Jalgaon blues

I still remember driving from Aurangabad to Jalgaon and the entire stretch would be barren land and farmers could barely get a crop a year,” says Ghanshyam Dass, recalling his first visit to Jain Irrigation’s headquarters, in 1987-88. “But now all you can see is green fields with very prosperous farmers growing three or four crops a year,” says the independent director on the company’s board.

As India’s largest micro-irrigation company, Jain Irrigation has certainly played a key role in bringing prosperity to rural India. With the central theme of agriculture running across its all businesses, the company supplies drip and sprinkler systems to farmers, is into food processing, PVC pipes and solar and renewable energy among other things. 

But right now, some of its stakeholders aren’t feeling very prosperous. Amid a huge sell-off by institutional investors, its stock is down 63% in the past year (against an 8% rise in the Nifty). Mounting debtor dues led to a yawning working capital gap which the company funded through debt, and that’s eroded profitability. While revenues grew by 22% on average since FY10, earnings fell by about 5% during the same period.

With its receivables position worsening by the day, Jain Irrigation was staring at possible losses as some of its foreign currency loans are due for repayment in the next 18 months. To regain investor confidence, the management is not only restructuring the core business, it is also infusing fresh capital. Question is will this be enough? 

Welcome change 

Not long ago, Jain Irrigation was a thoroughbred on steroids, with revenues growing 46% on an average and earnings growing by an equally impressive 70% between FY05 and FY10; the stock saw a ten-fold increase during that period. The market couldn’t get enough of the stock, it seemed. That changed two years ago, when political changes in Maharashtra, Andhra Pradesh, Karnataka and Tamil Nadu – which contribute around 80% of the company’s revenues – led to delayed subsidy payments.

The result: a sharp jump in receivables, from Rs.1,000 crore in FY10 to Rs.1,692 crore in FY11, which climbed even higher in FY12, to Rs.2,271 crore. “With government finances being tight, every company dealing with the government has been affected” defends Anil Jain, managing director, Jain Irrigation. “Payments are late but we have never lost money.”

In a bid to fund its burgeoning working capital requirement, the company took additional debt on its books, with total debt increasing by 55% to Rs.3,799 crore since FY10 while interest costs have more than doubled to Rs.476 crore over the same period. “I think Jain Irrigation went overboard in extending credit to farmers. Its receivables cycle is almost double that of the industry,” says a senior executive at a competitive firm who didn’t want to be named.

Well, that’s changing. The company now asks farmers to make the entire payment upfront and then collects the subsidy from the government. Earlier, the farmer would pay 10-50% of the cost upfront, depending on which state he came from, and the company would collect the balance from the government. Under the new business model, if the farmer is unable to put the entire amount, he will have to consider financing options.

Jain Irrigation has stepped in with a non-bank finance company (NBFC) called Sustainable Agro-commercial Finance where it will hold 40% stake, IFC Washington will hold 10% and the balance will be with promoter entities. With approvals from the Reserve Bank in place, the NBFC is likely to be operational from October 2012 onwards, initially in Maharashtra and then taken to other states in Phase II.

Till the NBFC scales up its operations, Jain Irrigation will also act as banking correspondent for banks like Yes Bank and IDBI Bank and complete the know-your-customer formalities for these banks so they can lend to farmers. According to Jain, with farmers now paying interest on their loans, they will put pressure on the government to release payments faster. 

Many feel the move to shift the burden of collecting subsidy payments from the company to the farmer was long overdue. “When the company announced its NBFC plans, the markets misunderstood them. But some merchant bankers came and asked me, ‘Why they did not do this earlier?’” says DR Mehta, former chairman of Securities and Exchange Board of India (Sebi) and an independent director on the company’s board. “If the company had done this from day one, there would be no liquidity problem.”

Of course, this isn’t the only company facing delayed payments. Others in the space, too, are struggling with similar issues. “We have been cautious in increasing our sales and capacities despite growing demand,” says Ashok Sharma, chief executive, agro and allied businesses, Mahindra & Mahindra which forayed into micro-irrigation last year. “We have been conscious not to take any irrational decision that would impact our financials or working capital management.” Sharma says the company gets dealers to put up the upfront payment along with the farmer to avoid a long receivables cycle. 

 Even as Jain Irrigation makes the transition in its business model, over the past two to three quarters, it had started to go slow on states where the subsidies were getting delayed the most. The maximum impact of that was seen during the June 2012 quarter when micro-irrigation systems revenues fell by 32% y-o-y. “When you are going through a business model change, there will be a period where you will not have the growth you had in the past,” points out Anil Jain. “There will be a period of lower revenue and earnings, but it is a deliberate strategy.” The company is confident that by end FY13, government dues will be down to Rs.600 crore compared with Rs.1,200 crore a year ago.

The change in strategy will mean muted revenues and earnings for the company in the short term. “The management had to choose between growth and preserving the balance sheet,” says Nikhil Vora, managing director, IDFC Securities. “While they cannot do much about the delay in government receivables, the increased leverage in the business is coming off. The NBFC will help reduce its dependence on government receivables and the recent capital infusion will add to its financial muscle.”

Much needed cash

Indeed, the funds couldn’t have come at a better time. In early September, Jain Irrigation managed to raise more than $200 million through a mix of external debt, equity and convertible debentures. It also issued $12 million worth of equity warrants at an average of Rs.87 per share to the promoters. By replacing some of its high cost short-term loans (13-14%) with lower coupon bearing foreign currency loans, the company hopes to save almost Rs.80-100 crore on annual interest.

“Given the tough macro environment, the fact that the company has managed to bring in long-term capital into their balance sheet is a huge positive,” says Manoj Bahety, associate director, Edelweiss Securities. Jain Irrigation has $70 million worth of loans coming up for repayment in the next 18 months and the company plans to replace its old loans with the foreign currency loans it has just raised, thus avoiding the forex losses that would have impacted its profitability.

Sanjay Bakshi, professor at Management Development Institute, Gurgaon,  has his doubts on whether the FCCB issuance will help the company in the face of a depreciating rupee. FCCBs to him are a zero-sum game because the buyers’ desire is to maximise risk-adjusted returns and the sellers’ motive is to minimise cost of capital. 

He elaborates, “Raising money overseas in a foreign currency is a bad idea for most Indian companies. For a while FCCBs appeared to be a good deal for both sides - the borrowers got low interest rates, and the lenders got “attractive” conversion options. But how can a deal be great for both sides in a zero-sum game?”

 Post the FCCB and the equity warrants conversion, the company’s equity will be diluted by 17.4%, something the market didn’t take kindly to. “Diluting equity when the stock is at a multi-year low is definitely not in the best interest of the minority shareholders in most cases (the exception being the stock is overvalued even at a multi-year low price). Ideally, equity dilution must be done when the stock is trading at a very fancy multiple,” says Bakshi.

But the management is confident that while equity dilution will impact earnings in the short term, the savings on interest costs will offset the dilution impact. “Post the funding, we can focus on growth and profitability rather than liability management and that will add to earnings growth,” says Jain.

Check and proceed

Despite the inherent challenges, there is no doubt that the potential for micro irrigation is huge in India. Of the 69 million hectares under cultivation, only 5 million hectares are under drip or sprinkler irrigation, with Jain Irrigation accounting for 55% of the market. In contrast, more than 50% of cultivated land in the US is under drip irrigation while the figure for Israel is over 95%.

 Drip irrigation scores over the traditional method of flooding the fields as it not only uses 40-60% less water and increases irrigation efficiency by 80-85% compared with the 30-35% using traditional methods, it also consumes less electricity and labour. “We have been successful in breaking the mindset that ‘I have water so I don’t need drip irrigation.’ Increasingly, farmers are looking at drip irrigation to improve crop yields,” says Ajit Jain, joint managing director, Jain Irrigation.

The company has a wide range of micro-irrigation products, carefully built through a string of acquisitions. Five of its eight overseas acquisitions have been in the micro-irrigation space, including the 2006-buyout of Chapin Watermatics, which pioneered flat drip irrigation systems in the US in 1963, and Naandan Irrigation in Israel, which pioneered the sprinkler system in 1956.

“Our acquisitions have always been for market entry, technology or R&D skills that can be leveraged to build new products,” says Ajit Jain. Given the large product portfolio, he adds, the company can provide irrigation solutions at various price points. It can cost anywhere from Rs.10,000 to Rs.45,000 per acre to implement a micro-irrigation system, depending on the crop, level of automation and water source. 

Farmers have also started realising the benefits of drip irrigation as better yields lead to shorter payback periods. “The payback period is around two years, or three or four crop seasons, which is very good,” says IDFC’s Vora. “And because of the short payback period, drip irrigation has become a structural growth story in India.” 

Micro-irrigation has grown to become a Rs.3,500 crore industry in the past decade and is expected to touch Rs.4,000 crore by the end of this year. However, much of the industry’s future growth will continue to depend on the efficiency of the government’s payment mechanism. “The delay in payments could slow down industry growth, which will be at the expense of the farmer and at the cost of overall availability of water for agriculture,” declares Mahindra’s Sharma. “So there is a definite need for governments to improve their process of subsidy payments.”

Companies crib that the subsidy procedure is both complicated and time-consuming; in some states like Maharashtra, it can take up to a year to get payment. There are exceptions, of course, such as Gujarat, where payments are made in 60-70 days. “If this learning is applied to Andhra Pradesh and Maharashtra, we could really overcome the payment bottleneck,” says Sharma.

Balancing act

Even as the company tries getting out of the hole it has dug itself in, the hope is that it’s other businesses such as food processing and pipes, which together contribute 50% to revenues, will help soften the blow of falling revenues in the micro-irrigation systems business. “There is always the chance that in a season one of our businesses may not do as well as expected, but we have other businesses to make up for the fall,” says Ajit Jain.

 The company has given a guidance of 20% revenue growth in its pipes business, 10% growth in its food processing and over 50% growth in the small but fast-growing solar and renewable energy business. In the pipes business, Jain Irrigation has a market share of 15% and is the largest player in India providing solutions for potable water distribution, sewage and transportation of gas. 

The company is also a significant player in the food processing business. It processes several fruits and is the world’s third-largest producer of dehydrated onions. It is also the world’s largest manufacturer of mango pulp, puree and concentrate and has a strategic tie-up with Coca-Cola for supplying mango pulp worldwide and concentrate for its brand Maaza, which is growing at 35% per annum.

“Coke tells us they are hoping to grow their business three or four times over the next   seven to eight years, so there is significant growth potential in the food processing business,” says Anil Jain. The other businesses include manufacture of plastic sheets, solar and renewable energy and tissue culture. While these contribute only a minor portion of revenues, they come with interesting growth prospects, especially the solar business, which has grown from Rs.15 crore to Rs.350 crore in the past four years. Will all these allied businesses be enough to wash away the effect of the irrigation business? 

Certainly, things have gone spectacularly wrong in the past for Jain Irrigation – and its clawed back pretty well. Will history repeat itself? Post liberalisation, Jain Irrigation forayed into IT, merchant banking, advertising, telecom and even leased a granite quarry. To fund these ambitious projects, the company invested around Rs.400 crore, taking on debt of Rs.250 crore.

As it turned out, none of these new forays took off and the company started to bleed after being financed by inter-corporate deposits borrowed at a usurious rate of 28%. With funds diverted from the core business, revenues whittled over 50% to Rs.135 crore in 2000 and losses started to mount. The stock price which traded at Rs.90 in March 1996 tanked to Rs.4 in March 2002. 

A new lease of life came in 2001 in the form of Aqua International Partners, which offered to bail out the company. The only catch: it wanted management control. “The promoters are the first to admit when they have gone wrong and they have no problem giving up their stake if it means better things for the business,” says director Dass. “Founder Bhavarlal Jain decided to cede management control in the interest of the business.”

The fund invested Rs.183 crore for a 49% stake, while the promoter stake fell from 73% to 37%. The company used the funds to rectify the financial mess, turned its focus back to the core business and exited all unrelated ventures. Interestingly, Bhavarlal Jain issued a half-page advertisement in The Economic Times in November 1997 to apologise to the company’s stakeholders for the diversifications gone wrong. 

The business environment currently is just as challenging. But people who work closely with Jain Irrigation believe its management is its strength. “While we are concerned about its receivables position, business fundamentals remain sound and we believe the company will bounce back, given the management’s strong commitment to the business,” says BK Batra, deputy managing director, IDBI Bank, one of the leading bankers to the group. Foreign institutional investors, however, are in a less forgiving mood. Institutional holding in the stock has fallen from 56% to 50.51% in the past year with two major institutional investors, CLSA and Columbia Acorn International, selling part of their stake in the past two months. 

The September quarter will continue to be a bad one for the micro-irrigation business. The management though expects FY13 revenue growth to be marginally positive on hopes of the MIS business improving during the second half. Analysts aren’t so confident. “I think it will take longer for the company to get back to its normal growth path,” says an analyst who didn’t want to be identified. “It remains to be seen how farmers take to the changed business model – will they accept it or defer their purchases.” 

Certainly, the reliance on subsidies has only gone up in the recent past. Earlier, state governments subsidised 50-60% of the cost of micro-irrigation systems but now, with an eye on vote banks, subsidies in some states have gone up to 80-90%. So, the dependence on the government has increased not only due to growth in micro-irrigation business but also because of the quantum of subsidy pay out. That may take more than a couple of quarters to sort out, but few question the long-term potential of the business. 

The Jain Irrigation stock is currently trading at a level hit in November 2008 when the market was in the midst of a global meltdown. “In the current scenario, investors are unlikely to be kind to companies with stressed balance sheets”, says Bahety. According to him, a re-rating of the stock will depend on the management’s ability to bring down government receivables, which in turn will ease their working capital requirement. While a 10% downside exists at the current level of Rs.61, it would only provide investors a more attractive level to buy into the stock.