Jitendra Kumar Gupta Moneycontrol Research
At the peak of Rain Industries' market capitalisation in 2018, renowned value investor Mohnish Pabrai was sitting on a 12x gain. Unfortunately, the stock plunged from the highs of Rs 436 per share to current levels of Rs 119 a share -falling by almost 70%.
While Pabrai is still sitting on a 3x return on his original investment made at around Rs 40 a share in 2015, he believes that the stock is cheap and still holds good potential.
To substantiate his point, he looks at the future cash flows of the company relative to its current market price. "Rain is being valued these days at $560 million (Rs 4000 crore). A bad year for the company would mean floor earnings of perhaps $100 million (Rs 714 crore). A good year may produce more than $250 million (Rs 1785 crore) in after-tax profit. Perhaps average earnings will be $150 million (Rs 1071 crore). However, we have to add to that Jagan’s (Rain’s Managing Director and 40+% shareholder) magic with reinvesting earnings at a high ROE. In that scenario, “floor earnings” may very well be $200 million (Rs 1428 crore) in a few years. Rain is cheap based on estimated future cash flows if the intrinsic value does not increase. It is insanely cheap if earnings are redeployed at a 30+% after tax annual return," said Pabrai in his recently published annual shareholder letter.
Before we dwell on cash lets understand its business. Rain Industries generates close to 72 percent of its revenue (exports accounting for 85 percent) from calcined pet coke (CPC) and coal tar pitch (CTP), which are the derivatives of crude oil and coking coal respectively. These products are used by aluminium producers.
Rain is a global player in this segment supplying to some of the world's biggest aluminium producers like Rio Tinto and US-based Alcoa from its manufacturing facilities in the US and other parts of the world. In the domestic market, it supplies to all the leading players such as Hindalco, Nalco and Vedanta and others.
Rain has been a major beneficiary of the upturn in the commodity cycle, particularly aluminium, post-2014 and 2015, in terms of both driving the benefits of higher volumes and better realisations.
With the improvement in operating environment and pricing, operating assets started throwing more and more cash thus improving its ability service the debt it borrowed for the capex and acquisitions in the past.
In the current year, the company is expected to make a net profit of close to Rs 1000 crore as against, Rs 320 crore net profit in the year 2015. Interestingly, the company has been utilising this cash to reduce its financial leverage. Its interest coverage ratio this year is expected moved to over 4 times as against a low of 1.4 times in the year 2014.
Coming back to the utilisation of cash, during the first three quarters of the current financial year (company follow calendar year), the company has already produced close to Rs 1,000 crore of cash profits, which is quite good for a company of a balance sheet size of about Rs 12,000 crore. This is precisely an investment argument that Mohnish Pabrai puts in his letter that if the company can deploy this additional cash at high RoE, the benefits of the same would be visible in the coming years.
"In the last 3+ years that we have owned Rain, I have seen Jagan Reddy make one smart decision after another. In fact, I have never seen Jagan make even one dumb decision. He has made very large capital allocation calls over the last 12+ years and they have been flawless. It is a remarkable record. He is a dream manager," said Pabrai.
A good capital allocator would weigh various options and deploy capital in the deserving businesses and activities that results into maximising shareholders value in terms of creating decent returns; justifiable enough for the equity risk and the opportunity cost.
"Every year, Rain is going to hand Jagan $100-$250 million in cash. It will get intelligently redeployed. And each time he’ll probably increase market value by 2x or more of the CapEx spend. It would be very dumb to say goodbye to such a gifted leader and capital allocator," he said.
Mohnish, who is known for patiently holding on to his multi-baggers stocks, may not say goodbye easily particularly when the business is run by competent managers and intrinsic value much higher than the current market price.
Theoretically, at 1.5 to 2 times price to book value, every incremental cash or equity capital deployed in the business through the capex or other means should create incremental market capitalization of 1.5 to 2 times, apart from the value that comes from the existing business.
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(Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here)
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