Today Merrill Lynch unloaded 1.5 Cr worth of Rain Industries, the reasons for the same are unclear.
The depressed valuation of this leveraged, underfollowed, niche market, stable margin, and oligopolistic natured business provides an opportunity for a serial capital compounder.
Currently Rain trades 2.7x 2013E earnings with a market capitalization of â*12.0 bln (US$195 mln). While a margin squeeze in the companyâs calcining business explains most of the earnings compression, a number of factors have contributed to Rainâs depressed valuation, namely: i) despite an acquisition valued at ~4.0x Rainâs market value investors have not seen any earnings accretion to date; ii) investors are worried of the companyâs leverage ratios; iii) the aluminum industry is out of favour with aluminum prices falling 25% since Jan -2011;
**Quality of Business.**Rain operates as a market leader in both pet coke calcining and coal tar distilling, which are best described as oligopolistic. Barriers to entry for these businesses include: regional markets created by notable transportation cost, longstanding customer and supplier relationships, strategically located facilities, and trademarks and patents.
**Management Plans and Interest.**Rain is operated by a well-aligned management team with a track record of prudent capital allocation. Jagan Mohan Reddy is the CEO of the company co-founded by his father, and overall the Reddy family owns ~40% of Rain Industries providing significant alignment of interest. Management is well aware of its depressed valuation and plans to return capital to shareholders while de-leveraging the corporate structure. From 2007 to 2012 Rain reduced its net-debt from US$728 mln to US$413 while returning 12% of income to shareholders.
Overall, Rain is worth in the ball park of â177/sh;Even using the âTight Marginâ scenario across all business segments, Rain should still be worth roughly â72/sh, or 80% more than its current price, providing little downside.
Disclosure: Taken a small position in Rain