Smooth operator

With a robust fleet and strong operational efficiency, VRL Logistics has done well. Will its winning streak last?

From politician to publisher to businessman, Vijay Sankeshwar, head of logistics firm VRL Logistics, has certainly come a long way in life. 65-year-old Sankeshwar flagged off his goods transport company with a single truck in 1967, ferrying goods between Gadag and Hubballi, and has never looked back since. Skepticism from friends and family about deviating from the family business of publishing, the inherent difficulties of poor infrastructure, an apathetic government with policies not conducive to the business and an idea before its time didn’t deter him from taking his business forward. 

Today, the ₹1,504-crore (as of FY14) company operates more than 3,546 trucks (of which 1,166 are less than five years old, 2,375 are debt-free and 1,235 are fully depreciated) and has the largest fleet of commercial vehicles in the private sector in India. VRL provides general and priority parcel delivery services — known in logistics parlance as less-than-truckload services — courier services and full-truckload services through a network of 624 branches and 48 strategic transshipment hubs and 346 agencies in 28 states and four UTs across the country. 

The transport business caters to a range of industries, including FMCG, food, textile, furniture, apparels, pharmaceuticals and metals. In addition, the company ferries passengers on a fleet of 455 buses (of which 399 buses are less than five years old, 87 are debt-free and six fully depreciated) across the country. The surface transport segment provides the bulk of revenue at 76% as of December 2014, compared with 21% from the passenger bus transport segment. The company’s wind power generation business, air charter services and hospitality services contribute to the remaining revenue. What brought VRL into the limelight, however, was its IPO, which opened on April 15 in the ₹195-205 price band and was oversubscribed a record 74X, receiving 120 crore bids for the 16.2 million shares offered. 

HNIs subscribed to the issue about 251X, with qualified institutional buyers bidding 58X and retail investors subscribing nearly 8X. Fresh equity worth ₹117 crore offered by the company and an offer for sale of ₹1.45 crore held by institutional investor NSR-PE Mauritius LLC were up for grabs and the promoters managed to sell ₹0.25 crore. Following this, the promoter stake has come down to 70%, the retail investor stake holding being 25% and institutional investors holding limited to 5%. 

Of the equity worth ₹117 crore, ₹67.4 crore is supposed to be utilised for purchasing 248 new trucks and ₹28 crore for repaying debt, with the rest set to be reinvested. The stock listed on the exchanges at a hefty premium of 43% and ended the day at ₹293 after touching a high of ₹309.

According to Pratik Tholiya, research analyst at IIFL, the stock is trading at 11X its FY17 earnings of ₹18.2, which is relatively inexpensive compared with peers such as Gati and TCI, which trade in the 18-25X FY17 earnings range. “At a time when economic growth remains sluggish, VRL registered 20% revenue CAGR over FY10-FY14 owing to a diverse client base and strong brand name. With a likely improvement in macroeconomic climate and its large fleet size and superior track record, VRL is poised to post 43% earnings growth over the next two years led by healthy margin expansion,” says Tholiya, indicating that things can only get better for the newly listed logistics company. 

However, the real factor that has proved to be a shot in the arm for the company is the fact that in an industry that is very cost- and capital-intensive, it has managed to keep costs down to a bare minimum thanks to ingenious cost-saving measures undertaken by Sankeshwar and his ilk. “We try to incorporate changes in technology (such as monthly MIS) and cost efficiencies into our operations. We cannot simply pass on all input hikes to our customers or else we will lose them,” says Sankeshwar. These initiatives have helped VRL enjoy better margins (17%) against 12% for Gati and 9% for TCI.  

Home remedies

VRL Logistics operates its own fleet of vehicles to reduce dependency on hired vehicles and retain control on its value chain and service quality. It also has dedicated in-house maintenance facilities at Hubballi, Karnataka, as well as satellite workshops pan-India, along with access to spare parts and fuel.

These facilities reduce expensive on-road repairs and unplanned detours for repairs and minimise downtime due to breakdowns. The company also has a re-engineering department and a tyre repair unit at Hubballi to repair tyres and engines, thereby increasing their longevity. However, the single-largest input cost for the company is the price of diesel, which in December 2014 amounted to 27% of revenue. 

The company requires nearly 250,000 litre of the fuel each day. Of this, for 170,000 litre, it has tied up with Indian Oil Corporation for bulk orders, allowing it to procure diesel ₹1.2 cheaper than the competition across 70 locations in India. In case of a hike in diesel prices, VRL generally takes some of the increased costing as a hit on its own books and passes on the rest to its customers. 

For the remaining 80,000 litre, it operates two of its own diesel pumps at two locations in Karnataka, where it purchases the fuel directly from refineries, saving an average ₹3 on every litre compared with the market rate. The company also buys tyres directly from manufacturers, cheaper than market prices. It purchases tyres from Michelin and Ceat Tyres under an agreement that allows it to get tyres 8-10% cheaper than market rates and assured buy-back of used tyres by Michelin. 

Similarly, VRL also has a tie-up with Ashok Leyland and Volvo Commercial Vehicles, its two main vehicle suppliers, whereby the companies have set up dedicated spare parts facilities at the former’s Hubballi facility, allowing it to procure spare parts 20-25% cheaper than market rates. It also has an in-house body-building facility at Hubballi for trucks and buses, equipped to fabricate vehicles with lighter and longer bodies, resulting in a 10% increase in tonnage and increased margins per vehicle compared with outsourcing. 

While its competitors also get discounts, VRL manages to leverage the fact it owns the largest fleet to get steeper discounts. TCI and GATI outsource their trucks from trucking companies who charge extra for their own margins and profits, whereas VRL has a fleet of nearly 4,000 trucks of its own. VRL’s in-house technology team has also developed an enterprise resources platform to track the optimum allocation of resources across branches and transshipment hubs on a real-time basis with strict financial controls. Additionally, software applications have been developed to track timely services and spare parts replacement. 

Of course, there is also the RFID system, which tracks consignments on a real-time basis. All this has led the company to have one of the highest operating margins in the industry. However, FY13 and FY14 saw margins dip to 15% and 14%, respectively, as compared with 18.7% and 17%, respectively, in FY11 and FY12%, thanks to problems arising from the Telangana dispute and the continuing spike in diesel prices every 15 days. Yet, by December 2014, its margins had bounced back and the company reported gross margins of 30%, Ebitda margins of 17.2% and an Ebitda of ₹220 crore respectively. (see: Bumpy ride) Assuming favourable commodity prices in future, these variables should only improve.

Future roadblocks

Despite diesel prices going down significantly of late, the company has not reduced its freight rates. “Diesel prices fluctuate every 15 days or so and we cannot revise our prices that quickly. Secondly, other input costs such as salaries, rents, toll charges and service tax remain a challenge. In such a scenario, we cannot revise our prices,” says Sankeshwar. The company is also not too worried about the proposed ban on heavy commercial vehicles in Mumbai and Delhi.

“The ban is only on vehicles above nine years of age, whereas we have many trucks below that age plying in the two cities. Also, our older trucks can still ply to the satellite suburbs of these two cities,” explains Sankeshwar. The expected economic revival is likely to have a positive rub-off on the freight industry as well. Says Sunil Nalavadi, CFO, VRL Logistics, “The road transport segment contributed 58% to the total surface transport requirement in 2008-09 and this will go up to 81% by 2018. Further, the share of non-bulk commodities, which is VRL’s area of expertise and the company’s main business, was at 73% in 2008-09 and is set to go up to 81% by 2018.” 

VRL is also not heavily dependent on a few customers for its revenues, with no single customer contributing more than 1% revenue in the goods transport segment in FY14 and the top 10 customers contributing less than 5% to revenue. The revenue from paid and to-pay customers (those who have to pay in advance and book the consignment and customers who book the consignment and pay before taking delivery of goods, respectively) is 11% and 60%, respectively, consisting primarily of SMEs, distributors and traders.

The ongoing account customers (the ones to whom the company provides a monthly billing facility) comprise 19% of revenues. With a majority of receipts being received prior to arrival at the final destination, the company is able to realise cash instantly, which ensures lower working capital requirements. This revenue mix has in the past ensured that bad debts do not balloon to more than ₹10 lakh in a year. Also, debtor days have reduced from 28 days in 2011 to 19 days at present. 

The company has a hub-and-spoke model of distribution, through which it is able to transport various parcel sizes and provide customers access to multiple destinations for booking and delivery, including remote locations. In a people-intensive business like trucking, hiring and retaining drivers is of paramount importance. Thus far, VRL has been able to recruit experienced and qualified drivers (it has close to 6,000 on its rolls) as full-time employees, with attractive salary structures and incentives linked to performance, despite the fact that the business has a high attrition rate. In this business, attrition is seasonal, with drivers going home to attend to their crops and returning after harvest. 

The GST fillip

Yet another event that could boost the company’s fortunes is the introduction of GST and the transport bill. GST will mean that multiple taxes for products across different states will get scrapped and replaced with a uniform centralised tax, leading to cost efficiencies. It also means that logistics players like VRL would then be able to set up centralised hubs in a region — catering to the entire supply requirements of a part of India — instead of having to set up multiple warehouses for the same.

However, the introduction of GST will not, contrary to popular belief, mark the demise of the unorganised logistics space, what with
this segment constituting 85% of the total market. There might be some slackening of demand, though, as a uniform tax will make the services of the unorganised players unattractive. 

In the past, due to different tax rates in different states, manufacturers often chose unorganised players for tax evasion purposes, as they did not come under significant government scrutiny. With a uniform tax rate pan-India, manufacturers are likely to go with logistics players who have a pan-India network, leading to a drop in the share of unorganised players.

However, with a strong union presence and the reluctance of the government to let this space wither, unorganised players will still remain a competitive threat to the organised segment. To improve its footprint across the country, the company is now planning to increase the number of branches and transshipment hubs in the northern, central and eastern regions of the country, as opposed to the south, its traditional stronghold, where it has 613 branches. The company plans to open 60-80 branches over the next year. 

Meanwhile, revenues in the transport business have grown from ₹860 crore in FY12 to ₹1,130 crore in FY14, a CAGR growth of 15%. The company’s bus service, through which it provides passenger transport in high-density cities in Karnataka, Maharashtra, Goa, Telangana and Tamil Nadu, has grown at a CAGR of 19% over FY12-FY14. In Q3FY15, VRL generated revenue of ₹260 crore, amounting to 20% of total revenue.

It plans to expand its fleet, enhance geographical coverage and increase margins through better route optimisation and maximising customers by indirect marketing and through its commission agents. This, coupled with the fact that the transport bill — set to introduce a unified vehicle registration system of vehicle permits — is likely to be introduced soon, will lead to cost and operational efficiencies, helping this segment grow. 

Charting the path

VRL also plans to focus on growing its general and priority parcel delivery services, as this will ensure a diverse base of customers, higher rates per load and incremental revenues with superior margins (currently, 67% of consolidated revenue comes from the less-than-truckload segment). “Our strategy is to grow the less-than-truckload business by increasing our network of branches, transshipment hubs and agencies in the central and eastern parts of India. We will continue to control input costs like fuel and vehicle maintenance here,” says Nalavadi.

But the business is not without risks. VRL’s business is highly dependent on freight volumes and passenger occupancy. The high fixed costs do not vary with these two factors and any reduction in these two and freight rates can impair operations.

Secondly, this industry is heavily reliant on drivers and any shortcoming on VRL’s part in attracting and retaining drivers could force it to decrease pick-ups and deliveries or outsource trucks at commercially unviable rates, denting margins and profitability. Also, 67% and 12% of its trucks and buses, respectively, are over five years old.

On an average, vehicle maintenance makes up about 9% of overall revenue and the older the fleet gets, the higher the maintenance costs are likely to move. 

VRL has posted a top line and post-tax profit CAGR of 20% and 19%, respectively, between FY10 and FY14 despite a challenging macro environment. (see: Against all odds) Its return ratios, however, have declined sharply, with RoCE and RoE being 22% and 43%, respectively, in FY11 and 16% and 19%, respectively, in FY14.

“Our RoE has declined steeply due to a PE transaction in FY13,” says Nalavadi. NSR picked up a 22% stake for ₹175 crore, of which primary was worth ₹125 crore and secondary was worth ₹75 crore. In the IPO, NSR made a gain of about 298 crore; it still owns a 5% stake in the logistics player. The company had total debt of ₹603 crore in FY12, which has since come down to ₹471 crore in 9MFY15, with a debt to equity ratio of 1.4. (see: In good books) VRL was able to bring down its debt by improving cash flows over the past three years and with the help of the money raised in the PE transaction.

Historically, the logistics sector has had a 2.5X correlation with GDP — with every 1% increase in GDP, the logistics sector grows by 2.5%. With the Indian economy and GDP set to pick up, the expectation is that freight volumes will also pick up and this augurs well for VRL. Which is why IIFL institutional equities expects VRL to register an earnings CAGR of 43% between FY14 and FY17 on an average revenue growth of 15%, led by an expansion in Ebitda margins by 330 basis points, all of which will help generate free cash flows and reduce the debt to equity ratio to below 1.

Expectations of an economic revival and more new customers will ensure better utilisation of truck capacity, lowering overall costs. This will lead to operating leverage, which should help expand margins by 330 bps, leading to an average earnings growth of 43%. Tholiya of IIFL, who has set a target price of ₹350 for the stock, says, “The company has a strong brand name and an excellent track record. Its strong relationship with suppliers and customers will lead to cost efficiencies and its loyal client base and attractive valuation leave a lot of room for growth.” With the recent correction, the stock is now trading at ₹280 (as on May 8), making it worth a bet.