Rain Industries - An oversold de-leveraging play

I saw this Youtube video where Mohnish is talking about Rain and Suntek.

Here’s what I feel about this company and also Mohnish’s holding POV:
Pros:

  1. As Mohnish mentions, this company is owned and operated by a Maverik who will stop at nothing to optimize the operations, not only reducing, but converting dangerous waste SO2 emissions into useful byproducts which can be sold in the market. He will create ingenious in-house developed products like Anhydrous Carbon Pellets which remove dependence on GPC.
  2. Mohnish also mentions something very fascinating about the Debt and its structure: The company has not put down any collateral for the loan, meaning, if the business fails and there is no debt repayment, the company does not really lose anything else from any of the other businesses. So Rain takes a giant 1B$ loan, tries to make a business work (which imo has 90% chances of working). If it does fail (10% chance), then the company loses revenue from this stream, but still has the rest of its businesses intact since there is no collateral for the loan.
  3. The loan was taken by raising money via international bonds, getting Meryl lynch and Goldman to underwrite such huge bond issues demonstrates the power of the operating business for Rain.
  4. The biggest pro which Mohnish referred to and which I can also agree with is the severe under-valuation of Rain. A company with Sales of 12k INR in a trough year is available at a market cap of 2600 crores. I think the only risk analysis to be done here is whether they can cover their interest payments. The fact that global interest rates are going down is good for Rain. They can potentially refinance their debt at even lower rates now (current rates are around 5-7% as someone else mentioned) which could reduce the debt risk even more. Current interest coverage ratio is 2.36 which seems like a medium comfortable place to be in. The TTM Operating Cash flow is 1,569 cr for a 2400 cr market cap company. This is what Mohnish refers to as a P/E of 1 buy.

Cons:

  1. Mohnish, for all his bullishness on Rain had actually reduced his position in Rain. This does not necessarily mean that he does not believe in the company, merely that he found a better use for his money (better investment). His holding went down from 9.99% to 8.17% that it is now.
  2. A lot of investors have said that “avoid companies that are too over-leveraged and you are going to be fine”. This is in general very sound advice. Is rain the exception that proves the rule? I don’t know.
  3. As many others have said, Rain finds itself in a cyclical business. But one thing I have come to appreciate over the years is that almost all businesses are cyclical. Even banking, often touted as a secular growth story, is a cyclical business. Have a look at ICICI bank or axis bank earnings and you’ll see what I’m saying. Pharma? cyclical. All businesses where the input or the output is considered to be a commodity are cyclicals. That does not mean that they do not make for good investments. Having said that, would I hold Rain for 10 years? probably not.

All in all I would urge folks to go over Mohnish’s interview as well as other informative valuepickr threads such as the ART of valuation and Towards a capital allocation framework. Rain industries in my mind is a Type B business with great management and debt risks that has high probability of returning 5-6x the capital (at least) in 2 years. That is the way I would treat it.
Note: The management seems to try and convert it into a Type A business with increasing value added products, and so forth.

Disc: Not invested yet, but plan to add a small 5% position over next few months, specially post Q2 results (rain industries creates its AR aligned with calendar years) where revenue and profits would fall dramatically.

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