Deep Dive 2.0: Bharat Rasayan

[rohitbalakrish_]

Hi Guys,

What a market we have had in the last few days.

First up @divygupta splendid work on Axtel Template. Every word of appreciation is thoroughly and richly deserved.

This whole thing looked to me as a complicated task, based on what pictures @Donald uploaded, however I got super excited reading your Axtel note. So Thanks again!

I have spent some time on Bharat Rasayan over the last few days, and I took it up a challenge to see if I can fill this up. I am not sure if I have captured all the nuances- a lot of the praise I hear from the existing investors who track the co is about the Dahej plant- I haven’t seen it myself - so the feel for me on that point is low.

One more point - before doing this exercise, I didn’t really feel the benefits of this as the story is usually clear in your head, but one thing I would say is that after filling up this sheet- I think it just makes it CLEARER. I usually write an Investment Note before my purchase and that is usually comprehensive, but this sheet sort of just cuts to the chase and focuses on the key points and you can be concise and focus on key points, which some-times may get lost in an investment note.

I would love to get feedback from @desaidhwanil, @ananth and @ankitgupta as they have been tracking the co for a long time and have posted copious notes from their interactions with the management . Big thanks to them!

Standard Disclaimer- I don’t own any shares in Bharat Rasayan. Bharat Rasayan_Deep Dive _ Template_Rohit Balakrishnan.docx (78.1 KB)

[sohamdas]

Hi All,

Please find attached the first draft of Bharat Rasayan thesis. I have tried to merge the insights from the thread in VP(Ankit’s messages) and blend with Ankit’s thesis here.

Bharat Rasayan Thesis_Soham Das.docx (120.7 KB)

[Vpayasam]

Dear All,

Please find the transcribed stock story of Bharat Rasayan @ankitgupta version of it. Hope I could do justice and transcribe your thought process. Looking forward to hear it from you and improve where ever needed.

Vamsi_Bharath Rasayan Stock Story_Final.docx (578.4 KB)

Thanks a lot for @Donald for this wonderful opportunity and the help offered in the process. Learning effect has been tremendous for me personally. Just in the process of justifying one argument from the analyst, there are so many questions one has to answer himself.

The template which is used to analyse a stock is a result of multiple frameworks VP Seniors have developed over the years like Capital Allocation & Business Quality Business Quality and slotting a business in this flow lets us develop a mental process (model) to pursue the next one.

There are 3 tasks for me personally from here on:

• Try and Slot my portfolio using this framework and develop those 1-2 paras for each stock which Mr. D suggested

• Work on identifying levers of mental models and sharpen my ability to pull out information from the information overload we are presented with

• Working on my capital allocation as soon as I get a hang of the first two

I can only urge other serious learners to take up the process as the learning effect is tremendous. Excited to read Dhwanil Desai’s version sometime soon on it…

[ankitgupta]

Hi Guys,

Apologies for pitching a bit late. Thanks for putting in your time to work on the template and simplify it in a readable one. I first thought I would correct some of the factual errors being captured in the template. Bharat Rasayan is a B2B company and it is difficult to get data about the company (like it is for many B2B companies including PI’s CSM business where client confidentiality is extremely important). Furthermore, management doesn’t do concalls and interacts with investors only at the AGM. Most of the discussion with Donald was based on interaction with mine and few investor friend’s talk with management during AGM and feedback from suppliers/customers and industry experts.
First coming to @sohamdas template:

• Company doesn’t have a portfolio of 40 - 45 molecules. It has a portfolio of 20 - 22 products and plans to add 20 over the next few years.

• Benign impact of GST in weeding out lower purity production - I didnt get this point.

• I dont agree with the price reflecting high degree of undervaluation.

• I dont think there is a significant operating leverage potential in the company as per my understanding. For a company having gross margins of 30 - 35%, EBITDA margins of 19% are pretty good in my view. Some improvement might happen in margins with change in product mix, backward integration and increase in exports as % of sales.

• Entire sales of the company is B2B only - technical and intermediate. Break up of sales: sales to MNC for generic products (domestic and exports combined) - 50%, sales to group companies (Bharat group - BR Agrotech and Bharat Insecticide) and domestic companies for generic products (like Indofil, Rallis, UPL etc) - 35 - 40% and sales to MNCs for patented products - 5 - 10%.

• On the flip side, the MNCs have high degree of choice and no-exclusivity clauses in their contracts which may prevent them from “capability-shopping” - It takes a long time for MNC to switch its suppliers. Assessing capabilities, sticking to timelines, chemistry skills etc is important for them and relationship takes years to build even for generic molecules. For them, prices is not the most important criteria. For patented molecules, relationships are far more sticky. However, they do have a choice to go to other suppliers. The Nissan example that you gave might be true for the Rasayan standalone business but when they form a JV, invest in it and manufacture patented molecules there, switching might get a lot more difficult.

• The company is (and has been) actively pursuing CRAMS opportunities from Europe and specifically in the domain of patented molecules. The “winning” of even a single patented molecule manufacturing contract can lead to very long contract lives, highly sticky relationships and consequently better quality of earnings. - The company is already doing CRAMS for generic molecules for many European, American and Japanese customers. It is also doing manufacturing of patented products although their contribution to sales is pretty less currently.

• However if one were to take a longer time 2-3 year view, a 2-3x upside in the next 2-3years should be expected as the business itself will grow at that rate. I would be happy if it happens Frankly, on a conservative basis I am not sure on it and no one can predict upsides or downsides in the market.

• It has a market leading position in meta phenoxy benzaldehyde, lambda cyhalothrin, Piroxofoppropinyl, Thiamethoxam and Cypermethrin - Most of these products are highly competitive and efficiencies, backward integration and purity levels play a big role in it - Not sure how one would relate mix of prudence and smart business in it (too much jargon for me)

• This is so because registering chemicals in Western Hemisphere (i.e. US, Europe and Brazil) is significantly time consuming and costly. Increasingly since 2015, the company had been registering molecules that attracts significantly less attention from competition. However management has clarified that low competition, also implies higher margin, even if the volumes are lower. - Most of the generic products mentioned in above points are largely being exported and these have pretty high competition.

• The business has a negative free cash flow for now, owing to efforts to award higher discounts on the demand side and build supplier loyalty on the supply side. This has depressed its RoE and economic profit margin. This has lowered the overall quality of earnings for the business. - Business has negative free cash flow due to increase in working capital requirement with increase in scale and capex being done to increase capacity and backward integration into intermediate manufacturing. I am not sure for a growing manufacturing company, quality of earnings can be looked at it from free cash flow front. Furthermore, free cash flow dont have anything to do with RoE and company already generates healthy RoE of 30% plus.

• The growth of the business is amplified by three-fold forces – the industry is growing, the market share is poised to grow and the margins will improve. - It is difficult in any B2B business to gauge market share between players.

• However, on the flip side, this business also has a significant vulnerability in its production chain owing to its lone plant, at least till its new plant comes online. - The company has two plants - Dahej and Rohtak. Dahej is a much bigger plant compared to Rohtak and contributed more to the overall topline of the company.

• The analyst feels the promoter knows the number of each machine installed (!) which speaks volumes of his involvement with the business. - I meant he had once quoted in the discussion during the AGM that he even knows the serial number of the machine installed in the plant.

• One can allocate with a 2-3 years time horizon for a 2-3x rise in market cap. If it continues to execute well beyond 3-4 years, the business will be at a different level. If it doesn’t falter on Execution, the Management has a great chance to replicate its success over next 10 years. Expected appreciation of value is 25-40% (depending on the horizon) - I really dont know if anyone has the foresight to predict the price movements.

• Success in breaking through into new geographies is also extremely important as it will signal management capability, derisk the business from a single geography and bring diversity in the product basket. - It is already present in multiple geographies.

Kudos to you for putting up so much hard work in trying to extract information from the template especially when you were not even part of the interaction. It is my responsibility to pin point some factual errors about the company.
@rohitbalakrish_& @Vpayasam would give my pointers about the template sheet that you guys have prepared in few days.

[sohamdas]

Hi @ankitgupta
I was looking at the EIC of the Dahej plant and it looked like the number of molecules it is about to start manufacturing (new/expanded/no change) extends to 92.

Can you please shed some light here?

[Donald]

Guys,

My Sincere thanks for putting in the hard work. It will certainly inspire others, to do more.

At the same time, we have to inculcate some discipline so that valuable time of senior investors (who are quite busy) are not spent answering/correcting details put in by us. I did advise repeatedly - everyone please stick to only capturing the Analysts take in Ver1 - which is the public upload file (you can always do a ver2 for yourself - that includes blended thesis of your observations/opinions, data points, and those of others that confirm, build-on or even repudiate the Analyst’s take).

We are trying to capture different analysts take in its entirety/purity (just as captured by Donald hopefully without introducing major biases/data points of his own). The purpose of that - already explained before - is to expose systematically gaps/biases of individual takes - at least 3-4 Then we will consolidate, blend into official VP stock story.

Re-iterating again the DONT’s and DO’s

1. DONT include/blend any thesis of your own or data points - this is NOT your version. This is the Analysts version you are helping capture.

2. Do capture ONLY the Analysts version. Supply all necessary supporting data for the Analyst take, and expand on details from VP discussion threads, annual reports, presentations, AGM Notes, Concalls, Research Reports, Industry and Competitor reports/data, and the like

Hopefully Vamsi’s version will be close to Ankit’s and much more in sync. Rohit is experienced enough and has talked extensively to both Ankit and Dhwanil - so that version too many not need much time from Ankit for responding/correcting.

Now let’s do up Dhwanils version quickly.
I am sure now familiarity with the business is STRONG, and therefore capturing Dhwanils version is going to take much lesser time?

Progress here will incentivise me to immediately capture a skeptic version? from Rupesh.

Thanks again for being the early-adopters
You will benefit much directly, and indirectly that much I can assure you.
Look forward to the progress in this thread.

Hopefully this could lead to the first entry in Stock Story 2.0 !!
(with major contributions from the Community, there will be more ownership hopefully, there will be less gaps, and less biases captured, it will be much easier to keep updated, and so on…)

I am very hopeful, if done rightly and incentivised properly - there is huge potential to scale up this important activity in VP

[ashwinidamani]

Is there any work done yet on Red Flags in Bharat Rasayan. There are red flags galore ranging from Related Party transactions, concentrated shareholding, debtor days, promoters having same line of business in unlisted entities

[Vpayasam]

I was trying to understand the product development process and the market/players/industry structure involved - My Learnings are:

The distribution chain of the agrochemicals industry looks:

• Raw Material supplier explains itself (basic ingredients)

• Technical grade manufacturers - Are the ones that invest in higher chemistry skills and create molecules which are the active ingredients in all forms of products - Herbicides, Insecticides, Fungicides and so on…Hence a B2B business

A pesticide has two main components, namely, the active ingredient(s) and the inert ingredient(s). The active ingredient is the one that gives a pesticide its pesticidal action. It’s called the technical grade of a pesticide. The active ingredient is the technical grade of the pure pesticide. A pesticide is rarely applied in its pure form. It is usually formulated by adding inert ingredients that improve storage, handling, application, effectiveness or safety. The inert ingredient does not have any pesticidal action.

• Formulators - Are the ones who produce the final products (e.g. Herbicides) by mixing the active ingredients with inert ingredients (solvents, adjuvant and fillers) to achieve the desired formulation. Hence a B2C business

Pesticides are first manufactured as technical grade product, which has 85% or more of the active chemical ingredients as it has a higher commercial purity. The active ingredients are then mixed with inert ingredients (solvents, adjuvant and fillers) to achieve the desired formulation. The active ingredient kills the pest whereas the inert ingredient facilitates ease of handling, spraying and coating on plants

A very detailed presentation from Syngenta on the product development process here http://www.oxfordsynthesiscdt.ox.ac.uk/resources/SBM-CDT-Agrochemistry.pdf (it’s huge!!)

• And Intermediates (other product from BRL) which are also used in the synthesis of the active ingredient. They are raw materials used for the manufacture of the technical grade of active ingredient by chemical reactions or purification.

[rohitbalakrish_]

I have mentioned in my note. Those are risks for sure.

[Vpayasam]

These are findings till date on Red Flags

As with the nature of the business, the ability of the management to manage high working capital requirements effectively will determine the course of growth. Till now they have been very efficient in managing it. High ROE offsets the high capital turns (1.5 -1.7X) and is the advantage offered by the nature of the business where production efficiency is good but capital efficiency is poor

• Working capital for MNCs sale requirement
• Low creditor days combined with higher discounts → Higher supplier loyalty

Further input from @rupaniamit on shareholding through unrelated firms

Bharat Rasayan Ltd

I did some digging and sharing my findings below: Ambaa Sec Pvt Ltd holds 4.94% of stake since Dec 2006. No changes since 2006. No data available before Dec 2006. Ritesh Stock Broking holds 4.96% stake since March 2010 and still holding 4.75% Shiv Shankar Securities holds 3.62% since June 2008 and still holds 1.92%. At least on paper they look like “long-term” investors. Will be interesting to see shareholding pattern in FY19 AR because of recent fall. Based on findings so far there is good…

[Donald]

Thanks Ashwini for prodding at the right time. It’s over to you now, for a more complete Red Flags dissection.
We will get the bulls to defend.

But let’s do that part - the attack and the defence at the right place - Bharat Rasayan main thread.

[ashwinidamani]

Hi @supriyo Please resist from using negative words. We dont cast aspersions . We just identify if there are risks/red flags and how to model that in our valuations.

secondly, as @Donald said, lets move to BR Thread.

[ankitgupta]

I think we are diluting the entire discussion by not having some basic understanding of how cash flow from operations is calculated!
Please refrain from using such strong words until you have some strong ‘factual’ information about the company.

[ankitgupta]

Hi Soham,

Thanks for digging in the EC report of Rasayan for Dahej plant. You can find one for Saykha as well - BR EC Report_Saykha Expansion.pdf (7.1 MB)
Normally, what happens in an EC filing is that companies takes approval for as many products as possible so that they don’t have to go back to ministry in case of addition of new products. These is primarily to avoid delays in getting approvals in case of addition of new products. They file for products which they might be looking to manufacture 3 - 5 years down the line as well. Many of the times, the company might not even manufacture some of the products they file in EC.

[sohamdas]

Yes, I did find the one on Saykha as well (and was trying to project some details on the other greenfield project, no luck yet).

And thank you for clarifying the dynamics of the approval. Many thanks so 20-22 molecules it is then. Will get the second version corrected.

[Anant]

@ashwinidamani I am in agreement with you on raising red flags and those of us responding have absolutely no right to ask you to have a better understanding of business. The red flags are an outcome of Balance Sheet /Cash flow/P&L and other notes to accounts. I do appreciate the work you are doing.

@anantjain87 is a different anant jain, I guessed you were referring to me.

[Donald]

@Anant

@ashwinidamani I am in agreement with you on raising red flags and those of us responding have absolutely no right to ask you to have a better understanding of business.

Absolutely with Ashwini and Anant on this. That’s the whole purpose of the exercise. The forensic auditor does not need to have a deep understanding of the business in question. The job is ONLY to point out inconsistencies that crop up from a scrutiny of the Accounts statements, and Notes to Accounts. There can be differences in the interpretation of Inconsistencies. There can be deficiencies even when enough drill-down or drill-through is not done on the Account Statements. That’s all a part of our getting better at the job, and getting better at accommodating new roles into Team VP.

It is the also the job of the Forensics person to therefore stick to FACTS - and perhaps only to point to the inconsistencies - rather than share an opinion this way or that way. If any opinion shared (that is completely SHORT on facts and NOT substantiated by any datapoint) obviously there will be strident objections raised - that’s NOT the job of the Forensics audit, certainly NOT to play the Devils Advocate role - as highlighted in Alembic post. The devil’s advocate role is better played by Seniors who can address both sides of the story equally well - because they are (willing to) engaging deeper into the story - in order to better understand the facts, intentions, and implications.

I don’t think there are insults traded anywhere (especially on this [Alembic post] being referred to repeatedly (Alembic Pharma (Oral Solids ==> Injectables, Onco, Derma, Opthalmic) - #476 by Donald)) by me. I normally refrain from intervening in the red flags discussions - thats a deep subject matter expertise area - and leave it to professionals - CAs/Accountants to delve in. and sort out differing interpretations - not my expertise area, and neither my cup of tea. But I do and will intervene in future too - only to settle important basic guidelines - as in Alembic discussion, and also in Bharat Rasayan thread after this recent spirited animated discussion between passionate folks (I was unaware of for a few hours)

Let’s get better at this - as we understand each other and our intents better - while showing the maturity publicly needed. I am sure after 5-6 such exercises, all of us will settle down to a much smoother working relationship. Rest assured there is RESPECT - there are no insults - certainly not from my side. And I don’t think from Ashwini’s side either.

[vivek423]

Source: CARE report on Agrochemicals
@ankitgupta
Two questions:

1. Clearly India is doing extraordinarily well in exports of herbicides and fungicides while pesticide exports are declining. What explains this trend? Is it secular or temporary

2. Given that BR is largely into pesticides, could their expansion into fungicides and herbicides bring the next level of growth? Clearly, Astec is benefiting from being a fungicide technicals player inspite of being a less efficient operator than BR

[atul1082]

Finally what’s the take of VP on red flags raised? An average investor who is neither an expert in reading balance sheets not has a deep understanding of business gets confused and doesn’t know the outcome or which way to go?IMHO, we need to draw some conclusions on such findings or even to dig further .

Disc: no holding

[caspglko]

1-Globally Herbicides accounts for highest proportion around 43% of Total Pesticides sales. In India Insecticides account for highest sales of around 53%. This may be one of the reasons.
2-Efficiency is very subjective term. A pesticides producer manufacturing from basic stage will generally enjoy higher margin that buying Intermediate and doing final stage of reaction.