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Rites is a wholly owned Government company, a Miniratna (Category – I) Schedule ‘A’ Public Sector Enterprise. But before we get into any further analysis, we must explain what a Miniratna (Category – I) Schedule ‘A’ Public Sector Enterprise is?
WHAT'S A MINIRATNA?

Imagine you were a public-sector enterprise under the Central Government and you made continuous profits during the past three years. While in your quest to be profitable, imagine you also maintained a positive net worth and refused to depend on budgetary support from the government. Imagine that you worked with integrity and as such, never defaulted on repayments of interests/loans. you would then be called a Miniratna. In case you wanted to be a Miniratna (Category – I) you would have to do all the things we just spoke of and would have to show pre-tax profits of Rs. 30 crores or more in any one of the three preceding years.

So right off the bat we know that RITES is a profit-making company and a very good one at that. The company has grown at a decent CAGR of about 7% (Standalone) in the past 5 years. It has also maintained profit margins of ~25% and is virtually debt free. The company’s financials look so consistent primarily for two reasons.  
  1. The company generates a significant chunk of its revenues through contracts from the Government of India (Ministry of Railways) and other state/central agencies and on most occasions, these contracts are awarded to Rites on a nomination basis i.e. there’s only 1 bidder, RITES Ltd
  2. Most of its business comes from consulting and consulting usually have high margins          

Revenue - till Mar'17

1500 Cr.

Profits- till Mar'17

355 Cr.


This system works beautifully so long as investments in railways continue to rise and the general macroeconomic conditions are stable.
While we can’t predict the macro-economic indicators, we looked at total investments in railways. We are not going to bother with all the numbers here but investments are expected to reach record highs based on current government initiatives. This is perhaps best explained by RITES’ order book. As of November 30, 2017, their order book stood at 4800 Cr. Also, we looked at their revenues since 2002 and surprisingly they have managed to consistently improve their top line YoY except on 2 occasions; in 2009-2010 and in 2014-2015. If we had to speculate about 2009 we would tell you it’s probably because of the global economic slowdown. But in 2014-2015 the company’s revenues dipped due to a slowdown in its exports business. So, what happened?
Before we talk about exports we want to tell you that RITES conduct its business in four segments - Consultancy services, Exports, Turnkey Projects, and Renewable energy. The four segments' revenue contribution is highlighted below:
REVENUE CONTRIBUTION FY 16-17
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Company's business operations

1. Consultancy Services
Imagine the Ministry of Railways decides to create a new railway line in Udaipur. Rites would be nominated to execute the project. RITES in turn, would first conduct a feasibility study. It would then float a tender so that interested parties can offer their bids and build the actual railway line. Finally, it would see to it that the project is completed without any hassle. To do all this, RITES needs very little fixed assets and very little capital. The only capital they need extensively is human capital and they have about 3000 employees in total. Historically, Consultancy has been the biggest revenue generator for RITES
2. Exports
Apart from consultancy services, RITES exports locomotives and rolling stocks (any vehicle that moves on railways) to multiple other developing countries. This contributes to 27.8% of their total revenues (2017), a significant chunk. This export income largely depends on political relations and the line of credit extended by the government of India to other countries that purchase/lease locomotives from RITES. There isn’t any fixed pattern to this and we can’t tell you how this will affect revenues going forward, except that, with a slowdown in the Indian export sector you could possibly see a reduction in the export income of RITES.
3. Turnkey Projects

In the past couple years when the company’s export income has declined, it made up for it by engaging in another line of business i.e. Turnkey projects

Turnkey projects, unlike consulting projects actually involves building things. While the company has mostly restricted itself to railway development work till now, it aims to expand into airways and metros going forward. The only reason we mention this is because there was a rather interesting development recently.

The company was approached by the Indian Railway Stations Development Corporation Limited to contribute up to 250 Cr. by buying out 25% of its equity share capital. This proposal is in its preliminary phase and yet to be proposed for risk assessment and investment decision by the Company. However, Indian Railways Stations Development Corporation, doesn’t have a lot to show in terms of financials. It has a total net worth of 40 Cr. and last year made losses of 4 Cr. on a top line of about 2 Cr. So, this investment, if it goes through, will have some repercussions on the financials of RITES Limited.

But don’t you worry, because RITES seemingly has a ridiculous looking cash balance (includes other liquid investments) standing at about 1380 Cr. Maybe all that cash can be put to some good use

4. Renewable energy
The company has also made forays into generating renewable power through solar and wind as part of the government’s plan to reduce its carbon footprint by 2020. The Ministry of Railways in particular hopes to meet 20% of their energy requirements through renewable sources and RITES is poised to help them meet this target by providing Indian railways, access to clean energy. Although the revenue contribution from this business is insignificant today, it could increase considerably within a few years.
FINAL REVIEW OF RITES

So, all in all, the company has shown consistent growth in its top line, maintained high margins, largely remained asset light, has very little debt on its books and continues to declare consistent dividends as mandated by the CPSE Capital Restructuring Guidelines, i.e. the Company is required to pay a minimal annual dividend of 30% of its PAT or 5% of its net worth, whichever is higher, unless an exemption is provided. So, it’s a pretty good company all things considered?

Alas, there is a catch. While we don’t have the numbers for this year, it is likely that the company’s revenues will look flat based on the 9-month performance in the fiscal year 2018 (Rs. 936 Cr.). Also, while the company has maintained healthy net profit margins, a significant chunk of its profits (almost 20%) come from non-operating sources. And PSU’s haven’t really come out of the listing scene with flying colours recently.

So, the only question we can then ask is if it is priced fairly. Based on our calculations on FY18 earnings and issue price of 185, the PE equates to about 10.5. Also, there is a retail discount of Rs. 6 per share and we think its fair value. 

The company plans to raise ~Rs. 430 crores as part of the government's divestment plan. So, none of the money will go towards funding the business.

DISCLAIMER

No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments.

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