Analysis on Rallis India Limited

Rallis India, a Tata Group firm, has been around for more than 150 years. The business makes agrochemicals and is involved in the entire value chain of agricultural inputs, from seeds to organic plant growth nutrients. Rallis also provides contract manufacturing services to multinational organisations.

(A) Analysis of Profit and Loss Statement (P&L)

i) Sales Growth:

The first criterion to examine is a companies previous sales growth. Companies with a high-demand product or service have typically seen rapid sales growth in the past.

Rallies India ltd increased its sales from 1282 crores in FY2012 to 2470 crores in FY2020, a compound annual growth rate (CAGR) of around 8% year on year.

Companies that have risen at least at the rate of inflation or greater in the past should be preferred by investors. Its worth noting that extremely high growth rates, such as 50% or more, are unsustainable in the long run.

ii) Profitability:

Profitability can be measured using two key metrics: Operating Profit Margin (OPM) and Net Profit Margin (NPM).

OPM is the portion of sales income that remains after deducting the costs of producing those sales, such as raw material costs, employee costs, sales and marketing costs, power and fuel costs, and so on. Operating profit excludes expenses such as fixed asset depreciation, interest, and taxation. In addition, when calculating operating profit, we exclude non-operating/other income.

NPM is the net profit left over after a company has paid its interest, taxes, and depreciation. Net profit is the final remnant after all expenses have been met, and it is available to the company for reinvestment or distribution to shareholders as a dividend.

An investors goal is to find companies that have a high level of profitability that they have been able to maintain in the past. Companies with high profit margins can weather tough times while still making money for their shareholders.

Let us examine Rallies Ltds profitability. (Please keep in mind that some calculations in the table below may be off due to rounding off.)

We can see that Rallies India Ltd.’s Operating Profit Margin (OPM) is on average 15% from FY2012 to 2021. Similarly, the companys Net Profit Margin (NPM) has averaged 10% over the years.

An investor must prefer companies with reliable or improving profit margins to those with declining or fluctuating profit margins, as the latter may see profits in some years and losses in others.

iii) Tax:

A company with good accounting and corporate governance standards would want to pay all legitimate government taxes. The corporate tax rate in India is 30% plus surcharge for Indian companies and 40% plus surcharge for foreign companies. There are numerous tax incentive schemes for various companies/industries/states, etc., that provide numerous tax-saving avenues that businesses use to reduce tax expenses. Nonetheless, unusually low tax payments should raise red flags and should be investigated.

Let us look at Rallies India Ltd.’s tax payment history.

We can see that the company has paid most of its taxes at the corporate tax rate. Because of a change in Indias corporate tax rate in FY2020-21, the tax pay-out ratio has decreased.

Tax payments at the corporate tax rate is a positive sign. If an investor notices that a companys tax pay-out ratio is lower or higher than the standard corporate tax rate, she should thoroughly read the companys annual report to determine the reasons for the different tax rate. A lower tax pay-out ratio is frequently associated with the following factors:

·        Tax breaks are available to the company as a result of its operations in SEZs, etc.

·         The government offers export incentives.

·         Tax-free earning, such as interest earned on the companys investments in tax-free bonds.

·         Earning taxed at a lower rate, such as short-term capital gains on investments such as stocks and equity mutual funds, and so on.

As a result, an investor should thoroughly examine the annual report to determine the reasons for a lower tax pay-out ratio. Companies have disclosed a tax pay-out reconciliation table in the annual report in recent years as a result of the application of Indian Accounting Standards (IndAS), which reconciles the differences between the standard corporate tax rate and the companys actual tax pay-out ratio in the profit and loss statement. This table is very useful for understanding any differences in company tax pay-out ratios.

iv) Interest coverage:

Interest coverage determines whether the companys operating profits are sufficient to pay interest to lenders on funds borrowed from them. It is quantified by the Interest Coverage Ratio, which compares operating profit to interest expense:

Operating Profit / Interest Expense = Interest Coverage Ratio 

An investor should look for companies with at least a 3 interest coverage ratio. It implies that they make at least a 3 in operating profit while incurring a 1 in interest expense. A higher interest ratio provides a cushion during bad economic times, and the company will be able to service its debt even during bad times.

Let take a look at Rallies Ltd.’s interest coverage.

We can see that Rallies ltd has kept an average interest coverage ratio (C) of 24 over the last ten years. In recent years, the interest coverage ratio has surpassed 50 percent.

 A high interest coverage ratio for any company indicates that the company will be able to service its debt even in difficult times.

(B) Analysis of Balance Sheet (B/S)

i) Debt to Equity ratio (D/E, Leverage):

The D/E ratio assesses the composition of the funds used to acquire a companys assets. The assets of the company are used to produce goods and services that generate sales revenue for the company. The D/E ratio indicates how much of the companys total funds are its own (shareholder funds) and how much is borrowed from other lenders. A D/E of one indicates that half of the funds are brought in by shareholders and the other half is borrowed from lenders.

We prefer companies with very little debt. During difficult times when the company may not be able to make good profits, the lender will ask for their money, and the company may be forced to sell distressed assets to repay the lenders. If the company is unable to find buyers willing to pay a sufficient amount of money, it may go bankrupt. As a result, investors should favour companies with a low debt-to-equity ratio.

Let us examine Rallies Ltd.’s debt to equity ratio over time.

We can see that Rallies ltd has kept a debt to equity (D/E) ratio less than one in almost every year. The D/E ratio has decreased over time, from.26 in FY2012 to 0.04 in FY2021.

ii) Current Ratio(CR):

The current ratio (CR) of a company is calculated as the ratio of its current assets to its current liabilities.

Current Assets / Current Liabilities = Current Ration

Current assets (CA) are assets that will be consumed within the next year. They include inventory that is consumed and sold as a finished product within a year, cash and similar investments held by the company to meet day-to-day requirements, money due from customers (account receivables or debtors), and loans given to various parties that are expected to be repaid within a year.

Current liabilities (CL) are payables due within the next year as well as short-term provisions.

A current ratio greater than one indicates that the companys CA exceeds its CL and that the company would be able to pay off its short-term liabilities with the money it receives from current assets.

Let us examine Rallis India Ltds current ratio (CR) over time. (Please keep in mind that some calculations may result in a mismatch due to rounding off.)

Rallis India Ltd. has kept its current assets greater than its current liabilities in almost all years, which is a very healthy sign. Investors should seek companies with a current ratio of 1.25 or higher. 

(C) Analysis of Cash Flow Statement (CF)

This section contains information about the cash generated by a companys operations during the previous fiscal year (cash flow from operations or CFO). This chapter also includes information on cash used to make investments or cash received from selling investments (cash-flow from investing activities or CFI) and cash borrowed from or repaid to financial institutions during the previous year (cash-flow from financing activities or CFF).

An investor should concentrate on companies that generate a sufficient amount of cash flow from operations to cover their investment (CFI) and debt repayment needs (CFF). If an investor can find a company that generates so much cash that, after deducting CFI and CFF, it still has a surplus, she will have struck gold.

Let us examine Rallis India Ltds cash flow statement over time. Positive values indicate cash inflow, while negative values indicate cash outflow. (Please keep in mind that some calculations may result in a mismatch due to rounding off.)

Rallis India Ltd. has been generating a significant amount of cash from operations (CFO) year after year. CFO has increased significantly over the last decade, rising from 94 billion in FY2012 to 217 billion in FY2021.

We can see that Rallis India Ltd has been expanding its manufacturing capacities over the last decade, as evidenced by the negative cash flow from investing (CFI). However, almost all of the funds for investment in the plant and machinery have come from its operations. This is because the companys cash inflow has consistently been greater than its cash outflow under CFI.

As a result, an investor can see that the surplus CFO left over after accounting for the CFI outflow has been used by the company to pay dividends to its shareholders as well as repay its debt. Furthermore, Rallis India Ltd. has consistently paid a dividend of more than 20% of earnings over the last decade.

(D) Parameters based on a combination of B/S, P&L, and CF

Previously, we used ratios and growth rates based solely on figures from B/S, P&L, or CF. We did not use any of the ratios/parameters that use figures in these three financial statements.

A comparison of B/S, P&L, and CF is required because it provides a sanctity check on the numbers reported by any company. It will also provide additional insights into the companys financial position and operational efficiency.

 i) P&L and B/S combination:

Some of the indicators of a companys operational efficiency use a combination of P&L and B/S, such as:

·         Inventory turnover ratio,

·         Receivables turnover,

·         Payables turnover and

·         Asset turnover ratio etc.

These variables are the next level of analysis that an investor should perform once she is familiar with the parameters discussed above.

Even so, one analysis that compares P&L to CF is required for each investor to perform on each company she is researching. It compares cumulative net profit (profit after tax, PAT) over the last few years to cumulative CFO over the same time period.

ii) Cumulative PAT vs. Cumulative CFO:

A business that offers a product today may not receive payment right away. It is, however, legitimately eligible to receive it. As a result, accounting standards allow it to include this sale and its profit in the profit and loss statement. The money received from the buyer, on the other hand, will be reflected in CFO only when the money is actually received from the buyer.  As a result, when we compare PAT and CFO for any given year, they will differ. However, cumulative PAT and CFO should be similar over time.

If cumulative PAT is similar to CFO, it indicates that the company can collect its profits in cash from its buyers. If the CFO is significantly lower than the PAT, it means that the company, while legally entitled to the money from the buyer, is unable to collect it, or the profits are fictitious. In either case, the investor should steer clear of such a firm.

Let us compare Rallis India Ltd.’s cumulative PAT and CFO over time.

Rallis India Ltd. reported net profits of 1704 crores during FY2012-2021 and cash flow from operations of 1798 crores. This is a good sign for any business. 

Financial Analysis Synopsis

The financial analysis entails delving into three key components of the yearly report and thoroughly assessing them. The following are the three sections:

1.     Balance Sheet (B/S),

2.     Profit & Loss statement (P&L)

3.     Cash Flow statement (CF)

Before you get the impression that financial analysis entails a lot of arithmetic and complicated computations, let me assure you that financial analysis is just a study of two things:

Ratios & Growth Rates

As we learn more about financial analysis, well discover that it requires reviewing annual reports, noting down some key figures, and analysing various ratios of these figures and their growth rates over time.

To further simplify things, readers will be pleased to learn that an investor no longer needs to look at the financial information in the companys annual report and input them into a data analysis software like Microsoft Excel (excel). The investor can utilise free internet tools to obtain pre-packaged data files comprising financial details of companies, which he or she can then use in Excel to conduct a thorough examination. www.stocksemoji.com is one such free resource offered to Indian equity market investors.

We learned about financial analysis of a company in detail in the current article in the series "Selecting Top Stocks to Buy." The parameters discussed above are critical and should be sufficient for any retail investors basic due diligence. As we all know, there is no end to analysis, and analysts spend years analysing companies. There are hundreds of other ratios that can be used to gain additional insight into a companys financial position.

Even so, I believe that if a retail investor can analyse the eight parameters discussed above and, more importantly, understand the trend of these parameters over the life of the company, she will be able to easily select financially sound stocks from among thousands of options. She would also be able to avoid financially risky companies and save a significant amount of time that would otherwise have been spent researching such risky companies. Here is a summary of the eight financial parameters:

1.     Sales growth: Aim for high and sustainable growth of more than 15% per year. A growth rate of more than 50% is unsustainable in the long run.

2.     Profitability: Seek high and long-term OPM and NPM. We prefer companies with an NPM of more than 8%.

3.     Tax pay-out ratio: Unless the company qualifies for specific tax breaks, the tax rate should be close to the general corporate tax rate.

4.     Look for companies with an interest coverage ratio greater than three.

5.     Debt to equity ratio: Look for companies that have little or no debt. D/E 0.5 is preferred.

6.     Look for companies with a current ratio (CR) greater than 1.25.

7.     Cash flow: A positive CFO is required. Its ideal if CFO matches CFI and CFF outflows.

8.     Cumulative PAT vs. CFO: Look for companies with similar cumulative PAT and CFO over the last ten years.

Many times in the past, managements/companies attempted to use shortcuts to show good financial performance in reported numbers when the actual business on the ground was not doing well. These incidents have occurred all over the world, whether it was Enron in the United States or Satyam in India. Every investor should be aware of the tricks employed by such managements and conduct financial analysis to determine whether the performance displayed is genuine or fabricated. The above paragraph will assist readers in learning about common shortcuts used by businesses to dress up their financial statements.

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