RITES Limited Stock Analysis

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India aims to achieve a target of becoming a $5 trillion economy by 2025 and various initiatives have been taken in this regard. However, to achieve the target of $5 trillion economy by 2025, and meet the aspirations of the citizens of India, creating new and upgrading existing infrastructure will be the key to raising India’s competitiveness. One such initiative is the National Infrastructure Pipeline, which has outlined plans to invest more than 102 Lakh crore rupees on infrastructure projects by 2024-25.

A tweet from the Prime Minister’s handle on Independence Day read the following “National Infrastructure Pipeline is a project that will revolutionize India’s infra creation efforts. Many new jobs will be created, our farmers, youngsters, entrepreneurs will benefit. #AatmaNirbharBharat

Now from a business perspective, this brings a lot of opportunities in terms of upcoming investments in this sector. But the infrastructure sector has not been a favorite of the investing community for a variety of reasons. Infrastructure investments are highly capital intensive which requires high upfront investments along with the need for continued investments with cash/revenue realizations also being staggered. Moreover, the time from inception to completion of the projects makes it a risky investment. Add to it the recent IL&FS fallout leading to a panic mode in the investment community.

But what if there is a business that is well-positioned to take advantage of such an opportunity without the risks of high capital investments, Enter – RITES!

Rites is a wholly-owned Government company, a Miniratna (Category – I) Schedule ‘A’ Public Sector Enterprise. The company is in the business of providing transport infrastructure consulting and predominantly caters to the Government Sector (Indian Railways, PSUs, etc.)

The major services provided by the Company include Survey and Feasibility Studies, Detailed Design & Engineering, Project Management Consultancy, third party inspection, quality assurance, Construction Supervision, operation, maintenance, and rehabilitation of locomotives & rolling stock, leasing and export of locomotives & rolling stock, Energy management, etc. The company also has a presence in the field of transaction advisory for infrastructure projects being taken up on PPP (Public Private Partnership) model.

The company draws its revenues from the following services:

  • Consultancy Fee
  • Export Sales
  • Lease Services
  • Turnkey Construction Projects
  • Inspection Fee

Over the last 5 years, the company has demonstrated consistent earning power with a cumulative annual growth rate of 20% with an operating profit margin between 27-29%.

RITES Operating Performance

RITES – Operating Performance Snapshot

The net profit of the company has been increasing at a CAGR of 15% over the last 5 years with a healthy net profit margin of 25%.

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The company derives the majority of its revenues from consultancy fees reducing its vulnerability of deploying high capital for an extended period of time which is one of the key reasons why the infrastructure industry is termed as risky.

The revenue breakup in terms of the contribution for the last three years has been shown below:

RITES Revenue SPlit

RITES – Revenue Split

Two observations stand out here, first, the share from consultancy fee has been declining in the last 3 years with a shift towards higher export sales and turnkey construction projects and second is that the company has been deriving significant revenue from the other income head.

The move to turnkey construction from consulting dilutes the asset-light proposition of the company. The shift while boosting revenues is expected to hurt the margins of the company. While there has not been a significant shift in the operating profit margin of the company in the last three years, the increase in turnkey construction projects might be a cause of caution for investors.

The company has also gained from the increase in export sales. The combination of financial assistance through government budgets by countries and financial assistance by multi-lateral and bilateral agencies also accelerates the infrastructure creation. Line of Credit extended by India to several countries for their infrastructure / rolling stock requirements has created business opportunities for RITES.

On deep diving into the constituents of other income that the company generates we found that 142 Crores (~54%) of the other income comes from the interest from Banks and a large part of the other half comes from various export incentives that the company gets. Now, this is just a result of the high reserves that the company possesses (2383 Crores as of 31st March 2020).

High Cash in banks is not always appreciated in the investment community and is sometimes a question on the capital allocation of the management. But if we look at the 5-year track record of the company in terms of the return on incremental we see the following results:

 

Incremental Capital

Incremental Profit

Return

5 Year

1351

290

21%

3 Year

815

265

33%

1 Year

341

151

44%

 

*Capital & Profits in crores

These are enviable returns and speak volumes about the sound capital allocation capabilities of the company.

There are B2B/B2C companies, RITES essentially is a B2G (Business to Government) company providing its services to the government and sometimes for the government to other countries. This makes the company possess an intangible asset of a pseudo license when it comes to government facing projects which in itself is an economic moat.

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However, one drawback of dealing in a government facing projects is the delayed payments due to slow approvals and long timelines. The debtor days of the company stands at 124 days as of March 2020 as compared to 108 days in March 2019 and 137 days in March 2015.

The ratio of receivables to sales has been consistent in the range of 30%-35% in the past 5 years, while the company has made great progress in rationalizing the working capital requirements.

Head

3/31/2015

3/31/2016

3/31/2017

3/31/2018

3/31/2019

3/31/2020

Sales

1012.69

1217.82

1351.46

1497.45

2047.45

2474.41

Working

Capital

1212.08

1249.28

1382.12

1731.99

1846.55

1825.21

WC/Sales

120%

103%

102%

116%

90%

74%

Receivables

380.76

536.89

461.5

467.7

609.52

843.74

Rec/SALES

38%

44%

34%

31%

30%

34%

Inventory

6.68

49.43

50.42

9.38

104.93

10.67

Inv/Sales

1%

4%

4%

1%

5%

0%

However, when we look at the earnings quality of the business, we find that while the company has been generating consistent positive cash flows, they have been fluctuating over the years.

 

3/31/2015

3/31/2016

3/31/2017

3/31/2018

3/31/2019

3/31/2020

CFO

-88.52

463.14

555.14

410.04

163.58

319.08

Net Profit

312.21

338.64

328.38

342.48

469.51

616.1

CFO/Net Profit

-28%

137%

169%

120%

35%

52%

The company alludes to this point in the recent annual report when in the section of Impact of COVID 19 it notes that “A significant outstanding of USD 29 million from a foreign client, which was to be received in FY19-20, is now being realized during FY20-21, citing reasons of delays due to Covid-19”.

The volatile earnings quality in the last two years can also be attributed to a shift from consulting to turnkey construction projects.

The key driver for the growth of RITES is the public investment in the infrastructure sector. A look at the detailed report of the National Infrastructure Pipeline provides some encouraging results.

The estimated investments in the infrastructure sector has been 56.58 Lakh crore in the past 7 fiscal year with more than 70% of this investment coming from the central/state governments.

And the target for the investments in the next 5 years is pegged at 102 lakh crores!

The next logical question here is how much of this investment will benefit RITES, we know that the major area of operations for RITES is in the railway sector.

According to the report, 12% of these 102 lakh crores will be spent in the railway sector as compared to 10% spent in the last 7 years.

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The company also has a very healthy order book of Rs. 6223 Crores up from Rs. 4818 crores to weather the current COVID crisis.

However, RITES being a PSU company has made the investors wary of the opportunity to aggressively tap into the potential growth. Moreover, the increasing presence of private players in the bidding of contracts poses a risk for RITES’ growth.

The company also admits this point when it mentions in the report that “In view of increased globalization and opening up of cross-border business, there is a greater risk of competition from foreign companies in consultancy projects. RITES also faces certain competitive pressures from the existing competitors and new entrants in both the public and private sectors within India. Increased competition and aggressive bidding by such competitors can make its ability to procure business in future uncertain which may adversely affect its business, financial condition, and results of operations”.

While 25% of the order book of the company is from private orders, the company will have to keep improving its offerings to compete in this space with its private counterparts.

Also, a further shift from its consulting business towards turkey construction kind of work will dilute the value proposition that the company has right now.

So overall we have a virtual debt-free B2G business that has shown consistent earning power in the past with impressive return on equity possessing an intangible asset which makes it well-positioned to exploit the huge demand coming its way.

While the company has risks associated with its PSU structure and a shift from its asset-light value proposition, these downsides can be protected given the opportunity of further stake selling coupled with the government’s focus on raising revenues from such sources.

With a dividend yield of 6.55% and a PE ratio of 10.51 RITES might not be a compounding machine or a multi-bagger for investors but has a very high potential of giving decent returns for people willing to hold on it for an extended period.

And as the Oracle of Omaha says “I would be certain of a good return rather than hopeful of a great one”

Arpit Shrivastava’s LinkedIn Profile | Email: pg18arpit_s@mandevian.com

Cover Image: Musafir Namah

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Arpit Shrivastava
Arpit is an incoming Consultant at Deloitte USI Consulting and a graduate of MDI Gurgaon from the class of 2020. He believes that the past is about estimations and the future is about expectations. Hence, he loves connecting numbers of the past to narratives of the future to identify the story of strong businesses. He is an avid follower of the value investing principles laid out by Warren Buffett and Charlie Munger.
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