Analysis: Sharda Motor Industries Ltd

 Published: 02-Apr-19
Modified: 08-Jun-21
1. Sharda Motor Industries Ltd Research Report by Reader
2. Dr Vijay Malik’s Response
3. Analysis Summary
The current section of the “Analysis” series covers Sharda Motor Industries
Ltd, one of the leading manufacturers of the automobile exhaust system, seat
frames, seat covers and white goods parts in India.
“Analysis” series is an attempt to share with all the readers, our inputs to the
company analysis submitted by readers on the “Ask Your Queries” section of
our website.
In order to benefit the maximum from this article, an investor should focus on the
process of analysis instead of looking for good or bad aspects of the company.
She should learn the interpretation of different types of data and transactions and
pay attention to the parts of annual reports etc. used to get the information. This
will help her in improving her stock analysis skills.

Sharda Motor Industries Ltd Research Report by Reader

Sir,

I have tried to analyze a company named “Sharda Motor Industries Ltd “. Please
provide your views/recommendations and valuable feedback.

Regards,

Suranjit

About Sharda Motor Industries Limited:

Sharda Motor Industries Limited is primarily engaged in the manufacturing and

assembly of auto components and white goods components. The Company
serves as a ‘Tier I’ vendor for some of the major automobiles and electronics
original equipment manufacturers (OEMs). It has ‘state of art’ manufacturing
facilities across thirteen locations in seven states of India. The Company’s
product range includes exhaust systems, catalytic converters, suspension
systems, sheet metal components and plastic parts for the automotive and white
goods industries.
Sharda Motor Industries Ltd sells its products mostly within India with
insignificant export income.
The Company has two associate companies:

1. Bharat Seats Ltd (shareholding: 28.66%)

2. Relan Industrial Finance Ltd (47.12%)
and two joint ventures (JVs), both having 50% holding each

1. Toyota Boshoku Relan India Pvt Ltd

2. Toyo Sharda India Pvt Ltd.
The JVs provide a profit of ₹1 cr and associate companies of ₹8 cr and is
materially insignificant compared to the parent company’s operations.

Financial analysis of Sharda Motor Industries Ltd:

 cCFO>cPAT for 10yrs implies funds not being stuck at WC.

 Working capital is majorly funded by trade payables, the amount
written off is very little to nil as they are supplying to a few fixed OEM
customers who are funding the working capital by advances.
 In 10 yrs., Sharda Motor Industries Ltd has generated ₹784 cr cash
from its operations, which it used to do a capex of ₹422 crs leaving
behind free cash of ₹363 crs.
 In those 10 yrs., Sharda Motor Industries Ltd paid dividends of ₹64
cr, the interest of nearly ₹100 crs and reduced debt by ₹85 crs and
the rest remain as cash in the balance sheet. In future, it needs to be
seen what the company does with this cash since it has repaid all
borrowing now and is completely debt-free.
 In 2018, Sharda Motor Industries Ltd has generated operating cash
of ₹156 cr (before tax) and ₹182 cr in 2017
 Maintenance capex is of nearly ₹22 cr to ₹26 cr out of which ₹10 cr
to ₹15 crs spend is on R&D equipment maintenance. Therefore,
every year it is generating free cash of ₹120 cr to ₹130 crs.
 Repaid borrowings of ₹225 cr from 2014, has repaid all borrowings
by 2018 and is completely debt-free now. The company is paying
dividend regularly and the payout can increase after now being debt-
free.
 The balance sheet is full of liquid cash. Current financial assets of
₹300 cr (₹105 cr investments and ₹122 cr receivables and ₹74 cr
cash)
  Trade payables are ₹185 cr (which is more than its profits) and
inventory is ₹85 cr and ₹122 cr receivables. Very little to nil working
capital requirements to run a business.
 Long-term investments of ₹2 cr (in associate and JVs) which market
value is ₹154 cr as of 31 March 2018. Associate companies/JVs are
giving decent profits every year (with almost negligible assets).
 Property, plant and equipment (PPE) of ₹175 cr currently at 2018.
Sharda Motor Industries Ltd was increasing debt from 2009 to 2014 to fund its
capex within its capacity and repaid off fully from 2014 to 2018 and currently, it is
debt-free. Fixed asset turnover is in a rising trend after completion of capex. Both
debtor days and inventory turnover are steady and stable.
I think it is mainly because of contracts/arrangements with fixed reliable OEM
customers.

Therefore, because of the top three OEM customers, the company is steady in
most of the parameters.

Average fixed assets employed by the company in the last 6 yrs. is

approximately ₹245 cr and working capital of nearly ₹30 cr. So total assets
employed is ₹275 cr (245 +30). In addition, it is generating free cash of ₹130 crs
every year implying a return of more than 45% (130/275).

Current profit & loss statement:

 Revenue = ₹1155 cr,

 PBT = ₹116 cr,
 PAT = ₹88 cr,
 other expense breakup = ₹138 cr (₹58 cr of hire labour charges is
the main component followed by ₹13 cr power and fuel, ₹14.44 cr
R&D maintenance expense, ₹8 cr of legal expense)
 What is ₹8 cr of legal expenses? Isn’t it high?
Employee benefit expenses are ₹82 crs and ₹58 cr of hire labour charges in
other expenses suggests the company is hiring labour on a contractual basis
instead of permanent employees for maybe cost optimization.

 Finished goods sold (2017, 2016, 2015) in crs

 Metal parts = 937,833,784
 Fabric = 201,180,147
 White goods = 19,21,28
 Total = ₹1158 cr, ₹1035 cr, ₹960 cr
 Exports = ₹31 cr (2016), ₹29 cr (2015)
Exports are insignificant compared to indigenous operations. Metal parts
constitute nearly 80% of products sold and are the main driver of revenue.

Details of raw material and components consumed (2017, 2016, and 2015)

 Steel = ₹196.33 cr, 189, 177

 Fabric = ₹139.01 cr, 108, 102
 Others = ₹327 cr, 299, 285
 Total ₹662 cr (imported=20%, Indigenous=80% and is generally in
that range for previous years also)
As imports are bigger than exports hedging policy is being followed by the
company and rupee depreciation will affect it adversely which management also
mentioned in annual reports.

Upon analysing the above data, it seems that Sharda Motor Industries Ltd
benefits directly when its raw material (RM) prices decrease which directly flows
to its operating profit margin (OPM) and consecutively to net profit margin (NPM).
NPM has improved recently as interest reduced due to the company repaying
debt early. So going forward when RM prices increase, it will directly affect its
margins, which can lead to losses as it is at the mercy of huge OEMs and cannot
transfer the price rise. Sharda Motor Industries Ltd has repeatedly communicated
about this issue for many years. How can we find what type of pricing
arrangements it is having with its customers?

In addition, we can see that the self-sustainable growth rate (SSGR) is negative

territory to 1% but as money is not being stuck in working capital, therefore, we
can correlate that it falls under (C) class of companies in the SSGR article. In
such cases, SSGR can’t be considered, as sales are growing at 15% CAGR and
PAT by 25% for the last 9 yrs. and the company is debt-free generating excess
cash than its reported profits.
The company mentioned their customers in the previous year’s annual
report (AR):
2016 AR:
“Your Directors take this opportunity to express their grateful appreciation for the
excellent assistance and co-operation received from its customers i.e. M/s.
Hyundai Motor India Ltd., M/s Mahindra & Mahindra Ltd., Cummins Power
Generation, M/ s. Tata Motors Ltd., and M/s. Bharat Seats Ltd”
2015 AR:
“Your Directors take this opportunity to express their grateful appreciation for the
excellent assistance and co-operation received from its customers i.e. Hyundai
Motor India Ltd., Mahindra & Mahindra Ltd., M/s. Samsung Electronics India Ltd.,
M/s. Tata Motors Ltd. and M/s. Bharat Seats Ltd.”
It seems after 2015 M/s. Samsung Electronics India Ltd ceased to be their
customer and added a new customer Cummins Power Generation. It seems both
associate and JVs are immaterial compared to operations and assets of SMIL.

Management analysis of Sharda Motor Industries Ltd:

Shri Ajay Relan and Shri Rohit Relan are sons of Smt. Sharda Relan. Shri R.P.
Chowdhry is the father-in-law of Shri Ajay Relan. Remuneration of the promoters
is much on the higher side.
2018:
As per the company’s annual report, the remuneration ceiling as per the
Companies Act is ₹12.5 cr.

 Being 10% of net profits of the Company calculated as per section

198 of the Companies Act, 2013 – How do they arrive at this figure?
Aashim Relan (COO and son of Shri Ajay Relan) Graduate in Economics major
from “Emory University, Atlanta (U.S.A), 6 years in the company, joined on
28.06.2012, age 27 years, no previous employment is taking ₹1.28 cr as
remuneration, which is pretty much high for any fresh joinee. I may be wrong
here and it can be corporate rates. Please correct.

2017:
Total promoter remuneration of ₹7.1 cr (that too upon the demise of promoter
N.D. Relan from 2 June 2016. Therefore, the remuneration would be much
higher than reported) on PAT of ₹60 cr implies 12.8%.

While in the annual report, they have mentioned the ceiling being 10% of profits
of ₹8.2 cr as per AR 2017 – How do they arrive at this figure?

 An average Salary increase of non-managerial personnel is 12%

 An average Salary increase of managerial personnel is 22%
 (Shri Ajay Relan remuneration increased by 52%)
2016:
₹5 cr remuneration to promoters against net profit after tax (PAT) of ₹31 cr (16%
of PAT)

 The average increase in remuneration of all employees during the

year 2015-16 was 14%,
  Revenue from operations for 2015-16 has increased by 6%.
 The Profit before tax increased by 46.5% during the year. However,
profit after tax has decreased by 5.26%.
Percentage increase on remuneration of KMP: (i) CFO – 8% (ii) Company
Secretary – 11%, (ii) Shri N. D. Relan – 9.98% (iii) Shri Ajay Relan – 10.02%

2015:
The average increase in remuneration of all employees during the year 2014- 15
was 20%. The revenue from operations of 2014-15 increased by 7%. The profit
before tax increased by 55.89%.

(ii) Shri N. D. Relan-8% (iii) Shri Ajay Relan-(17%) (iv) Smt. Sharda Relan-89%
(v) Shri Rohit Relan-89%

It seems promoters are drawing salary much higher than the general
remuneration policy followed by other companies.

During FY 2015, the company has entered into a joint venture agreement with
Toyo Seat Company Limited, a foreign body corporate, incorporated in Japan, for
the purpose of design, development, evaluation, manufacture and supply of four-
wheeler seat components including devices and high tensile strength frames
for automobiles in India for domestic and export purpose and procurement and
export of seat parts from India. A new company namely “Toyo Sharda India
Private Limited” has been incorporated.
Sharda Motor Industries Ltd consistently has not spent its due amount in CSR
activities citing silly reasons:

 Amount to be spent for CSR 2018 = ₹1.16 crs

 Amount unspent = ₹1.05crs
Management explanation: Certain planned projects of capital nature carrying a
large amount of expenditure could not be executed due to regulatory and
technical hassle.
 Total Amount to be spent for 2017: ₹64.54 Lakhs
 Amount unspent: ₹49.54 Lakhs
Management explanation: Reasons for that can be extensive research made by
the Company on the different focus areas, identification of the suitable and
impactful programs, initiating long-term projects, which could not be capitalized
during the year. However, the scale of CSR activities undertaken by the
Company during the financial year has significantly increased. CSR spend of the
Company during the year has increased by almost 50% vis-a-vis last year
(2016).
This was also the case with previous years.
Shri Pradeep Rastogi, Chief Financial Officer of the company, has resigned from
the office of Key Managerial Personnel (i.e. CFO) w.e.f. 10 August 2016 and Shri
Vivek Bhatia has been appointed as Chief Financial Officer at his place w.e.f. 10
August 2016. It might be a normal thing but it raises a few doubts.

Promoters’ stake is very high at 74% and shares are held in the name of
individuals seems very encouraging. Promoters have their own skin in the
game and dividends might increase soon.

Sale of goods:

Domestic sales are recognized on the transfer of significant risk and rewards of
ownership to the customer, which takes place on dispatch of goods to the
customers from the factory. Export sales are recognized at the time of the
clearance of goods and approval of Government authorities.

So products might be rejected although the accounting might have been done for
results although chances may be very less.

Depreciation is provided using the written down value method.

It seems the company has extended the useful life of the plant & machinery
beyond as per the Companies Act, which will boost profits in terms of lower
depreciation rates. Is this valid? However, the company is using the same
depreciation method for years. Need your views upon that.

Non-current investments in associate companies (2) and JV (2) of ₹2 crs from

2014 onwards and remains the same. Recently invested Windage Power
Company Private Limited in fully paid up 17,500 (March 31, 2017: 5700 and April
01, 2016: Nil) Equity shares of ₹10 each. The company does not mention it as a
related party.

The total non-current initial investment of ₹2 cr amounts to the total market value
of ₹154 cr now.

Current investments & deposits = ₹114 cr in mutual funds, ₹22 cr of cash and
equivalents
The profit share of associate companies = ₹8cr and JVs = ₹1 cr.
One aspect to monitor is what the company does with such amounts of cash. It
could not go on capacity expansion and reinvest at such high rates to sustain
future growth as its customers are fixed and demand will be driven by them.
Whether it will be given to stakeholders or the associate company “Relan
industrial finance ltd”, will play the spoilsport needs to be seen.

Loans from Promoters:

The company has taken loans earlier from the promoters and related parties but
they carried the same interest rates as market rates. The management also
communicated this in a transparent manner and gets evident from related parties
as well. Currently, no outstanding loan as of 31st March 2018.
Major Customer: Revenue from three customers of the Company’s
manufacturing & trading business are Rs. 928.7cr (March 31, 2017: ₹913.95crs)
which is nearly 80% of total revenue. Because of these customers, they are
having steady business and steady OPM.
As communicated in the annual report:

“In case of sales, the Company has limited its credit exposure to OEMs and
dealers by providing a maximum payment period up to 60 days. However,
Company need not required to provide for any risk allowance on account of trade
receivable being bad and not recoverable as the amount of outstanding
pertaining to trade receivables, which exceeds the credit period allowed by the
Company is less than 2% of the total outstanding from them. Trade payables are
non-interest bearing and are normally settled on 90-day terms”
This may be the reason for having very less working capital requirements and
stable cash flow business in spite of being in a cyclical industry. As write-offs are
nil, CFO is more than PAT and long order visibility due to heavy reliance on
these OEMs. This is a double-edged sword and it could devastate the company if
any customer moves out.

The contract between associate companies and parent company:

It seems it is in all types of transactions with Bharat Seats Ltd.

Relan Industrial finance is in stockbroking services and is using the parent

company’s cash for broking in stock markets. Although broking is a commission-
based business but much a case of concern and risk of burning cash. Would like
to know your views on that.
As per the Independent Auditors’ Report:

“According to the information and explanations given to us, discrepancies

noticed on such verification between physical stocks and the book records were
not material and these have been properly dealt with in the books of account.”

“Further, there were no undisputed outstanding statutory dues as on the last day
of the financial year concerned for a period of more than six months from the
date they became payable except duty of custom of Rs.6.59 lakhs”
The same pending amount is from 2015 but no explanation is given in the annual
report.

1) The company has taken leases from its promoters and related parties. How to
find out whether the rates are as per market rates? Although other two leases
have expired and not renewed except lease from M/s. Sharda Enterprises. The
lease agreement was renewed on 01.07.2015 and is valid until 30.06.2020.

 The Company had taken a guesthouse on non-cancellable lease

from Smt. Sharda Relan. The lease agreement was valid until
31.01.2017. Lease rental amounting to ₹50.25 Lakhs (March 31,
2016: ₹60.10 Lakhs) has been debited to Statement of Profit and
Loss. No lease renewal after that.
 The Company has taken a Factory Premises on non-cancellable
lease from M/s. Sharda Enterprises. The lease agreement is valid
until 17.10.2017. Lease Rental amounting to ₹84.42 Lakhs (March
31, 2016: ₹84.14 Lakhs) has been debited to Statement of Profit and
Loss
 The Company had taken a Factory Premises on non-cancellable
lease from M/s. Sharda Auto Solutions Pvt Ltd. Lease Agreement
was valid till 30.06.2016. Lease Rental amounting to ₹10.25 Lakhs
(March 31, 2016: ₹43.74 Lakhs) has been debited to Statement of
Profit and Loss.
2) The company has purchased ₹5 cr worth of assets from Toyo Sharda and ₹2
cr worth of assets from Bharat Seals Ltd. Is it purchasing at a higher rate than
other market sources or is SMIL is getting any benefits from buying from these
related-party companies. How to get this information about what products and
what rates they are buying/selling?

3) Loans taken from related parties seem in line with as management said earlier
i.e. at 8-9% interest rates.
4) SMIL is supposed to receive ₹30 crs from Bharat Seals Ltd (associate
company). It seems it is recurring in nature due to its contract/arrangements of
such with the associate company.

In the case of Toyo Sharda India Private Limited, the joint venture, depreciation
on property, plant and equipment has been provided on the straight-line method,
which is inconsistent with the written down value method of depreciation used in
the case of SMIL. However, it is impracticable to harmonize; therefore,
adjustment for the same has not been made in the consolidated financial
statements.

Valuation analysis of Sharda Motor Industries Ltd:

The company is trading at a PE multiple of 11 which is below its historical

average PE band and does provide a margin of safety.
It has current investments of ₹105 cr and a non-current investment of ₹2 cr
which market value is approx. ₹150 crs and cash of nearly ₹75 crs totalling to
₹330 crs (105+150+75) of liquid cash. It has a current property plant &
equipment (PPE) of ₹175 cr.

It implies that we are getting assets of nearly ₹500 cr (330 +175) nearly 53% of
current market capitalization and a business that is generating ₹100-120 crs
of free cash flow every year. It is trading at a market capitalization of ₹945 cr.
If we consider all this we are getting this business at 3 to 4 times of PE, which I
believe offers a huge margin of safety.

Regards,

Suranjit

Dr Vijay Malik’s Response

Hi Suranjit,

Thanks for sharing the analysis of Sharda Motor Industries Ltd with us! We
appreciate the time & effort put in by you in the analysis.

Let us analyse the performance of Sharda Motor Industries Ltd over the last 10
years.
While analyzing the past financial performance data of the company, an investor
would notice that until FY2012, Sharda Motor Industries Ltd used to disclose both
standalone as well as consolidated financials. This is because, the company had
a wholly-owned subsidiary, Sharda Sejong Auto components (India) Limited,
which it, later on, merged with itself. As a result, from FY2013 to FY2015, the
company reported only standalone financials.
From FY2016 onwards, Sharda Motor Industries Ltd again started reporting both
standalone and consolidated financials to incorporate the impact of the
performance of its associate companies: Bharat Seats Limited, Relan Industrial
Finance Limited and its joint ventures: Toyota Boshoku Relan India Private
Limited and Toyo Sharda India Private Limited.

We believe that while analysing any company, the investor should always look at
the company as a whole and focus on financials, which represent the business
picture of the entire group. Therefore, while analysing Sharda Motor Industries
Ltd, we have analysed consolidated financials from FY2009-FY2012, standalone
financials from FY2013-FY2015 and consolidated financials from FY2016
onwards until FY2018.

Further advised reading: Standalone vs Consolidated Financials: A Complete

Guide
Financial and Business Analysis of Sharda Motor Industries Ltd:

While analyzing the financials of Sharda Motor Industries Ltd, an investor would
note that in the past, the company has been able to grow its sales at a rate of 5-
10% year on year. Sales of the company increased from ₹453 cr. in FY2009 to
₹1,155 cr in FY2018. While analysing the profitability of the company, an investor
would notice that the operating profit margin (OPM) of Sharda Motor Industries
Ltd has been consistent over the years in the range of 8-10%, which has
improved recently in FY2018 to 13%.

Sharda Motor Industries Ltd operates in the auto-ancillary industry, which is

highly dependent on the automobile industry. An investor would appreciate that
the automobile industry is a cyclical business, which witnesses its growth
associated with the growth phases of the overall economy. Because of the
cyclical nature of the customer industry (automobiles), the auto-ancillary
business also witnesses cyclical phases in their business. This is because
the automobile manufacturers are very large corporations when compared to
their vendors/suppliers (auto-ancillary players).
Automobile manufacturers have higher negotiating power over suppliers and as
a result, they are able to push tough contractual terms on their suppliers. It
results in continuous pressure on the prices the suppliers are able to get
from automobile manufacturers. Such cyclical characteristic of the business of
auto-ancillary companies along with weak negotiating position usually reflects in
the nature of fluctuating profit margins.
Advised reading: How to do Business Analysis of Auto Ancillary Companies
Investors would be able to recollect fluctuating profit margins in the case
of Gandhi Special Tubes Ltd, which is an auto-ancillary player, which supplies
steel tubes including fuel injection tubes to the automobile manufacturers.
Sharda Motor Industries Ltd has also communicated to its shareholders that it
faces continuous pressure from automobile manufacturers to reduce the prices
of its products. The pricing pressure from the customers along with the volatility
in the prices of the raw material is considered a threat by the company.
FY2015 annual report, page 53:

THREATS: The auto component industry has been exposed to many threat of

varying intensity. The hardening of interest rate, tightening money
supply, volatility in the price of raw materials and other inputs, currency
fluctuations, OEM’s demand for price reduction, stiff competition because of the
entry of Multinationals and their home country partnership, stringent in emission
norms and Just In Time supplies are the major risks and challenges faced by the
Companies.
The credit rating agency, CRISIL in its report of Sharda Motor Industries Ltd in
August 2014, highlighted the challenge faced by the company from raw material
prices and pricing pressure from its customers:

These rating strengths are partially offset by its moderate gearing, customer
concentration in SMIL’s revenue profile and the susceptibility of its operating
margin to increase in raw material prices and to pricing pressure from original
equipment manufacturers (OEMs).
Further advised reading: Credit Rating Reports: A Complete Guide for Stock
Investors
From the above discussion, an investor would anticipate that the profit margin of
any auto-ancillary player like Sharda Motor Industries Ltd would be very
fluctuating in nature as had been the case of Gandhi Special Tubes
Ltd. However, in the case of Sharda Motor Industries Ltd, the investor would
notice that the operating profit margin (OPM) has been stable and improving over
the years. The OPM has improved from 8% in FY2011 to about 13% in FY2018.
An investor would notice that the net profit margin (NPM) of Sharda Motor
Industries Ltd has also witnessed similar improvement over the years. The NPM
has improved from 2% in FY2009 to 8% in FY2018.

Further advised reading: How to do Financial Analysis of Companies

Such a trend in profitability is in sharp contrast to the expected performance of
any auto-ancillary company. As a result, an investor should analyse the company
further to understand the reason for the stability/improvement of profitability of
the company.

While analysing multiple documents related to the company, an investor gets to

know that the improvement of the profit margins of Sharda Motor Industries Ltd
over the years is a result of multiple factors:

1) Price revisions received from its customers (automobile manufacturers):

While analysing the February 2017 credit rating report of the company prepared
by CRISIL, an investor gets to know that Sharda Motor Industries Ltd is able to
receive price revisions from its customers. The report mentions that such price
revision comes with a time lag meaning that if the raw material prices increase
now, then Sharda Motor Industries Ltd get higher prices from its customers after
a few months/quarters. Nevertheless, such price increases allow the company to
maintain its profitability.
OEMs have always held a strong bargaining power with SMIL by virtue of their
size and market position. Although, SMIL does receive periodic price revisions
from the OEMs, these revisions remain affected by their financial standing and
willingness; as such, any benefit in the operating margin comes with a lag.
Further advised reading: How to do Business Analysis of a Company?

2) Improving operating efficiencies in business operations:

Sharda Motor Industries Ltd has been working towards improving its operating
efficiencies process automation and material management, which in turn leads to
lower wastage. These efforts lead to better operating profit margins and in turn,
reduce its vulnerability from an increase in raw material prices and the pricing
pressure from its customers.

An investor gets to know about these measures taken by the company from the
credit rating report of the company prepared by CRISIL in August 2013:

The outlook revision reflects CRISIL’s belief that SMIL’s operating margin over
the medium term will be less vulnerable to any possible increase in raw material
prices and pricing pressure from its original equipment manufacturer (OEM)
buyers. The extent of vulnerability of SMIL’s operating margin to the
aforementioned factors has reduced mainly because of SMIL’s improved
operating efficiencies, achieved through process automation and value
engineering, leading to better material management and lower wastage. These
process improvements led to greater control for SMIL over its operating
margin over the two years through 2012-13 (refers to financial year, April 1 to
March 31).
Further advised reading: How to Assess Operating Efficiency of Companies

3) Focus on research and development activities:

While analysing past annual reports of the company, an investor would notice
that Sharda Motor Industries Ltd has been continuously spending about 1.5% of
its sales revenue on research & development. Over the last eight years (FY2011-
18), the company has spent in excess of ₹100 cr on research and development.

Further advised reading: Understanding the Annual Report of a Company

The focus on research and development has produced multiple benefits for the
company, which included the process improvements leading to better control
over its operating margins discussed earlier.

As per the August 2013 credit rating report of Sharda Motor Industries Ltd
prepared by CRISIL:
The company could implement these process improvements as a result of its
consistent focus on research and development (R&D) initiatives. SMIL spent
around Rs.260 million on R&D over the three years through 2012-13,..
The company received a rating upgrade from A to A+ by CRISIL in October 2015
where the credit rating agency has pointed out continuous focus on research and
development and its benefits in controlling costs as one of the factors for the
increase in credit rating.

The rating upgrade reflects significant improvement in SMIL’s business risk

profile because of a better operating margin. The margin increased by 140 basis
points (100 basis points equal 1 percentage point) to 10.80 per cent in 2014-15
(refers to financial year, April 1 to March 31) from 9.41 per cent in 2013-14. The
increase was because of continuous research and development initiatives to
control costs, focus on automation, and tight control over raw material
procurement.
An investor would appreciate that an upgrade in credit rating leads to a lowering
of interest rates for the company, which in turn leads to improvement in profit
margins.

Further advised reading: Credit Rating Reports: A Complete Guide for Stock

Investors

4) Sharda Motor Industries Ltd ready with BS-VI products due to its
research and development activities:

Because of the continuous focus on research and development, Sharda Motor

Industries Ltd is ready with upgraded products, which meet the requirement of
new Bharat Stage – VI (BS-VI) emission norms. These new BS-VI ready
products are being sold to automobile manufacturers at higher prices.
Credit rating report by CRISIL, February 2017:

Continued focus on R&D, process automation, and value

engineering: Substantial investment in research and development (R&D)
infrastructure has enabled the company to achieve significant improvement in
the production process, and  launch products that match the stricter emission
norms of Bharat Stage-VI. This has led to improved operating efficiency and
various OEMs have placed orders for exhaust systems for new launches,
scheduled over the next 12-18 months. These high value-added products will be
sold at a significant premium over the existing ones.
This is in sharp contrast to another auto-ancillary player analysed by us, Gandhi
Special Tubes Ltd, which does not have a BS-VI compliant version of its current
products and as a result, faces a significant risk to its business in the near future.
From the above discussion, an investor would notice that Sharda Motor
Industries Ltd has been able to get comparatively better terms
from automobile manufacturers than other auto-ancillary players. Sharda Motor
Industries Ltd has spent significant money on research and development
activities and as a result, it has benefited from process improvements leading to
lower costs and BS-VI ready products leading to higher pricing from customers.
Therefore, an investor would appreciate that Sharda Motor Industries Ltd has
been able to have better control of its profit margins.
While analysing the tax payout of Sharda Motor Industries Ltd over the years, an
investor would notice that in most of the years, the tax payout ratio is in line with
the standard corporate tax rate prevalent in India. In certain years, the tax payout
ratio is significantly different like FY2012 (9%), FY2013 (40%) and FY2015 (-5%).
While analysing the annual reports for these years, the investor would notice that
the key reasons for such divergences are “Minimum Alternate Tax (MAT) credits”
and “deferred tax adjustments”.
Advised reading: How to calculate Deferred Tax Assets
FY2013 annual report, page 35:

FY2015 annual report, page 61:

Investors may contact the company directly to get further clarifications for the tax
payout ratio.

Advised reading: How to do Business Analysis of Auto Ancillary Companies

Operating Efficiency Analysis of Sharda Motor Industries Ltd:

i) Net fixed asset turnover (NFAT) of Sharda Motor Industries Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Sharda Motor

Industries Ltd over last 10 years (FY2009-18), then she notices that the NFAT of
the company witnessed a continuous decline over the initial years and later on, it
witnessed a continuous increase. NFAT declined from 4.23 in FY2010 to 2.94 in
FY2014. However, thereafter, NFAT increased from 2.94 in FY2014 to 6.03 in
FY2018.
An investor would appreciate that the decline in the NFAT in the initial period
during FY2009-14 coincides with the capital expenditure of about ₹300 cr done
by the company in FY2010-14.
In FY2010, Sharda Motor Industries Ltd had eight manufacturing plants whereas
by FY2014, the company had increased the number of plants to 13.

FY2010 annual report, page 23:

FY2014 annual report, page 28:

An investor would appreciate that whenever a company invests in manufacturing
plants, then it usually takes some time for the plants to be operationalized and
then reach optimal capacity utilization. During this phase of reaching optimal
utilization, the company would have already done all the investment but the
benefits in terms of higher sales would take time to come. Therefore, during such
phases, companies usually witness declining asset turnover ratios (e.g. NFAT).

Post FY2014, Sharda Motor Industries Ltd has not done any major capital
expenditure whereas the company has benefited from higher sales from the
plants operationalized during FY2010-14. As a result, the company has
witnessed good improvement in NFAT.

Further advised reading: Asset Turnover Ratio: A Complete Guide for

Investors

ii) Inventory turnover ratio of Sharda Motor Industries Ltd:

An investor would note that over the years, the inventory turnover ratios (ITR) of
the Sharda Motor Industries Ltd has been ranging from 11-13, which has recently
improved to 14.7 in FY2018.

Such a trend of ITR indicates that the company has kept its inventory
management under control and as a result, not allowed money to be
unnecessarily stuck in working capital. This is in line with the discussion above
where we noticed that Sharda Motor Industries Ltd has generated many process
improvements due to research and development, which led to improvement in
operating profit margins.

Advised reading: Inventory Turnover Ratio: A Complete Guide

iii) Analysis of receivables days of Sharda Motor Industries Ltd:

An investor would notice that over the years, receivables days of Sharda Motor
Industries Ltd have declined from 45 days in FY2010 to 36 days in FY2018.

Declining receivables days indicate that Sharda Motor Industries Ltd has been
able to negotiate improving credit terms with its customers. This can be a
probable result of its focus on product improvement by research and
development. Research and development activities have led to the ready
availability of BS-VI compliant products that are sold at a premium price to the
customer.

Further Advised Reading: Receivable Days: A Complete Guide

Credit rating report by CRISIL, February 2017:

Continued focus on R&D, process automation, and value

engineering: Substantial investment in research and development (R&D)
infrastructure has enabled the company to achieve significant improvement in
the production process, and  launch products that match the stricter emission
norms of Bharat Stage-VI. This has led to improved operating efficiency and
various OEMs have placed orders for exhaust systems for new launches,
scheduled over the next 12-18 months. These high value-added products will be
sold at a significant premium over the existing ones.
An investor would appreciate that the focus of the company on continuous
improvement of its products and the efforts to stay ready with the future
requirements of its customers (BS-VI) has led to improving operational
efficiencies for the company.

An analysis of receivables days along with inventory turnover indicates that

Sharda Motor Industries Ltd has been able to keep its working capital
requirements stable and under control. It means that Sharda Motor Industries Ltd
has been able to convert its profits into the cash flow from operations without the
money being stuck in working capital. An investor observes the same while
comparing the cumulative net profit after tax (cPAT) and cumulative cash flow
from operations (cCFO) of the company for FY2009-18.
An investor would notice that over FY2009-18, Sharda Motor Industries Ltd
Limited has reported a total cumulative net profit after tax (cPAT) of ₹349 cr.
whereas during the same period, it reported cumulative cash flow from
operations (cCFO) of ₹756 cr indicating that it has converted its profits into cash.
The cCFO of Sharda Motor Industries Ltd is significantly higher than its cPAT
primarily because of high depreciation (₹367 cr) and interest expenses (₹99 cr),
which are deducted while calculating PAT, while these are added back to PAT
when calculating CFO.

It is advised that investors should read the article on CFO calculation mentioned
below, which would help them understand the situations in which companies tend
to have the CFO lower than their PAT and the situations when the companies
tend to have CFO higher than their PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

Margin of Safety in the Business of Sharda Motor Industries Ltd:

i) Self-Sustainable Growth Rate (SSGR):

Further advised reading: Self Sustainable Growth Rate: a measure of

Inherent Growth Potential of a Company
Upon reading the SSGR article, an investor would appreciate that if a company is
growing at a rate equal to or less than the SSGR and it is able to convert its
profits into cash flow from operations, then it would be able to fund its growth
from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its
SSGR, then its internal resources would not be sufficient to fund its growth
aspirations. As a result, the company would have to rely on additional sources of
funds like debt or equity dilution to meet the cash requirements to generate its
target growth.
An investor would notice that Sharda Motor Industries Ltd has witnessed an
SSGR ranging from -9% to 2% over the years. While studying the formula for the
calculation of SSGR, an investor would understand that the SSGR directly
depends on the net profit margin (NPM) of a company.

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,
  SSGR = Self Sustainable Growth Rate in %
 Dep = Depreciation rate as a % of net fixed assets
 NFAT = Net fixed asset turnover (Sales/average net fixed assets
over the year)
 NPM = Net profit margin as % of sales
 DPR = Dividend paid as % of net profit after tax
(For systematic algebraic calculation of SSGR formula: Click Here)
As the NPM of Sharda Motor Industries Ltd has been very low consistently in the
range of 2-4%, therefore, the company has a low SSGR. The SSGR has
increased recently because of a sharp increase in the profit margins in FY2016-
2018.

The sales growth achieved by the company over the years is 5-10%, which is
higher than its SSGR. Therefore, investors would expect that the company would
have to raise debt from additional sources to fund its growth. However, in the
case of Sharda Motor Industries Ltd, the company has repaid all its debt in
FY2018 and has become debt-free.

While reading the SSGR article shared above, the investor would notice that we
have highlighted a situation (Case C), where companies that have SSGR less
than the current growth rate but still manage to reduce debt over the years. In
such cases, efficient working capital management ensures that the company has
a significant amount of CFO, which is not stuck in the working capital needs of
the company. As a result, the cash is available from the internal sources for the
capital expenditure needed for growth and reduce debt.

An investor is able to observe this aspect of the company’s business when she
analyses the cumulative cash flow position including free cash flow for the
company over the last 10 years (FY2009-18).

ii) Free Cash Flow Analysis of Sharda Motor Industries Ltd:

While looking at the cash flow performance of Sharda Motor Industries Ltd, an
investor notices that during FY2009-18, the company had a cumulative cash flow
from operations of ₹756 cr. However, during this period it did a capital
expenditure (capex) of ₹368 cr. As a result, it had a free cash flow of ₹388 cr.
(756 – 368).

Further advised reading: Free Cash Flow: A Complete Guide to

Understanding FCF
While analysing the past annual reports of Sharda Motor Industries Ltd, an
investor would notice that the company has used this FCF in various manners:

1. Dividend payments to the shareholders: The company has used

the FCF to pay a dividend of about ₹60 cr. (excluding dividend
distribution tax) to the shareholders.
2. Reduction of debt: Sharda Motor Industries Ltd used the FCF to
reduce its debt by ₹92 cr over the years. It used to have a total debt
of ₹92 cr in FY2009 whereas it is debt-free in FY2018.
3. Investment in financial assets/ joint venture/ associates: At
March 31, 2018, Sharda Motor Industries Ltd has cash &
investments of about ₹209 cr, which includes the investments of
about ₹30 cr done in joint ventures and associate companies.
Free cash flow (FCF) is one of the main pillars of assessing the margin of safety
in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The

Cornerstone of Stock Investing

Additional aspects of Sharda Motor Industries Ltd:

On analysing Sharda Motor Industries Ltd, an investor comes across certain

other aspects of the company:

1) Management Succession of Sharda Motor Industries Ltd:

While analysing the annual reports of Sharda Motor Industries Ltd, an investor
notices Mr. Aashim Relan who is the son of Mr. Ajay Relan (MD of the company),
joined the company in 2012 and is currently working as Chief Operating Officer
(COO).

It indicates that the company has put in place a management succession plan in

which the new generation of the promoter family is being groomed in business
while the senior members of the promoter family are still playing an active part in
the day-to-day activities.
Presence of a well thought out management succession plan is essential in case
of promoter run businesses as it provides for smooth transition of leadership over
the generations and provides continuity in the business operations of any
company.
Further advised reading: Steps to Assess Management Quality before Buying
Stocks

2) Remuneration of promoters of Sharda Motor Industries Ltd:

While reading the FY2017 annual report, an investor notices that on June 2,
2016, the promoter of Sharda Motor Industries Ltd Mr. N. D. Relan expired and
thereafter his wife Ms. Sharda Relan at the age of 81 years was appointed an
executive director of the company on August 10, 2016.

An investor would notice that in FY2018, Sharda Motor Industries Ltd has paid a
remuneration of ₹4.64 cr to Ms. Sharda Relan.

However, while going through the “Management Team” section of the website of
the company, the investor notices that the name of Ms. Sharda Relan does not
appear in the list of key management personnel. The “Management Team”
section of the website highlights the following eight personnel:
1. Ajay Relan (Managing Director)
 2. Aashim Relan (Chief Operating Officer)
3. Vivek Bhatia (CFO)
4. Sanjiv Kumar Yogi (Chief Purchasing Officer)
5. Sitangshu Goswami (President – Sales & Strategy)
6. Pradeep Rastogi (Legal & Strategic Affairs)
7. Nitin Vishnoi (Company Secretary & Compliance Officer)
8. Abinash Upadhayay (Chief People Officer)

The above assessment indicates that Sharda Motor Industries Ltd is not
highlighting one of the highest paid employees on its website as the key
management personnel. This might seem in contrast to the principle of
remuneration in proportion to the value added to the company. An investor may
also interpret the above situation as a case where the company has merely
shifted the remuneration, which was being paid to Mr. ND Relan to the account of
Ms. Sharda Relan.

Further advised reading: Why Management Assessment is the Most Critical

Factor in Stock Investing?
The total amount of remuneration taken by senior promoters (ND Relan, Sharda
Relan and Ajay Relan) has increased consistently over the years.
While analysing the past annual reports of Sharda Motor Industries Ltd, an
investor would notice that the promoters have been taking home the maximum
possible remuneration allowed by the statutory limits.

In FY2010, the overall limit for remuneration to the directors was ₹36,382,914/-
while the remuneration taken was ₹36,248,734/-. FY2011 annual report, page
47:

The above table also shows the method/calculation for arriving at the maximum
permissible remuneration of promoters/directors for any company.

In FY2011, the overall limit for remuneration to the directors was ₹31,128,889/-
while the remuneration taken was ₹31,433,330/-. FY2011 annual report, page
47:
In March 2014, Sharda Motor Industries Ltd proposed for paying minimum
remuneration to promoters irrespective of low profits in the year by taking central
govt. approval. FY2014 annual report, page 24:

RESOLUTIONS PASSED THROUGH POSTAL BALLOT:

Resolution No. 2 to 4 special Resolution under Section 198,269, 309 and other
applicable provisions of Companies Act, 1956 for payment of Minimum
Remuneration Shri N D Relan,Whole Time Director designated as Co-Chairman,
Shri Ajay Relan, Managing Director and Shri Udayan Banerjee, Whole Time
Director designated as Executive Director, with approval of Central
Governments.
Thereafter, Sharda Motor Industries Ltd started paying remuneration higher than
the stipulated limits by taking approval from central govt.

FY2015 annual report, page 36:

FY2016 annual report, page 40:

Based on the above discussion, an investor may observe that the promoters of
Sharda Motor Industries Ltd have ensured that they receive remuneration, which
is higher than the statutory limits by taking approval from central govt. approval
irrespective of the business performance of the company. Moreover, investors
would observe that Sharda Motor Industries Ltd seems to have shifted the high
remuneration being paid to Mr. ND Relan to the account of Ms. Sharda Relan
after his demise. The company is not highlighting Ms. Sharda Relan as key
management personnel on its website despite paying ₹4.64 cr as remuneration
to her in FY2018.
Investors may keep these aspects in mind while analysing Sharda Motor
Industries Ltd.

Further advised reading: How to identify Promoters extracting Money via

High Salaries

3) Costlier loans taken from related parties by Sharda Motor Industries Ltd
than the loans from financial institutions:

While analysing the past annual reports, an investor would notice that Sharda
Motor Industries Ltd has year after year taken loans from related
parties/promoters.

FY2010 annual report, page 35:

FY2012 annual report, page 65:

FY2014 annual report, page 47:

FY2016 annual report, page 75:

FY2018 annual report, page 74:

Therefore, an investor would note that the promoters/related parties have
continuously lent money to Sharda Motor Industries Ltd and earned interest on
the same from the company.

While assessing the interest rate, which is paid by Sharda Motor Industries Ltd
on these loans to related parties viz-a-viz loans from other financial institutions,
the investor notices that the interest rate on these loans from related parties has
been continuously higher than the interest rate on the loans provided by financial
institutions.

FY2014 annual report, page 44, 45 & 47:

The ECB loan consists of 2 loans:

i) First loan of US $ 2.0 Million was taken in August, 2012 and repayable in 15
instalments of US$ 133,333 commencing from 26.01.2014. The loan carries an
interest rate of 8.45% p.a.
ii) Second loan of US $ 6.0 Million was taken in January, 2014 and repayable in
Six instalments. The Loan carries an interest rate of 7.75% p.a.
c) Directors Loan: Payable on demand. The loan is taken on an interest rate
of 10% – 12%.
FY2016 annual report, page 72 & 75:

The ECB loan consists of 2 loans:

i) First loan of US $ 2.0 Million was taken in August, 2012 and repayable in 15
installments of US$ 133,333 commencing from 26.01.2014. The loan carries an
interest rate of 8.45% p.a.
ii) Second loan of US $ 6.0 Million was taken in January, 2014 and repayable in
Six installments. The Loan carries an interest rate of 7.75% p.a.
d) Loans From Related Parties: Loans from Related Parties are payable on
demand. The loan is taken on an interest rate of 10% – 11%.
Therefore, an investor may interpret that Sharda Motor Industries Ltd has access
to cheaper sources of funding from other financial institutions. However, it
continued to rely on the loans from promoters/related parties to meet its cash
flow requirements.

Investors may keep in mind that availing costlier loans from related parties when
other cheaper sources of funds are available to any company may seem an
attempt to shift disproportionate economic value from the company to the related
parties/promoters.

Further advised reading: How Promoters benefit themselves using Related

Party Transactions

4) Year on year depreciation expense of Sharda Motor Industries Ltd seems

high:

As per FY2018 annual report, page 57, under the new Indian Accounting
Standards (IndAS), the company has estimated the life of plant & machinery to
be 20 years. As per the Companies Act 2013, the useful life of plant & machinery
has been stipulated as 15 years.

IndAS is an attempt to align Indian account standards with the International

Financial Reporting Standards (IFRS), the management of a company is
permitted to use its discretion on the estimation of the useful life of assets based
on its own assessment.
Therefore, an investor would assume that on an average about 5% (=1/20) to
6.66% (=1/15) of the value of plant & machinery will be depreciated every year in
the profit & loss statement.

However, when an investor notices the depreciation charged by Sharda Motor

Industries Ltd on plant & machinery, then she notices that the depreciation
expense is very high than 5%-6.66%.

The fixed assets schedule in the FY2018 annual report, page 57 shows that on
plant & machinery Sharda Motor Industries Ltd expensed following depreciation
amount:

 In FY2017, depreciation of ₹31.2 cr on plant & machinery of about

₹117-120 cr, which is a depreciation exceeding 25%
 In FY2018, depreciation of ₹26.4 cr on plant & machinery of about
₹125-130 cr, which is a depreciation exceeding 20%

Further advised reading: Understanding the Annual Report of a Company

By looking at the above data, it seems that the company is depreciating its plant
& machinery at a rate of 20-25% every year. Such a rate of depreciation may
indicate that the useful life of plant & machinery is only 4-5 years.
An investor would appreciate that a high depreciation will bring down profit before
tax and in turn will reduce the amount of tax liability of the company.

Investors may contact Sharda Motor Industries Ltd and seek clarification for the
reasons of such seemingly high depreciation expense indicating very low useful
life of plant & machinery when compared with its stated accounting policies.

Advised reading: How should investors contact Companies/Management for

clarifications or additional information?

5) Family dispute in promoters leading to division of the business in Ajay

Relan and Rohit Relan groups:

It seems that Ajay Relan and Rohit Relan, who are the two sons of promoter N.D.
Relan, have been fighting in National Company Law Tribunal (NCLT) for the last
couple of years for their disputes including ownership of businesses. In February
2019, the two brothers have agreed to divide the overall business into two
divisions:

Rohit Relan group will control the automobile seating business of

Sharda Motor Industries Ltd constituting 26.38% of the total turnover
and the stake of the company in Bharat Seats Limited, Toyota
Boshoku Relan India Private Limited and Toyo Sharda India Private
Limited
BSE announcement dated March 9, 2019, page 3:

BSE announcement dated February 23, 2019, page 2:

  Ajay Relan group to retain rest of the business of Sharda Motor
Industries Ltd under its control.
The Rohit Relan group plans to control its businesses via a new company NDR
Auto Components Limited (NDRACL), which will be formed initially as a wholly
owned subsidiary of Sharda Motor Industries Ltd. Later on, all the shareholders
of Sharda Motor Industries Ltd (SMIL) will be given proportionate shareholding in
NDR Auto Components Limited.

Thereafter, the promoters will switch their shareholding in the companies by way
of gift/transfer etc. and the public shareholders will end up owning the same
shareholding in NDRACL as well as SMIL.

BSE announcement dated March 9, 2019, page 5:

As a result of the proposed Scheme, the Resulting Company will issue and allot
shares to each member of the Company, whose name is recorded in the register
of members on the record date as per the share entitlement ratio mentioned in
the Scheme. Thus, all the existing shareholders of the Company on the record
date shall become the shareholders of the Resulting Company.
Therefore, it seems that at the time of division of the business between the two
factions of the promoter family, the public shareholders will have the same
interest in the business but now divided into two companies: NDR Auto
Components Limited (NDRACL) and Sharda Motor Industries Ltd (SMIL). As a
result, it seems that for the public shareholders, the family arrangements do not
affect the existing economic value.

6) Disputes with joint venture partners of Sharda Motor Industries Ltd:

While reading past annual reports of Sharda Motor Industries Ltd, an investor
notices that its joint venture Toyota Boshoku Relan India (P) Ltd has not paid
₹8.62 lac since 2015.

FY2015 annual report, page 88:

FY2018 annual report, page 70:

Investors may appreciate that the amount involved in this issue is a small
amount. However, the fact that a small amount is outstanding from the joint
venture since last 4 years and is being disclosed as pending in the annual
reports year after year indicates that there might be some dispute/larger issue in
the JV partners in their understanding/co-operation.
We believe that investors should assess such situations to ascertain whether
there are underlying disputes/deteriorating relations between the joint venture
partners.

An investor may note that Sharda Motor Industries Ltd is already fighting a case
against its other joint venture Toyo Sharda India Pvt. Ltd in National Company
Law Tribunal (NCLT):

BSE announcement, October 25, 2018, page 2:

Investors may seek further clarifications from the company in relation to these
disputes.

7) Seemingly speculative derivative transactions by Sharda Motor

Industries Ltd:

While reading the FY2018 annual report of the company, an investor notes that
the company has recognized losses on derivatives contracts, which are not
considered as hedged.

FY2018 annual report, page 134:

The derivative transactions, which are not designated as hedged may include
speculative bets taken by the company in derivatives segment of the markets.

Further advised reading: How to Identify if Management is Misallocating

Capital
Investors may contact the company to seek clarifications about these
transactions. Investors may ask the company whether it enters into speculative
derivatives transactions.

It is important because, in FY2008-10, many Indian companies suffered due to

derivatives transactions, which went the wrong way and the companies were
forced to undergo restructuring/declare bankruptcy. Investors may read the case
of Indo Count Industries Limited to read more about a company, which
suffered a loss of about ₹150 cr on derivatives transactions during this period
and had to enter restructuring.
Advised reading: Analysis: Indo Count Industries Limited

8) Sale/ Disposal of assets year after year by Sharda Motor Industries Ltd:

While reading the past annual reports of the company, an investor would notice
that the company has been deducting significant amounts from its fixed assets
under sales/disposal year after year.

FY2016 annual report, page 79:

FY2015 annual report, page 72:
Further advised reading: Understanding the Annual Report of a Company
Overall, in the last 10 years (FY2009-18), the company has disposed of assets
amounting to ₹100 cr.

However, the annual reports of the company do not provide details in terms of
identification of the assets disposed of or the reasons for such disposal.

Investors may contact the management to seek further clarifications in this

regard.

Advised reading: How should investors contact Companies/Management for

clarifications or additional information?

9) Nonpayment of undisputed custom duty liability by Sharda Motor

Industries Ltd:

While reading the past annual reports of the company, in the annexure to the
auditor’s report, an investor gets to know that Sharda Motor Industries Ltd has
not paid a customs duty of ₹6.59 lac. An investor may also note that as per the
independent auditor, there is no dispute in relation to this customs duty.

FY2018 annual report, page 49:

Further, there were no undisputed outstanding statutory dues as on the last day
of the financial year concerned for a period of more than six months from the
date they became payable except duty of custom of Rs.6.59 lakhs.
While reading the annual reports of the previous years, the investor notes that
this undisputed custom duty is pending since FY2015.

FY2015 annual report, page 58:

There was no undisputed amount outstanding at the year end for a period more
than six months from the date they become payable except custom duty of
₹6.59 lacs.
Further advised reading: Understanding the Annual Report of a Company

10) Error in the annual report of Sharda Motor Industries Ltd:

While reading FY2018 annual report, on page 29, company states that its
promoter Mr. Ajay Relan holds 41.27% shares in the company:

Except Shri Ajay Relan and Shri Aashim Relan, who are holding 41.27% and

5.12% equity shares of the Company respectively, none of the above employees
holds more than 2% of the equity share capital of the Company as on 31 st
March, 2018 as per Rule 5(3)(viii) of the Companies (Appointment and
Remuneration) Rules, 2014.
However, when the investor reads the details of shareholding of each of the
promoters’ at page 22 of FY2018 annual report, then she notes that the
shareholding of Mr. Ajay Relan in the company is 32.19:

Further advised reading: Understanding the Annual Report of a Company

Investors would note that there is a difference of about 9% in the data of
shareholding of Ajay Relan in two different places in the annual report. If an
investor adds the shareholding of Ajay Relan (HUF) in the company of about
0.32%, even then, the difference cannot be reconciled.

Moreover, in the above image, an investor would note that the promoter Ajay
Relan has sold 19,663 shares of the company in FY2018.

Investors may contact the management to know the reasons for the difference in
the shareholding details of Ajay Relan at different places in the annual report. It
might be a simple typographical error or the company may wish to rectify the
same.

Moreover, investors may seek clarifications regarding the reasons for the sale of
the shares by the promoter of the company.

11) Sharda Motor Industries Ltd was listed on stock exchanges soon after it
was formed and even before its first plant was functional:

While going through the website of the company, an investor would notice that
Sharda Motor Industries Ltd was formed in 1986 and it came out with an IPO on
Delhi Stock Exchange in 1987. The IPO was even before its first large scale plant
became functional in 1994.

The company’s shares were almost non-liquid for many years. As per FY2010
annual report, there was no trade in the shares of the company at Delhi Stock
Exchange since 1998.

FY2010 annual report, page 22:

There was no transaction in the company’s share during the last financial
year. The shares of the Company were last traded on 22nd January, 1998 at the
price of Rs.13/- per share.
Further advised reading: Understanding the Annual Report of a Company
Later on, the company listed its shares on the Bombay Stock Exchange (May
2013) and National Stock Exchange (September 2015).

Other queries:

 With regard to the level of lease rentals being paid by the company
to its promoters, investors may contact the company to seek more
details about the location and size of the properties. Once investors
have these details, then they may use public and information
sources to know whether the company is paying lease rental, which
are in line with or are higher than the market rate in those locations.
 Similarly, in case of purchase of assets from the joint venture,
investors should seek clarifications from the company about the
assets, which are purchased. Only after these details are available,
then the investor may use other sources to know whether the assets
are purchased by the company at a fair value.

Margin of Safety in the market price of Sharda Motor Industries

Ltd:

Currently (April 1, 2019), Sharda Motor Industries Ltd is available at a price to

earnings (PE) ratio of about 10.4 based on the consolidated earnings of FY2018.
The PE ratio of 10.4 offers a small margin of safety in the purchase price as
described by Benjamin Graham in his book The Intelligent Investor.
However, we recommend that an investor may read the following articles to
assess the PE ratio to be paid for any stock, takes into account the strength of
the business model of the company as well. The strength in the business model
of any company is measured by way of its self-sustainable growth rate and the
free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, a low
PE ratio of the company’s stock may be signs of a value trap where instead of
being a bargain; the low valuation of the stock price may represent the poor
business dynamics of the company.
  Further advised reading: 3 Principles to Decide the Ideal P/E
Ratio of a Stock for Value Investors
 Read: How to Earn High Returns at Low Risk – Invest in Low
P/E Stocks
 Further advised reading: Hidden Risk of Investing in High P/E
Stocks
Analysis Summary
Overall, Sharda Motor Industries Ltd seems a company operating in a cyclical
industry, which has been able to protect and improve its profit margins over the
years. The key reason for such performance seems to be the focus of the
company on research and development activities, which have led to the company
being ready with technologically advanced products (BS-VI) for the future
requirements of its customers.

Over the years, Sharda Motor Industries Ltd has created value for its
shareholders. However, when an investor notices certain aspects like high
remuneration of promoters and loans from related parties taken by the company
at interest rates, which are higher than the interest rates charged by financial
institutions, then she realizes that there is a possibility that the promoters may
have favoured themselves over minority shareholders.

The settlement of the ownership dispute between the promoters factions seems
to be neutral for the current economic interest of public shareholders. However,
Sharda Motor Industries Ltd is also fighting the case against one of its joint
ventures in NCLT and another of its joint venture is not paying the dues to the
company. It is advised that investors may seek clarifications from the company in
this regard.

Advised reading: How should investors contact Companies/Management for

clarifications or additional information?
An investor may also get clarifications from the company about its seemingly
high depreciation levels, speculative derivative transactions as well as
sale/disposal of fixed assets of about ₹100 cr over the last 10 years (FY2009-
18).

Investors may also seek clarifications from the company about an undisputed
custom duty liability, which Sharda Motor Industries Ltd has not paid since
FY2015.

Going ahead, the investor may keep a track of profit margins of the company to
monitor whether the company is able to retain its competitive edge. Investors
may also monitor the remuneration level of promoters and the amount of loans
from related parties and the interest rate applicable to such loans.

Investors may keep a close track on the developments related to the family
settlement of promoter group and the dispute of Sharda Motor Industries Ltd with
its joint venture.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Sharda Motor Industries Ltd. However, investors should
do their own analysis before making any investment related decision about the
company.

You may use the following steps to analyse the company: “Selecting Top
Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”
Hope it helps!

Regards,

Dr Vijay Malik

P.S.