Redington India Ltd: Imperfection is not Incompleteness

 Stock Idea: Redington India.

(This business study of Redington India Ltd is taken from the Monthly Newsletter (Jan-21 Edition) of this Blog. The sample of Jan-21 edition was shared at this blog on 28th Jan, 2021)

Stock: Redington India Ltd		Financial Performance (Fig in Cr)
Description	(Amt)	Description	Up to Dec-20	FY-2019-20
CMP (On 28.01.2021)	135	Sales (Inc other income)	41500	51500
Market Value	5240	Net Profit	483	534
PE Ratio (Annualized)	7	Cash	3100	2368
Net worth (Sep-2020)	4500	Purchases-Stock in Trade	39200	48600
Dividend Yield	3.00%	Purchases/Sales	94%	94%
		Debt	827	2537

More than the perfection of the market (stock market), it is its imperfection which is more beneficial and attractive. I usually say this and someone questioned me why more value in negativity. But I told him that Imperfection is not incompleteness...negativity...deficit as is generally taken. It is not the absence of creativity and skill but closeness to these. Perfection lies with the Almighty. When we move into a garden...there is no perfect order...leaves are scattered all over...not perfect but it is not incompleteness or disorder or chaos because the garden looks beautiful...in fact this imperfection makes it look more beautiful. Perfection may not be that perfect from the perspective of enjoying or living. So the market is imperfect because it is its basic nature and it is beautiful, lively and creative only because it is imperfect. As they say-Best is the enemy of the Good and this is not more relevant elsewhere than in the stock market.

So perfect stocks are those picked imperfect and amid imperfection. Redington I feel is one of the best fit in this category- It has done perfect to improve its business, margins and balance sheet but as of now lying in a corner ignored and so at low valuation due to market imperfection but it is a great investment opportunity only because of this imperfection.

Redington India is a global IT products distribution giant just behind Ingram Micro. It is an investor owned, Board managed and professionally run company as promoters have exited by selling their entire stake. At present, Synnex group which is a global giant in IT product distribution is having 24.2% stake, Affirma capital 15.8% (an arm of Standard chartered PE), MF 11.5% and FIIs/FPIs having 3.3% stake in it. Its turnover is massive Rs. 51500 cr with 40% business coming from India but India is going to be their fastest market. Its top 5 vendors are-Apple, Dell, HP, Samsung and Lenovo. Distribution is a high volume low margin business which makes it one of the toughest business with high entry barriers as it is very tough to create large scale supply chain, managing inventory of countless products, offering credit/financing to promote growth, long term relationships with suppliers and vendors, logistics, market making, technical support. And amid all this complexity they have to keep an eye on working capital management so as to ensure a reasonable level of margins (ROE). In distribution business, working capital is the plant and machinery and so the success and viability of distribution depends upon how well they manage this as higher levels of inventory and debtors blocks huge amount of capital straining returns and growth. 

This year they have improved their working capital massively and generated large free cash flows as their working capital days have been improved to 14 days from 38 days last year. But this was due to significant collections due to covid and so this will stay around 30 days which is the normal practice in industry of giving credit period of 1 month. I remember this figure was in high 60-70 days some 3-4 years back so they have done massive improvements in their working capital. Working capital is like plant and machinery for a distributor. In 9 months this year they have improved EBITDA by 11% in spite of the Covid lockdowns across the globe and generated Free cash flows of staggering 2761 cr (this will cool down to some extent next year). Its ROE stands around 17% but I think this will see huge jump this year and very soon we will see this touching 25%.

But in spite of making massive improvements in working capital management in last 3-4 years it is still trading at low PE of 7-8 while Ingram Micro is trading at 25-30 PE during this period. Somehow, I feel market is not being able to value and understand its high entry barrier business because it requires huge resources and planning for building this gigantic supply chain in low margin distribution business.

Distribution business is very tough as they have to establish their relevancy in the present era of cost cutting where some product channels see them as not adding any value to the product chain. But it is not….distribution is a very complex function, needing huge resources for keeping inventory, giving credit to resellers, market knowledge, providing after sales servicing and training etc. Just imagine how big resources Producers would need to block in these activities if not for distributors like Redington. Distributors earn their bits by achieving efficiency in the supply chain and economy of scale. Distributors like Ingram Micro and Redington, in order to fight another war of relevancy, have entered into the distribution of Cloud computing business. Earlier some suppliers were doubtful but then they see the value addition and now most of the cloud computing suppliers are having distributors. Redington is distributing the cloud products of Microsoft in India.

Distribution is one of the most important functions in the entire value chain of a product from production to final consumption. And when we talk about value chain then it implies that distribution function adds “value” to the product. How? Distributors adds value in the form of creating market for the product, bulk procurement and redistribution, financing, inventory management and logistics, after sales services, knowledge of the local markets etc. Distribution is inherent in the entire value chain because the function like financing, storing large quantities, market creations etc. are very important in order for a product to get demanded and sold. People think that the likes of Flipkart, Amazon will eliminate the distributors but they are wrong because then they will become the distributors itself because somebody has to perform these distribution and marketing functions so if Amazon holds the inventory, provide credit, ensure delivery then they are playing the role of distributors. If they are not doing then it is sure that either the producers themselves or someone else is doing this function. Retailers keep small quantities of many products from different producers so they need the services of distributors to procure these small quantities whenever they need.

Producers want and need to focus on the designing, innovation, production and branding functions and these require a lot of capital. So blocking further capital in the distribution channel will be very risky for them as they can only afford to take that much risk hence they need the services of distributors in placing and managing the product and supply chain. So distribution needs large investments and lack of proper distribution strategy can make or break a product in the tough market conditions. Apart from the need for big investments, one can gauge the value addition by distribution function on its own from the fact that if retailers or consumers try to arrange for self-procurements of goods from producers then this will render them very costly…in fact unaffordable. So Distributors has independent value addition in the form of lowering the cost of product and that’s why new disruptions like ecommerce will in most optimistic case will only transform (not eliminate) the distribution function and may result in cost savings and better efficiency. In traditional product distribution, distributors with their immense value addition result in the creation/enabling of a transaction which without them could not have been possible (Like without distributors a new product can’t be sold to customers as who will create the awareness of the product by market making).

Take the case of Cloud computing where people were expecting the death of IT distributors. But as I have said distribution is inherent in the entire supply chain of a product from production to the final sale to the ultimate consumer. When internet came many expected the death of middlemen as they felt the producers would sell directly to consumers but the result was the emergence of much bigger Distributors/Retailers in the form of Amazon/Alibaba. Cloud computing has in fact widened the market of IT products as many small firms can now afford costly IT systems which earlier were too expensive for them. But reaching these millions of new firms who are prospective clients of cloud computing need the support from IT distributors like Ingram/Redington in the form of financing, technical support, market making, logistics etc. These distributors have long term relationships with these firms and they can impact or motivate them to look at Cloud computing as a low cost option for their IT system requirements because in the end Cloud providers are competing with many other similar vendors so they need the help of these “market gurus” and as they can rely upon the expertise of these distributors so they can focus on their core work which is offering new services/products under cloud.

Redington’s third party logistic business “proconnect” is growing very fast. Proconnect is having one of the biggest logistic capacities in India with 155 warehouses covering 6.7 m Sq feet. In 2015, it was getting some 70% revenue from Redington but now the same is just 13%. Total revenue is around 500 cr and the same is growing fast and this one is going to be a big contributor in the future growth and valuation of Redington.

Some Critical Events and Decisions to put Redington into High Growth

But apart from low valuation in high growth sector, there are some other very critical factors which can catapult this one into another high growth orbit and that is the coming growth of local electronics goods manufacturing in India. Indian Govt. is promoting the local manufacturing by offering Production linked Incentive (PLI) schemes. Indian Govt has launched a Rs. 50000 cr production-linked incentive (PLI) scheme to boost the electronics goods manufacturing in India. Global giants like Samsung, Nokia, Foxconn, Wistron etc. are already going to ramp up their Indian manufacturing to benefit from the PLI scheme. I think local manufacturing will increase the demand for its services big time and this is going to be a big catalyst event for it. Second, I feel as Redington has good cash reserves so time is ripe for it to do some good acquisition in technology space or logistics space and I think we may see something on this very soon. Third, the demand of Data centers/cloud will grow much faster with 5G and Redington is already a big force in it and it will see high growth in this vertical and I think it may even increase the services offered in relation to Data centers/Cloud.

Summary of Analysis levels Involved in the study of Redington India:

1. Level 1 (Lower relative valuation) – Low valuation (7 PE) keeping in view the scale, low debt, high entry barrier, significant improvements in working capital (Plant and machinery).

2. Level 2 ( Industry level growth and restructuring)- IT products demand is going to see high growth in India and across the globe and Redington  is nicely poised to participate in this growth. Another massive industry level event is local electronics goods manufacturing in India.

3. Level 3 (Forecasting of management decisions which may result in massive future growth and value unlocking) – They have already done the great work in last 3-4 years which is not rewarded by the market. However, its management still has the scope for another round of decision making to lead it to massive growth. The decision to be taken by management for doing some acquisition in technology or logistic space and then to capture market share in high growth cloud and increasing their service offerings are the key strategic actions to be taken by the management.

(This study is a business analysis of the company under consideration. 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 own 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).