Ploughing a profitable strategy

The Reserve Bank of India (RBI)'s approval to Jain Irrigation for setting up a non-banking financial company (NBFC) could help the company address various issues relating to high working capital and debt.

The company's stock, under pressure since about a year, has seen some uptick lately. However, analysts believe the stock can rise higher, given the current valuations and the positive impact of the development on earnings in the long run. At Rs 88, the stock is currently trading at 10 times the estimated earnings for this financial year and eight times the estimated earnings for 2013-14.

Origin of debt
On July 6, the company announced RBI had approved its planned NBFC, already incorporated as Sustainable Agro-commercial Finance. The NBFC, a joint venture between the company's promoters Jain Irrigation and IFC, would commence operations with capital of about Rs 200 crore. As an NBFC, it can leverage capital by as much as 7 times, and this would enable it to finance management information systems, contract farming, small business loans, etc, to farmers.

Jain Irrigation sells micro-irrigation products wherein the government provides subsidies. However, till the subsidies are paid by the government, these are shown as receivables by the company. These receivables, when due for almost a year, result in higher borrowings. This has contributed to the company's debt rising in recent years. For 2011-12, it is estimated at Rs 3,700 crore, against Rs 2,988 crore in 2010-11. Also, the debt is about twice the company's equity, and interest costs are eating into profits.

LONG-TERM GAINS
In Rs crore	FY12E	FY13E	FY14E
Sales	4,650	5,071	5,748
OPM (%)	19.0	17.5	17.6
Net profit	255	261	343
EPS (Rs)	6.3	6.4	8.4
PE (x)	14.0	13.8	10.5
RoE (%)	15.3	13.6	15.5
E: Estimates           RoE is return on equity/shareholders’ funds Source: KR Choksey Research

Strategic gains
If the company can manage its receivables without compromising on revenue growth, there could be huge synergies. While the Street would monitor the developments, the NBFC can play a large and meaningful role. "We believe the approval for the NBFC would help the company ease its stretched working capital cycle (steep gross receivable days of the micro-irrigation segment stood at 340 at the end of 2011-12)," Manoj Bahety, Edelweiss Securities analyst, stated in his report after the development.

Though current receivables may not be transferred to the joint venture, incremental receivables could be funded by the NBFC.

As a result, the company's requirements for funds, relative to sales, would decline, which in turn would streamline its debt and reduce the interest cost, leading to better earnings in coming years. Estimates suggest Jain Irrigation's revenues would rise to about Rs 6,000 crore by 2013-14, compared with an estimated Rs 4,650 crore in 2011-12, a rise of about 30 per cent. Importantly, the incremental growth in revenues would not be accompanied by an increase in receivables and interest costs.

The receivables, expected to stand at about 45 per cent of sales in 2011-12, would decline to 31 per cent of sales in 2013-14. Analysts expect the debt to remain at current levels, about Rs 3,700 crore, over the next two years.

Accordingly, interest costs, as percentage of sales, is expected to fall from eight per cent in 2011-12 to six per cent in 2013-14, hastening growth in profits. Analysts expect the company's net margins to improve by 50-100 basis points over the next two years.