Why Did Nandita Agarwal Parker Of Karma Capital Buy Rico Auto?

Ashish Dhawan is the single largest shareholder of Rico Auto with a massive holding of 68,68,128 shares as of 30th September 2014 (down from 72,73,092 shares as of 30th June 2014). Nemish S Shah of ex-Enam is the second largest shareholder with an (unchanged) holding of 29,01,900 shares.

I gave a brief description of Nandita Agarwal Parker Of Karma Capital a few days ago. I described her as a “contrarian value investor” with a “focus on finding stocks with asymmetric risk-reward characteristics”.

Karma Capital’s latest stock pick is Rico Auto, a micro-cap with a market capitalisation of only Rs. 580 crore. On Friday, 31st October, it bought 7,59,187 shares at Rs. 43.08 each in the name of the “TARRA FUND”.

Rico Auto Industries Limited, an engineering company, incorporated in 1983 started commercial production from 1986 and supplies a range of high precision fully machined aluminum, and ferrous components and assemblies to automotive original equipment manufacturers (OEM) worldwide. It engages in designing, developing, tooling, casting, machining and assembling aluminum and ferrous products. Its exposure in terms of sales to 4W is ~45% (incl 10-15% to CV) and the rest is to 2W. Aluminium castings contribute about 75% of sales while the rest is ferrous.

In the immediate past, Rico Auto ran into serious financial crises. It borrowed heavily to invest in the business. However, the slowdown in the economy meant that the business did not take off. Rico suffered heavy losses and defaulted on repayment of its loan liabilities.

However, since then, Rico has scripted a turnaround. It recently sold its entire 50% stake in FCC Rico to FCC, Japan for Rs. 495 crore. It intends to use the proceeds to reduce the debt.

To understand the present dynamics of Rico Auto, we have to turn to the latest research report by HDFC Securities (pdf) which lists out the positive factors as follows:

(i) Rico is divesting its 50% stake in JV company, FCC RICO Limited to its JV Japanese partner FCC Co. Ltd for a consideration of Rs. 4,950 Mn. Rico had invested ~Rs.3.95 cr in 1997 and now it is selling this stake at Rs.495 cr making a neat profit. We believe the completion of stake sale in FCC RICO could be done by Dec 2014.

(ii) Exports are the next big strategy for the RICO. Management has been betting on higher exports next year led by higher current outstanding export order book. Rico Auto expects exports to contribute around 23-24 percent to revenue this year from 20 percent in the previous year.

(iii) Improvement in the financial performance would depend on a sustainable improvement in liquidity and credit profile of the company. We expect liquidity profile to improve led by recent proposed divestment of company’s entire 50% stake in FCC Rico Limited for a gross consideration of about Rs. 495.0 cr is likely to help improve its financial risk profile.

(iv) Rico has more than sufficient capacity to cater to expected higher demand from auto industry in India and abroad. Management has indicated that no additional/major capax is required in the near term as its current utilisation is around 55 percent and expects improvement going ahead on the back of high growth.

(v) Rico is technologically superior company in niche area of auto components and its near term troubles can be mitigated once the stake sale in FCC Rico is completed.

At this stage, we must remember the advice given by Raamdeo Agrawal and Hiren Ved recently. Both are extremely bullish on auto stocks. Raamdeo Agrawal said “we are in an amazing situation in terms of auto companies” and “the best of the auto boom is ahead”. Hiren Ved echoed this when he said that “the auto sector is leader of the pack in this bull market” and that “The sector typically does well in the early cycle because it has got huge operating leverage”.

We must also remember the advice of Amar Ambani of IIFL. He suggested that instead of buying auto stocks, one should buy auto component stocks like LG Balkrishnan, Banco Products, MM Forgings, Phoenix Lamps etc. Even Minda Industries, recently recommended by Sushil Finance, is a strong contender.

So, from the looks of it, it does look like Nandita Agarwal Parker has carefully thought out her investment decision. She has chosen the auto component sector on the basis that the sector will boom in the foreseeeable future. Within that sector, she has chosen a stock that is not so much in fancy amongst investors and which offers the best bang for the buck. Her calculation is that as and when the company reports better financial performance (owing to the reduction in debt and better operating metrics), investors will get attracted and the stock price will surge. This thinking is corroborated by HDFC Sec’s analysis that Rico’s “near term troubles can be mitigated once the stake sale in FCC Rico is completed by December 2014“.