High Debt- High Growth Dilemma. Case of ‘Ramkrishna Forgings’
Given the bull run of metal stocks, I have been on the lookout for stock in this sector that has started to show the growth in the numbers but still have a lot of value left. In my quest, I came across a company called “Ramakrishna forgings(RKF)”.
Based out of Jharkhand, the promoter-driven company is primarily into making forged components. Forging as a process/product does not require a lot of expertise and therefore is a commodity business with low margins. In the simplest term, it involves heating steel and then forging them into required shape through pressure or hammering.
The market size for the forged product in India is around ₹30,000 cr with Bharat forge being the largest player followed by RKF. There are a significant number of small players but given the capital intensive nature of the business, it serves as a deterrent for others to scale up. In order to generate an incremental ₹1 of sale, the industry needs to spend about ₹0.9 towards fixed asset
But with higher value-added products one can get better margins. That’s why RKF has been investing heavily to enhance capacity as well as get into machined and more complex products.
There are 3 categories of products manufactured by the company: Rolled, Forged & Machined.
RKF supplies its products to OEMs & Commercial vehicle(CV) companies such as Tata Motors, Ashok Leyland, Bharat Benz etc in the domestic market and Dana, Volvo, Daimler etc in the export market.
CV segment is cyclical in nature and in particular, H&M(Heavy & Medium) CV which is the core business for RKF, is the most cyclical.
In order to derisk itself, the company started focusing on the Export market since 2013-14 and have been successful in setting up its presence in those markets.
Despite all the efforts, the CV industry slowed drastically in both US(particularly class 8 truck) and the Indian markets in 2017 leading to de-growth in revenue. The cycle picked up towards end of Fy17 which is now reflecting in the quarterly growth numbers.
The company also has been spending over Rs 10 Cr on R&D which is going to bear fruit for the company sooner or later.
To grow aggressively, RKF has made heavy investment to the tune of Rs ₹900cr since 2014 through a mix of debt and equity.
Raised capital by way of issuing fresh shares to IFC. Currently, it has debt on the balance sheet to the tune of ₹850 cr.
Spent ₹70 cr to set up 4 press line to manufacture front axle beam, crankshafts, connecting rods.
Another aspect of the expansion has been the company improving content per vehicle i.e. manufacturing more number of products required for any vehicle. Co. have been adding 150+ products every year.
In FY17 alone, the company paid around Rs 75 cr in interest which is about 8.5% of net sales. But with the recent performance, the company looks comfortable in meeting its obligations. One indirect advantage with capex is that the company will have to pay a lower tax due to increased depreciation for the first few years which will boost the profitability.
Despite all these, there are certain causes of concern:
1. If suppose the 2017 scenario repeats itself, the company with such a heavy borrowing will be the first one to suffer.
2. Increasing steel prices is a concern for the company as it takes 6 month before the company is able to transfer the increase in cost to the customers.
3. Many customers citing their lackluster performance due to the sector cycle try to minimize the increase, thus squeezing the margins of companies like RKF.
4. Location– Being located in the eastern part of the country has its disadvantages. All the auto ancillary or CV companies are mostly located in Pune industrial area(Western India). That increases the logistics cost. The largest forging company ‘Bharat forge’ has set up its facilities in the Pune vicinity.
On analyzing the recent past numbers, we can see that EBITDA margins have remained stagnant, that would mean the Profit margins are due to ‘Volume growth’ and the effect of value-added products or operational efficiency is still to be felt.
While analyzing a company, it is almost impossible to get a perfect company.
One should weigh both the positive and negative points and take a decision accordingly.
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