Another blog entry is below
Monday, 11 March 2024 at 1:20:25 PM
So I have now read a few more annual reports all the way up to 2023. One thing is clear to me. The management is extremely conservative. They take on debt only for capex and then as soon as they generate any cash flow, they pay off that debt. So what has suddenly changed for the company is that they have started receiving a lot of foreign orders. In FY2023 about 50% of the revenue was from foreign orders. This led to massive improvement in profitability. And the primary reason for the same is the difference in gross margin. So if you take out the cost of raw materials then any domestic orders give the company a gross margin of 15-20%. On the other hand export orders give them a gross margin of 50%. Without any great increase in cost. So the overall volume that the company is doing has not increased by a lot. I figured this out by looking at the units of power consumed. The same is declared in the notes to the financial statements. It is a good proxy to figure out whether revenue is increasing due to increase in price or increase in volume. But the power units consumed have only gone up by 15% or so. Whereas revenue went up by 50%. Now there are a few obvious questions.
First is how much capacity does the company already have and how much of it is currently utilised and how much more capacity can the company build quickly. So the company currently has 4000 MVA annual capacity and they are scaling this up to 7500 MVA by July 2024. They are at about 100% capacity utilisation right now and with the rate at which they are growing (50% annually in revenues), I am expecting them to quickly consume their 7500 MVA capacity too. So the good thing is that the land which they already have allows them to scale up to 30,000 MVA which is 4x their capacity in July 2024. So the company does not have any immediate problem in scaling up their producing capacity to meet the demand in the market.
Next is what is driving this increased demand. My opinion is that the usage of captive renewable capacity by industries is growing massively now. I say this because Shilchar does not work with any government clients. They mostly work with private clients. But the private sector in India is a minority player when it comes to transmission of power or when it comes to the discom business. So what is the private sector going to use their transformers for? Also, the company’s transformers are of small capacity (remember majority are 66KV or less). And yet their business is growing at 50% y-o-y. How? My sense is that private sector companies have realised that captive renewable power generation is now much more reliable as compared to lets say 10 years earlier. The equipment, the technology is all now mature enough to give entrepreneurs the confidence that they can start using renewable power generation within their own industrial complex to power their machinery. One more reason could be compliance with green energy standards being set by the EU. So a few years back EU started making claims that how they are reducing the amount of carbon emissions within their own geographies. For example the amount of carbon that Germany was emitting in the year 2000 per unit of GDP was far greater than the same number in 2020. So what happened? How did EU actually reduce carbon emission and at the same time continued to increase their GDP? And the answer is that a lot of the physical things which were produced in the EU started getting produced in Asia. Think about car headlights. If I am assembling a car in the EU today and I want to buy headlights for that car, will I decide to produce the headlights myself or will I ask someone else to produce them. And where am I likely to find a supplier for headlights who offers it to me for cheap but at the same time does not compromise on quality. And the answer has been Asia. And therefore Asia started doing a lot more carbon emission and therefore on paper you saw that how fast carbon emission intensity has come down in the EU. So climate activists started reminding the EU that climate change will not stop just because the EU has physically shifted its emissions to some other country. And therefore they started pushing the EU to somehow convince their asian suppliers to reduce carbon emissions as well. Now how could the EU do this? After all they have very limited control over their Asian suppliers. Also, green technologies were not really efficient. So it did not make sense for Asian suppliers to move on to inefficient green power. But that is not the case anymore. Green power is very efficient and reliable today especially when using it captively. And that is what Indian industry is now doing. There is a company called RACL Geartech. They produce car parts in Noida. They mostly export to EU. Recently they have announced that they have built captive revenwable energy generation to power their own factory. The EU is now also sort of using tariffs to force asian suppliers to start using green technology. And RACL Geartech is a testament to that. They realised that they will become uncompetitive due to tariff barriers in the EU if they do not start using green power. This may also be a malign way for EU to enforce its technology domination. I do not completely know the facts yet. I am still exploring this angle. Is the EU pushing for green power because the patented technology to produce green power is owned by the EU? Even if that is the case, for now it makes sense for suppliers to shift to green power. And I suspect that is what is pushing industries to figure out their own sources of green power and not completely depend on the grid for green power.
And I think this is the niche that Shilchar is trying to exploit. They built small and medium power transformers which need to collect the electric current being created by many solar panels and then step up the voltage so that the electric current can be used to power the machinery of a factory. Each factory is different and each factory using different machinery and therefore the voltage at which electricity if required is different. Also, each factory has different physical space. Therefore the number of windmills that can be put or the number of solar panels that can be put is different in each factory. And therefore the transformer to step up this electricity has to be different each time. And this is the reason that demand for customised transformers is going through the roof right now. Shilchar has been specialising in transformers for the solar and wind energy for about 10 years now. And now finally the demand is coming in for their competence. Also they have a strong balance sheet which can fund their working capital requirement as revenues continues to grow up fast. This is an industry where you have to give credit. And therefore as a manufacturer you are constrained when revenue is growing fast but you dont have the ability to borrow from banks to fund your working capital requirement. That is not the problem with Shilchar. They are debt free today and have a lot of plant and machinery and land against which they can borrow. And they can also borrow against their receivables. They have not resorted to bill discounting till now. That would impact the margins. But why do they need to? They have easy access to financing.
Another thing working in our company’s favour is that they have a track record. They can point potential customers and ask them to check out renewable energy transformers that were installed 10 years back at a client site and are still working fine. You need a track record in this business. People find it extremely tiring to change their power generation mechanism repeatedly. And therefore they won’t mind paying more for a reputed supplier and that is what Shilchar is.
The business is run by the promoter Alay today. He is nearing 60. His elder son is 34 and has been working at the company for more than 8 years. For now the family seems do be doing a decent job of running the company. They have started taking out more money from the company though. I dont mind this. But I do want some understanding of how are they going to structure it. For example till now Alay was taking a fixed remuneration from the company. Suddenly as profitability went up, he has started taking 3% of profits too in addition to his fixed remuneration. Also the company has started buying expensive cars of about 2 crores or so. So I dont know when again will the promoter increase his own compensation or that of his family and what exactly is the framework that he is going to follow for this. Also there is a private company ‘Nile Transformers’ which has the son as a director. This company is also in the business of manufacturing and selling transfomers. So I want more clarity regarding this company. What is the requirement of this company in addition to the listed company which is owned by the family? Shilchar sold transformers of about 1.3 crores to this private company. But I dont know what were the margins in that transaction. This is not a major red flag. But I am hoping that the company will clarify the nature of this relationship.
This company will continue to do well as long as they maintain their focus on building customised transformers. The west suddenly wants to replace China for all its imports. Indian manufacturers who respect product excellence and honesty should continue to get a lot of business from this company. I will keep monitoring the progress here.
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