Hercules Hoists Ltd: Warehousing Automation

Stock investing is all about value investing i.e. picking a stock at a price which is much lower than its intrinsic value (real worth). And most people think that this real worth is basically a handiwork of financial analysis which calculates Real worth of a stock based on earning growth, balance sheet strength etc. But this is just post mortem. The most important factor in the value investing formula given by Sir Benjamin Graham was not the evaluation of these financial parameters but it was the mysterious “g” in his formula which was the most important factor in the valuation matrix. This “g” denotes the future growth rate and this is where investing starts and ends. This growth rate is not a financial entity it is just represented as a financial figure.

To understand the growth prospects of a company requires thinking like a businessman. One has to understand the whole nitty-gritty of a particular industry-raw material, substitutes, strength of entry barriers, user industry, global competition, future threat or opportunities…and the list is endless but this concludes why stock analysis is so complex because it looks like dealing in finite numbers but it is most affected by infinite business/economic variables. This effectively means looking into the future demand supply trends and this is where creativity, intuition, wisdom and knowledge enlarge the vision to sniff the future much ahead of others and this is the most decisive factor in business and in stock investing.

Sometimes I feel that stock picking is getting increasingly difficult. In old times, there was information scarcity and only the privileged ones had the timely access to relevant financial and economic data affecting companies in stock market and so they could pick valuable gems cheaply and much early. But today most of the data is available freely and quantum of privileged data is very less (although that is still important). But this democracy in data availability means one has to expand his vision further to look far deeper into the future and gasp the coming economic trends.

We are also in our journey to understand what changes GST will bring into the business land scape of India. Logistics is no doubt one sector which is going to see revolutionary changes because in its earlier avatar it was most effected by fragmented structure of Indian taxation system where each state has its own set of taxes and businesses were taking investment decisions not from the point of view of operational and business sense but to save multiple state level taxes.

GST is a massive financial engineering and it is bound to change the way we were doing businesses. In an ideal economy, business decisions should be based on sound operational economics and efficiency rather than an exercise to fit the business operations into the tax or accounts regime. Tax/revenue authorities should keep the business economics in mind while framing tax laws rather than businesses designing their businesses to tax laws because taxes do not generate business profits rather businesses generate the resources for taxes.

Earlier, we have picked Hercules Hoist Ltd (Click here for earlier study) as one of the beneficiary of impact of GST on logistics. In the past one year after we picked Hercules Hoist things are looking in much better shape.

GST to revolutionize the warehousing in India

Supply chain and logistics is the most important function in the entire chain of production to final consumption and it requires huge resources. And warehousing is the most important part of the entire logistic function because excellency in warehousing implies low cost of warehousing, low inventory levels, low pilferage but earlier due to state level taxes like CST companies planned their warehousing just to avoid high taxes. Earlier, every state was a foreign territory as far as movement of the goods was concerned and each state levied a number of taxes on goods coming into their state from outside state. But amid this complex tax structure, some relaxations in taxes were given like when goods were moved inter state not out of sale but stock transfers no CST/Entry tax was charged. So companies, in order to avoid multiple level taxes, just operated small inefficient warehouses in each state and this along with other factors has resulted in higher logistics costs which are twice (14% of GDP) the cost in developed countries (7% of GDP).

So warehousing in India only meant “godowns” which were just a structure with no automation and did not provide any value added services. So companies operated small shabby warehouses in each state they operated which resulted in operational inefficiencies and huge resources were blocked in the form of high inventories, maintenance of large number of inefficient warehouses.

But all this has been going to change after the implementation of GST. After GST there are no state level markets and India is a one big market and no matter from where you operate the taxation is same. so now companies can plan their supply chain and logistics keeping in view the operational efficiencies rather than tax savings.

Earlier, the focus on tax saving resulted in small low tech warehouses and the average size was some 10000 sq feet and almost 90% of the warehousing space is controlled by small unorganized players. At this small scale it was not possible to invest in mechanization and automation. So there was no economy of scale, no control and overall inefficiency. But after GST, the average size of a warehouse has touched 1 lac sq feet and companies are investing big in mechanization and automation and so now the true worth and value of a good warehousing system will be realized. Warehouses of the size of 4 lac-5 lac sq feet are underway.

As one can see, it is impossible to manage these large scale warehouses without being equipped with smart mechanization and automation.

So these smart fully equipped warehouses present huge opportunity for Hercules Hoists which is one of the largest suppliers of material handling solutions in India.

Warehousing industry is undergoing great consolidation and increasing merger and acquisitions will take place and the sizes of warehouses will increase significantly to make possible the automation. This greater scale will also positively impact the IT cost of deploying Warehouse management system (WMS) and ERP systems which was not possible earlier and due to these technical advancements in warehousing entire supply chain will reap the benefits.

Apart from GST, there are other reasons which are creating the demand for large scale automated warehouses:

1) The growth in manufacturing due to “Make in India” initiative. High end large and smart Warehousing and logistics systems are required to support this scale of growth in manufacturing.

2) The warehousing and logistics sector has been granted the infrastructure status which means they can get funds cheaply with payment stretched much longer time.

3) The huge demand for high tech large scale warehousing from E-commerce sector. E-commerce is all about reaping the benefit of scale so large fully automated warehouses are the first thing they need to create value for themselves.

Hence, no doubt these large smart warehouses are going to save the costs of logistics of companies.

The most important factor is reduced inventory costs. Inventory consumes huge resources in the form of cost of production, storage costs, theft, damage, obsolescence etc. So optimal inventory levels are the ultimate aim of any supply chain as the same will maintain the overall efficiency of entire supply chain. Earlier, companies were always facing either the situation of excess inventory or low inventory leading to loss of business.

Infact, the efficiency of a supply chain system is gauged from the levels of inventory-how much capital is lying idle due to inventory carrying costs which can otherwise be used for other productive uses. So optimal inventory level is the prime aim of any supply chain manager.

Due to the use of hub and spoke model for inventory control across the entire supply chain, faster movement of goods due to fewer/no state border checks, lower number of warehouses, higher efficiency of warehouses due to automation etc. means companies can maintain pre-GST supply chain service levels with much lower levels of inventory as they can move the goods fast. So no surprise that inventory costs are coming down. As per recent studies, inventory levels have come down by some 30%-40% which are increasing the profitability.

Consumer durable industry is going to see almost 50% fall in warehousing costs while FMCG sector will see 25% fall. This is due to the fact that lead time for consumer durables are around 2 days so consumer durable players can easily supply the existing markets from fewer but larger warehouses like from Haryana warehouses they can cater to Punjab, Uttarakhand, UP and Himachal Pradesh easily which are major consumption centers in the country.

The stock turnaround time for FMCG is much lower (24 hours) due to reasons like small scale of distributors/retailers, availability of substitutes in the form of other brands so they are required to maintain more warehouses as compared to consumer durables but still due to operational efficiencies their cost will fall some 25%.

So as we can see the investments in smart warehousing will be more than offset by the savings in the cost of carrying inventories.

Also, small and low key warehousing further takes away the scope of movement of cargo by rail due to short distances as railway frieght is cheaper by some 30-40% in long distance cargo. I feel, with the coming of dedicated freight corridor warehousing and logistics will be further benefited.

Further, there will not be much consolidation in clod chain logistics as they are very capital intensive to build and so it is not easy for companies to leave some capacity just like that which they can do for low key warehousing where their investments are low.

The warehousing sector is witnessing big activity

Earlier, due to small size and small opportunity, large organized players and PE investors have avoided warehousing sector. But now this is one of the most sought out sector. In the last 4 years, investors have put around $3 billion in warehousing and this accounted for around 26% of the total private equity funding in the real estate sector during this period.

Demand for Grade A warehouses (Large automated) is growing and going to cross about 300 million sq feet by 2022 from approx. 140 million sq feet in 2018. So as we can see, this requires massive investment in capacity in the coming 3-4 years.in the next 2 years, investments of around Rs. 45000 cr are going to be made in grade A/B warehouses and some 100 Million Sq feet of warehousing space will be created.

Grand opportunity for Hercules Hoists Ltd

So, this gigantic scale investments and activity in large format warehousing is going to create high demand for material handling equipment for warehousing and this is where Hercules Hoists ltd comes into picture.

Hercules Hoists has established itself as most trusted brand in Indian material handling market and cater to almost all of the manufacturing industries including logistics and counts leading manufacturers as its customers. It operates under “Indef” and Hercules “Hoists brands”.

The scope of its products for material handling systems in warehouses is enormous. Like, its electric wire/chain hoists can be used for overhead material handling in the warehouses. Overhead material handling in the warehouses increases productivity, enhance safety, improve ergonomics and maximize available floor space. It has many other innovative products like iCranes and iStacker which are created for logistics sector. I do not see any reason why Hercules should not be able to benefit from high demand for warehouse mechanization and automation.

Although, Hercules Hoists provides material handling solutions to a number of manufacturing industries but I think its high growth phase is coming now due to growth in warehousing and further due to the revival of investment cycle in other industries. Indian industries were slow on capital expansions due to high debt levels in the past, high interest costs, bank NPA’s resulting in banks not providing loan to industries. But now after a long period of consolidation the investment cycle is going to pick up.

Recent financial performance points towards revival

Its operational performance in the recent 2 quarters points towards revival in its fortunes. In sep-18 quarter results, its turnover increased to 30 cr from 17 cr in sep-17 while its PBT excluding other income was at 3 cr vs 20 lac. Similarly, in Dec-18 quarter results, its turnover increased to 25 cr from 17 cr in Dec-17 while its PBT excluding other income was at 2 cr vs 70 lac.

I think, companies were waiting for more clarity on GST laws/rules before going ahead with their investment plans in warehousing etc. So it was not that they started investing in warehousing right after GST in July-17 instead they waited for the clarity and common sense. I think 2018 was the year of action and from now on the pace is only going to increase so it is possible that we may see high growth in the topline of companies related to this space like Hercules Hoists.

I am waiting for mar-19 quarter result for Hercules and I think it should see some 80%-100% growth in the topline. Further, Hercules does not need any capital investment so soon as I think it can sustain the topline levels of 300-400 cr without any capacity expansions so it implies we are going to see the major impact of this growth in the scale of operations for Hercules in the bottom line as it is also nil debt company. Further, as a nil debt and Bajaj group company there will be no shortage of funds in case it needs investments in capacity expansion in the future.

At present, i care more about the growth in top line than bottom line because there is huge scope of growth in scale of operations. And at current low scale of operations bottom line anyway is not relevant. But still even at such a low scale of operations, at CMP of 115 it trades at PE of 28 (If we take into account the recent performances then the same will around 20-23) which is good because at this juncture i could not have cared even if it was in losses. But this better financial performance is due to conservative and superior use of capital.

I am buying this one regularly and picked good quantity when it fell below 100. Few days back, picked at 115. CMP is 115. This one is good high quality Tier 3 stock (Risky) and I think this may turn out to be another Nelco for us.

But this being Bajaj group stock, nil debt and investments in its books provides high margin of safety and even I put it as Tier 3 but this riskiness is not due to its books/balance sheet weakness but due to the fact that most of its valuation will come from future growth only.

Further as explained in the earlier post that  it is having stocks of various Bajaj group companies like Bajaj Finserv, Bajaj Auto, Bajaj Holdings and Bajaj Electricals and MF valuing some 250 cr, has 2 acre vacant land in Mulund in Mumbai (I think it should get around 70-80 cr). So out of 400 cr market cap, some 320-330 cr (80%) belongs to Investments and land. So we are getting the rest of the company with one of India’s best material handling brand for just 20% (80 cr). It earns around 10-12 cr as dividends from these investments which provides the stability to the bottom line.

Apart from Hercules Hoists, I think Redington, which is my another favorite stock, is going to be benefitted from GST due to low cost of inventory for its distribution business and its focus on third party logistics business. Other large scale Logistics players like Mahindra logistics and Future supply chain will also be the key beneficiaries. 

Also, these giant scale warehouses need Pre-fabricated steel/material and Pennar Engineered building solutions and Everest Industries can be the beneficiaries as these two are one of the biggest but I have not studied these two in detail so not in a position to offer any further view.

In the end, I am going to touch something about the high standards of Bajaj group and this is why I think even after being a small company Hercules is still a safe bet for us.

Something about Bajaj group

Let me share something of my opinion about Bajaj group. Bajaj group is one of the best professionally managed group. Their family members start the job right from the shop level and they have to prove their mettle. Nothing is based on the family ownership quite unlike other promoter owned companies. Very few people know the strong family roots of Bajaj brothers. They are incredibly smart and choose the best person to run the business keeping apart their egos and family ownership.

Rahul bajaj is the current patriarch of the family/businesses and he is an institution in himself. He came to the small town Akurdi in 1965 (Bajaj Auto) and he still stays in this small town in factory colony. I have great respect for Rahul Bajaj and I think he was and is way ahead of the likes of Munjals, Ambanis. There was a time in 1970’s when there was a 10 year waiting for Bajaj scooter but still Rahul never tried to profiteering (as people were dying to offer much more than the market price) but still Rahul offered the best scooter and authentic price.

Bajajs are very down to earth people. The founder Jamnalal Bajaj had two sons- Kamalnayan and Ramkrishna Bajaj. Both were ardent followers of Gandhi and Jamnalal donated everything to Gandhi. Both sons were the real force behind the growth of the empire.

Now let me come to the bigger story-The current leader Rahul is the son of Kamalnayan and Shishir was his brother and a sister Suman. Ramkrishna has three sons- Shekhar, Niraj and Madhur. But for the entire world they were five brothers…there was nothing like cousin brother between them and the most able of them was running the best companies…in fact Bajaj Auto was created by Rahul so he was the leader. But still entire family shared everything…they have pocket money, leaves etc. in equality. However in 2000’s there was a fight between brothers and Rahul was shocked when one of 5 brothers wanted separate business. He along with other 4 tried hard to persuade him to stop demanding. You’ll be surprised to know that it was Rahul’s real brother Shishir who was fighting and other 4 were together and Rahul was leading them. Shishir’s son Kushagra was over ambitious albeit with great abilities but he wanted to build something on his own.

So brothers parted (Only one) and Shishir got Bajaj Hindustan and Bajaj Corp (I think they own some big power plants also). But rest of the 4 brothers are still together and running the other giant group companies. Rahul’s sons Rajiv and Sanjiv are running Bajaj Auto because they have proved their ability. Even Rahul had many differences of opinion with son Rajiv (like stopping scooter production which Rahul did not want) but still he never interfered and Rajiv has his own style. But Rahul has always praised him for his toughness and leadership.

Shekhar Bajaj runs the other Bajaj house biggie-Bajaj electrical. Many times Rahul has told that his younger brother Shekhar has never doubted and wanted a place in Bajaj Auto as he knows that Rahul is running the best show and Shekhar is doing the best in Bajaj electricals. Bajaj electricals is one of the best electrical goods company enjoying great brand strength (one of my investments, Study posted at this blog also). So as you can see there is nothing like bad managing in Bajaj group…the best of them will lead the show. I think the other brothers Niraj and Madhur are associated with Bajaj Auto. So it is still a close knit family…true Indian joint family…sharing everything among them.

This is why I have so much faith in Bajaj group.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. Reach me at oscillationss@yahoo.in).