High Expectations

Jitendra Nath Gupta might not have had enough chances to haul up corporates during his stint as executive director of  the Securities and Exchange Board of India, but he is making up for lost time by going after managements through his not-for-profit corporate governance research and advisory body, SES Corporate Governance. As part of this initiative, in February this year, SES came out with a report detailing its comments on the agenda of Gateway Distriparks’ (GDL) extraordinary general meeting on March 8.

What got the goat of SES was that the management of the logistics-to-cold chain major was seeking approval to double the commission rate of Gopinath Pillai, the chairman and non-executive director (NED), from 1% to 2% of GDL’s net profit and for other NEDs at 1% for the next five years, effective FY13. “The resolution has inherent conflict of interest since the board of directors will be deciding their own remuneration for a period of five continuous years. Additionally, the total commissions payable to NEDs will be increased beyond the limit of 1% proposed in Section 309 of the Companies Act (provided the company receives central government approval). Each of the above is not considered a good corporate governance practice,” stated the report.

To put the hike in perspective, the report mentioned that if one were to apply the 2% commission rate for the previous five years and calculate the potential increase the resolution may result in, the commission paid over FY08-FY12 would have increased 478%, from Rs 1.20 crore to Rs 8.12 crore.

More importantly, SES pointed out that Pillai, being an NED, is not involved in the day-to-day operations and the increase in remuneration was more than what is being paid to the managing director. “The company has stated that the chairman devotes substantial time and attention to the company. However, SES is of the opinion that an NED cannot be making a more significant time contribution to the company compared with the managing director. Hence, unless the company reclassifies Pillai as an executive director, the hike in commission payable is unjustified,” the report said. Besides, the company also didn’t have independent committees in place to oversee remuneration payable to senior executives and executive directors and for director appointments.

Expectedly, the proposals went through the EGM. “In this country, all said and done, promoters continue to call the shots, given their substantial holdings. Our idea is not to single out any company or management but to ensure overall corporate governance standards improve so investors take cognizance and prevent good businesses from turning bad,” says Gupta. GDL’s management did not participate in this story, citing the silent period in the run-up to an IPO filing.

To be fair, the governance issue aside, the management at GDL has delivered the goods. While consolidated revenues have more than doubled over the past five years (FY09-FY13), from Rs 450 crore to Rs 950 crore, profits have surged 77%, from Rs 77 crore to Rs 136 crore (see: Beating the blues). The question is: if the management is seeking a bigger slice of profits in the coming five years, can investors also be assured their pound of flesh? 

Interestingly, while bottomline has shown 12% CAGR over the past five years, stock returns have been tepid at 5% from Rs 98 (April 1, 2008) to Rs 125 (March 28, 2013). That’s not surprising, given that the company’s fortunes are intricately linked with that of the economy, which is in the doldrums. The management, however, is looking at other engines of growth beyond the core container freight stations business to focus on the rail container business and cold storage logistics vertical under Snowman, which is in the process of going public. That could also largely explain why the stock has held its ground at Rs 100 levels, despite the bloodbath on the Street.

Three-pronged

GDL has three distinct business divisions: the container freight services business; rail container/inland container depots, a division that engages in rail movement of containers to major maritime ports; and the cold chain and storage and logistics division, which it acquired through a 50.1% equity stake acquisition in Snowman Frozen Foods in November 2006. A container freight station (CFS) is a location for storing container cargo either en route to a port for shipping overseas or for cargo being imported and sent to its final destination. GDL is one of the largest CFS players in India, handling 500,000 TEU annually and its CFS division accounts for 31% of total revenues, but contributes a higher share to the bottomline at 48%. 

In a JV with the Punjab government, GDL had established Punjab Conware, a container terminal at Navi Mumbai. This was earlier gutted in a fire but is now back on stream and is expected to add capacity of another 60,000 TEU. In all, GDL has six CFS, including the one at JNPT, which has a cargo handling capacity of 300,000 TEU and to which a fourth terminal is being added. The company also has two CFS in Chennai, and one each in Visakhapatnam and Kochi; the last is being ramped up to 50,000 TEU. 

But while the new terminals have added capacity and increased throughput, this has been offset by the slowdown in exim trade — in Q1FY14 the CFS division lost 8% y-o-y in volumes. Over-congestion in the key JNPT terminal also means that business is often lost to Mundra and Pipavav terminals. While traditionally the CFS business has been a cash cow, delivering Rs 80-90 crore of free cash flows on average in a year, of late it has been hit by severe competition from the likes of Gati and Allcargo, forcing GDL to undercut prices. Rising costs in the form of labour, transportation and sub-contracting charges haven’t helped. The fallout of a reduction in volumes and realisation has been an 11% y-o-y drop in revenues as of Q1FY14. 

Going ahead, the outlook for the CFS business is far from rosy. In a concall following the first quarter results, GDL deputy CEO R Kumar conceded, “Obviously there is an impact on imports because bulk of our revenue comes from imports. Particularly, the capital equipment and other expansion plans of manufacturing industries are not taking off and this will have an impact on our business and profitability. If the rupee stabilises, we could see some boost to volumes.”

However, analysts believe that more than the CFS business, it is the rail container business and cold chain businesses that promise the big kicker in coming years. Says a domestic fund manager who holds the stock as part of his top 10 mid-cap holdings, “CFS is more like a fixed deposit, but the exciting part is the rail container business, which has very high entry barriers. Despite the presence of 14-odd players, after Concor, it is GDL that has the edge, given its unique model.” Just what is so cutting-edge about the rail business?

On the fast track

GDL runs the rail container operations via a subsidiary, Gateway Rail Freight (GRFL), which owns and operates a fleet of 21 trains, the second-largest in the country after state-owned Concor, and 235 road trailers at its rail linked inland container depots (ICDs) at Garhi, Ludhiana, Kalamboli and Assauti (Faridabad). GDL entered the container rail segment in 2007 when the segment was opened up for private participation. Of the 14 private operators who applied for licences, many scaled back their operations after realising that the segment is capital intensive and has a long gestation period. GDL, however, incurred a capex of some Rs 800 crore over FY07-12 and took the pain of losses till FY11 before achieving turnaround in operations in FY12. 

More investment coming in the form of the Delhi-Mumbai industrial corridor and the dedicated freight corridor planned for the same will bode well for logistics players such as GDL. Though roads account for a higher share of transportation, the cost efficiency of container movement via railways for distances over 500 km is well known, with the cost of transporting containers by road as much as 30-50% higher than rail. On the busy Delhi-Mumbai route, while the cost of transportation per TEU is between Rs 28,000 and Rs 42,000, it’s more than Rs 62,000 by road, points out Krishnakant Thakur, analyst with Espirito Santo Securities.

Moreover, GDL has implemented double stacking in the Garhi-Harsaru-Pipavav route. Double stacking entails two containers stacked on top of each other on a single bogey, thereby increasing capacity. This will improve its margins since double stacking increases operational costs by only 40%. 

In order to limit empty running of rakes on return journeys, it has also optimised routes. In effect, rakes while returning may stop over at an interim destination carrying freight and then run empty from that point onwards. 

GRFL is also the beneficiary of telescopic rate benefits introduced by Indian Railways. Simply put, this means that, earlier, if a rake travelled from point A to B to C, it would have to pay charges to the railways for both journeys. Now, it has to pay only once, from origin to final destination. 

Then, in April 2013, the railways also partially answered a long-standing plea to do away with haulage charges, when it announced a 13% rollback on haulage charges for rakes running empty. GRFL has also started implementing a hub-and-spoke model for its rail services using the Garhi ICD as the hub for various spokes or nodes, thus reducing empty running significantly.

Going ahead, the implementation of the dedicated freight corridor is expected to give a big fillip to the company. With line capacity utilisation varying from 115% to 150% on the existing trunk routes of Howrah-Delhi on the eastern corridor and Mumbai-Delhi on the western corridor, passenger trains are taking priority over goods trains in an already-clogged railway network. The DFC is expected to result in high share of freight for operators, especially GDL, since its ICD at Garhi-Harsaru and Faridabad are in close proximity to the DFC alignment, at 87 km and 54 km, respectively, from Dadri. 

Not surprisingly, Niraj Mansingka of Edelweiss Capital is bullish on GDL. “We are confident that the rail freight sector is set to grow because of the proposed Delhi-Mumbai industrial corridor. Secondly, double stacking is likely to glean away market share in the longer term from trucking transporters.”

While the long-term looks good, in the short term the economic slowdown is proving a challenge. In Q1FY14, GRFL sales dipped 7% on a y-o-y basis owing to a 15% drop in volumes in the quarter owing to a sharp slowdown in exim trade. Says Sonam Udasi, head, research, IDBI Capital, “In the near term, the outlook for the container and rail freight services businesses looks tepid. We don’t see any earnings growth happening here.” In 2009, Blackstone group invested Rs 300 crore in GRFL in the form of compulsorily convertible preference shares, which can be converted in FY14 or FY19. If Blackstone decides to convert these rather than exit, it will infuse significant funds into GRFL. And while the rail business will gain traction in the coming years, so will the cold chain business. 

Ice, ice baby

Gateway operates its cold chain and logistics subsidiary Snowman Frozen Foods, now known as SLL, in which it holds a 53% stake, in partnership with Mitsubishi Logistics Corporation, Mitsubishi Corporation, Nichirei Logistics group and the International Finance Corporation, who collectively own 26% stake. The Bengaluru-based Snowman provides temperature-controlled storage services, catering to customers such as HUL, Baskin Robbins, Pizza Hut, Mother Dairy and ITC, among others. While contributing only 15% to Gateway’s consolidated revenues, it is the fastest growing business segment seeing the most traction, having registered 58% y-o-y turnover growth in Q1FY14 and expected to generate 54% CAGR revenue growth by end-FY14. 

SLL has a nationwide presence in over 100 cities with distribution to more than 4,400 outlets and currently has a capacity of 53,130 pallets (refrigeration boxes in which both food and non-food perishables are stored), which will increase to 70,000 pallets by end-FY14 and 80,000 pallets by end-FY15. Traditionally, this sector suffers from a lack of proper capacities and adequate infrastructure. So the scope for expansion and growth is huge. According to a Technopak report, the market for cold chain storage and transportation is expected to grow from Rs 18,490 crore currently to over Rs 32,000 crore by FY15. Add to that the entry of foreign retailers and SLL’s future prospects seem self-evident. In September this year, the company plans to list on the bourses with an IPO. While the guidance from the management has been that this will provide funds for its expansion plans, it is not clear whether there will be any part exits by existing investors (it had recently raised Rs 60 crore from PE fund Norwest).  

Cool stock

Though the stock has not been a great performer on the bourses, it has been resilient to the volatility in the market. At current levels, the stock is trading at under 10 times estimated FY14 earnings. Unlike most of its competitors, GDL is under-leveraged with a net debt-to-equity ratio of 0.13 in FY13. For now, analysts have largely retained a bullish view on the stock, given the traction in the rail container business, with Edelweiss looking at a price of Rs 169 and Espirito, Rs 167. “Gateway has invested significant capex in all its businesses. As the macro climate improves, it is well poised to cash in on rising demand in the CFS and rail freight services segments,” says Mansingka.

However, Udasi of IDBI Capital, which has a target price of Rs 129, feels if the Snowman listing doesn’t take off, it could be an overhang for the stock. Further deterioration in exim and domestic trade could result in meaningful decline in revenues for Gateway. Though the management hasn’t given any guidance for FY14, in the concall, Pillai said he sees marginal growth in CFS but is “more optimistic” about the rail and Snowman businesses. While valuations do appear attractive, increasing volatility could offer better entry levels for long-term investors.