Since many people have added detailed plant visit notes, i just wanted to add some top of mind things which personally have helped me build conviction after the plant visit. I will structure it in a Q&A fashion.
Question: Given that EVs use lesser transmission gears, how do we think about terminal value of RACL?
Answer: Through a very insightful discussion with Gursharan & prabh sir, we realized that current set of EVs are poorly designed, this is very well exemplified by Ola scooters which find it hard to climb on flyovers & even though rated speed might be 100 kmph but its very difficult to drive at that speed during all conditions. This primarily happens because the Power torque curve when not using transmission gears are distorted. In fact, they are seeing newer generation of EV designs are increasing number of transmission gear modes from 0 to 1 to 2 etc. The value reduction in transmission gears when going from ICE to EV might not be as high as current flawed EV design imply and this is an active area of mechanical engineering research & has to be tracked.
Question: Why does RACL get & retail prestigious customers like ZF?
Answer: I have only heard about this aspect from Charlie Munger when describing the founder of BYD Wang Chunafu. That is the ability to visualize, design, conceptualize & plan the process required to make an auto component when you see one. Because this is all RACL gets from ZF, a drawing of a part. Then, they need to think of the optimal combination & sequencing of different processes like forging, laser cutting, heat treatement, welding, Gear Milling, Hobbing, Threading, dethreading in order to create that part for the customer. There have been instances, where RACL was able to make complex parts with multiple gears using simpler & more efficient processes than even their clients like ZF. ZF specially is a very prestigious client because ZF is itself a gear making company. The very fact that ZF is buying finished gears from RACL speaks volumes about their processes. To me the moat is in the core team led by gursharan sir who spends a lot of his time thinking about what new core capabilities & technologies to incorporate & add to RACL’s repertoire of capabilities. (I believe it would be wisest to ask gursharan sir questions about technologies in concalls and not next year Capex etc).
Question: How will this 25% type growth be realized?
Answer: While their clients like ZF, Man trucks, BRP are growing & outsourcing more parts to RACL (incrementally of complex nature & thus higher gross margins), personally i believe the next leg of non-linear growth will come from working direcly with PV companies like BMW, mercedes. Right now, RACL supplies to PV through ZF & is thus a tier 2. The jump from tier 2 to tier 1 wont be easy, but can be very rewarding since the TAM is larger (higher ticket size & volumes). Personally, i dont think they should have much difficulty to grow to 1000 cr in few years doing what they are doing currently. But if they can crack PV tier 1 market, then the TAM becomes much larger & in my biased opinion the path from 1000 cr to 2000 cr becomes easier (The reason i am thinking about such questions is to ask myself what can be their growth advantage period & thus what might be a good valuation). They also have enough land here to go to 1200-1500 cr Revenue IMO. There is enough land nearby for them to do brownfield nearby if they choose to do so. The business conditions under new UP government have improved dramatically in every way one can imagine.
Question: When there is recession like conditions & high inflation in Europe, how is RACL growing?
Answer: Because of their core capabilities, their culture of excellence , that very thing which drives high gross margins & high cross cycle ROEs, that is the very thing which drives their growth as well. While Auto anc suppliers in Europe are becoming uncompetitive & going bankrupt due to high cost of energy, now credit, high cost of steel, labor cost was always high, no such problems in Bharat. Favorable macro conditions in all of these factors of production of course drive shift in economic value towards us. Core capabilities like RACL’s (culture, innovation, core team, 0 defect policies, we could see this everywhere in the plant, low tolerance for pollutants, willingness & ability to deliver above & beyond what client asks for. Faster, cheaper, better designed) allows them to capture that economic value.
Question: What are the key risks i see?
Answer: They are running on a fast paced treadmill. This particular high growth treadmill requires large capital expenditure. And we saw why. State of art machines. Very high machine to employee ratio. high degree of automation. When they create a new plant, they make sure that machines in older plant are also upgraded every once in a while so that any customer doesnt feel short-changed. All of this capex, a growth rate higher than ROE, and unwillingness to dilute equity forces them to increase debt. This remains to me, the biggest risk. The balance sheet risk. If for whatever unseen once in a decade/century reason their clients stop giving them orders, then debt costs can become higher than cashflows can support.
Disclaimer: I am invested, biased. I do feel there can be some near term headwinds (in terms of growth rates going from 25% to 15%) but the long term permanent economic value creation opportunity here are very attractive.
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