RACL - Full Stock Analysis

About the Company

Raunaq Automotive Components Limited (RACL) was incorporated in 1983 and is engaged in manufacturing transmission gears and shafts for automotive and industrial applications. The Raunaq Group initially promoted the company. However, due to financial difficulties, the company was referred to Board for Industrial and Financial Reconstruction (BIFR) in 2001. Post-restructuring and with a new management team under the leadership of Mr. Gursharan Singh (CMD), a former employee, RGL came out of the BIFR purview in November 2007.

RACL is engaged in manufacturing automotive components, transmission gears, shafts, and other gears related to power transmission to engines. RACL also manufactures drive train parts for Tractors, Two Wheelers, Electric Cars, Three Wheelers, Cargo Vehicles, Light and Heavy commercial vehicles, etc. The company has also expanded into sub-assemblies, industrial gears, high-precision machine parts, sprockets, and ratchets.

The company has two manufacturing plants. One in Gajraula (UP) and another in Noida. The Gajraula plant is 100 km from New Delhi, while the Noida plant is 15 km away.

The company mainly supplies OEMs and has a highly reputed client base. Those names are BMW, Kubota, KTM, Honda, Yamaha, Schneider Electric, BRP Rotax, etc.?

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Highlights of Investment

Strong Moat - The products are highly technical and have to be designed in coordination with customers who avoid switching vendors, making it difficult for new players to enter.

High Switching Cost - Customers have to run rigorous tests on every aspect of the product as well as the vendor and hence avoid switching vendors unless absolutely necessary. Most customers enter into long-term contracts.

Thin Margins - Most companies in this segment work on single-digit margins. RACL, however, has been able to deliver and sustain double-digit margins.

Client Base - The company has a solid customer base diversified across geographies and vehicle categories. Most customers started with a single product but are now purchasing multiple products. The company has an excellent track record of retaining clients and adding new ones.

Useful Product - The main product that is gears is essential to the OEMs purchasing it. The company is even working towards building gears and other components for electric vehicles to be prepared for any disruptions in the auto industry.?

Strong Client Base

The company has been a reliable vendor for BMW for more than 7 years.

The company started serving Kubota with two products and is now serving over 100 products at three of its facilities in Japan, Thailand, and USA.

Has many more names on its list, like I.T. Switzerland (SAME Group Company), KTM AG (Austria), Schneider Electric (Germany), Dana (Italy & China), Piaggio – Italy, Vietnam, BRP Rotax – Austria. Some names in the domestic market include Yamaha, Piaggio, SML Isuzu, and TVS Motors.?

RACL has gotten these clients after building trust and reliability with years of flawless delivery. These clients do not switch vendors unless absolutely necessary. RACL has never lost a client because of unsatisfactory services. Most of these clients enter into long-term contracts, some of which are even 10 years long; this provides stability of demand even in turbulent times.

Holding on to these OEMs while maintaining better-than-industry average margins at such a small scale speaks volumes about the management’s competence.?

Diversified across Geographies

RACL serves companies in Japan and Europe that are known to only work with vendors that follow strict quality control guidelines. This adds to RACL’s credibility and gives them an upper hand while negotiating new deals with new customers.

A diversified client base also helps RACL weather any temporary negative exogenous factors in any particular country.?

Also, the companies RACL supplies to further sell their products in the broader market spread across many other countries, further diversifying their user base.

Diversified across Vehicle Segments

RACL sales are well diversified amongst multiple vehicle segments.

It is important to note that segment-wise, the company’s reliance on the 2-3 wheelers remained highest, with the segment contributing 61% of revenue in FY20 as against 59% in FY19

Future Prospects

EV requires High Quality - Various reports on EVs suggest that the transmission cost of an automobile will go down from 25% in ICE currently to around 5% in EV. Even Mr. Gursharan Singh pointed out in one of the annual reports that transmission gear and shaft value are expected to go down in the future. However, since EVs mostly use single-speed transmission and run on a single-gear ratio, the quality will have to go up to ensure maximum efficiency. Since value will go down, the competition will be stiffer to gain the market share, and hence, only companies that are low-cost producers with the highest quality and have invested a lot in the technology will survive. We believe RACL meets these criteria.

Passenger Vehicle Segment - The company recently started serving clients in the passenger vehicle segment. The management has expressed strong interest in expanding this market which could hold potential for substantial growth.

Capital Expenditure

Recent Capex - The company has invested close to 50cr in CAPEX each year in the last 2 years, which should drive future growth. The company is gearing up to provide drivetrain solutions to the future of mobility, i.e., Electrical Vehicles (EVs). The company has already invested substantial capital expenditure in the recent past. As of today, it is ready to cater to the high-precision drive train components for E-mobility solutions.

Future Capex Plans - The company is expected to incur more CAPEX for the installation of new plants and machinery. A combination of debt would do the funding of the same: equity mix of 3:1. The ongoing expansion is on account of the new orders received by the company from new customers in the export market.

Financial Statements

• Sales Growth has been consistent.
• The company has maintained a much better than industry average Operating Margin.

• Cash flow from operating activity has been consistently positive even with high debtor days.?

Risks and Concerns

Working Capital Intensive - The business of the company is working capital intensive. The cash conversion cycle is over 200 days. The clients also enjoy good bargaining power in this industry, leading to stretched working capital cycles.

Cyclical Industry - The auto industry is cyclical in nature. The slowdown in the auto sector globally can dampen the growth at which the company is growing.?

Saturation Point - Most Auto Ancillary companies have a history of not being able to sustain sales growth after a certain point. RACL, however, still has much scope for customer acquisition as well as more sales from existing customers.

High Debt - Even though the company has a good record of managing capital and already has orders in the pipeline for which the debt was raised. There still exists implementation and financial risk. The turbulence caused by the pandemic also needs to be factored in.??

Concentration Risk - RGL has moderate concentration risk, with the top five customers contributing ~67% of revenue in FY22. This number was 85% in FY20; this indicates that the company is focused on reducing this risk.

Electric Vehicle Disruption

3 Wheelers - 5% of revenues came from 3-wheelers, which are at a high risk of disruption. This might affect revenues in the short term.

Recreational Vehicles - ATV/RVs contributes around 18% to revenues, and RACL supplies to Bombardier Recreational Products (BRP), a leader in this field. This segment is unlikely to see EV disruption anytime soon.

Tractors - 20% of revenues come from Tractors; this segment is also far from seeing EV disruption today.

2 wheelers - 50% of its sales come from high-end 2-wheelers. These vehicles are bought more for the purpose of recreation and experience. There is a lower chance of this segment seeing a shift to EV since that would significantly hamper the experience part.?

Disclaimer

All information present in this report is purely for research and educational purposes. No statement in this document should be considered investment advice. The writers of this report are not registered financial advisors and do not take any responsibility for actions taken by anyone based on this report. Please consult your financial advisor before making any decisions. As of the date of publishing this article, the author does not have any holding in this stock.