RACL Geartech is an auto-ancillary manufacturing precision gears and related parts for 2-Wheelers, 3-Wheelers, Agriculture Equipment and Recreational vehicles. Company has a strong value-added manufacturing business on the back of low-volume & high-value products for high-end vehicles of customers like BMW, KTM, Kawasaki, Kubota etc and derives 70% of business from exports.
Anyone who is not familiar with the company can read our full research report on the company here; we have also talked about value added manufacturing as a business model in the report-
RACL has been doing very well since last few years with growth in excess of 30% and should do similar kind of growth in FY24. The market has rewarded company’s performance and the stock is up nearly 10x in last ~3 years.
However, this strong scaleup has brought up a challenge in terms of capital requirements. RACL’s business construct of low volume, high value, high margin, but with high inventory & working capital requirements provides it with a ROCE of ~20-25%.
But given that the company has been growing at 30%+ rates, the internal cashflow generation is not enough to support this growth and thus the company has increasingly raised debt. Company’s debt has nearly tripled over last 2-years from ~Rs85 crores to ~Rs200 crores.
Though the overall leverage is relatively comfortable at the balancesheet level, it is having a relatively large impact on the PnL. In FY23, on a PBT base of ~Rs51 crores, RACL has an interest cost of ~Rs20 crores, which is quite large.
We believe that it is a right time for RACL to monetize its debt; and there are clear positive outcomes in doing so-
At its current market cap of ~1000 crores, it will need to dilute 20% to clear its entire debt. Doing so will increase its earnings by a substantial 40% given the high interest burden it has.
Even after considering the equity dilution, the company’s EPS will increase by ~17%. And more than anything it will give the management more room & flexibility to invest behind growth as the cashflows available to the company would also be higher without the interest burden.
Company’s management has been vocal that they don’t want to raise equity; but we believe that equity dilution is not necessarily a bad thing. There have been enough examples in the past wherein companies have used equity as a tool to their advantages.
Natco Pharma is one example that we have previously talked about on how its management has always leveraged capital markets to its benefit. You can read about it here- Weekly Insights #6- Natco Pharma: Buyback Support & Where is the Upside?
Another good example here is that of Safari Industries. Everyone knows the story of how Safari went from nowhere to being a dominant player in an industry like Luggage wherein successful scaleup of new players is extremely difficult. And one of the things that helped Safari was its ability to raise equity capital. Safari’s business scale & construct never provided it with enough capital to support its growth & ambitions; and thus, it raised equity capital multiple times to reach a stage today wherein it has that scale & construct to support its growth & ambitions through internal accruals itself.
In summary, we believe that equity is an extremely important capital tool for listed businesses to fulfill their growth ambitions and that equity dilution done to support high levels of growth over & above what business’s current construct can support is not a bad thing at all.
That’s it for this week, new insight coming up next week. So stayed tuned!
Surge Capital is a trade/brand name used by Ankush Agrawal (Individual SEBI Registered Research Analyst INH000008941) to provide equity research services in the Indian Equity Markets.
“Registration granted by SEBI, and certification from NISM in no way guarantee performance of the Research Analyst or provide any assurance of returns to investors”
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More details: https://www.surgecapital.in/disclosures
Stock specific investment disclosure:
RACL Geartech- Invested. Not Traded in last 30 days. Active recommendation in Research Service.
Natco Pharma- Not Invested. Not Traded in last 30 days. Not an active recommendation in Research Service.
Safari Industries- Invested. Not Traded in last 30 days. Active recommendation in Research Service.