down with Nasdaq 100 index ending the week at 5.86%.

The poster child of rally in US (Nvidia), was down 13.59% this week.

On the other hand macro indicators like Gold and Dollar Index continue to advance. Gold ended the week up by another 2% at USD 2391.77/OZ and Dollar Index is back above its 105. US bond yields too continue to hold up at above 4.62% for 10Yr.

Against this backdrop, the resilience in Indian market continues to shine. Our resilience so far has been protected by the earnings growth. If we do miss even a single quarter of this growth, chances are the market will correct.

Probability of such a fall seems low as ongoing capex both by public and private sector is chugging our economy at an incredible GDP growth rate of 7%+.

Speaking of earnings growth, below are the few good ones that were declared this week.

As represented above, a wide variety of companies continue to display healthy bottom as well as topline growth.

Finally, to answer your question - what am I doing with my portfolio in this trouble brewing macro environment?

Absolutely nothing - apart from looking at earnings and hunting for my next fat pitch.

Subscribe to #TheWrap🌯 by clicking on the below button.

Subscribe to TheWrap🌯

Questions?
Reach out to us at 📩 help@investkaroindia.in or WhatsApp us at 📞+91-8297-756-798

Charts for Upcoming Week

1. Ashiana Housing

   Highest weekly volumes combined with price momentum

2. Marksans Pharma

   Rising weekly volumes and price momentum

3. Morepen Labs

   Price took support at 40Week EMA and rising past its resistance zone

4. PNB Housing

   Rising volumes and price momentum

5. Refex Industries

   Price picking up momentum with a slight rise in volumes

6. Repco Home Finance

   Price broke out of its resistance set 5 years ago

7. Saregama

   Rising volumes and price momentum combined with breakout of its trendline

8. Swelect Energy Systems

   Rising volumes and price momentum combined with stock price at all time high

9. Techno Electric & Engineering

   Rising weekly volumes and price momentum

10. Universal Cables

    Strong Price momentum and all time highs

This week’s important insider trades:

Buying

1. Lyka Labs: Promoters bought 8.82% of the company worth 36.27cr

2. Imagicaaworld: Promoters bough 5.63% of the company worth 222.33cr

Selling

1. Teamo Productions: Promoters sold 1.3% of the company worth 1.4cr

Notes from Tar on this week’s Announcements 📝

Over 8713 filings were made by companies on NSE and BSE combined this week, what you see below are ~94 handpicked announcements (~1.08% of total filed) after filtering out all the noise.

Further, there are 27⭐ announcements (~0.3% of total filed) that you should absolutely do not miss. The ⭐ is decided based on the impact of the announcement on the company.

Share

⭐ denotes must read corporate filings

Capacity Expansion / New Ventures

1. Varun Beverages commences production of soft and energy drinks from its new plant⭐

2. SEPC to set up compressed biogas plants based on patented technology⭐

3. Brigade to invest 400cr in developing office space in Chennai

4. Thermax inaugurates its new wastewater treatment solutions facility

5. Steel Strips Wheels starts supplying aluminum wheels⭐

6. Kirloskar Ferrous Industries resumes operations of blast furnace at its Hiriyur plant

7. Endurance Technologies to expand its aluminum and die casting capacity

8. Vesuvius India inaugurates its new mould flux manufacturing plant

9. Rajoo Engineers inaugurates its new manufacturing facility in Rajkot⭐

10. Rushil Decor commences production from its new plywood factory

Joint Ventures / Collaborations

1. Jio Financial Services to set up a wealth management and broking business with Blackrock⭐

2. Ajooni Biotech inks a new contract with national dairy development board

3. Adani Enterprises to set up a joint venture with Singapore based King Power International and venture into duty free retail business⭐

4. Sasken Technologies enter into a strategic partnership with Joynext

5. Veranda enters into a strategic partnership with Pearson

6. Airtel to merge its Sri Lanka operations with Axiata group

7. Sterling Tools signs an MoU with South Korea based Yongin for EV components facility⭐

8. Dixon Technologies enter into an agreement with Longcheer to manufacture smart phones⭐

Order Wins

1. Deep Industries receives a new order worth 81cr from Oil India

2. ITCONS E-Solutions receives a new order worth 9.16 lakhs

3. Meson Valves receives a new export order worth 7.03cr

4. Happy Forgings receives a new order worth 500cr⭐

5. Insolation Energy receives solar modules new order worth 55.71cr

6. Intellect Design Arena wins a new deal from National Bank of Kuwait

7. Ramkrishna Forgings receives a new order worth 270cr⭐

8. ITCONS E-Solutions receive a new order worth 5.9 lakhs

9. Maestros Electronics & Telecommunications receives a new order worth 4.46cr

10. Remsons Industries receive a new order worth 30cr

11. Powergrid wins a new transmission order

12. Dynacons Systems & Solutions receive a new order worth 233cr from NABARD⭐

13. Pantabyte Technologies receive a new order worth ~19 lakhs

14. Sonalis Consumer Products receive a new order worth 35.1cr

15. Gulshan Polyols receive a new order to set up a PCC plant

16. Power Mech Projects receive new orders worth 232.03cr⭐

17. Talbros Auto JV receives new orders worth 1000cr⭐

18. Ramkrishna Forgings to supply power train components to US based EV company⭐

19. DJ Mediaprint & Logistics receive a new order worth 6cr

20. RVNL receives a new order worth 440cr⭐

21. Kranti Industries receive new order worth 70.76 lakhs

22. Inox Wind receives a new order for 210 MW of wind turbine generators⭐

Acquisitions

1. Uma Exports acquires Swastik Oil Refinery from bankruptcy court

2. Mercury EV Tech acquires majority stake in an electronic motor cycle manufacturing company⭐

3. Cipla acquires a beauty and personal care business

4. Ambuja cement to acquire a cement grinding unit for 413.75cr

5. Hinduja Global Solutions acquires a majority stake in a broadband company

6. Infosys acquires an engineering R&D company

7. ITC acquires a cloud consulting company

8. Happiest Minds acquires businesses of Macmillian Learning India

9. Indo Count Industries acquires a US e-commerce brand⭐

USFDA / Regulatory

1. Jubilant Pharmova receives VAI report in a USFDA audit

2. Marksans Pharma receives 5 observations in a USFDA audit

3. Caplin Point Labs receive a USFDA approval for its new drug

Merger / Spin-offs

1. Oriental Carbon & Chemicals Demerger approved⭐

2. Gorani Industries and Blow Hot Kitchens merger is cancelled

3. Ujjivan Financial Services and Ujjivan Small Finance Bank merger is approved by NCLT

4. Aditya Birla Fashion and Retail demerger update

Open Offers / Takeovers

1. Kinetic Trust

2. Sueryaa Knitwear

3. Suncity Synthetics

4. Vikalp Securities

5. Fortis Malar Hospitals

Stock Split

1. Premier Explosives

Delisting

1. Uniply Decor

2. Inspirisys Solutions

Rights Issue

1. Yug Decor

2. Edvenswa Enterprises

3. Sobhagya Mercantile

4. Tractors India⭐

5. IIFL Finance

6. Banas Finance

Exchange Migration

1. Knowledge Marine and Engineering

Name Change

1.  IM+Capitals to Fedders Holding

Fund Raising

1. Dhampure Speciality Sugars raises 7.36cr via preferential issue of warrants to promoters

2. Hazoor Multi Projects raises 486cr via preferential issue of shares

3. Star Housing Finance raises 25cr in loans from LIC Housing Finance

4. Manappuram Finance to raise upto USD 500 Million⭐

5.  Motilal Oswal Financial Services to raise 1000cr via NCDs⭐

6. Reetech International Cargo raises 2.1cr in loans from Axis Bank

7. Arfin India raises 52.5cr via preferential issue of shares

8. Natural Biocon to raise 19.45cr via preferential issue of shares

9. Ace Software Exports to raise 45cr

10. Sterlite Technologies raises 1000cr via QIP⭐

11. HB Estate Developers raises ~23cr via preferential issue of warrants

12. IFCI raises 500cr via preferential issue of shares to Govt of India⭐

13. Lancor Holdings raises 55.47cr via preferential issue of shares

14. Marsons Ltd raises 80.25cr via preferential issue of shares

15. Harshil Agrotech raises 44cr via issuance of convertible warrants

16. Permier Explosives to raise upto 400cr⭐

First Presentation or Concall

1. First Presentation, KP Green Engineering Ltd

2. First Presentation, South West Pinnacle Exploration Ltd

Other Important Announcements

1. Reliance Naval Engineering to relist on exchange post takeover by Swan Energy⭐

2. Axiscades Technologies receive a credit ratings upgrade

3. Biocon secures exclusive supply agreement for Ozempic in Brazil⭐

4. Hindustan Zinc is now world's third largest producer of silver from integrated operations

Between 100cr to 300cr Market Cap

1. DCG Cables & Wires Ltd: A wires and cables company

2. Teerth Gopicon Ltd: An EPC company

1. Sunil Singhania Interview

2. China’s Shipbuilding Industry

3. How drones are taking over War

4. Why the largest hotel chains do not own most of their properties

Share

Tell us how we are doing?
Let me know in comments, your feedback helps me keep improving this newsletter.

Leave a comment

See you next Sunday!

Peace ✌️
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

Shapoorji Pallonji Mistry Sr, the son of Pallonji Mistry and heir to the Shapoorji Pallonji group, was furious. No one in Angrezi Bazaar seemed capable enough to fix his electric iron - an coveted item of luxury in those days.

Just when he was about to give up, he came across Meherwan Daruvala, who ran a small electric shop in Angrezi Bazaar, called Wilson Electric Works. Just like Shapoorji, Meherwan too belonged to the enterprising Parsi community of Bombay. Unlike Shapoorji though, Meherwan came from humble means. While the Mistry’s started their business in 1865 and by 1927 were synonymous with the likes of Tata’s, the Daruvala’s were just getting started.

Impressed by Meherwan’s work and abilities, the two soon struck a friendship. That friendship eventually translated into a business relationship when their sons (Pallonji Mistry and Yazdi Daruvala) formalized the partnership by acquiring 51% stake in Wilson Electric Works. It was then, the name ‘Sterling’, from the Mistry’s family investment firm Sterling Investments, was added as a prefix and so birthed the company - Sterling & Wilson Ltd.

That business relationship has survived almost a century across generations of family members and has led to construction of iconic projects like the Taj Mahal hotel in Mumbai (the electric work was done by Sterling & Wilson, constructed by Shapoorji Group and owned by Tatas), the Sultan Qaboos Palace in Oman, the Reserve Bank of India building and the World Trade Center at Cuffe Parade, Mumbai, among others.

In 2019, Sterling and Wilson, demerged and listed its solar EPC business on the National and Bombay Stock Exchanges.

This, is the business of Sterling and Wilson Renewable Energy.

Subscribe now

Part One: Current Business of The Company

Sterling & Wilson Renewable Energy is primarily into the business of setting up large scale renewable energy parks, comprising of mainly solar, wind and battery energy storage systems. The firm, is an engineering, procurement and construction contractor also known as an EPC contractor.

In an EPC business, a company (EPC contractor) is given the responsibility to execute, manage and build a large project. One of the most well known EPC firms in India is Larsen & Tubro, which also happens to be one of the largest EPC companies in the world.

The above graphic highlights various stages of an engineering, procurement & construction (EPC) contract. In some markets, procurement of raw materials function is part of the EPC business and is included in the contract, while in others the client procures and supplies the raw materials.

Another key part of EPC lifecycle is the Operation & Maintenance stage, also known as O&M. Operation & Maintenance is the higher margin, low risk and long sticky revenue business and in most cases is granted to the same company building the project.

The above is a detailed yearly revenue breakup for Sterling and Wilson Renewable Energy from its listing year (2019) to present.

At the heart of it, its a simple business.

But this simple business comes with a myriad of challenges, some of which nearly bankrupted Sterling & Wilson several times.

What are turnarounds?

Before we proceed any further, lets first learn what are turnarounds in investing. To explain turnarounds, here is the legendary Peter Lynch.

As Lynch explains, turnarounds are stocks that went through a tough business phase leading to accumulation of losses, high debt and are most often ignored by the market.

What makes them a turnaround stock, is a trigger - usually an internal change in the way business is performed or a takeover by a new management.

There is a popular market saying, “Turnarounds seldom turn”, which means that most turnarounds fail but when they do succeed they can be humongous wealth generators.

In Indian market there are several recent examples of successful turnaround companies.

Companies like RACL Gear Tech, which was a bankrupt business once, was taken over by a new management, the stock since has returned 20x, or Sangam Renewables which was another failing solar EPC business before being taken over by the giant Waaree - the stock has since returned a massive 175x.

The key questions to ask in turnarounds are:

1. What is the trigger that leads to change in profitability of the business?

2. How close or far away is that trigger?

3. Is the debt on balance sheet manageable?

4. How much of the debt is due in the short to medium term?

5. Is there any real evidence in the company’s financials indicating a turnaround?

In the next sections, we will explore the answer to some of these questions.

Share Invest Karo India

Part Two: The Past & The Present

Before we begin to understand the triggers for the company, we need to explore what went wrong and the events that led to Sterling & Wilson Renewable Energy to where it is today.

The Global Dominance

When Sterling & Wilson Renewable Energy started its operations in 2011, there was a single mission - to become the largest Solar EPC player in the world.

By 2019, right around the time of IPO, Sterling & Wilson succeeded in achieving this mission - but that success came at a cost.

At the time of IPO, the company had projects across almost every major solar geography - Middle East, Africa, Australia, Americas, South East Asia. If there was a large solar project in any part of the world, the company was there to bid for it.

Sometimes even at unfavorable terms.

The demand for solar projects in India was thin, solar and renewables were yet to take off and across the borders in Middle East - the oil kingdom was doling out orders to construct many Gigawatts worth of solar projects vs few Megawatts in India.

Sterling & Wilson was present to bid for all them, even constructing the largest single site solar project in the world, at the time.

Unlike India, which is a Balance of System (BoS) market - where procurement (primary equipment, i.e. solar modules) is the responsibility of the client instead of EPC company.

The contracts Sterling & Wilson was signing on, included everything.

For a fixed contract price - Sterling & Wilson would do everything from procurement of materials to building the required project in very specific time period. This meant that if there were any cost overruns due to delay in construction or increase in price of raw materials etc., the company had to bear all of them from its own pocket, further putting pressure on the tiny single digit EBITDA margins.

Now to Sterling & Wilson’s credit, finishing projects before the due date was a norm in the company and as far as raw materials were concerned - cost of solar PV modules was falling for more than a decade driven by technology advancements, increased demand and giant capacities in China.

Something must have to really go wrong at multiple fronts for the company to incur losses in these projects. You know, like the world would have to shut down, everything would have to come to a standstill, Chinese govt would have to stop granting subsidies to new solar capacities and solar PV module production in China would have to come to a complete halt for several months at a time.

The possibility of all these events occurring at the same time was so miniscule, the company never thought to protect itself from it.

The probability so tiny, such an event would almost never occur.

Almost.

#AD

If you like this write up, please do consider supporting us by subscribing to our paid weekly market newsletter called #TheWrap🌯.

By subscribing to the TheWrap, not only you get a data portal and highly curated market insights, but you also enable us keeping such deep dives free for everyone else.

Below is a short video that explains #TheWrap🌯 in detail. Hope to see you as one of our subscribers.

Subscribe to TheWrap🌯

#End of AD

2020: The World Locks Down

As the pandemic raged across the world in 2020 and most of 2021, Sterling & Wilson found itself in an increasingly tough spot. Unable to work at most sites due to shortage of workers or lockdowns, combined with increasing prices of solar modules and other necessary equipment, the company was forced to concede and call ‘force majeure’ on most of its contracts.

This cancelling of contracts led to a barrage of lawsuits as clients didn’t want to pay up for unfinished work. To Sterling Wilson’s credit, the circumstances under which these contracts were signed in 2019 or before, were suddenly very different in 2021. To their client’s credit, Sterling Wilson should have protected itself better by foreseeing and demanding specific clauses to be enabled in these contracts.

Every EPC business works on very thin margins and as such opts for short term working capital loans to fund itself. When client’s of Sterling Wilson opted not to pay, it had to default on these loans triggering a downward spiral of its credit ratings, which made future borrowing more expensive.

It also increased legal costs for the firm by many folds, as client sued, creditors sued and Sterling Wilson sued them back.

It was the start of rough times for the company.

Between 2019 and financial year ending 2023, the company’s revenues dropped by 75%, from 8240cr in 2019 to just 2015cr. Further, the company went from positive operating margins of 8% to reporting negative margins for the next 10 quarters.

The pandemic had added Sterling & Wilson to its long list of business fatalities.

Amid rising debt, low funds and increasing litigation, the promoters of the company looked to sell 40% stake to shore up funds and found their white knight in Reliance.

On February 9, 2022 Reliance New Energy, a subsidiary of Reliance Industries purchased a 40% stake in Sterling & Wilson at 375/share for a total of ~737.5cr.

2023: There is Light At The End of The Tunnel

In the week of 17th July 2023, Sterling & Wilson’s posted its Q1FY24 results with first indication of positive gross margins. That week, the stock price went up by ~27% with volumes higher than last 658 days.

The market took it as an early signal that maybe the tough phase for the company was ending. The litigation cases were increasingly coming to their closure with the company winning most of them. Lenders were able to agree on terms to refinance loans at higher rates and the troubled legacy order book of the company was increasingly being replaced with domestic orders.

Indian solar market too had drastically changed since 2019. The government’s push for increased solar in total energy output of the country meant that very large orders were now being granted by most public sector undertakings with an overall ambitious goal of reaching 400 GW worth of solar capacity by 2030.

Today *(Oct 2023), the company’s order book comprises of 98% domestic orders - which has always been profitable even during the tough phase from 2019 to 2023.

In its latest quarterly results, the company has achieved profitability on a standalone basis, though remains loss making on a consolidated basis. The losses however have been narrowing.

Most of these losses, stem from the legacy international order book for the company that is still loss making. As the revenue from profitable domestic orders gets increasingly recognized in financial statements, the consolidated financials should also turn profitable.

Even in its international business, the only major new large deal worth over a billion US dollars is for a US govt funded project in Nigeria. It is expected that the deal will be profitable and as such in due course, the international EPC part of the business should also turn profitable on a standalone basis.

With a good understanding of the past and present state, lets now turn our attention towards the current challenges facing the company.

Share

Part Three: Challenges & Triggers

The main challenge (and its a big one) with the company today is that it is short on funds. As of month ending September 2023, the company had only 55cr in its bank account with total debt at 2,123cr.

That’s a lot of debt!

The past three years of troubled phase and losses have led to accumulation of this debt at pretty high interest rates.

The per quarter interest expense has increased nearly 3 times to now at 64cr. Combine that with the lumpy cash flow nature of the EPC business and shortage of funds in bank and you can see why the company defaulted on its short term loan payment in September 2023.

To shore up liquidity the company and turnaround, the company is focusing on below areas.

1. Fund Raising of 1500cr

   The company will raise 1500cr via equity issue in November 2023 in order to strength its balance sheet. Some of these proceeds will be utilized towards short term debt payment while others would be put towards working capital as the company increasingly bids for large upcoming domestic orders.
   Now, issuance of equity isn’t that great for minority investors like you and me as it leads to dilution of ownership and more shares in the market but without this fund raise and further capital infusion, I doubt the company will remain viable as a going concern.

2. Collect due indemnity payments from promoters

   The promoters of parent company, Sterling & Wilson, owes the company upwards of 400crs which is due in November 2023. The company has asked the promoters to repay earlier so that it can pay back the 135cr amount it defaulted on in Sep 2023.
   These dues relate to the indemnity agreements signed between the three promoters (Mistry’s, Daruvala’s and Reliance) of the company.

3. Focus on a Business Turnaround

   As the company wins increasingly large orders in domestic market, it is also gaining up on efficiencies. Most of these large projects are centered around key geographies which enables the company to deliver more at lower costs as they are able to utilize equipment and personnel much more effectively.

   Further, the company is also focusing on increasing the share of higher margin O&M business by bidding for third party O&M contracts.

4. Optionalities

   Very large orders like those of Nigeria and upcoming ones from promoter Reliance, should bode well for the company in driving revenue, cash flows and ultimately profitability.

   Subscribe now

Part Four: Risks & Valuation

Risks

There are several risks in the company as of today, some of these are listed below.

1. Fund Raising: Needless to mention, all future liquidity hopes of Sterling & Wilson Renewable Energy are dependent on the upcoming successful fund raising of 1500cr.

   Any hiccups with this would mean short and medium term issues for the company.

2. Time to Turnaround: As Peter Lynch mentioned in the video earlier, timing with turnaround is of utmost importance. Through the company’s last two quarter’s financial we can devise that margin and profit trajectory are in right direction, the debt alleviation plan remains to be seen.

3. Various Promoters: The company effectively has three promoter groups, the Shapoorji group, the Daruvala’s and Reliance. While Reliance is the largest shareholder, the board chairman remains Khurshed Daruvala. There are six board seats with Reliance being represented by 3 and remaining 3 distributed between Daruvala’s and Mistry’s. When you have too many cooks at the helm, there is always a chance of things going awry.

4. Future Funds: Like all turnaround, here too, the future funding of projects and business earnings depend on current business turning profitable. If the company fails to turn profitable in the next four quarters, it may lose out on the lucrative bidding window of several large PSU projects.

Valuation

The company is valued at the bottom of the pile and as if it was going to fail - which isn’t something out of the ordinary for turnarounds. The stock price has remained in a pretty tight range for most of its listing history.

Technically too, the stock is at its major support zone and any fall in prices below 245 should be worrisome.

Conclusion

“Fast cars and turnarounds are not for the faint hearted”

Time will tell whether Sterling & Wilson’s story that started in the alleys of Angrezi Bazaar in Mumbai will come to an end or will the last three year will be but a small hiccup in an otherwise almost a century old story of the company.

Like all turnarounds, you have to be careful and consider every tiny detail as an investor.

In case of Sterling & Wilson Renewable Energy, there is a light at the end of the tunnel. Today, as an investor you do not know, whether that light is a speeding train hurling towards you or an opening to an oasis.

I hope this write up helped you understand the business of Sterling & Wilson Renewable Energy in a holistic manner. If you enjoyed reading this and have any feedback or insights, please share by leaving a comment below 👇

Leave a comment

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

Are you tired of sifting through endless market noise and economic jargon?

Look no further, because The Wrap is here to deliver exactly what you need: concise, hard-to-get insights in just 5 minutes or less!

Get ready to dive into three key areas that matter most:

🌯 Market Breadth and Health: Gain a comprehensive understanding of market dynamics and trends

🌯 List of Stage 2 (aka Strong) Stocks: Each issue contains a link to list of stage 2 strong (momentum) stocks, handpicked via manual screening of over 2000+ stocks

🌯 Insider Trading Activity: Uncover the moves made by industry insiders before it hit mainstream news

🌯 Special Situations & Important Corporate Announcements: Discover exclusive highlights from this week’s noteworthy corporate announcements. If there is an important corporate filing, we will cover it!

No fluff, no distractions—just the essential information you need to stay ahead in the investing game.

Fast paced, light hearted and filled with information, that’s TheWrap.

Subscribe now

Get ready to unwrap a world of exclusive insights every week with The Wrap!

Armed with an engineering degree from BIT Mesra and an MBA from XLRI Jamshedpur, Rajiv joined Microsoft in 1992 and quickly rose the ranks to become its youngest managing director at the age of 33.

After a stint of 14 years, Rajiv left the comfort and familiarity of Microsoft for the shores of Private Equity.

Yet, that entrepreneurial echo within, nagged him. He wanted something more.

So, in 2008 as a global financial crisis was brewing, Rajiv made his way back home to India. Rajiv’s plan was to hunt for a struggling company (no shortage of those in 2008) and help turn it around into a success.

His search would end in 2009, when he came across ‘Subhiksha Realty Private Limited’. Subhiksha was a small private real estate developer in Mumbai but had an even smaller IT Infra services division within it called - CMS Computers.

Rajiv would convince Blackstone to back him and help purchase CMS Computers from the erstwhile promoters.

Fast forward 14 years, and a change of promoters (Blackstone would later sell entire stake to Barings Private Equity), CMS Info Systems, as its now called, is the leading end to end cash management solutions company operating in India.

The company is debt free, growing its topline by 20% every quarter and boasts return ratios greater than 25% with an EBITDA margin of almost 30%.

This is how the business of CMS Info Systems works.

This article took over 100 hours of research and 10 hours to write. Please consider sharing and subscribing to help support us and grow.

Share

Current Business of CMS Info Systems

The current business of CMS can be broadly classified into three main categories

1. Cash Management (contributes about 65% to the overall revenue)

2. Managed Services (contributes about 30% to the overall revenue)

3. Technology Solutions (recent but fast growing - contributes about 5% to overall revenue)

Here is detailed explanation of each business line:

ATM Cash Management

This is the bread and butter for CMS and accounts for the largest share of the overall revenue pie. In this segment, CMS helps banks replenish their ATMs with cash as and when required.

The revenue structure is based on a fee per trip along with a fixed yearly fee. CMS has over 72,000+ ATMs across India under its management. Every 1 out of 2 outsourced ATMs in the country is managed by CMS. This is a mature steady line of business and 90% of revenues are annuity based.

CMS has a 46% overall market share in India for ATM Cash Management.

Retail Cash Management

Similar to ATM Cash Management but for retail outlets. CMS here helps retail chains like DMART, Reliance Retail, petrol pumps etc. transfer cash from their outlets to respective banks.

One of technology innovations in this area by CMS is their offering called Cash-X. Via Cash-X, CMS offers retail outlets deposits in their bank accounts as soon as the cash is picked up and reconciled by a CMS pick up van. This enables a retail chain to get access to their cash deposits within hours instead of days.

The revenue structure in this segment is linked to volume along with pick up points, with 70% of total revenues being annuity based.

CMS has a 36% overall market share in India for Retail Cash Management.

Cash In Transit

In this offering, CMS works with banks to transfer cash from one branch to another within a city or across cities.

CMS helps 12,000+ bank branches transfer cash every single day.

Revenue structure is based on 3 to 5 year contracts with 80% revenues being fixed in nature. CMS has a 26% overall market share in India for Cash In Transit services.

Together, the above three business lines (ATM Cash Management, Retail Cash Management and Cash in Transit), form the overall cash management vertical of CMS.

Self developed efficient route technology helps CMS generate industry leading margins of 25%+ for the cash management business. As the number of touchpoints in this line of business expands, so will these margins due to high operating leverage built in to the nature of the business.

Banking Automation Solutions

CMS helps banks automate their banking functions via ATMs. If you have ever used an ATM that both accepts and dispenses cash - it is an example of a banking automation. Similarly, ATMs that help you change card pins, print passbooks, deposit cheques etc. are examples of banking automation.

In this business line, revenues are linked to sale of banking automation services along with a 7 to 10 year maintenance revenue contract.

Sale and Maintenance of ATMs

CMS also engages in sales as well as routine maintenance and repair of new and existing ATMs. To participate in the ‘Make in India’ movement, CMS has also recently set up an ATM manufacturing plant in Chennai, India.

Card Personalization Services

Anytime a bank issues a credit or debit card, it has the customer name and other details on it. This is usually outsourced by banks to authorized vendors like CMS.

Card personalization is a very tiny part of overall revenue for CMS.

Brown Label ATMs

Brown Label ATMs refer to those ATMs that are owned (by a bank) but operated by a third party service provider like CMS. Usually banks float tender offers and require the third party to purchase and maintain a brown label ATM on their behalf.

In exchange, the banks pays a yearly fee to the third party service provider.

This is a capex intensive business area and as such CMS tends to participate very selectively. It has a target of setting up less than 1,000 Brown Label ATMs per year and is happy to cede market share to other competitors.

The above four business lines, together form the managed services vertical of the business - which generates about 30% of the overall revenue pie.

Overall EBITDA margins for managed services tend to stay below 20%.

Remote Monitoring

This is the most exciting and rapidly growing business segment for CMS today. Via remote monitoring, CMS enables banks to leverage sensors, cameras and other software based automations to effectively govern the security of their ATM sites.

In a simplified manner of speaking, CMS is automating the job of security guards at ATMs. A typical bank spends about Rs 45,000 per month to provide round the clock security for each ATM site. Via CMS remote monitoring offering, banks can achieve the same (if not more efficient security) at less than Rs 10,000 per month.

CMS is also able to provide this service at scale by monitoring all ATM locations from a central site, there by further reducing the cost.

The remote monitoring business is rapidly growing, with revenues scaling from 0 to 100cr in less than 12 months.

CMS envisions providing the remote monitoring solution to retail chains, gold loan branches, NBFCs etc.

Being a software and fixed recurring revenue business, margins are also north of 40% in this segment.

Security Software Solutions (CMS Algo OTC)

This is an ATM access security software service. Whenever an ATM needs to be unlocked to add or remove cash, a bank needs to verify the person performing that service is legit.

Via CMS’s Algo OTC software, a bank can perform this service remotely and in an automated fashion. CMS also helps the banks meet any new RBI guidelines by updating the software on the fly to be compliant in real time.

Multi Vendor ATM Software Management Solution

Another offering by CMS is Algo MVS - which enables banks to upgrade and maintain the software on their ATMs irrespective of which vendors they purchased the ATM from.

In both CMS Algo OTC and Multi Vendor Software Solution, CMS is a market leader in India.

Share

Industry Analysis

Global Landscape

In mature economies like US and Europe, cash management is a consolidated oligopoly industry with the top two players owning more than 90% market share.

The biggest names worldwide are the likes of NCR Corporation, Brinks Incorporated, Loomis AB and Diebold Nixdorf. All these four companies have been around for a while, with NCR being the oldest and the largest among them, having been incorporated in 1884.

While revenue from cash management still contributes to a large chunk of the overall pie for all of them, all four players have, in recent years, shown a tendency to move towards more software-oriented solutions - similar to what CMS has been building for the domestic market in India.

While the global players are 5x larger in size than CMS, their margins are at best less than half of what CMS is able to deliver.

CMS is also growing much faster (~20% quarterly growth rate) than its global peers, who, being much larger and in more mature markets, average at a single-digit growth rate.

Domestic Industry Landscape

While globally, the industry is consolidated and oligopolistic, in India, there are a large number of international as well as domestic players competing in various sub-segments of the market.

Post demonetization, this market has been consolidating at a rapid pace, and existing players are either conceding market share, exiting parts of their business, or leaving the industry all together.

CMS has been able to leverage its strong debt-free balance sheet to take advantage of the consolidation in the industry. The playbook for CMS has been to buy an existing competitor at a slump sale valuation, leverage its relationships with banking customers, and up sell them the new offering as a package in addition to the existing services. Banks, too, prefer to give their business to one large player instead of several smaller ones.

This strategy has enabled CMS to grow faster than any of its competitors and increase its overall market share. Buying cheap and scaling rapidly also lead to high return ratios for the company.

Apart from CMS, the other Indian listed competitors include AGS Transact Technologies, SIS Securities Limited and Radiant Cash Management Services.

Porter 5 Force Analysis

In order to cement our understanding of this industry, here is a Porter's Five Forces analysis of CMS Info System’s business model.

Few things are evident from this analysis.

1. CMS Info Systems has some pricing power for its services but they also tend to be largely dependent on regulation and its customer’s willingness to pay. Regulation so far has been favorable for CMS and banks are willing to pay for quality services especially if a vendor can offer end-to-end integrated platform like CMS. This is reflected in the rapidly growing margins trajectory - with EBITDA margins increasing from mid teens to almost 30% today.

2. Another observation is the increasing number of competitors opting to exit the market and overall market share being consolidated among the larger players. This is also partly driven by regulation - the regulator has over the years increased compliance. Example of these include the requirement to upgrade all ATMs to a cassette swap instead of traditional locker based, live tracking of all cash vans and timelines to reconcile cash. This increasing cost of compliance is driving smaller players out of the industry and acting favorably for larger players, like CMS.

3. Finally, the threat of substitute from a shift towards digital payments is real and ever growing. UPI has been a great differentiator and enabler for India to move towards a more digitized payment system. However, this move hasn’t impacted the cash usage in the economy. Cash in Circulation - a metric used by RBI to describe cash usage has essentially increased at an annual rate of 5.33%.

   

   This increase in cash usage is not just across rural and semi urban areas but even within developed metros. In-fact, the state of Karnataka has the highest ATM replenishment rate at Rs 1.73cr per ATM per year across India!

   Subscribe now

It is clear from the above analysis, that CMS is witnessing tailwinds in its business driven largely by increasing pace of industry consolidation - leading to operating leverage kicking in. While the threat of digital payment looms, in the short to medium term, the use of cash seems to be stable and persistent in the economy.

Financial Analysis of the Company

CMS boasts of healthy, fast-growing financials. The 3-year sales CAGR has been 11%, while profits in the same timeframe have grown by 31%.

The margin profile has accelerated in recent years. CMS has gone from earning 17% EBITDA margins in 2019 to 28% in 2023. The main reasons for this growth have been operating leverage along with an increased share and growth of higher-margin businesses like software solutions.

A minor area of concern within the financials is the large share of intangible assets when compared to the overall fixed asset pie. Total intangible assets (goodwill, etc.) accounted for more than 50% of the total assets in 2019. However, this figure has sharply reduced and is now at 25% as of March 2023.

Valuations

Overall, at 18x trailing twelve-month earnings and 10x EVEBITDA, the company seems reasonably priced given the backdrop of an accelerating growth rate and increasing margin profile.

The company also boasts a 25% dividend payout ratio and a debt-free balance sheet with over ~1400 crore in reserves.

The management has guided for a doubling of the topline by 2025 and an immediate yearly growth rate of 18%.

So far, they have been ahead of their target goals.

Risks and Growth Triggers

Risks

There are three main key risks for CMS Info Systems:

1. Market Structure Risk

   CMS largely derives its business from the use of cash in India's economy. Given the adoption and focus from the government to digitize the economy, there is an increased risk to the business.

   While the use of cash may not decrease in the next 5 to 10 years, the same cannot be stated with a high degree of certainty for the following 10 years.

2. Regulatory Risk

   The company operates in a highly regulated industry. Any adverse regulatory changes can quickly erase margins and hinder growth.

   RBI, so far, has been pushing for stricter compliance and supporting the formalization and growth of the cash management industry.

   However, governments and policies can be unpredictable, and they tend to change every few years.

3. Promoter Risk

   The promoter for CMS is a large private equity fund - Barings. The PE fund has been liquidating their stake in the company, and all PE funds have an exit timeline.

   There may be a risk of increased share supply, which could keep the share price down or in range for an extended period.

Growth Triggers

There are several growth triggers for CMS playing out today, I will highlight the three main ones:

1. Increasing pace of consolidation in the Industry

   As mentioned earlier throughout this article, the industry in which CMS operates is undergoing rapid consolidation. CMS, being a leader in the industry, stands to benefit from this change, leading to a higher market share.

2. Scaling up of New Business Verticals

   CMS has been successful in rapidly scaling up new business verticals like remote monitoring, which has reached a revenue run rate of 100 crore within 12 months.

3. Incubation of New Business Lines

   Constant innovation combined with the luxury of a strong balance sheet allows CMS to incubate new business lines. The latest business incubation is focused on cash collections - an area that is largely unorganized but crucial to the business of a bank.

   ---

   Below is an excerpt on cash collections business from the CMS Investor Day.

   “In the collection space in India, the focus has been primarily on lending money rather than collecting money. Our idea was to create a business model that addresses this gap by leveraging three key elements. Firstly, there are numerous small, semi-organized or unorganized collection agencies in the country, but none of them have achieved scale or operate nationwide. Secondly, the collections value chain encompasses technology, contact centers, and customer outreach, each handled by different companies. Lastly, there is a lack of a comprehensive solution that combines all these aspects. This interested us the most, as banks seek partners who prioritize reputation management and brand integrity. Currently, we are in the incubation phase, assembling a team and hiring experienced leaders from the industry. Our focus in the upcoming year will be on piloting and investing in the business, working with large NBFCs and exploring partnerships with additional organizations. This year will serve as a pilot period to evaluate the scalability and success of our approach.”

   Rajiv Kaul, CMS Investor Day, May 2023

Share

Conclusion

In my view, CMS Info Systems is a company undergoing metamorphosis. The business is transitioning itself from a cash management company to a business solutions company for financial institutions.

The company is run by able and proven management, available at reasonable valuations and exhibiting accelerated growth.

There are terminal risks to the business due to increased digitization of money but these terminal risks seem to be more than a decade away. Cash in India is sticky, as evident from RBI’s data.

The business also is pushing to transform itself by incubating new revenue lines that are agnostic to the form of money.

I hope this write up helped you understand the business of CMS Info Systems in a holistic manner. If you enjoyed reading this and have any feedback or insights, please share by leaving a comment below 👇

Leave a comment

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

If you enjoy Invest Karo India, it would mean the world to me if you invited friends to subscribe and read with us. If you refer friends, you will receive special rewards and access to market tools used by me on a daily basis.

How to participate

1. Share Invest Karo India. When you use the referral link below, or the “Share” button on any post, you'll get credit for any new subscribers. Simply send the link in a text, email, or share it on social media with friends.

Refer a friend

2. Earn benefits. When more friends use your referral link to subscribe, you’ll receive special benefits.

• Get Market Breadth Dashboard for 10 referrals

• Get Access to My Private Screeners for 100 referrals

• Get 30 Min of 1-1 Video Chat for 500 referrals

Visit the leaderboard

Here is a sneak peek at your first reward just 10 referrals away 🎖️

Refer a friend

Thank you for helping get the word out about Invest Karo India!

India's consumption-driven growth, which helped it buck the global trend in 2022 following the post-pandemic reopening, appears to have stalled. Out of the approximately 4,253 listed companies, only about 42% reported growth in both topline (sales) and bottom line (operating profit) compared to the previous quarter in Q3FY22.

To gain a better understanding of Corporate India's Q3FY23, we will be analyzing four key metrics across industries - trailing twelve months (TTM) vs. previous year (PY) sales growth, TTM vs. PY operating profit growth, current quarter (CQ) vs. previous quarter (PQ) operating profit growth, and CQ vs. PQ sales growth.

In an effort to provide a more accurate picture of results, companies with a market capitalization below 100 crore have been excluded from the analysis. This is because such firms tend to have an outsized impact on overall results of an industry and can distort the true state of affairs.

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

The Backdrop

To provide you with an accurate understanding of the results, it is important to first contextualize the current global economic environment. Here's a brief summary.

Interest rates around the world are on an upward trajectory, driven by central banks mission to control inflation. High interest rates tend to have a cooling effect on an economy in two ways - first, it incentivizes people to save rather than spend and secondly, it sucks the excess ‘liquidity’ out of the system as it becomes expensive to borrow.

A combination of the above two is supposed to reduce demand and there by help tackle the inflation problem. Reducing demand (i.e. consumption) has a direct impact on earnings growth of companies.

Furthermore, rising interest rates can also impact companies that rely heavily on borrowing to finance their operations. As borrowing becomes more expensive, these companies may face higher interest costs, which could further eat into their profits.

The US Federal Reserve, which is widely considered the most important central bank in the world, has raised interest rates from their historic low of 0.05% in March 2020 to 4.57%, representing the fastest increase on record. It is expected that the Fed will continue to raise rates throughout this year, potentially reaching a range of 5.5% to 6%.

But what does this mean for you, and particularly for corporate earnings?

In the short term, consumers are being encouraged to save rather than spend, as they are offered higher returns on bank deposits. At the same time, borrowing money has become more expensive, as higher interest rates translate to higher EMI payments.

Below are the interest rates for traditional fixed deposits at some of the major Indian banks. Banks are willing to provide as high as 8.3% today for you to deposit your money with them. So if you were, for example, thinking of buying a second car for Rs 10 Lakh, you are being disincentivized to the tune of Rs 83,000 as the opportunity cost.

Similarly, yield on risk free assets like 6 month US Treasury Bill is now higher than the earnings yield of S&P500. So for a low risk dividend seeking investor, it now makes more sense to buy a 6 month US Treasury Bill than invest their money in S&P500 index.

However, it's not all doom and gloom. There is some positive news for the global economy, as two of the most significant costs - oil (energy) and shipping (transport) - have decreased significantly in the past 12 months. This should help corporates offset some of the pressure from higher interest costs.

Now that we have established the global economic backdrop, let's shift our focus to analyzing the earnings of each industry within India's corporate sector.

Share

Across Sectors Sales and Earnings Growth

After excluding companies with a market capitalization below 100 crore, the remaining data indicates that around 77% of companies reported sales growth compared to the previous year. However, only around 51% of companies reported sales growth compared to the previous quarter.

In terms of earnings, approximately 56% of companies reported earnings growth compared to the previous year, while around 53% reported earnings growth compared to the previous quarter.

The data clearly indicates a slowdown in topline, though corporate India is able to withstand margin pressure to some extent.

Upon examining individual industries, it is clear that the slowdown is most pronounced in sectors that deal directly with consumers. Industries such as footwear, consumer goods, automobiles, and FMCG have all reported a slower pace of topline growth.

For example, only 56% of listed companies in Footwear industry reported a quarterly sales growth. Similarly in FMCG, only 38% companies reported a quarterly sales growth. Further, on a consolidated basis, median quarterly sales growth across FMCG companies stands at a negative two (-2%) percent.

The only sectors that reported both, a strong quarterly as well as yearly sales growth are - Aviation, Jewellery and Cement.

The worst impacted sectors are chemicals, textiles, paper & packaging and education - all of them reporting a negative median quarterly sales growth.

Retail and Hospitality which includes sub sectors like Hotels, Retail Stores, Cinema Chains, Restaurants and QSR, were the biggest beneficiaries of re-opening reporting almost a ~50% median sales growth, but even there topline growth has slowed down sharply this quarter to just about ~19%.

When it comes to earnings growth, the overall picture is much healthier. Corporate India has, in most cases, managed to protect its operating margins to a significant extent, as input costs such as energy and freight cool off in conjunction with recent price hikes.

Industries like cement which took several price hikes in second half of 2022, have clearly benefitted with about 81% of listed companies reporting an increase in operating profit vs pervious quarter.

Here too consuming facing sectors like FMCG continue to suffer with almost zero median growth. It remains to be seen if the consumption economy revives or declines further in the next quarter.

Subscribe now

Sector Wise Analysis

BFSI

In the BFSI segment, the best performance for this quarter belongs to banks (both private and public combined). The median quarterly sales growth for banks, came in at 8.1%. Apart from banks, in the listed exchanges, MCX did very well with an actual quarterly sales growth of ~13%.

Among banks, Ujjivan Small Finance Bank is the clear winner when it comes to both YoY and QoQ Sales growth, followed by AU Small Finance Bank and IDFC First Bank.

In terms of pure EPS growth, however, Equitas Small Finance Bank takes the lead, followed by Bank of Maharashtra and Punjab National Bank.

Turning our attention towards another big sector within BFSI - Insurance. Here too, most companies continue to struggle with the only two exceptions being - Star Health and Religare Enterprises.

Railways

Most companies within Railways sector are doing well, driven by the big government capex push. Among, all the companies Jupiter Wagons stands out.

Although most railway companies are experiencing significant growth in their topline, Jupiter Wagons, Titagarh Wagons, Integra Engineering and Kernex Microsystems are the only ones achieving notable growth in bottom-line, i.e., operating profit.

Retail & Hospitality

The last 12 months for retail and hospitality sector were the gift of God. Almost all of hospitality sector has been growing on steroids driven by ‘revenge spending’ and post pandemic reopening.

The best performing sub sector within the entire retail and hospitality sector - Amusement Parks!

Imagicaaworld Entertainment and Wonderla Holidays, two listed amusement parks, have reported remarkable topline growth in both quarterly and yearly periods.

Meanwhile, cinema chains have taken the lead in terms of operating profit growth. It's worth noting, however, that this growth rate is abnormal, as both PVR and Inox Leisure were impacted by the pandemic in the previous year.

The topline growth of hotels is varied, with companies like Mahindra Holidays & Resorts struggling to grow, despite tailwinds in the sector. On the other hand relatively unknown firms like, UP Hotels, the owner of the Hotel Clarks chain, and EIH Associated Hotels, a JV of the Oberoi group, have exhibited the best overall performance at both quarterly and yearly levels.

Now, let's shift our focus to one of the most adored sectors in the retail and hospitality industry - the QSR and traditional restaurant chains.

Among them, Speciality Restaurants - the company behind the popular 'Mainland China' and 'Asian Kitchen' restaurants - stands out as a clear outlier.

Among pure QSR names, Westlife Development - operator of McDonald’s stands out.

Contract Manufacturing of Electronics

The median yearly topline growth for electronics contract manufacturing space has been ~16% and median yearly bottom-line growth around ~19%.

Here, three companies - Amber Enterprises, PG Electroplast and Calcom Vision stand out among the rest.

Footwear

Within the footwear industry, some of the most popular and beloved stocks like Relaxo seem to be clearly struggling while other ignored names like Bata India emerging as clear leaders.

This space was also a recipient of the re-opening tailwinds and has been growing topline at a median growth rate of ~26% and bottom line at ~32%.

The quarterly growth rate has slowed down sharply to ~1.7%, so some headwinds maybe ahead.

Defence

Companies across the defence sector in India posted a ~8.4% quarterly median topline growth and a similar ~8.5% quarterly bottom-line growth.

Most listed companies in this sector are quite different from each other in terms of product offerings, maturity and technical capabilities, as such it is hard to do a like for like comparison.

Some of the companies that stand out are Solar Industries, Astra Microwave Products and ship developers like Mazagon Dock Shipbuilders.

In terms of pure quarterly EPS Growth, BEML takes the pole position.

Paints & Adhesives

The median quarterly growth rate for Paints & Adhesives companies was at a negative 0.8%. The only company that stands out here among its peers its Jyoti Resins and Adhesives.

Jyoti Resins and Adhesives has been quite consistent, beating out its peer group in almost all of yearly and quarterly growth metrics.

Healthcare

Within the healthcare sector, hospitals have published the best yearly topline performance, increasing sales by ~10.6%. The worst performing part of healthcare seems to be diagnostics with this quarter’s median topline growth coming in at a negative 6.3%.

Narayana Hrudayalaya, KIMS, Dr. Agarwal's Eye Hospital, and Lotus Eye Hospital are among the hospitals with the highest level of performance

Auto

Autos, which were the star performing sector of 2022, showed signs of slowing down this quarter. While the median yearly sales growth for auto companies comes in at a impressive 18%, the quarterly sales growth was at a negative 3.3%. Only about 30% of auto companies reported a positive sales growth vs previous quarter.

Among the names that stand out are - Olectra Greentech, Kabra Extrusion Technik, Automotive Axles and NDR Auto Components.

Chemicals

Chemical sector too, broadly speaking, seems to be reeling under pressure. The earnings growth, both yearly and quarterly, in this sector is non-existent, with a median quarterly topline growth of a negative 6.8%.

High valuation of companies in this sector, also makes it prone to severe stock price corrections amidst a sub par performance.

The fertilizer companies appear to be the only area showing strong performance within the wider chemical sector. Nearly all fertilizer companies have reported robust double-digit growth rates, and in some cases, even triple-digit growth rates.

Notably, National Fertilizer stands out as an outlier, boasting approximately 295% yearly growth in operating profit and about 75% yearly growth in sales.

Share

Conclusion

In summary, the Q3FY23 earnings analysis of Corporate India reveals a mixed bag of results, with indications of a slowdown in consumption-led growth. While certain sectors such as Railways, Hospitality, and Defence are performing well due to various reasons, there is a lack of broad-based earnings growth. Even within large sectors such as chemicals, only specific sub-sectors, like fertilizers, are showing strong performance, with very few companies in that sub-sector performing exceptionally well.

Given the absence of widespread earnings growth, it may become increasingly challenging to select winning stocks going forward, particularly when coupled with a challenging global economic outlook. Therefore, it is likely that the overall market will consolidate for at least another quarter.

As a first-time earnings analysis, certain sectors such as technology were not covered due to ongoing data organization efforts at my end.

While this article may contain a lot of metrics and data, I look forward to hearing your thoughts, criticisms, feedbacks and comments on how I can improve this for the next quarter.

Going forward, this will be a regular exercise on my part and you can expect a detailed earnings analysis like this, once every quarter.

Please do leave a comment and share your valuable feedback.

Leave a comment

Thankyou for reading. Until next time.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

You probably consumed MCC today, in the form of medicine, food or even cosmetics. Microcrystalline Cellulose, which in its raw form looks like a white powder, is derived from wood pulp and serve as a excipient in medicines, binding agent in food and stabilizer in cosmetics.

Think of it as a naturally occurring packaging material that is non harmful to humans.

So why is an investment newsletter talking about some weird powdery packaging material? Well, that’s to do with the business we will be exploring today.

Sigachi Industries is a 33 year old family run business that is one of the leading global suppliers of Microcrystalline Cellulose. The business publicly listed itself among much fanfare in Nov 2021 with listing day gains of over ~250%.

The stock price has since corrected by over ~50% and now hovers at ~INR 315/share, as of this writing.

Like most families, this business too is complicated with a lot of pros and cons. It is also undergoing a significant transformation of itself, something it has exceled at in the recent past, just before its public listing.

Through this write up, we will explore the global microcrystalline cellulose industry, get introduced to the various players operating in the local as well as the global market, explore the current financial and growth triggers of Sigachi and also look at several red flags of the company.

By the end of this article, you should be well versed with the business, that is, Sigachi Industries.

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

Global Micro Crystalline Industry

The global micro crystalline industry can be segregated into two major type of players - giant established corporations and everyone else. MCC as a product finds its primary application in pharmaceutical industry, which accounts for a lion’s share of the demand - currently around ~70%.

The finished product is also low value, commoditized, as such the pharma giants and other large corporations tend to stick to a single supplier of the product to ensure quality control.

Since the product is low value in nature, the producers of MCC find it relatively easier to pass on any price hikes and raw material related inflationary costs pressures. As such the margins tend to remain stable for everyone involved in the entire value chain.

The supply of MCC product always outpaces the demand due to its commoditized nature and a simple manufacturing process.

Further, regional players have a consolidated market share for their respective geographies. For example, DuPont is the primary supplier to majority of innovator pharma companies in North America and Sigachi being an outside company limits itself to generic pharma companies.

Finally, there are two major changes ongoing in the industry.

First is the shift of manufacturing from high cost locations to low cost locations like Thailand. Being a low value and thin margin product, it has become increasingly challenging for suppliers to keep manufacturing MCC in high cost geographies like US and EU.

This is evident by two facts

1. Sigachi and every other MCC manufacturer in the world, sources its raw materials from a high cost geography, refines and manufactures MCC in a low cost country and then sells its back to a high cost geography

2. Companies like DuPont (the worlds largest supplier of high grade MCC) setting up manufacturing facilities across Thailand

Second major change in the industry is the onset of ‘value added’ MCC products. The manufacturers have started producing various purity grades and types of MCC depending on the end customer usage, in order to differentiate themselves.

A value added product also helps the producer make higher margins and garner a larger wallet share from the customer.

Now that we have understood the industry Sigachi operates in, lets explore the company in detail.

Subscribe now

Current Revenue Profile of Sigachi Industries

Sigachi has been growing its revenues at an approx. CAGR of ~20% for the last six years. The company used to do ~100cr of sales in 2018 and should be able to close this year will net sales of more than ~300cr.

Further the company’s operating margin profile has increased from ~12% to now stable at ~20% per year.

The main boost in margins have come from the R&D push by the company. It has over the years refined its manufacturing process and has been able to produce more with less raw materials, thereby saving costs and increasing margins.

Topline growth is aided by the company really sweating its assets. Sigachi has an asset turnover of ~1.2x, which is really healthy for an asset heavy manufacturing company.

The company is primarily an export oriented firm, with exports representing ~75% of its topline and rest accounting for domestic sales. Primary customers of the company are large distributors of MCC and other pharma and food ingredients.

The company has three manufacturing plants spread across Gujarat and Hyderabad, with all three of them are running at above 95% capacity.

Owing to high capacity utilization, the company is expanding its manufacturing capacity by over ~50%. New capacities will come online mid 2023 and early 2024.

The company boasts healthy return ratios, with both return on equity and capital employed exceeding ~25%.

So on paper, Sigachi looks like a great company. It has a large export oriented customer base, new capacities coming online, high demand for its product, great margin profile and a fast growing topline.

But when we look a little bit deeper, several red flags start to emerge. Lets explore them in detail.

Share

Financial Shenanigans

Red Flag #1 🚩

The Company doesn’t own its own IP

Just before Sigachi was about to IPO, the company sold all of its trademarks, brand names and even the name ‘Sigachi’ to its owners, for a measly sum of Rs 2.4 lakhs.

In return, for the privilege of using the name Sigachi along with other trademarks and brand names, the company is set to pay 1% of sales as royalty to the promoters starting 2025.

Further, this royalty agreement is only valid till 2035, post which if the promoters choose, they can reset the agreement or even bar the company from using the trademarks and any other intellectual property again.

Below is the excerpt from their IPO document that calls out this clause in detail.

Red Flag #2 🚩

The Incentive for the Promoters reside in the topline growth and not the bottom line

As a minority shareholder, your incentive to invest in the company for the long haul is a essentially a bet that the company will grow its bottom line, i.e., profit after tax. As a company makes larger profits, these profits eventually should make way to your bank account in the form of dividends.

Companies do well over time when both promoters and minority shareholders’ incentives are in sync. This is not the case with Sigachi.

Since the promoters incentive are clearly at the topline growth (owing to the 1% royalty agreement we spoke about earlier), the company has been ‘diworsifying’ into various ancillary businesses.

So far in its limited history of being a public listed company, Sigachi has

1. Hired consultants and then cancelled plans to open an ethanol factory

2. Launched a nutritional premix product range via taking a lease on a premix manufacturing plant

3. In process of launching a OTC healthcare segment and investing to build a domestic distribution network in India

All of the above are not related to its core business, i.e. making cellulose based excipient products.

Meanwhile, the debtor days for the company have increased from 77 days to now 88 days with receivables (credit sales) accounting for over ~25% of the overall sales.

Red Flag #3 🚩

A whole lot of related party transactions

Apart from the upcoming royalty payments to the promoters, the company has been leasing properties from its owners.

Below are the few excerpts from the IPO Document.

Below are some of the properties controlled by the promoter and used by the company on a rental basis.

The company’s corporate office, manufacturing plant, guest houses all are owned by the promoters and the rent on these seem abnormally high.

Further, the company’s rental expense has increased by ~25% just in last year!

The are more red flags like abnormally high promoter remuneration, non-independence of audit committee, but I sense that you get the gist!

Lets now explore some of the growth triggers and current valuations of the company.

Subscribe now

Growth Triggers

Sigachi has two main growth triggers ahead

1. A 50% increase in capacity that should disproportionately aid in topline growth

2. Launch of Croscarmellose Sodium or CCS as a new product

We spoke about the capex growth trigger earlier in this write up, lets explore a bit about croscarmellose sodium or CCS.

CCS is a high value, high margin product that is also in high demand by the pharma industry. It is used as a disintegrant in medicines to ensure the API in the medicine gets digested at the right time when its in the body.

This would be a new product for Sigachi and it aims to leverage its existing customer relationships to sell this higher margin product in addition to MCC.

In my view this product can easily help Sigachi maintain or even extend its margins from ~20% to ~25% range in the short term.

Valuations

At the current stock price of Rs ~315 per share, the market is assigning a 10% earnings growth to Sigachi.

This seems low for a company that will expand its manufacturing capacity in near term and introduce a higher margin product. The company is also able to easily pass on higher raw material and related costs to end customer, there by giving us confidence that a ~20% operating margin profile will stay.

Technically the stock looks strong and has so far managed to stay well above its immediate support of Rs ~240 per share.

Maybe the market doesn’t like the long laundry list of related party transactions and royalty agreements along with the ‘diworsification’ into unrelated segments.

Share

Conclusion

Sigachi Industries, as per me, is a typical case of a good business run by a greedy promoter. The company is minority shareholder un-friendly but at the same time has lot of earnings trigger.

Given the misplaced promoter incentives, its anybody’s guess whether the topline growth will ever translate into bottom line for the company.

I will be a trader of the stock and not an investor.

I hope this write up helped you understand the business of Sigachi Industries in a holistic manner. If you enjoyed reading this and have any feedback or insights, please share by leaving a comment below 👇

Leave a comment

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

It was a tough job.

Less than 5% of India’s population at the time travelled by air and a miniscule percentage of that availed services of an airport lounge. For a price conscious country, longue services at the airport were a luxury limited only to business class travelers. Debit and credit cards were possessed by a few and even fewer were aware about the free airport lounge perks as part of their card service.

However, things were changing.

Since 2008, air passengers in India have increased at a CAGR of 11.64%. In absolute terms, this means that more than 200 Million Indian passengers will travel by air in 2022 vs less than 50 Million that used to in 2008.

More airports in India were opting to build a lounge and banks were issuing more debit and credit cards with airport longue perks. The international airport lounge aggregator at the time, Priority Pass, had a very small presence in India and considered India to be a very small market not worth investing in.

There was a clear vacuum in the market for an India focused lounge aggregator that helped connect lounge operators at airports with customers of card issuing companies availing lounge perks.

So in April of 2008, Liberatha left her job at Plaza Premium Lounge and registered ‘Believe Tradelink Private Limited’ with registrar of companies in New Delhi.

Fifteen years later, in 2022, Believe Tradelink Private Limited would IPO as Dreamfolks Services Limited and become the largest lounge and airport service aggregator of India.

This is how the business of Dreamfolks works.

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

Current Business of Dreamfolks

Dreamfolks business is simple.

In its IPO document, it describes itself as an ‘airport service aggregator platform’. In simple terms, the company is the middle man that helps airport service operators (like lounges, food and beverage stores, spa chains, meet and assist operators etc.) seamlessly provide services to customers that are leveraging their credit or debit card perks at the airport to avail such services.

The below visualization is an example of a really simplified version of their service.

In real world, there are millions of passengers and tens of banks, corporate clients etc. issuing cards with airport service perks and tens of lounge and airport service operators in India. Dreamfolks finds its use in facilitating business through all of them in a seamless fashion.

A more comprehensive version of Dreamfolks services is show below.

As evident from the above visualizations, there is indeed a need for a middle man that can work with banks, card networks and service providers to facilitate business.

However, there are no ‘network effects’ or ‘proprietary technology’ at play here. Anyone with little bit of capital and inclination to replicate Dreamfolks business can do so without any headwinds.

Lets explore this a bit in detail.

Industry Structure for Airport Service Aggregator

To explore the industry structure in depth, we will be leveraging the Porter’s Five Force Model. The model will help us understand the business of Dreamfolks, its competitive advantages (if any) and current industry structure in depth.

If you’re unfamiliar with Porter’s five forces, you may read the below Twitter thread to familiarize yourself.

Dreamfolks Porters Five Force Analysis

Below is a detailed five force analysis for the industry Dreamfolks operates in.

Few things are evident from this analysis.

1. Dreamfolks does not have any bargaining power with either its suppliers (airport services) or its buyers (card issuing companies). As such the margin profile for Dreamfolks is razor thin. The company works on a single digit EBITDA margin spread and has indicated in various interviews that margin gap between the price it has to pay to lounge operators vs the price it charges to card companies cannot exceed 15%.

2. Further, Dreamfolks does not have any leverage to increase its commission or margin spread rates. On both sides of its business (airport service and card issuing companies) the market is highly concentrated.

3. Though the barriers to entry are less, so far no one has challenged Dreamfolks business. It has so far operated and continued to gain market share without any competitor resisting. Apart from Dreamfolks, the only other lounge aggregator that operates in India is Priority Pass. Priority Pass has largely ignored the business in India as the market was too small but in future, if it gets aggressive, it wont take much for it to regain market share from Dreamfolks.

4. Dreamfolks technology stack is off the shelf and can be replicated easily. This is evident by the expenses and staff that company keeps to upkeep its technology stack. For the year ending 2022, technology spend by the company was Rs 79 lakhs and only 12 out of the 60 people it employs, were full time technology developers.

Subscribe now

Its clear from the above analysis that instead of being a ‘platform technology business’ like the company has so far advertised itself, it is a low margin commodity technology business without any barriers to entry that is thriving because of the absence of any real competitors in the space it operates.

Having said that, it doesn’t mean that this is a bad business or doesn’t have any future growth triggers. The company has been investing in building new lines of revenue growth, some of which we will explore in the next segment.

Revenue Profile & Growth Triggers for the Company

The current revenue profile of Dreamfolks is 95% lounge service fee and 5% fee related to other airport services like food & beverages, meet and assist, airport transfers etc. The company has 60% market share of all lounge traffic and 99% market share of all lounge traffic paid for by cards.

All 60+ lounges spread across India are part of its portfolio with about 12 lounges exclusively catering to Dreamfolks and not its competitors like Priority Pass. However, these 12 lounges are in non metro and tier 2 cities that do not attract much footfall. The top lounges in the country (based in Delhi, Mumbai and Bengaluru) do not have any exclusive arrangements and are free to cater to both Dreamfolks and its competitors like Priority Pass.

There are several growth triggers for the company both in the short, medium and long term. Some of these are explored below.

Increase in overall air passenger traffic and passengers availing lounge access

The biggest growth trigger for the company is the continued increase in air passenger traffic within India. About 8% of existing air passenger traffic avails a lounge access and as more air passenger increases in India, the more the number of passengers availing lounge services, there by aiding Dreamfolks to expand its topline growth.

To aid in increase air passenger traffic, Government of India has launched UDAN scheme which is focused on building air travel access to Tier 2 and 3 cities there by allowing more citizens of India esp. in non economic zones to travel by air.

This bodes well for Dreamfolks, whose revenue growth is tied at hip to increase in domestic air travel.

Railway Lounge Access

Another area of growth for the company is access to lounges at railway stations. Dreamfolks currently has 8 railway lounges in its portfolio and is expected to enroll more as Indian Railways get modernized.

Though at nascent stages, this revenue line has a lot of potential for future growth.

Foray into South East Asia and Middle East Markets

Dreamfolks has saturated the Indian airport lounge market. For it to grow fast, it needs to expand overseas into South East Asian and Middle Eastern markets. While the company has presence in most countries via partnerships with local lounge operators, it does not have any tie ups with banks and card issuing companies of these countries.

At present, Dreamfolks only makes money whenever an Indian card holder avails access to an international lounge at one of the overseas location partnering with Dreamfolks. As such, the percentage of overall revenue that Dreamfolks generate with overseas operations is miniscule.

To fix this, company has begun exploring partnerships with banks and card issuing companies in local geographies.

Ancillary businesses like loyalty program management

Another promising area of growth for Dreamfolks is foray into loyalty management programs for corporates and organizations. While the company doesn’t have any active offerings at the moment, it has expressed a desire to build such offerings in near future.

Clients other than Card Issuers opting to provide lounge perks

In its intention to diversify client base from banks and card networks, Dreamfolks is now partnering with corporate clients, telecoms and online travel agencies.

For example, Vodafone Idea’s highest tier postpaid plan allows its customers to avail 4 free international or domestic lounge access. Dreamfolks is the servicing agent behind that perk.

Share

Risks to the Company

MDR rate changes by RBI

The biggest risk to the business of Dreamfolks is RBI reducing MDR or Merchant Discount Rates. Merchant Discount Rate is charged by card issuing companies every time you transact with a debit or credit card. The fee generated from MDR is what powers the perks (lounge access, cashback etc.) provided by card companies to its customers.

RBI until very recently has been focused on reducing costs of digital transactions including card based transactions. In its recent discussion paper, dated Aug 2022, RBI has expressed a desire to reduce these rates even further.

While the policy is only at discussion stage at present, if and when RBI reduces MDR in India, it is expected that card issuing companies will lower the perks available on its cards. Since majority of Dreamfolks business is based on lounge perks being availed by debit and credit card customers, any reduction in said perks will significantly impact the overall revenues of the company.

Competitor like Priority Pass getting aggressive and willing to work with a lower margin rate than Dreamfolks

The second big risk to Dreamfolks business is its competitors like Priority Pass (who have so far overlooked India) getting aggressive in gaining market share and willing to work at a lower margin rate than Dreamfolks. Since banks and end customers do not care which backend service (Dreamfolks or Priority Pass) helps in availing lounge access, Dreamfolks may lose a significant chunk of its revenue in such a scenario.

Priority Pass already has a tie up with Kotak Bank to provide lounge access to its highest tier customers.

Collison Group, the owner of Priority Pass also recently boosted its India leadership by announcing a dedicated country head, a first for the company. Sumit Prakash, an industry veteran will now lead the India & South Asia business for Priority Pass.

The company has also launched a dedicated India focused service for airport lounges.

High Working Capital and Lack of Financial Controls

Dreamfolks until 2021, didn’t have a Chief Financial Officer. It hired one in late 2021 as it prepared for IPO. There have been several instances when Dreamfolks as a Private Limited company failed to file its financial statements properly with the Registrar of the Company. Even in its maiden conference call in Nov 2022, the company’s CFO found it hard to explain simple details on working capital cycle and receivable vs payable days to investors. Further, the company’s CFO is paid just 30 lakhs in annual salary vs more than 3 crores, the company’s CMD (Liberatha) draws annually. This mismatch in pay for top management (other than promoters) highlights the lack of quality talent available to the company.

The company also has more than 50% of its net sales as receivables and while receivables as a percentage of sales is expected to reduce over time, the company has written off bad debts every year in the three year financial documents it has provided at the time of IPO. Moreover, the provision for bad debts by the company remains awfully low and is not in accordance with the previous years bad debt trend.

In my view the company lacks appropriate financial controls and needs to invest in this area to appropriately represent its financials.

Inability to tie up with overseas card issuing banks and Competition from established aggregators in international market

The company’s foray into international markets will only start contributing to topline meaningfully if and when it is able to tie up with overseas card issuing companies. Any challenges to tie up with said companies will hamper any growth in overseas market.

Further, there are established players like Priority Pass, Lounge Buddy and Dragon Pass that already operate in the international market. These players have strong relationships with both banks and lounge operators and it is expected that Dreamfolks will face a lot of competition to break its competitors hold in these markets.

Share

Valuation

The company’s valuations at the time of writing this article are okay and not necessarily a bargain. The company is expected to publish an EPS of ~10 for the year ending March 2023, which puts its current PE at 37.

The main trigger for growth remains the growth of domestic air passenger. The company in my view is a proxy for air passenger growth in India.

The company has low fixed and operating costs. With just 60 employees and low technology spends, the company can generate a faster than normal growth in bottom line as topline continues to expand. However, since the delta between the rates charged by Dreamfolks to banks and card issuing companies vs the amount it has to pay to lounge operators is fixed at 15%, I do not expect a high double digit EBITDA margin growth.

Being an asset light business, the company has high asset turnover, which in turn helps it to generate more than 20% ROCE even with single digit EBITDA margins.

Conclusion

In my view, Dreamfolks is a decent business that is available at ‘okayish’ valuations today.

There are issues with the company with regards to its financial controls and regulatory overhang on merchant discount rates.

However, it fits as an excellent proxy for an investor looking to add some exposure to the growth of aviation sector in India.

For an investor in this company, the key metrics to track are

1. Growth of passengers availing access to an airport lounge

2. RBI decision and policy feel on Merchant Discount Rates

3. Company’s ability to build new engines of revenue growth (Railway Lounges, Loyalty Programs, International Business etc.)

I hope this write up helped you understand the business of Dreamfolks in a holistic manner. If you enjoyed reading this and have any feedback or insights, please share by leaving a comment below 👇

Leave a comment

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

At the turn of the century, United States was facing a big environment problem - that of acid rains. Acid rain occurs when sulfur dioxide content in atmosphere exceeds a certain permissible limit. The rapid industrialization of US during the 1900s meant that the country was burning more fossil fuel than it did ever before. Without a strict emission control policy, this increased burning of fossil fuel led to very high content of sulphur and nitrogen in the atmosphere which in turn, led to frequent acid rains.

The Clean Air Act of 1990 aimed to systematically reduce the amount of sulphur and nitrogen in US atmosphere. The act in itself though wasn’t anything extraordinary, but the mechanism of ‘cap and trade’, through which the act proposed to regulate and reduce the sulphur levels, was a new invention.

This is how ‘cap and trade’ worked ⤵️

US EPA (Environment Protection Agency) would set a limit on permissible yearly sulphur emissions for each industry. All the participants within the industry were allowed a maximum emission limit based on the size of their business.
This is the cap part of the ‘cap and trade’.

If a company within the industry required a larger emission allowance than allotted, they had to buy it from the quota of another company who may not be using it.
This is the trade part of the ‘cap and trade’.

US EPA would yearly reduce the allowed permissible sulphur emission limit, thus requiring all companies within the industry to work on long term plans to reduce their respective yearly emissions.

Companies which were successful in reducing emissions beyond their yearly quota, could sell their unused emission credits to other companies within the industry and generate income.

The price of the emission credit itself was decided based on the demand and supply of credits within the market. The higher the price, more the incentive for industry participants to reduce emissions.

This cap and trade policy worked wonders for the US. Since its implementation in 1990, sulphur di oxide levels in US atmosphere are down by ~95% (see chart above) and acid rains are a thing of the past.

In 1997, United Nations Framework Convention for Climate Change (UNFCCC) met in Kyoto, Japan to discuss binding emission reduction targets for 37 industrialized countries and the European Union.

To enforce these emission targets, the Kyoto Protocol policy was adopted. This led to the establishment of the first international carbon market system and ‘cap and trade’ was at the heart of it.

Shortly after the Kyoto Protocol, China opened its first environmental market exchange, followed by US and most other developed countries.

The modern day carbon markets in the last two decades have exploded in value, with majority of the growth coming in 2021.

Global carbon markets today are valued at ~750 Billion USD and have grown every year for the last five years. 2021 was a banner year with trading value increasing 2.5x compared to previous year.

The main reason behind this growth were the pledges made by several governments, in the run up to COP26, to cap respective carbon emissions by 2050. The largest growth was seen in the European Union market, which also happens to be the biggest carbon market in the world as well as the most regulated.

This article aims to serve as a primer for carbon markets. We will explore everything from the basics of how carbon markets work, to the scope and future of such markets in India as well as globally.

The structure of the article is as follows:

• Part One: Types of Carbon Markets

• Part Two: The Carbon Credit Lifecycle

• Part Three: Current Demand & Supply Dynamics

• Part Four: Problems with Carbon Markets

• Part Five: How to Invest in Carbon Credits

• Part Six: Carbon Markets in India

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

Part One: Types of Carbon Markets

There are two types of carbon markets

• Compliance Carbon Market

• Voluntary Carbon Market

Compliance carbon markets are the ones set up by a government regulatory authority. This is the same type of market that was set up for reducing the sulphur emissions by United States in 1990 via the Clean Air Act. The buyers and sellers tend to be businesses operating within the industry and are bound to reduce emissions by law.

Voluntary carbon markets on the other hand are set up by independent certification bodies and have no direct regulation from the government. The buyers in these markets tend to be large organizations that want to voluntarily offset their carbon emissions. Example of this would be Google buying carbon credits to offset its yearly carbon emissions.

Over 99% of all carbon market transactions in 2021 (about ~750 Billion USD in value) took place in compliance carbon markets. Compare that to voluntary carbon market, which managed less than 1% of all transactions in 2021, with a combined value of less than ~1 Billion USD.

There are also two types of trading systems,

• Cap and Trade

• Baseline and Credit

We have already explored cap and trade at the beginning of this article. Lets now understand what is a Baseline and Credit system.

What is a Baseline and Credit System?

Baseline and credit system assumes the current emission growth rate of a company in line with its yearly growth and extrapolates it into the future. This serves as a baseline for the company’s carbon emissions.

If in a particular year the company emits more than its baseline, it has to buy carbon offsets to reduce its emissions. Similarly, if the company emits less than its baseline, it can sell the ‘extra unused emissions’ as carbon credits.

The important part to note here is that both cap and trade as well as baseline and credit systems work for only compliance credit markets. Each country’s regulatory authority that sets up and governs these markets decide whether the trading system will be based on a cap and trade system or a baseline and credit system.

For example, European Unions Emission Trading System (EU ETS), the largest carbon market in the world, is a cap and trade system. Whereas, China’s latest carbon market, the National Carbon Trading Market, is a baseline and credit system.

Since voluntary carbon markets are not regulated by a Government authority, their trading involve an entire lifecycle and several participants, which we will explore in the next part.

Share

Part Two: The Carbon Credit Lifecycle

Voluntary carbon markets are not regulated and as such require several third party agencies to verify the origination of the carbon offsets.

A typical voluntary carbon market will include the following participants:

1. Project Developer

2. Carbon Offset Standard Agencies

3. Third Party Auditors and Consultants

4. Project Investors

5. Carbon Brokers

6. Carbon Exchanges

7. Credit Buyers

Project Developers: can be any organization (public, government or private) that wants to set up a carbon offset project. There are about 170 types of carbon credits ranging from renewable energy projects like biomass cookstoves to reforestation projects to energy efficiency projects. Basically anything that can help reduce carbon from the atmosphere.

A project developer has to build these carbon offset project in accordance to the detailed standards set by the carbon offset standard agencies like Verra. If a project developer fails to adhere to these standards, they will not be able to sell carbon credits generated from the project.

Carbon Offset Standard Agencies: These are usually not for profit organizations that run a registry / database of very high value verified carbon offset projects. The agencies are responsible for setting the standards required for a carbon offset project to meet a certain quality and qualify as authentic.

There are several of these around the world but by far the biggest of them all are Verra and Gold Standard.

A stamp of approval from any of these mean that the carbon offset generated from the project are of the highest standards of quality and have been verified by independent third party auditors.

Each of these standards are several hundred pages long and require compliance with complex criteria to qualify. The details of each standard are out of scope of this article but at a very high level, all of them require compliance with four key pillars - Real, Additional, Verifiable and Permanent (explained below).

Third Party Auditors and Consultants: These are companies that help project developers understand the standards set by agencies like Verra and ensure the entire process from project development to registration of project, third party audits, listing of project and finally sale of carbon credits is done in a smooth fashion.

Companies like EKI Energy Services fall under this category of the value chain.

Subscribe now

Carbon Exchanges: These are similar to financial exchanges like Nasdaq, NYSE, NSE and BSE, but are oriented towards carbon markets instead of traditional finance. Unfortunately, not many of these exist yet but we are witnessing some fast developments in this space globally.

One of the oldest carbon exchange is CTX Global and more recently Salesforce announced that it will launch a new carbon exchange called ‘Net Zero Marketplace.’

Closer to home, in India, we have companies like IEX working with the Government and various agencies to launch India’s own carbon market.

In the next part, we will explore the demand and supply dynamics of both compliance as well as voluntary carbon markets.

Part Three: Current Demand and Supply Dynamics

The Demand Side

Almost entirety of demand today for carbon credits is top down regulatory driven with the European Union representing over 90% of the global turnover. Carbon markets in EU are much more advanced, liquid and mature than their global counterparts.

Overall, there are about 17 existing and operational regional carbon markets, concentrated across North America, European Union, China, South Korea and New Zealand. Post COP26 and Paris Accords, several new carbon markets are under development across the world.

Apart from government mandated demand, there is demand for carbon credits in compliance markets from industry organizations as well.

The global aviation industry adopted a policy on reducing carbon emissions via a cap and trade program known as CORSIA. CORSIA was meant to help international flights cap and gradually reduce their emissions starting 2016. What was perceived as a big tailwind for carbon credit industry, ended up being a dud as international air travel witnessed massive decline due to global pandemic and has since yet to return to pre-pandemic levels.

As countries and global industry organizations commit further to cap and reduce their carbon emissions, expect higher demand for carbon credits in these markets.

The shipping industry, which accounts for 2.5% of global carbon emissions, is already exploring a compliance program to regulate and reduce its carbon footprint.

Subscribe now

Demand in voluntary carbon markets though small today is growing at a rapid pace. Innovations in allowing individuals to offset emissions for their flights, meals etc. coupled with already existing demand from organizations willing to voluntarily reduce their emissions, is enabling the demand for carbon credits in voluntary markets to grow by leaps and bounds.

The Supply Side

In compliance markets, supply of carbon credits is via the governing regulatory body. Its under the voluntary markets where supply of carbon credits gets complicated.

As we have discussed earlier in this article, there are about 170 types of carbon credits differentiated based on their origination, quality as well as verifiability. High impact verifiable and permanent projects like direct air carbon capture are priced the highest as demand for these exceeds the supply. Whereas low impact non verifiable and less permanent solutions like reforestation programs tend to get valued at the lowest end of the price spectrum.

The below table provides a detailed overview of metric tonnes of CO2 offset sold at various price points for each type of carbon credit.

Each carbon credit type traded on the market has a project backing it. Most of these projects are based in India, Brazil, Africa, Thailand and China. Majority of these projects, however, suffer from the biggest problem currently ailing the carbon credit market - that of permanence and verifiability.

Share Invest Karo India

Lets dwell a bit deeper into these issues.

Part Four: Problems with Carbon Markets

The key problem that ails the carbon market today is of verifiability. How does a carbon credit buyer know for certain that a project actually removed the amount of carbon from atmosphere as it claims to do.

To add problems further, the current market structure is designed to help the cheapest solution for carbon offset. However, these cheap solutions usually are the least verifiable projects and generally do not live up to their claims.

The problem is so extensive, that even large credible institutions like Disney and JP Morgan Chase, have fallen victims to these unverifiable and dubious carbon offset claims.

The below video summarizes these key points well.

In the next segment, we will look at ways through which one can invest in carbon markets today.

Share

Part Five: How to Invest in Carbon Markets?

The easiest way to get exposure to carbon market is to buy an ETF that hold futures contracts for most liquid carbon markets globally. As of writing this article, there are 6 ETFs available that invest directly into carbon credit markets.

Each ETF has its own methodology and as a retail investor this is the least cost path to get exposure to carbon credit market in your portfolio.

Other than ETFs, an investor can get exposure to carbon markets by investing directly into companies that are associated with this value chain.

The Indian bourse listed EKI Energy Services is a third party consultant that helps project developers traverse through the lifecycle of a carbon credit.

If instead of a middleman, an investor wants to get exposure to carbon credit project developers, then Toronto listed Carbon Streaming Corporation is a worthy option.

Carbon Streaming Corp (Tickr: NETZ.NEO) is a financier of several different carbon credit projects. The companies business model (as shown below) is to provide upfront payments in the form of financing to a project developer. Once the project is developed, Carbon Streaming Corp receives a certain portion of carbon credits from the project as payment.

Finally, there are carbon exchanges like the ones from Salesforce and India listed IEX, both of which we discussed in Part Two of this article.

The carbon credit market is small, non standardized and still at very early stages. As such the choices to invest are limited, but I do expect the market to grow very fast in the coming years.

Speaking of fast developments, lets now explore the scope of carbon markets in India.

Part Six: Carbon Markets in India

On August 08, 2022 India passed an amendment to the Energy Conservation Act, which among many other things aims to establish both compliance as well as voluntary carbon markets in India.

As per the draft blueprint by Department of Energy, India plans to consolidate its existing Energy Saving Certs as well as Renewable Certs into a larger carbon credit program while establishing a national carbon market in a phased manner.

If implemented in its existing form, India would be able to standardize the issuance, monitoring as well as trading of its carbon credits. This would be the first step in a long road, to create a highly liquid and mature voluntary carbon market like that of the EU. In such a scenario, companies like IEX which already facilitate trading of ECerts and RCerts, stand to benefit the most.

So that was the detailed primer on carbon credits. I hope through this article, you were able to learn more about this niche area of investing.

Are you excited about carbon markets? Do you have any exposure in your portfolio?
Let me know in the comments 👇

Leave a comment

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

Why am I telling you something that you already know?
Cause, to understand the events of today, we have to understand the financial events that took place at the start of the Covid-19 pandemic.

Nations around the world weren’t prepared for an event like the Covid pandemic, and who can blame them. The last known pandemic (Spanish Flu) happened more than a 100 years ago in 1918, much before globalization and commercial air travel was a thing.

Before Covid, pandemic preparedness in the modern world was meant for medical text books. Not a single financial book ever talked about economic implications of a pandemic, much less prescribe the playbook of necessary steps required to steer the economy through one.

So when the pandemic hit in Jan 2020, Reserve Banks around the world were entering uncharted territory. By March of 2020, when the entire world shut down and everything came to a standstill, the US Federal Reserve along with US Congress took a few bold steps and announced unprecedented liquidity measures to support their economy.

Anyone who wanted to borrow money, could at dirt cheap rates.

Free stimulus money of upto USD 1200 was sent directly to every US citizen, small businesses were allowed to borrow money at extremely favorable rates, unemployed citizens were granted additional USD 600 per week in payments (~31,000 USD per year) and US Fed cut its interest rates as close to zero as possible.

The Fed had one goal at the time - to prevent US economy from a depression onset by the severe and unrecoverable destruction in demand.

By providing ease of money in an otherwise troubled economy, the Fed orchestrated the greatest financial maneuver in the history of economics. It was able to ensure the demand stays intact even though almost every major part of the economy was shut.

These moves of US Fed were replicated by major central and reserve banks across much of the western nations.

What these central banks failed to judge accurately is when to stop the pandemic era stimulus measures - and it is at this point of failure our story begins.

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

Part One: Too Much Demand, Too Little Supply 🏷️

Economics and finance are usually termed as social sciences. They do not have any rigid rules of hard sciences like E = MC^2 in physics or the covalent bonds from chemistry.

Most of the rules in economics are malleable and depend on the context of the situation, except one.

If demand rises faster than supply, prices rise.
If supply rises faster than demand, prices fall.

This demand and supply rule of economics, is maybe as close to a scientific rule as we would ever discover.

When demand increases much faster than supply, prices rise sharply.
This sharp increase in prices is what is termed as inflation.

The pandemic era stimulus measures helped keep the demand intact around the world but supply side of the equation deteriorated. Lockdowns across majority of the world ensured that factories weren’t running at their maximum capacity and cargo shipping lines, which carry nine out of every ten products globally, came to a standstill.

When the world slowly returned to normal, restoring these supply chains took time. The previous two decades of globalization also meant that more products move from eastern part of the world (Asia) to western part of the world (EU and North America).

These skewed trade routes led to problems like ports getting clogged, long shipment wait times and not enough labour, which contributed to the initial inflationary pressures within the global economy. These initial pressures were felt by businesses and we witnessed profit margins for majority of companies reducing by mid 2021.

Subscribe now

Employment levels in US were still rising all through this period and as such US Fed maintained that inflation is transitory. To their credit, inflation wouldn’t have been such an issue, had it not been for two simultaneous events that twisted the global supply chain further in 2022 - the Russian War and the Chinese lockdowns.

Part Two: Grains, Fuel and Everything Else 🌾

8.5% of the global wheat supply
70% of global neon gas supply
40% of global krypton supply
46% of global sunflower oil supply

Before February 24th 2022, these stats about Ukraine weren’t common knowledge.

That changed with Russia’s invasion; overnight Ukraine took centerstage. Apart from sending supply shock to global food, semiconductor and edible oil markets, the war also destabilized the oil and natural gas markets of the world.

Russia accounts for 10% of global oil production and 8% of global natural gas production. To make matters worse, major economies in European Union, like Germany, rely a large part on Russia for their energy requirements.

Just within days after Russian invasion, global oil prices rallied 40% to hit an all time high of $138 per barrel.

Prices of oil, wheat and edible oil impact everyone in the world.
When oil prices rise, everything gets expensive.

Russia’s invasion of Ukraine was an unseen shock - even though Russia was building a military presence on Ukrainian borders for months - few expected Russia to launch a full scale invasion of another sovereign nation in Europe.

The global energy market was suddenly caught off guard.

At any other time, this invasion would have been the top news across the world, but not this time. The war had barely begun, when four days later on 28th February 2022, a large scale outbreak of Covid-19 (omicron variant) emerged in the largest city of China - Shanghai.

China managed to relatively escape the wrath of Covid for majority of the last two years. As soon as pandemic emerged, the Chinese government shut down borders and isolated any cases it could find. While this helped keeping the fatality count low, it also lead to another healthcare issue.

The Chinese population at large hasn’t developed a natural immunity against Covid like the rest of the world has. So when omicron emerged, its impact was minor for majority of countries but deadly for China.

Within days of first omicron case, thousands of cases started to emerge in Shanghai followed by Beijing - two of China’s largest cities. China’s Zero Covid Policy also meant that they had no option but to lockdown these cities and along with it - two of the most important cogs in the global supply chain.

Together Beijing and Shanghai account for a large share of global supply. The port of Shanghai is in fact the busiest port of the world for almost a decade now.

With both these cities under lockdown, the already stressed supply chain of the world, squeezed even further.

These two unrelated and isolated events (Russian War and Chinese Lockdowns) contributed to the acceleration in otherwise already steady growth of inflation around the world - which brings us to where we are today.

Share Invest Karo India

Part Three: Will there be a Recession? 📉

As I write this post, on a Wednesday night (15th June 2022), in the background US Fed is announcing the highest increase in Fed Funds Rate since 1994.

I wont get into the details of how Fed Rates impact an economy and stock market. If you want a primer on that, you can go through the below Twitter thread.

The inflation is US is at a 40 year high of 8.6 per cent against the Fed’s target of 2 per cent.

Developed economies like US do not normally have inflation 4 times their target.
The last time inflation was running rampant in US was during the early 90s and Fed then didn’t have to combat a broken supply chain along with a pandemic recovery!

Inflation isn’t just high in the US, its impacting a majority of countries around the world - a direct effect of the broken supply chains.

Share

So when supply chain keeps getting stressed and demand is overheating in an economy, we either have to fix and increase the supply or reduce the demand for us to able to control price rise - and its effect - inflation.

Since Fed cannot really control the supply side and new production capacities along with production bottlenecks in real world take time to resolve, the only option we have at the moment is to reduce demand.

A faster than expected reduction in demand will eventually lead to a recession - a degrowth in corporate earnings along with income and spending levels of individuals.

As an investor, the correct question to ask ourselves today - isn’t whether there will be a recession or not - it is what will be the severity of such a recession and how long will it last?

While the consensus states that their will be a recession, the jury is still out on the severity and duration of such a recession.

Part Four: Impact on India

So there will be a recession in US, EU, UK and much of the western world, but what does that mean for India?

During the pandemic when majority of western world was busy distributing cash to its citizens, Indian Reserve Bank treaded lightly. The RBI was accommodative to the extent necessary and our Government made policies that were targeted at specific sections of the society rather than a blanket one size fits all approach.

That conservative approach of RBI is helping us tame inflation today. While the inflation in India is high as well, it is no where near the 4x of upward target of 6%.

To put this in context, current inflation rate in US is well above 8% (4x of Fed’s long term target of 2%). Had RBI been as aggressive as US Fed during the pandemic, inflation in India today might have been as high as 24%.

Add to this, our banking system along with the government are flushed with cash and possess strong financials.

So while there maybe a slowdown in overall economic growth rates of India due to a recession in western world, the extent of such a slowdown will be limited.

This trend also shows itself in the broader stock market indices. Over the last six months, Indian stock market have been more resilient compared to their peers in Europe and America.

This resilience comes against the backdrop of the highest FII outflows from India in more than a decade.

So why are FIIs selling if India is doing so great?

A simple logical explanation is because India has done so great. When you look across the emerging market options available to institutional investors globally, there are pretty much only four major markets to invest in - China, Taiwan, South Korea and India.

Traditionally China has taken the lions share of emerging market allocation, followed by South Korea, Taiwan and then India. No institutional investor allocating to emerging markets looks at India in isolation, its always a comparison vs other countries.

When money moves out of emerging markets its moves out across all countries as a risk off approach. Because India has relatively performed stronger than other markets, more money moves out of India as that’s where institutional investors have profits to take off the table from.

Subscribe now

My Investment Strategy

So all of the above ultimately brings me to my investment strategy for next two years.
Here are some of the assumptions I am working with.

• There will be a recession in EU, UK and US

• Severity of the recession will be mild in US

• Extent of such a recessions will last upto 18 months (start to mid 2024)

• India’s economic growth will slow down but still remain above 6%

• India will still remain the fastest growing economy in the world

• Stock markets will gyrate between volatile to sideways until 2024

• Intense bull market run will not start again until after the elections of 2024

• Valuations will cool off to the lowest or mid quartile range from current highest quartile range

• Recent speculative SPAC listing in US will continue to get butchered and may prove to be a good hunting ground for high risk high return investments

• FIIs will return to India late 2023 with a higher allocation that they have made ever in the past

I will put a caveat here that these are just my assumptions and not necessarily what will happen. I have made the above assumptions based on the factors described throughout this article and in my view the above have a decent probability of playing out.

Based on the above assumptions, below is my simple investment plan.

• Continue to be very stock specific and extend the timeline of building full position from weeks to quarters

• Allocate to index where a large correction has already occurred and underlying fundamentals of index constituents remain robust - Nasdaq 100 and Bank Nifty for example

• Build and continue to hold at least a 15 to 20% cash position until end of 2023

• Sell positions where inflationary headwinds are eroding fundamentals and earnings

So as you can see, from supply chain issues, inflation, Russian War and Chinese lockdowns there are little fires everywhere across the world 🔥

Whether these little fires turn into a full fledge blaze is dependent on

1. How fast supply chains get fixed

2. How central banks and governments around the world act through the upcoming recession

Do you have an investment plan? What assumptions described above do you not agree with? Let me know in the comments 👇

Leave a comment

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

It is for this reason, banks have over the years tried to categorize and formulate risk in the form of credit scores or rudimentary human driven processes and questionaries that can some how help them identify ‘true risk’ associated with grant of a loan.

These primitive methodologies designed in late 1980s are still prevalent around the world and used by major financial institutions to disburse trillions of dollars in loans.

All this in the age where your social media feed is decided by an algorithm.

Why can’t the same technology that drives your social media feed be used to improve the process of determining risk associated with grant of individual loans?

Three folks at Google in 2012 asked the same question and decided to start a company to solve this very problem. Ten years later, their company is valued at over $10 Billion.

This is the story of Upstart.

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

Part One: What is Upstart? 🤖

Upstart is an ‘AI’ driven credit lending platform.

If you are a professional data science practitioner like me, you know Artificial Intelligence does not exist. When companies like Upstart advertise themselves as AI driven, what they really mean is that they have several proprietary machine learning algorithms working together to execute a certain task.

In case of Upstart, its the combination of several machine learning models that work together to help identify and define true risk.

True risk in case of lending is identifying the probability of default on a loan.

Therefore, Upstart is a Machine Learning driven platform that helps identify true risk and leverages this proprietary technology to helps banks offer more loans at reduced risk when compared to other traditional models like credit scores.

The Heart of Upstart ❤️

At the heart of Upstart, lives its machine learning driven risk model.

To develop a successful machine learning model, you need three things:

1. Data Variables: Think of these as your columns in a spreadsheet with each column defining a characteristic of a borrower, i.e. education, income levels, age, number of dependents etc.

   In 2014, Upstart started with 32 of these variables, today it has over 1600 and this count is only going to increase from here.

2. Data Count: The above variables mean nothing if there is no actual data present for them. Think of data count as rows in a spreadsheet. The larger the number of rows, the more data Upstart models can consume and more accurate they can become.

   Upstart has over 9 Million+ of these data points and all of these come from the actual real world data Upstart gathers from the loans that originate from its platform.

3. Learning Algorithms: The final piece of our puzzle is a learning algorithm. A learning algorithm is bunch of coded instructions that over time modifies itself to learn from the data supplied to it and gets better at the task required from it.

   In Upstart’s case, the main job of a learning algorithm is to predict the probability of default for a loan.

   In 2014 Upstart started with two basic learning algorithms. Today it has over 16 different models that feed into each other trying to predict everything from probability of prepayment, default, income fraud, identity fraud and interest rate optimization.

This is where things get exciting.

This part of the article is very important to understand the competitive advantages of Upstart later, so please bear with me if it gets too technical.

In the domain of machine learning, there are two main types of learning concepts - supervised learning and unsupervised learning.

Think of supervised learning as a teacher teaching you in a class. You’re given very specific instructions to follow and your job is to follow them as accurately as you can.

Unsupervised learning is when that teacher doesn’t give you any instructions whatsoever but instead tells you what the answer should be. Your job is to figure out the instructions required to arrive at the answer accurately.

The way unsupervised learning works is the algorithm learns from previous ‘experiences’ and gets better at the job required from it automatically.

I will let the below video help you understand how unsupervised learning works in real life. In the video there are two unsupervised learning algorithms competing against each other in the game of hide and seek.

Both algorithms job is simple, one has to get better at hiding and other at seeking. Watch till the end to understand how dramatically these algorithms can improve themselves without any additional input.

The learning algorithms and data Upstart collects from its platform are its biggest competitive advantages. Over the years, Upstart has been busy trying to remove all human elements from these learning algorithms while making sure they stay true to their purpose - to identify true risk.

“We are in the process of removing all human based involvement in decision making. There is still a lot of work to be done and until 2016 we were just building the foundations of our model. We are trying to automate every corner of our codebase that isn’t machine driven today and we are confident that over time we will be able to achieve that.” - Paul Gu, Co-founder and SVP, Upstart

What started as a simple binary classification model is now a combination of several automated learning algorithms that feed off from the real world credit data and make each other better.

Over time the improvement in the output of these algorithms at Upstart will be more dramatic than any financial analyst at Wall Street can predict today.

This inbuilt competitive advantage is also evident in Upstart’s business flywheel shown below.

More Data → More Sophisticated Models → Higher Approvals of Loans

Subscribe now

The Problem to Solve 🧮

Upstart’s mission is to ‘enable effortless credit based on true risk’.

Four in five Americans have never defaulted on a loan yet almost 50% of them have credit scores that wouldn’t qualify them for a low interest rate loan. This gap in lending is the problem Upstart is trying to solve.

By leveraging data and machine learning techniques Upstart can more efficiently estimate ‘true risk’ than traditional models ever can. Upstart’s model lead to a 75% reduction in loss rates for banks while increasing the conversion rates by 10x.

By estimating risk better, Upstart’s bank partners can disburse more loans at much lower risk profiles, while consumers can avail these loans at cheaper interest rates.
A win-win scenario for everyone.

Upstart, in essence, has built a better mouse trap - one which banks can use to approve more loans while controlling their risk and driving default rates lower.

How Upstart makes Money? 🪙

Upstart is a two sided platform - on one side they market and create a funnel of prospective loan seekers via their website Upstart.com and on the other hand they have 40+ bank partners that can either choose to underwrite these loans directly from the Upstart’s website or opt in to create a white label solution of Upstart’s platform for their own customers.

Upstart makes money primarily three ways.

1. Referral Fee: This is usually 3 to 4% of the loan value charged to banks whenever a successful loan transaction is made via Upstart’s platform.

   This segment makes up for majority of Upstart’s revenue, representing over 94% of Q4 FY21’s revenue.

2. Platform Fee: This is a fixed dollar fee per loan charged to banks for the privilege of using Upstart’s platform

3. Servicing Fee: This represents a fee collected from banks or institutional partners to service the loan i.e. collections, reporting etc. This usually represents 0.5% to 1% of loan value.

Upstart does not charge any fees to consumers. This revenue model works well as bank partners only pay to Upstart if they are using the platform while consumers do not pay anything.

A logical question to ask here now would be as to who is underwriting these loans?
The answer is - its a mixed equation.

When Upstart enters into a product category they usually underwrite a small percentage of loans (2%) to get the ball rolling. Majority of loans are underwritten by its 40+ bank partners which have the privilege to later sell these loans to Upstart’s 100+ institutional investors like Goldman Sachs, JP Morgan and Morgan Stanley.

Upstart doesn’t want to take any credit risk on its balance sheet and doesn’t want to compete with banks either. It’s goal is to help banks adopt technology and seek Upstart as their primary lending technology partner.

Read Invest Karo India in the Substack app

Available for iOS and Android

Get the app

Part Two: Financials, Risks and Valuations 📈

Financials 🏦

Upstart’s revenues have grow at a blistering pace since its public listing. Revenue each quarter has increased in triple digit percentage when compared to previous year.

Q4 of 2020 for example, Upstart did around $87 Million in topline. The same quarter in 2021, topline was $305 Million representing a 252% year over year increase.

The primary driver behind this revenue growth is the increase in the loan transaction volume on Upstart’s platform. Transaction volumes in Q4’21 were up by ~230% when compared to Q4’20.

As Upstart gains more recognition and becomes a brand, these transaction volumes should increase further.

While the topline is increasing, bottom line too is showing signs of improvement. Upstart’s contribution margin has been increasing from mid 30’s to now 52 percentage points for the latest quarter.

Contribution margin represents how much money Upstart makes from the transaction volume on its platform.

Risks 🚩

Lending is a Cyclical Industry
The biggest risk to Upstart’s revenue projections is that it works in a cyclical industry that is bound to follow the ebbs and flows of the larger economic outlook.

When economy is thriving, credit and lending demand is sky high and banks feel comfortable in underwriting a larger portion of loans. When economy is in a recession, credit demand is at its lows and banks tend to be more risk averse.

Since, Upstart’s revenues are directly linked to loan transaction volume on its platform, its revenue will take a hit whenever the state of the economy turns. With inflation running sky high in US and Federal Bank increasing interest rates, it is possible that US economic growth slows down to an extent in the near term.

Concentration of Loan Book

While Upstart has 40+ banking partners on its network, a majority of loans originating from Upstart are underwritten by a single bank, Cross River Bank. While the dependency on Cross River Bank has reduced over the years from 83% of all loans underwritten in 2017 to 60% of all loans underwritten in 2020, it still represents a large chuck on their loan underwriting volume. If Cross River Bank were to pull back tomorrow, it would represent a sudden liquidity crunch on Upstart’s platform.

Upstart has been onboarding other small and medium sized banks (their target area) to improve liquidity and reduce dependency on any single banking partner. A typical bank partner onboarding process for Upstart takes anywhere between six to fifteen months, so going from 40 to a 100 banking partners will take some time.

Concentration on Customer Acquisition Funnel

While Upstart has been trying to market itself and establish a standalone brand name, a major chunk of its customer funnel comes from a single source - Credit Karma, a loan aggregator website.

The concerning part is that even though Upstart has increased its marketing budget by several times in the last three years, the percentage of customers acquired via Credit Karma and dependency on it has increased from 28% in 2017 to almost 60% in 2020.

While this is not of immediate concern, if Credit Karma were to shut down tomorrow, Upstart would lose a part of its major customer acquisition funnel. This dependency highlights the importance for Upstart to build and control its own customer funnel and establish itself as a brand.

Valuation and Earnings Triggers 💰

Earnings Triggers 📊

Until recently Upstart was a single product company and was present only in the market of personal loans.

They are now slowly expanding into other lending verticals namely - Auto Lending, Small and Medium Scale Business Lending and Mortgage Lending.

Each vertical has a larger market than personal loan business. To me, Upstart’s foray into personal loans was just a proving ground and having built a successful business there, they can blitzscale the learnings from personal loan business and apply to scale up auto, business lending and mortgage businesses.

Auto Lending is the first market they are targeting for 2022 and this is our first major earnings trigger.

From the capital they raised from IPO, Upstart acquired Prodigy Software, a provider of cloud based automotive retail software to auto dealerships. Upstart later rebranded Prodigy Software to Upstart Auto.

“While Amazon and Shopify have modernized the online shopping experience, the auto industry has been left behind. Upstart is on a path to reduce the cost of auto financing, and we can accelerate this opportunity with a modern multi-channel purchase experience.” - Dave Girouard, CEO, Upstart

Leveraging Upstart Auto, Upstart wants to help dealers in US manage and sell cars while also providing auto financing options through the Upstart platform. Their target for 2022 is $1.5 Billion in transaction volume from Upstart Auto.

Upstart Auto has already started showing signs of taking off. Earlier this month, in March 2022, world’s largest car manufacturer Volkswagen, announced its partnership with Upstart to modernized its dealerships by leveraging the Upstart Auto Retail platform.

“When we started working with Upstart Auto Retail, they were an up-and-coming startup in the digital retail space. We chose them because other platforms simply did not meet our needs. Having worked with them now for so long, it has been nothing but a success story,” stated Josh Lever of Platinum Volkswagen.

“They worked with me at the dealer level and took our dealership’s needs into consideration. I cannot thank the team enough for developing such a robust product around what dealers need today.”

The Mortgage and Small and Medium Business Lending are much bigger markets than Auto, Upstart has a target of 2023 to launch viable products for the same.

Valuations 💸

Upstart’s market cap has been no stranger to volatility. Having IPO at $20 a share in December 2020 at a $2 Billion valuation, Upstart saw its share price climb to $400 at its peak valuing it at $33 Billion.

Valuations have since cooled off and entered a realm of reality. Upstart today, as of writing this article is valued at ~$10 Billion which is a 7x NTM Price to Sales multiple.

In my view this valuation is much more reasonable but doesn’t represent a bargain with a margin of safety.

In the spirit of full disclosure, I do have a position in the company at $78 per share and I will look to slowly increase my position as and when the share price presents a reasonable value.

Part Three: Conclusion 🏁

I believe Upstart to be one of the true FinTech companies of our generation. The leadership team is strong, mission motivated and they have clearly build a product that helps all the users on its platform.

The opportunity and market size is large enough for Upstart to become a $100 Billion player and still not represent a large percentage of the market. Their technology is hard to replace with high barriers to entry and applications around the world.

Being a professional data science practitioner who loves finance, its exciting for me to see a company leveraging and applying the great parts of machine learning and cutting edge developments in this field to the world of finance.

What do you think about Upstart? Let me know in the comments below.

Leave a comment

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

News headlines are filled with the collapse of Lehman Brothers and the onset of the Great Financial Crisis. Stock markets around the world have tanked anywhere between 40 to 70% from their last peak, made earlier in 2007. Economic outlook all over the world is grim and money seems to be running on short supply.

It’s against this backdrop, a young Sahil Barua is brainstorming various business ideas from his dorm room in IIM Bangalore. As the economic conditions throughout 2008 deteriorated, so did his hopes to launch a start up.

He closes the lid on his business plans and takes a job as a management consultant with Bain & Co. Little does Sahil know at the time that he will meet his future co-founders at Bain and three years later in 2011, they will together lay the foundation for what will become a $3 Billion logistics company.

This is the story of Delhivery.

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

Part One: From Hyper Local to eCommerce 🚚

Delhivery started as a hyperlocal food delivery service in New Delhi.

In 2011, restaurants were increasingly being introduced to the power of internet and while Zomato was helping them coming online, food delivery was still managed by individual restaurants.

There was money to be made in streamlining food deliveries and so Sahil along with his colleague Suraj Saharan quit their consulting jobs with Bain and started Delhivery.

What started as a successful hyperlocal food delivery service quickly pivoted to building a logistics firm for eCommerce.

The main motivation to pivot was the scale of opportunity and absence of anyone else trying to optimize logistics for eCommerce. Traditional players were accustomed to delivering documents, pre paid orders and movement of freight where as in eCommerce, there is usually a two way logistics channel - business to customer and then customer to business.

The latter is usually return orders and cash collected from customer in case of cash on delivery, which were 90%+ eCommerce deliveries at the time. None of the existing logistics players were accustomed to this new way of delivering goods and their network built and optimized for old logistics industry would take a complete rebuild from the ground up to cater to this new segment.

This was an area ripe for opportunity for Delhivery. They could build a new logistics company that was designed from the ground up for eCommerce - and so they did.

Subscribe now

Traditional Logistics vs Delhivery

Traditional logistics players work on a Hub and Spoke Model.

Deliveries collected from various places are sent to a central distribution and sorting hub for further processing. The hub then further sends these packages to smaller sorting facilities until they are sent to delivery centers responsible for each delivery area.

This model is slow and works well when time isn’t of the essence.

Delhivery follows a point to point model. Each facility in this model acts as its own hub and sorting facility. This allows Delhivery to pick up packages from anywhere and directly send it to the nearest sorting facility which further processes it directly to the facility closest to delivery destination.

This model is fast and with a lot of help from technology Delhivery is able to reduce the delivery time from a few weeks to a one or two days.

The model works even faster when number of nodes in the network increase significantly.

Below is an illustration of the Delhivery Logistics Mesh Network.

As illustrated above, Delhivery has a mesh network on a scale unlike anyone else in India. In a city like Mumbai, where eCommerce deliveries are high, they can simply add more nodes and meet the demand. Where as in Tier 3 cities where eCommerce deliveries are considerably less compared to Mumbai, they can make do with a fewer nodes.

For a traditional player following a hub and spoke model, this agility in enhancing the network doesn’t work as they have to incur considerable spend to introduce a new hub in the model.

This is Delhivery’s competitive advantage #1.

A Lot of help from Technology

On the face of it, Delhivery looks like a logistics company, but as you peel through the layers, you will discover almost every single aspect of their logistics network is operated via their proprietary technology stack.

In Delhivery’s case, they like to build the technology first and logistics later.

The company has over 80 proprietary self developed applications that work together to help Delhivery deliver millions of packages every year. Delhivery further goes ahead and collects data points on each of these deliveries. Machine Learning optimized algorithms continuously consume these datapoints and work tirelessly behind the scenes to optimize this logistics network even further.

This is the same playbook Amazon has used over the years to help it become the largest, fastest and most reliable logistics company in the world.

Delhivery’s logistics technology is so successful, that they are now exposing it as a SaaS offering to other enterprises and customers.

Excerpt from their DRHP ⤵️

“We intend to externalize our logistics operating system as a platform and a SaaS offering by enabling other logistics service provider, logistics-tech companies, and enterprise and developer partners, in India and globally.”

This SaaS offering on its own can be a significant pie of their revenue a couple years down the road.

Test for their technology prowess came in during the Covid lockdown in March 2020.

In March 2020, when India announced a completed lockdown, the logistics industry came to a definitive halt. Ten days later when the country selectively reopened, Delhivery by leveraging its ‘Logistics OS’ was able to selectively activate 8300 pin codes for essential delivery and re-establish operations overnight simply by looking at unstructured data (announcements by local, state and national authorities).

An example of the applications developed on their technology stack is Orion, the application they use for Truckload Freight Management. Delhivery being an asset light firm, owns a tiny portion of delivery fleet (less than 8%), rest of it is either leased or sourced via Orion.

Orion helps match demand from shippers with suppliers of truckload capacity in real time. The application was primarily built to help Delhivery source delivery fleet from its network partners, but now has an added optionality of being launched as a standalone SaaS based offering for other large logistics companies.

Deeply integrated technology is Delhivery’s competitive advantage #2.

Why own an asset when you can lease it?

Logistics by its very nature is an asset heavy, upfront capex driven business.

A typical logistics company requires warehouses, distribution centers, fulfilment centers, staff to deliver and manage packages, delivery fleet and capital to run the business. All this before even it can begin to deliver its first order.

It should come as no surprise then, that more than 95% of logistics industry in India is fragmented and made up of small business owners running a logistics service at a very small scale.

For example, 85% of Road Transport companies in India own less than 20 trucks that drive on an average less than 300 kms a day. 90% of warehouses in India are smaller than 10,000 sq feet in size.

These small businesses cannot become mid to large scale companies unless there is technology to help them vastly increase their logistics network via partnerships with larger companies.

Delhivery through its technology solutions found a way to effectively build and run a marketplace for this vast network of small scale untapped capacity of truck fleets and warehouses throughout India.

Most of this demand in this marketplace today is from Delhivery itself.

Excerpt from their DRHP ⤵️

“Our systems function as a managed marketplaces that match partner capacity with Delhivery internal and third-party client demand based on partners’ service quality ratings and pricing.

This approach has enabled us to quickly expand to geographically dispersed locations, optimize loads, improve our cost structure and maintain flexibility in handling seasonal demands while incurring minimal fixed costs and capital expenditures.”

Delhivery’s motto is to invest in critical infrastructure while leveraging everything else via its network partners.

Delhivery owns a little assets of its own but leases a lot of them.

The company effectively has 12.42 Million sq. ft of logistics space available to it throughout India that cover over 17,045 pin codes which are serviced by its self owned and partner contracted fleet of trucks delivering over a billion packages weighing almost a million tonnes for its 21,000+ customers.

Pretty big and noteworthy numbers for a company started less than a decade ago.

This ability to scale up its logistics network without having to burn a lot of cash is Delhivery’s competitive advantage #3.

Partner and Automate

The little assets Delhivery does own on its own are highly automated. Take for example, their Gateways - which are the largest logistics facilities forming the core of their network.

Gateways are the big nodes in their mesh logistics network that handle all types of packages and perform majority of the tasks. The entire delivery network functions as fast as Gateways can. It is for this reason Delhivery has invested heavily into automating every single aspect of their Gateway functions that can be automated.

Packages are sorted automatically as soon as they arrive to a Gateway, with some Gateways being completely automated, capable of handling upto 32,000 shipments per hour.

Partnerships are another area where Delhivery has started to excel. In order to grow operations across border and stabilize Indian revenues, the company has entered into strategic alliances with FedEx and Aramex.

Any packages coming through the FedEx or Aramex networks to India will be delivered via Delhivery through its domestics logistics set up. Similarly any packages originating out of India to International destinations on Delhivery network will be serviced by FedEx and Aramex.

Apart from FedEx and Aramex, Delhivery already has a partnership with UPS which they entered into in 2019.

This ability to struck partnerships with strongest global players, helps Delhivery expand its network without any additional costs and is its competitive advantage #4.

Before we move on to financials, above is the brief timeline of Delhivery since its incorporation in 2011.

Leave a comment

Part Two: All About Money 🪙💰

Revenues

70% of FY21 revenue for Delhivery, or 2,550cr out of 3,635cr was from express shipment of deliveries for other eCommerce websites.

The rest 30% of revenue is divided between Part Truck Load (11%), Supply Chain Services (11%), Full Truck Load (6%) and Cross Border Delivery Services (3%).

Needless to mention an overwhelming majority of this revenue pie is linked to growth of eCommerce in India. Delhivery acknowledges and mentions this as one of their key risks in their DRHP.

Excerpt from their DRHP ⤵️

“Although we continue to diversify our customer base, e-commerce customers contribute a majority of our shipment volume. Accordingly, our business and growth are highly correlated with the growth of the eCommerce industry and more generally, commerce, in India.”

Delhivery is slowly diversifying into other industry verticals like shipment of customer electronics, consumer durables, FMCG, healthcare, lifestyle, automobiles and manufacturing.

Overtime the dependency on eCommerce should go down but I doubt it will ever be less than 50% of the overall revenue pie.

Reducing Losses and Increasing Income

Like most start ups, Delhivery is a loss making company. Unlike most start ups though, Delhivery has a clear path to profitability as their revenues are growing at a CAGR of 44% while losses are reducing.

The two main top expenses for the company are

1. Freight Handling and Servicing (76% of Revenue)

2. Employee Benefit Expenses (16% of Revenue)

As the company’s operations expand and volumes increase, operating leverage should play out and help reduce the freight handling expenses to a more manageable extent.

The employee benefit expenses however, are here to stay and may even increase in future as the company attracts and tries to retain more technological talent.

Increasing income and reducing losses, made Delhivery cash positive for the first time in 2021.

The losses might be reducing but make no mistake, this will never be a high Gross Margin business unless optionalities like their SaaS based offering for ‘Logistics OS’ playout and starts contributing to a significant chunk of revenue.

Debt

As of June 20, 2021 Delhivery had about ~342cr of long term and short term debt on its books. Much of this will be repaid from some of the proceeds from IPO.

Customer Concentration

A key area of risk for Delhivery is the customer concentration. An average of ~45% of revenue comes from just five customers.

Delhivery does not disclose the name of these customers but it is safe to assume some of these five customers are largest eCommerce companies in India like Flipkart, Myntra, Amazon etc.

Most of these large eCommerce players are investing in logistics capability of their own and only hire Delhivery when their own internal logistics systems are running at full capacity. As such as and when the logistical prowess of these eCommerce companies increases, their dependency on Delhivery should reduce and as such Delhivery’s revenues from these customers.

To counteract this revenue concentration risk, Delhivery has set its sights on a different kind of customer - the D2C (Direct to Customer) companies. These are your mom and pop small internet businesses that do not have the scale to invest in logistics of their own but want to primarily sell their products on the internet.

Delhivery onboards these customers and provides them with the logistics capability for them to conduct their business online. As of FY 21, some 675 out of 21,000 customers Delhivery caters to, were D2C companies.

D2C is kind of going through its own renaissance in India and is expected to grow faster than traditional large scale eCommerce.

Share

Part Three: Valuations and About The IPO

Objectives of IPO Offer

The company is raising 3750cr in its IPO via issuing fresh equity. Out of this 3750cr, 2500cr will be used for organic growth - expanding the current logistics network and upgrading and improving its ‘Logistics OS’ proprietary technology stack.

The remaining 1250cr will be used to fund acquisitions and other inorganic growth opportunities.

Majority of the company is owned by venture and private equity funds, with original founders collectively owning less than ~8% of the entire company.

The DRHP currently does not indicate how much these VC and PE funds wants to offload their stake in the IPO.

Valuations
Updated on 11th May 2022

Delhivery finally launched its IPO today seeking a market cap of 35,000cr at the upper band of the IPO price range of Rs 462 to Rs 487 per share.

This valuation target, by any stretch of imagination is towards the extreme end.

To give you some perspective, you can buy most of the listed profitable logistics companies in India for 35,000cr or you can buy a single loss making Delhivery.

The pre IPO financing round for Delhivery pegged its valuations at 22,500cr (~$3 Billion) just a few months back, so even with that in mind its quite a formidable ask to list oneself at 35,000cr market cap.

While Delhivery has a great business that one day maybe can recreate what the likes of FedEx did for America in 1980s, today the price is too high to take that gamble.

As with all the other IPOs, I will follow my rule and wait for six to twelve months before taking a call to invest.

Conclusion

Logistics is a high barrier capex heavy sector and Delhivery through the use of its own proprietary technology stack has enabled itself to raise these barriers to entry even further.

In my opinion, Delhivery is a good proxy bet to play the growth of eCommerce industry in India.

After my deep dive on Nykaa, this was the second company, I personally really enjoyed reading in depth and writing about.

I hope your experience was the same.

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

Disappointed, the trio gets news that the Russians are trying to offload a few repurposed Intercontinental Ballistic Missiles (ICBMs), so they head east. Over a few too many rounds of vodka, they stuck a deal to buy three ICBMs for $21 Million. The Russians, would later back out of the deal and try selling ICBMs to Elon for $21 Million each, $63 Million in total.

Frustrated by the experience, Elon Musk, in a typical Thanos like fashion would utter the words, “Fine, I will do it myself”, and so will take place the birth of SpaceX.

Twenty years later, this singular experience, would go on to change the dynamics of space industry as we know it today.

Welcome to the Space Age 🛰️

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

Part One: The Past that Led to The Present

The roots of modern day space industry started just after World War II, in the period known as Cold War. From the ashes of World War, emerged two super powers, Soviet Union (USSR) and USA. Both countries were fighting war by proxy and in an effort to prove their superiority over other, they targeted space as their battleground and science as their weapon of choice.

USSR won the first battle with the launch of Sputnik I, the world’s first artificial satellite.

US couldn’t stand USSR’s accomplishment and soon after increased its funding towards exploration of space, with the set up of a dedicated organization in 1958, called NASA.

Just like that, we were off to the races, between two super powers of the world, competing to outdo each other in the exploration of space. The same technology that was used to propel missiles in World War II, was now being used to put a man on the moon.

Ten years after NASA was established, on July 20th 1969, Neil Armstrong became the first person to ever walk on the surface of the Moon.

Space race, would continue for another 20 years, till 1989 when Berlin Wall fell, marking the end of the Soviet Union empire.

The fall of Berlin Wall was a pivotal moment in history, it established United States as one true super power in the world but that also meant the billions of dollars, US was spending on space missions weren’t necessary anymore - there was no one to compete with!

NASA’s budget shrank every year after that and with it so our advancements in space technology. Rockets remained pretty much the same and costs of sending anything to Earth’s orbit was so expensive with so little return that only governments could fund it.

Until that is till 2001, when Elon Musk set about to launch his own rocket company.

Subscribe now

Part Two: A Commercial Rocket Launch Every Week

The largest cost for any space mission used to be the rocket carrying the freight to either Low Earth Orbit (LEO) or Geosynchronous Stationary Orbit (GSO). Unless cost to launch a rocket reduced by orders of magnitude, no real commercial space missions were feasible.

This was the key problem, SpaceX aimed to solve.

Before SpaceX arrived on the scene, the best of rockets used to cost ~$25,000/kg. Today in 2022, they cost less than ~$1000/kg. By the end of this decade, this cost will further reduce down to $100/kg.

This reduction in launch costs is the key reason behind the boom in commercial space industry. Its finally cheap enough for even high school kids to send their own satellites in space.

Another key tailwind is the miniaturization of satellites.

Meet Dove, a satellite designed by Planet Labs. For those of you who are reading the name of the company for the first time, Planet Labs is a part Google owned company that scans every inch of the world every day all year round.

If you’re reading this article from your roof or from an open ground, look up, there is a high chance that your image is being taken by one of these satellites.

Creepy? Maybe. Impressive? Hell Yeah!

This simple palm sized satellite is many times more powerful than some of the giant satellites we sent to space in early 2000s.

Miniaturization of electronics (camera, mic, processing units) is also directly effecting the miniaturization of satellites. In most cases today, satellites use off the shelf electronic parts, some of which are the same as the ones used in your phone.

So what happens, when the technology you need to send to space gets smaller in size and lighter in load while costs to send something in space decrease by orders of magnitude?

You open the floodgates to space centric business plans and rocket launch activity.

Today, there is a commercial space launch every single week and its dominated by two companies - SpaceX and Rocket Lab.

Much of the commercial activity today is centered around launch of small satellites to the Low Earth Orbit (LEO) but other space centric businesses are starting to emerge right around the horizon.

Share

Part Three: Making Money in Space

There are a few ways to make money in the space business, let’s explore them.

The most common way is to help other businesses reach space in a cost effective manner. The simplest way to achieve lower cost is to design reusable rockets - something SpaceX and Rocket Lab are very good at.

There is a flurry of start ups trying to race ahead and build the best in class cheapest reusable rocket solution today. Some of these are mentioned below.

This is an industry that has extremely high barriers to entry. Even the paint that goes onto a rocket needs to be approved and certified.

I will let, Peter Beck, CEO of Rocket Lab, explain all the barriers to entry for a rocket company.

High barriers to entry doesn’t necessarily mean that it is a very lucrative industry. Unfortunately, the entire industry yearly revenue for rocket companies in 2022, taps out at $3 to $4 Billion per year.

Nine out of ten rocket companies shut shop even before their first launch. The ones that can make a commercial reusable rocket work are truly special.

When SpaceX lands its Falcon 9 booster on a ship, its essentially landing a sixteen storey high building on a tiny remote controlled drone ship in the middle of Pacific Ocean - if that’s not magic, I don’t know what is!

So when the primary industry is not big enough today, the only way to survive is

1. Have a billionaire backer like Musk in case of SpaceX and Bezos in case of BlueOrigin

2. Expand into ancillary industry services

SpaceX is building Starlink to provide a secondary income that should fund all the upcoming R&D. Rocket Lab is expanding into becoming a one stop shop for satellite components, providing at scale manufacturing of bespoke parts.

As the industry matures, I expect a large consolidation to take place with only a few players left standing.

Should I write a detailed deep dive into Rocket Lab, a company I am personally invested in? Leave a comment below 👇🏼 and let me know.

Leave a comment

The second way to make money in space business is to build a constellation of satellites that can stream and transfer data to any part of the world.

BlackSky and PlanetLabs are examples of using satellites to image and monitor entire Earth and subsequently selling that data to customers.

The final way to make money in space business today, is to execute government contracts. NASA, for example, is the biggest customer for SpaceX.

Everything related to space is being taken over by private companies and government agencies today are handing out contracts rather than build everything on their own.

Two of the biggest upcoming government contracts are

• Artemis Mission - building a permanent station on Moon

• Building a new International Space Station

These two are big gigantic leap worthy missions that will cost billions of dollars and companies are lining up to get the right to execute even a single part of the contract.

When the next humans step on Moon in 2024, they will be there to set up a permanent outpost.

The current International Space Station is reaching its end of life, the next one will be built by a private commercial company instead of governments.

Axiom Space is the leading organization that has won several contracts from space agencies around the world to build specialized habitats for them. We will have a new commercial space station ready and functioning by the end of this decade.

Part Four: Space, The Final Frontier

So there will be increased rocket launch activity, we will build a new space station, maybe several of them and a new base station on Moon.

Then what?

How does this industry keeps progressing and make reoccurring revenue and ultimately profits that will help move it from a niche industry to mainstream?

This next part may sound like science fiction but I assure you its rooted in reality.

There are many things that are only possible in the gravity less environment of space. Take Organ Printing for example. Yes! we have the technology to print organs from bladders to even hearts. Millions of patients die every year while waiting for an organ transplant, this soon could be a thing of the past.

Microgravity enables manufacturing for far superior products that are not possible otherwise on Earth.

Apart from manufacturing cool things in space, we are also gearing up to extract and mine materials out of space objects - moon, asteroids etc.

Again, this isn’t science fiction, its reality and will be happen far sooner than you realize. The tiny country of Luxembourg has even passed regulations enabling space mining companies to set up in the country.

Today, space industry is at its nascent stage. In terms of the internet age its like Netscape browser was just released and people are yet to discover what e-mail is.

Its still very much a wild wild west.

But unlike the internet age that took twenty years for companies like Amazon, Google, Apple and Microsoft to become trillion dollar corporations, the next trillion dollar space company might be just round the corner.

Thank you for reading! see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

To put things into context, Tesla in 2012 barely managed to sell 10,000 of their cars. Electric vehicles were a distant dream, at best, telecom companies were flashing in their brand new ‘high speed’ 3G internet service and Apple had just released it’s state of the art iPhone 5!

Fast forward 10 years to 2022 and Tesla is doing over ~$75 Billion in annual revenue, selling just shy of a million electric cars every year, last of 3G services in US are being shut down and 5G services are being rolled out in most developed countries in the world.

World moves fast!

This write up is my attempt to imagine what 2032 may look like. Now, I do not claim to see the future or predict it accurately, most of what I have to say today may not turn out exactly as written but by looking at data and ground up research, we can make an educated guess into what technologies will succeed and how dramatic these transformations may be.

I will also not bore you into stating the obvious - electric cars will be the norm or renewables will power the majority of the electric grids.

With that, lets dive in.

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share Invest Karo India

Prediction #1

The world of Gaming and VFX will overlap and consolidate

This one is pretty obvious and already happening without us realizing it. Gaming industry today is many fold bigger than all of movie and music industry combined. Technologies are made for gaming first and adapted for movies later on.

If you’re a fan of the TV Show Mandalorian, you maybe surprised to know that entire VFX for the show was done in Unreal Engine by Epic Games (the makers of Fortnite). There was no typical ‘green screen’ used in the show, backgrounds and visual effects were pre rendered in a game design software and simply added via Led Screens while filming.

The implications of such a move? Millions of dollars and thousands of hours that were spend on VFX are now reduced to simple pre renderings costing you no more than a subscription to a software. It is for this reason that gaming companies are in 2022 buying out VFX companies like Peter Jackson’s Weta being bought out by Unity.

A typical gaming company of 2032 looks very different from a gaming company of 2022. In 2032, gaming companies earn most of their revenue by licensing out their world creation software - to movie studios, smaller game design studios and other indie developers, just like today you can subscribe to a Adobe software and have access to the same tools as a professional.

Further, all gaming in 2032 is streamed, think of Netflix but instead of an on demand movie or tv show, you get to play a game from an endless continuously increasing library.

Signs of this change are already showing - with Google experimenting with Stadia, Amazon with Luna, Netflix with their minor games related to their IPs, Microsoft with xCloud and PlayStation with PS Now.

So what does all this mean to you as an investor?

Well, for starters, a proxy bet would be the underlying software providers to these gaming companies - Unity being an example of such. The other is small gaming companies, will find it increasingly hard to compete in a space that is getting major attention from deep pocket Big Tech. In 2032, gaming industry is highly consolidated and dominated by players that have technology and online distribution as their strength first and creating immersive games second.

If you would like me to do a deep dive or hold a webinar into Gaming and Metaverse related companies, please leave a comment.

Leave a comment

Prediction #2

Low Skilled jobs ranging from farming to truck driving will be automated
(*at least in the developed world)

This one isn’t that hard to predict. Most of the western world is going through a labor crunch esp. in low skilled areas. The reasons behind it vary - from an aging population to a more educated and skilled workforce and finally inability for a worker to survive on a low skilled pay.

Some western countries like Canada are tackling this problem by allowing more immigration. More than 80% of growth in Canada’s population is due to immigration alone. The country of 30 Million people, wants to allow over 361,000 new immigrations every year starting 2022.

The reason for this mass immigration is simple - Canada has an aging population which if not revived with a much younger workforce can collapse its economy and social security systems in the coming years. Today, if you are college graduated and below 30 years of age, you can get a Canadian PR visa in a few weeks.

The problem with such immigration is - most immigrants are skilled and do not migrate to a developed country like Canada to work in restaurants, drive a taxi or apply for other low skilled jobs. So as the population ages in the coming decade, the high skilled jobs are the first to get filled with immigrated population, the low skilled ones - well, they will keep facing labor supply crunch and thus are ripe for - automation.

In 2032, low skilled jobs in countries like Canada are increasingly automated. Take farming for example. Canada is one of the largest producers and exporters of grains and food in the world. An average farm in Canada is around 700 hectares in size and uses machinery that costs millions of dollars. These farms will be the first in the world to adopt technology that will make them increasingly automated.

Before we see autonomous cars, we will have autonomous tractors. The logic behind it is simple - its much easier to program a tractor or any other farm equipment to operate on a piece of walled off empty farmland than it is to program a car to operate autonomously on a road filled with multiple other vehicles and pedestrians.

Signs of autonomous farming equipment are already emerging. Below is video by John Deere - the largest farming equipment manufacturer in the world showcasing their new fully autonomous tractor.

The farm of 2032 is self farmed - with minimal supervision involved.

Another area to get automated is truck driving - again with autonomous vehicles. TuSimple - a company listed in US already operates completely autonomous trucks for UPS every single day.

As these trucks make more trips, the autonomous driving software will get better at an astonishing pace. Expect to see more autonomous trucks in future.

The underlying need for all of this automation is the aging population and unavailability of enough labour supply to fill these jobs. As these jobs get more automated, the pay for such low skilled jobs will further reduce and drive even further shortage of labour until we reach a point where these jobs are automated to a large extent.

So what does all this mean to you as an investor?

Look for companies that are enabling this automation. Automation for passenger vehicles is far away, but in 2032, farmlands are completely automated. John Deere for example, is not considered by many a bet on autonomous vehicles, yet it is!

Look for opportunities where others aren’t. If there is consensus around an investment thesis, its usually the wrong investment to make.

Share Invest Karo India

Prediction #3

Space Industry will worth many Trillions of Dollars

Space, the final frontier for humanity. In 2022, Space Industry is largely ignored by the investment community - it is seen as a small niche industry that makes less than $10 Billion in revenue every year. But by 2032, Space Industry combined will worth many trillions of dollars and growing at high double digit rates.

Here is why I say so.

Access to Space is Democratized

The main challenge for any form of space industry to take place was access to economical launches. This in 2022 has been fixed to a large extent - there are multiple successful rocket launch companies, SpaceX and RocketLab being the two most successful ones.

As a result, launch activity has exploded.

From just about 20 satellites being launched in 2009, we have reached velocity of ~1000 satellites being launched in 2022. This pace will sustain through the coming decade. Today, the use case for space transportation companies is the small-sat industry, tomorrow, the use cases will be far and wide.

Take for example, building a new space station. The current International Space Station is nearing its end of life and will soon be burnt up and decommissioned by NASA by 2028.

The next space station to be built, will not be sponsored by a Government agency like NASA. Instead, there will be multiple space stations developed by private companies in collaboration. Just like today in 2022, companies lease out commercial office space from real estate companies, in 2032, companies will be leasing out space (no pun intended) on the Space Stations orbiting the Earth.

Take for example, Axiom Space, a company that specializes in building space habitats. It was recently awarded $140 Million contract by NASA to build habitats that can attach to the current International Space Station.

The same company, signed a deal with Tom Cruise’s production company to build a studio in space!

In 2032, space stations are commercial and operated via private companies. The same space station is used by movie studios, research companies and new age businesses that can only operate in environment of space - 3D Organ Printing for example.

So what does all this mean to you as an investor?

Look for companies that enable this industry to take place. It is not easy to build a rocket company, a sustainable reusable rocket company - even harder. This is an industry with the highest barriers of entry - even the paint that goes onto a rocket has to be approved first. When a rocket launches, the entire aerospace surrounding it has to be seal off from activity. In 2032, when the rush for space age is in full swing, it is these rocket or space transportation companies that will be the prime beneficiaries.

I will let Peter Beck, the founder and CEO and Rocket Lab, explain this further.

Subscribe now

Prediction #4

The most significant advancements will be made in the world of Biology - Not Necessarily Healthcare but Biosciences

In 2022, synthetic biology is at the cusp of its commercialization. Advancements in the field of CRISPR and precision fermentation over the last decade have finally made it possible for humans to control and program biology.

Today, we can make enzymes and bacteria in lab do whatever we want to.

Want to revive the smell of a 200 year old extinct flower? Well, we can do that. Want to make enzymes that take all the waste material out of a chemical plant and produce valuable products out of them? That’s possible too.

In 2032, biosciences effects every product that you use without you ever knowing it. The chemical used to make the products you use - they are 100% carbon neutral - all thanks to an enzyme. The food you consume - 100% organic and disease free without using a single harmful pesticide - all thanks to the wonders of synthetic biology.

Enzymes in 2032 is a buzzword, similar to how Artificial Intelligence and Electric Vehicles are a buzzword today in 2022. The largest chemical company in 2032, doesn’t have any chemical plants - it instead manufactures and sells enzymes that help boost the output of other chemical plants in a carbon neutral way.

Another advancement in the field of Biology, will be precision medication.

Today, traditional drug manufacturing companies only invest R&D money into areas where there are a large enough pool of patients. This unfortunately ignores those that suffer from rare health disorders. In 2032, patients of all types are cured no matter how rare the disease is - all thanks to sharp decline in R&D due to gene sequencing.

So what does all this mean to you as an investor?

Look for areas where companies are enabling this movement. The guys at Andreessen Horowitz, famous for coining the term ‘Software Eats the World’, are today focusing on companies that enable this movement towards biosciences. They even run a podcast called ‘Bio Eats World’.

Gingko Bioworks is an example of a company that is enabling this movement.

So, those were my four predictions for what the next decade holds and where it is headed. I do not claim that these will turn out exactly as I have described them here but by looking at data and researching from grassroots its easy to get a sense of where some of these industries are headed.

No matter what the year 2032 may look like, I am sure it will be an exciting time to be alive.

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

From its humble roots of selling bicycles in 1956 Ludhiana Punjab, to becoming the world’s largest two wheeler company is an extraordinary feat. Maintaining the momentum, protecting its market share and setting sights towards ‘Future of Mobility’ is something special.

Yet this giant, that sells its products in over 40 countries globally, has manufacturing capacity of over 9 million units annually and churns out a new two wheeler every few seconds from one of its eight production plants spread across India, Bangladesh and Colombia, is valued for about ~1x Sales.

This is my attempt to find out - Why?

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

I won’t bore you with the history of Hero, there is more than enough material to read on the internet and if you’re from India, chances are you probably already know about it, as Hero is a household name.

Instead, this write up is focused on the journey of Hero, since the dissolving of its joint venture with Honda, steps taken to rebuild the R&D foundation and what the next decade may look like for the company.

Part One: The Big Set Back

December 2010
Business news headlines around India are reporting Hero Honda’s 33% jump in sales for the month and Hero’s stock is on an upwards trajectory, rewarding its shareholders a ~40% increase in share price that year, out beating the market index by a wide margin.

Yet the atmosphere in the board room, at Hero Honda’s headquarters in New Delhi is not pleasant. What the world doesn’t know yet, is that in less than 15 days, the joint venture between Hero and Honda Motors will dissolve.

Hero’s partnership with Honda was a pivotal moment in its history. The two companies formed a joint venture in 1983 to produce motorcycles for the domestic market. Honda was to supply Hero with R&D while Hero would work on scaling up manufacturing. The arrangement worked well and their partnership, soon catapulted HeroHonda to become the largest two wheeler company in the world by early 1990s.

By 2010, the same partnership was hindering growth for Hero. Honda was never completely forthcoming with the R&D and used it as a leash to control the ambitions of Hero. The initial agreement with Honda, also meant that Hero wasn’t allowed to scale up its export business beyond the boundaries of India and had limited presence in Bangladesh, Nepal and Sri Lanka - tiny markets at the time.

Meanwhile at its home base, in India, competition was brewing from every nook and corner - Bajaj, TVS and Eicher Motors were foraying into premium models and wanted to gain market share from Hero. To add to this competition, user preferences were migrating from motorcycles to automatic scooters, an area dominated by Honda Motors with their Activa offering.

Breaking up with Honda was the logical choice - a tough one but the only way out if Hero wanted to become a global brand.

When two parties agreed to dissolve their partnership, an agreement was formed that Honda would continue to supply R&D and engine designs to Hero till 2014. Honda would later back out of this agreement as Hero forayed into scooters.

The culmination of these events led to the decline of Hero’s market share in the two wheeler space - particularly in the premium category. Hero Honda Karzima used to rule the premium segment of the market, but by mid 2015’s offerings from Bajaj (Pulsar), Eicher (Royal Enfield) and TVS (Apache) took the top spot. Hero instead chose to double down on its entry level offerings, an area its still the leader in today.

Part Two: Hunt for Growth Begins

2016 to 2021
2016 was the year when Hero started to lay the foundation for its future growth. It launched a new R&D center in Jaipur, India followed by another one in Germany.

The same year Hero would invest and become the largest investor in a little known electric vehicle upstart from Bengaluru called Ather Energy.

Over the last five years from 2016 to 2021, Hero has been busy breaking the shackles of its past.

It has forayed into international markets - now supplying its products in over 40 countries globally, eight of which are growing substantially. It has also reworked its mission statement, setting its sights on the ‘Future of Mobility’, not limiting itself to just two wheelers.

Hero’s goal is to produce and sell another 100 million vehicles in the coming decade (Hero has sold 100 million two wheelers since its inception).

Meanwhile back at home in India, headwinds would grow stronger for Hero.

The last five years haven’t been kind to the auto industry - first came demonetization in Nov of 2016, followed by NBFC crisis of 2018, followed by transition to BS-VI transmission norms in 2019 and then finally the pandemic of 2020.

Most of its peers were impacted, but Hero felt the burden more. A major chunk of Hero’s sales comes from entry level motorcycles targeted at the rural segment of India. Hero distributes these motorcycles via 6000 touchpoints spread across the nation. No other auto manufacturer in India has such a wide distribution network.

While most of its peers have reported sales CAGR of anywhere between 4 to 11% for the last 5 years, Hero’s sales have grown at mere 2%. The main reason behind this deviation is the presence of its competitors in the premium segment.

In auto industry, the only way to protect your margins is to have a balance of entry and premium products. Entry level products lets you build scale while premium products help you in pricing power and delivering better margins. Sway too much on either side and you either risk losing your margins or not have enough demand to implement economies of scale in your business. Since Hero product mix sways too much on entry level side, it has scale but not as much pricing power.

Hero is fixing this by offering more premium variations to its existing products.

Splendor Canvas is an example of such an offering. The investment in R&D has also started to yield results - helping Hero launch more premium products with its Xpulse and Xtreme range. Competition remains tough in this category with names like TVS and Bajaj dominating the market share.

Another step taken by Hero to further alleviate the margin pressure is to implement a company wide cost savings program called - Leap. Leap was implemented in 2014 and has over the years helped Hero cut through the headwinds amid an inflation in commodity prices. Hero today saves enough money today, to delay the price hikes on its products and thus help protect its market share within the entry level segment.

The same Leap program has helped Hero maintain an operating profit margin of above 12%, even in the toughest of years.

You would imagine, five years of headwinds would have depleted the financials of an auto company - but not Hero. Hero Moto Corp financials today are envy of its peers. The balance sheet has negligible debt and cash reserves of over $2 Billion. The main business of Hero still throws up almost half a billion dollars worth of Free Cash Flow every single year, three times more money than Hero plans to spend annually.

The only piece missing in this puzzle is growth. Let’s explore where the growth for Hero will come from.

Part Three: Racing Ahead

Exports

Hero’s strategy with exports is two fold - first it helps the company produce and sell more of what its already good at - entry level motorcycles, and second it helps offset some of the sales erosion that may take place in India on account of transition to electric vehicles.

While a Hero motorcycle can be found in over 40 countries globally, only eight of them account for the lion’s share of the export business. Within these, Bangladesh, Mexico, Colombia and Nigeria are the fastest growing markets. The single thing common between these four - they are all immune to EV adoption, at least in the short term.

Take for example Nigeria, where Hero sells an entry level bike named Hunter. Electrification of a country like Nigeria is far away, motorbikes are still the primary form of transport in the country, referred to as ‘taxis’ by the locals. Hero developed Hunter from the ground up for the Nigerian market. Its designed to carry a heavy load, is durable and beats existing products on mileage - thereby allowing a Nigerian ‘taxi’ driver to earn more.

This is an example on how Hero is catering to a global market by designing and selling products suited for each individual geography.

To grow its exports fast, Hero has borrowed a page out of the playbook of its erstwhile partner - Honda. When Hero enters a new market, it does so in partnership with an established local distributor. This way, Hero doesn’t have to spend a lot of money on building a distribution network in each country and can focus on building products instead. Such a model has worked well for Hero in each of its fastest growing markets - Mexico, Nigeria, Bangladesh and Colombia.

Hero has a target of 15% sales volume from its export business by 2025.

Premiumization

When it comes to selling premium models, there is no brand more iconic than Harley Davidson. Hero has a partnership with Harley to manufacture, market and sell products under the Harley Davidson brand in India. These products will be targeted at the highest end of the market allowing Hero better margins and maybe some room to gain market share in this category.

Today’s Hero’s market share in premium category is at a mere 1.6%.

The company is further beefing up its product portfolio in the 160cc to 200cc category with its XPulse and Xtreme range. It plans to launch one new product in this segment, every year for the next four years.

Making progress is this category is important for Hero - this is the most EV immune part of the two wheeler market and allows Hero to improve its operating margins to above 20%.

Subscribe now

Spare Parts

Hero started selling motorcycle components in 2013 under the brand ‘Hero Genuine Parts’. In 2014 this business was making 1800cr in revenue every year, today it makes over 3200cr ever year and is growing at double digits (even during the pandemic).
Hero plans to have 10% of annual revenue from this line of business by 2025.

Spare Parts are a lucrative and very high margin business for any OEM, Hero has further enhanced the margins in this area by backwards integrating into manufacturing these parts on its own. Today over 25% of spare parts are produced in house by Hero, rest outsourced to ancillary companies.

Making over half a billion dollars a year just doing spare parts sales is no easy feat.

Electric Vehicles

Final part of this growth puzzle is Electric Vehicles. Hero has been ahead of its peers in embracing the transition to EVs. Its first investment in EV space was Ather Energy (~38% stake today). Another big leg up came with the partnership with Gogoro, a Taiwanese based company that has championed battery swap and go technology for two wheelers. Finally, Hero is also developing its own EVs two wheelers in house, with first one to launch in March of 2022.

To an outsider, this approach to electric vehicles may look messy - too many fingers in too many jars type approach, but there is a method to this madness.

Whenever a new technology enters the market, it is imperative to test out multiple approaches in order to assess which technology works for which segment of the population. Just like today, everyone doesn’t buy entry level motorcycles, tomorrow everyone may not choose to buy a standardized electric scooter that tops out at 65km/hr.

Hero’s approach to electric vehicles is to test out what works in the market by making product options available for every segment of the population.

Ather 450X for example is a premium electric vehicle, capable of fast charging and reaching speeds of upto 80km/hr. Gogoro’s SmartScooter can reach upwards of 100km/hr. and is center around battery swap and go technology that mimics the experience of refueling.

While very little is known about Hero’s own electric vehicle scooter, the glimpses provided by Dr. Munjal (CEO of HeroMotoCorp) shows that its capable of fast charging and is designed to keep affordability in mind.

Hero is taking the same approach to electric vehicles as the auto industry has taken to motorbikes in the past. Motorcycles come in three categories - Entry (100-125cc), Deluxe (125-150cc) and finally Premium Segment (150cc and above). Electric Scooters too seem to be transitioning to that segmentation - affordable (Hero’s own EV) , premium (Ather) and swap & go (Gogoro).

Hero plans to launch two electric vehicles in 2022 and thereafter one new electric vehicle every single year till 2030. Out of the total capex of 10,000cr, Hero plans to spend in the coming decade, 50% is reserved for development of EV products.

If you want me to do a deep dive into Gogoro and Electric Scooter space in India, please leave a comment.

Leave a comment

Part Four: Feet on Ground, Eyes at Sky

Investment Thesis
In my view, the worst is already baked in to the valuations of Hero today. The headwinds of last five years couple with slow growth has led market to discount what the future and near term holds for Hero Moto Corp.

I foresee a strong case of rerating for Hero in 2022 as the company transitions to launch more electric scooters and build its product catalogue for EVs. Couple that with strong double digit earnings growth driven by exports, rebound in domestic sales and a growing ancillary business - and you have a good investment thesis.

Everything that could go wrong, seems to be already baked into the price, implying a high margin of safety for future revaluation.

Risks

This isn’t to say that there are no risks to the company. There are a growing breed of upstarts in India that are scaling up and launching new electric scooters. Backed by Private Equity giants they have a single mission - to electrify India by 2025. The two major ones to watch out for are Ola Electric and Simple Energy.

There are other ones too but they all lack scale. To succeed in any kind of hardware business, especially in the business of making two wheelers you need scale.

The only two upstarts focusing on implementing scale today are Ola (10 Million annual capacity) and Simple Energy (12.5 Million annual capacity).

The good news is, reaching scale needs time and Hero doesn’t have any shortage of its own funds to deploy in this war for EV market share.

Another major risk, I see in Hero today is cannibalizing its own sales. A EV scooter sold by Hero will be counted as a substitute purchase - an existing customer of Hero who was supposed to buy a bike may now buy a electric scooter from them. So increase in sales of electric vehicles may mean an equivalent decrease in sales of motorcycles for Hero. While for the likes of Ola, a sale is a sale, it is not competing against its own existing products.

A higher than expected slowdown in entry level segment due to this transition to EVs is another major risk for the company as entry level bikes are its bread and butter.

There are a bunch more smaller risks and anti-thesis in the company - I sourced a couple from the community at Twitter - leaving a few of them for you in the segment below.

Risks and Anti Thesis Pointers sourced from Twitter

Thank you to everyone who contributed, sorry I wasn’t able to include them all. If you want to read the entire thread all possible risks within Hero, you may access via below link.

Hero Anti Thesis Pointers

Few good ones, are highlighted below.

Conclusion

The entire investing case in Hero today can be summed up in a single line - can a value bet of today become a growth bet of tomorrow?

Going by their history, the events that led up to valuations of today and incremental earnings triggers of next 5 years - I certainly think so.

Thank you for reading, see you in the next one.

Peace,
Tar

Disclaimer: The information provided in this article is for informational purposes only and should not be construed as investment advice. The analysis and insights presented are based on publicly available information, and while efforts have been made to ensure accuracy, we cannot guarantee the completeness or reliability of the information.

Investing in securities carries inherent risks. This post should not be relied upon as a substitute for independent research or consultation with a qualified financial advisor.

The author of this post and the platform on which it is published do not provide personalized investment recommendations or financial advisory services. Any investment or trading decisions you make based on the information provided in this post are solely at your own risk.

Neither the author nor the platform shall be held responsible or liable for any loss or damage arising directly or indirectly from the use of or reliance on the information contained in this post. Readers are encouraged to conduct their own due diligence and seek professional advice before making any investment decisions.

By accessing and reading this post, you acknowledge and agree to the terms and conditions outlined in this disclaimer.

Some of these regulations have worked, while others have failed miserably.

The Electricity Amendment Bill of 2021, is different. It focuses on the root causes of the problem and devises solutions accordingly, rather than try fixing them with a Band-Aid (as previous regulations did).

The method opted by the Bill to fix these ailments, is to bring about large changes in the Industry - ranging from privatization of distribution companies to mandatory sourcing of renewable energy.

Whenever there is a regulatory disruption in an establish Industry - the ground is fertile for opportunity. This article is an attempt to identify such emerging opportunities.

Before we proceed, please consider sharing this write up with your friends or on your social media.
My aim, through these write ups, is to reach out to as many people as I can, so that they can make informed financial decisions.

Share

This article is divided into the following parts:

1. Current Problems with the Energy Sector in India

2. What does Electricity Amendment Bill 2021 proposes?

3. Opportunities arising out of Electricity Amendment Bill 2021

4. Conclusion

1. Current Problems with Energy Sector in India

Within the Indian Energy Sector, the current public electricity distribution companies are a ticking time bomb waiting to explode and impact the financial stability of the entire industry.

Together, all state owned electricity distribution companies (or DISCOMs), owe upwards of INR 75,000cr (~$ 10 Billion) to power generation companies. To complicate matters further, most of these DISCOMs have large debts to various state and national banks.

Financial conditions of these DISCOMs today is so bad that even after subsidies and various monetary schemes by central government (UDAY etc.), they are unable to turn a profit or breakeven.

Below table is taken from a report by Power Finance Corporation of India. It shows the difference between cost and revenue structures of distribution utilities. Notice, how in the revenue structure, the total is still ~50,000 cr. short to breakeven. Take away the regulatory grants and subsidies and it gets worse.

These state owned DISCOMs haven’t made enough significant investments in upgrading the transmission and distribution infrastructure. The old infrastructure along with inefficiencies of a government owned utility company and political use of cheap electricity to win votes - has over the years translated towards India becoming the only large economy in the world where AT&C losses are upwards of 22%.

AT&C stands for Aggregate Technical & Commercial Loss, it is the difference in total energy generated by the grid vs total energy commercialized.

AT&C is a measure used to understand how much electricity produced by a country is wasted or lost (via transmission or theft or other inefficiencies)

As you can see from the above Figure, states who have privatized distribution of electricity (eg. Delhi and Maharashtra) report much lower AT&C losses compare to states where distribution of electricity is still under the control of state government (eg. Arunachal Pradesh).

Among the myriad of challenges, include GST and taxation. As electricity comes under State Government, there isn’t a standard nation wide taxation policy. It is left upto State Governments to decide how they want to tax electricity consumption - which in some states is taxed as high as 20%.

To complicate matters further - lots of taxes and duties are levied on coal (responsible for over 50% of electricity generation in the country). Even though coal is under GST regime, electricity consumption is not - which prevents utilities from accessing the input tax credits as per GST policies. It is estimated that just inclusion of electricity under GST will reduce cost of electricity consumption by 17paise per unit across the nation.

Subscribe now

Today, the central government has to infuse funds to this sector every year (~90,000cr in 2020 alone) while the collective debt of state owned discoms stand to touch ~6 Lakh cr. This trend is obviously not sustainable and if something isn’t done anytime soon - the entire sector maybe on the verge of collapse.

To prevent this from happening - the parliament is about to pass the Electricity Amendment Bill of 2021 in the upcoming winter session.

Let’s now look at the major parts of this Bill.

2. What does Electricity Amendment Bill 2021 proposes?

Regulatory changes are not new to the power sector in India. Over the previous two decades, multiple regulations have been introduced with the objective to fix specific ailments within the sector.

The last major change was the Electricity Act of 2003, which introduced multi year tariffs and 25 year Power Purchase Agreements along with power trading and open access.

Open Access allows consumers with requirements of more than 1MW to source electricity directly from generators instead of distribution companies

Since 2003, specific regulations have been introduced to either stabilize the financial stress within the sector or to reduce the AT&C losses we discussed earlier.

The Electricity Amendment Bill of 2021 is primarily targeted at

1. Introducing private distribution companies and allowing end consumers to choose a distribution provider - a private company or a state owned player

2. Reducing AT&C losses within the system by making it mandatory to install smart meters

3. Enabling larger consumption of renewable energy by allowing for fixed renewable power purchase obligations

4. Giving more powers to the regulator to settle disputes and regulate the system by bringing more efficiency and transparency (like RERA did for real estate industry)

Let’s take a closer look at the first three.

Share Invest Karo India

Multiple Distribution Companies and Consumer Choice

The Bill recognizes that today distribution companies across the country are monopolies, either government or private. This reduces competition, disincentivizes the distribution company to invest in efficiencies and improving service, and leaves the customers with subpar experience and high electricity rates.

The Government now wants to delicense this entire sector. No longer a distribution company will require a license (which are limited and controlled by the state) to operate. Instead anyone in the country can apply to become a distribution utility.

To operate legally as an electricity distribution company, they have to register themselves with the appropriate commission in the State. As long as these companies meet the eligibility criteria, their applications will be approved within 60 days. Upon approval, a distribution company will remain bound by rules, regulations and oversight of the State Electricity Regulatory Commission (SERC).