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Unravelling ace investor Radhakishan Damani’s interest in debt-ridden logistics major, Gati

Adit Mathai

"The e-commerce business is seeing 100% y-o-y growth and its cash flows will make up for lacunae in other business segments" —Mahendra Agarwal, founder and CEO, Gati

On December 31, 2013, even as Mumbai resounded to the sound of late night partying and the BSE remained shut, legendary investor Radhakishan Damani was turning his eagle eye to an unexpected target, picking up four million shares at an average ₹43 a share for a 4.6% stake in logistics and surface express major Gati. Damani, arguably one of India’s best value investors, has an enviable track record of making the right calls. Granted, this wasn’t his only move in the logistics sector over the new year — through his investment companies Brightstar Investments and Derive Investments, Damani also picked up over 2.5 million shares for a 3.5% stake in Transport Corporation of India (incidentally, Gati was carved out of TCI in 1989) — but why Gati? After all, the stock has been facing heavy weather for some time as a protracted recession and diminishing export import trade has put a lid on its growth.

Indeed, Gati has been reeling under debt for the past few years. As of March 2012, it had a debt of ₹534 crore with a topline of ₹1,180 crore. To be fair, the Secunderabad-based firm did take steps to reorganise and pare debt. In June 2012, it entered into a joint venture agreement with Japan’s Kintetsu Worldwide Express, under which Gati hived off its core surface express division into a separate entity, selling 30% stake in the process and gaining ₹148 crore through equity infusion by the Japanese firm. With this, the company transferred ₹330 crore of its debt burden to the new company. Much of the newly-infused capital from the deal was used to repay debt, with a little being used for working capital requirements and upgrading existing infrastructure with the Japanese partner’s know-how. 

As of Q1FY14 (Gati follows a July-June financial year), on a consolidated basis, debt is still ₹392 crore. Says CFO Sanjeev Jain, “Most of our debt now comprises term loans, which we may be able to refinance at a lower rate of interest since Care and Icra have given the new division an -A rating.” To be sure, interest costs for Gati Kintetsu have already reduced from ₹63 crore in FY12 to ₹44 crore in FY13. 

As for Gati, it still has a standalone debt burden of ₹210 crore comprising FCCB bonds worth $22 million repayable by December 2016 and commercial loans for working capital for the freighter and e-commerce business to the tune of ₹70 crore. Jain explains that Gati intends to sell a land parcel in the NCR region to redeem the bonds. And coming to the working capital loans, the management believes the e-commerce business will deliver exceptional growth that will take care of any loan obligations. “The e-commerce business is seeing 100% y-o-y growth and the cash flows generated here will make up for any lacunae in any other business segment and see us through,” says Mahendra Agarwal, founder and CEO, Gati. Indeed, Gati has a target of achieving ₹1,200 crore turnover from the e-commerce business by 2020, up nearly 50 times from ₹25 crore in FY13. And perhaps that, in a nutshell, explains Damani’s interest in the company. Being in the retail business himself with his D-Mart chain of stores, Damani surely knows how the retail business is booming both online and offline. 

Will this click?

Currently valued at $13 billion (₹80,000 crore) by KPMG and the Internet and Mobile Association of India, the Indian e-commerce sector is set to grow at 30% CAGR, compared with 9% globally. Associated industries such as logistics and warehousing will come in for their share of growth as well. Gati has been quick to realise the opportunities here. In 2005, it created a separate division catering to e-retail. Set up with an investment of ₹5 crore, the division is setting up a dedicated ‘e-fulfillment’ centre in Mumbai to provide last-mile connectivity, managing inventory, packing and distribution. It has a fleet of 200 vehicles and 300 bikes catering to 6,700 pin codes across the country, including in tier 2 and 3 cities. Gati’s e-commerce division is its fastest-growing, clocking 20% quarterly growth for the past few quarters. It has also posted 20% plus Ebitda margins. 

Though Gati runs its own online marketplace called Gati E-connect, where vendors register and maintain their own catalogue of products and decide pricing, business from this is minuscule. Most of its revenue comes from established online retailers such as Myntra, Naaptol, TV18 and Flipkart. Gati currently delivers 15,000 packages per day, which the management intends to scale up to 30,000 per day by end-FY14. From a revenue of ₹12 crore in FY12, it now has a revenue of ₹25 crore and the target is to achieve ₹65 crore by end-FY14. Over the next five years, the company expects the e-commerce business to grow at a CAGR of 75%, which will result in revenues over ₹1,200 crore by 2020. The division already generates a free cash flow of ₹10 crore, which should only increase exponentially as business grows. “The revenue from the e-commerce segment will be enough to sustain Gati as a consolidated entity. Its share of the revenue mix is increasing and we expect this division to be more profitable than our distribution business,” says Jain. 

To achieve this, Gati will expand its network to include more locations and streamline its commercial processes such as cash on delivery (COD). The group’s big rivals in this space are Blue Dart and Aramex, both established players themselves. What sets Gati apart? “We have an in-depth understanding of COD services and an extensive reach, including world-class warehouse and transportation management systems and an ability to deliver goods just two days after the transaction, which is an industry best,” declares Jain. 

Industry-wide, the changing shopping habits of Indians, led by the convenience of shopping from home as well as increased internet penetration are driving e-commerce growth. The big opportunity, though, really lies in the opening up of B2C e-commerce to FDI (100% FDI in B2B e-commerce is already allowed). If that goes through — the expectation is that the nod may come through as early as March 2014 — there is every possibility that big international players will seek JVs with domestic logistics players to ensure a seamless supply chain. And given that 90% of the logistics business in India is in the unorganised sector, it is the few established players, including Gati, that stand to gain tremendously. Kavita Vempalli, research analyst at Nirmal Bang Securities, is gung-ho about the company’s prospects. “Gati is one of India’s largest organised logistics player with a pan-India presence. So it would be a preferred partner of choice for any international player.” But will its e-commerce drive be enough to offset Gati’s underperformance in other businesses?

Slowing things down

For the past several years, the Gati group’s Achilles’ heel has been its shipping division. Hived off as a separate subsidiary — Gati Ship — in FY12, the business has been making losses due to the slowdown in the exim trade, an inability to procure cargo orders and the fact that two of its vessels were dry docked for a significant period of time. For FY13, Gati Ship registered a revenue of 25.4 crore, a negative Ebitda of 10.8 crore and a loss of 31.4 crore, compared with negative Ebitda of 7.3 crore and a loss of 10.4 crore in FY12. In May 2013, the group divested 40% of its stake in Gati Ship to Hyderabad’s Riba Constructions for 20 crore. “If the company’s losses aren’t contained in the next two quarters, there will be a further divesture where Gati becomes a minority shareholder. We could also look to exit the business completely,” Jain says. Analysts second that less-than optimistic view. “Unless there is some sign of revival in exim trade, the shipping business will continue to be in the doldrums,” says Vempalli. “At a loss of 3 crore per quarter, it definitely affects the group’s consolidated PAT.”

Corrosive debt

Interest costs have been eating away Gati’s profits

Shipping isn’t the only division that’s ailing. In 2007, Gati acquired a cold chain business, Kausar, catering to clients in the healthcare, meat and poultry, biopharma and quick service restaurant sectors. While it has plans to open its first cold chain warehouse in Gurgaon in association with a private equity firm, the numbers for Gati Kausar aren’t encouraging. The division generated a revenue of ₹ 45.8 crore, an Ebitda of ₹4.9 crore and a loss of ₹2.4 crore in FY13, compared with a revenue of ₹40.2 crore, an Ebitda of ₹5.9 crore and a PAT of ₹2.1 crore in FY12. The loss in FY13 was on account of higher depreciation from investments made while acquiring a 65-vehicle fleet in FY13. Analysts aren’t too worried because Gati Kausar is already making cash profits, although break even at the PAT level is not expected before mid-FY15.

Adding it up

Gati’s distribution and supply chain subsidiary chips in most to turnover  

The silver lining for the group is that the core business is actually doing pretty well. Now known as Gati Kintetsu Express, this is the express distribution and supply chain subsidiary and contributed 82% to group turnover in FY13 (see: Adding it up). The overall economic downturn, the slowdown in GDP and IIP, especially in the automotive sector (a key contributor to revenue), has taken a toll on this business as well. Nonetheless, says Vempalli, “Owing in part to the restructuring of the business with Kintetsu, debt and interest costs reduction, a renewed focus on the SME sector, acquisition of Japanese clients and gradual recovery in the economy, Gati Kintetsu has managed to outperform its peers.” In fact, it registered an Ebitda of ₹87.8 crore and a PAT of ₹33.6 crore in FY13 versus an Ebitda of ₹15.3 crore and PAT of ₹1.1 crore in FY12. Gati Kintetsu gets 70% of its business from the road transport segment, with the rest split evenly between air and rail. Here, Gati is the No.2 player, after Blue Dart, with a 20% share of the organised logistics business in India. It has a pan-India reach, serving 653 of the country’s 657 districts with 4,000 leased trucks, seven rail bogies and a network of 16 major warehouses. 

Still, FY13 was a difficult year for most logistics players and Gati is no exception. The weakening in exim trade, increasing fuel costs, a slowdown in the air freight business and tight liquidity affected the firm adversely. How did it cope? “We tried to increase our topline. We optimised our surface transport network by sending vehicles on different routes and cut down on intermediary hubs for transporting parcels. We also passed on cost hikes to our customers.” Tech initiatives and enhanced service offerings have also helped growth — from real-time tracking of consignments and vehicles and 24/7 CCTV coverage of transport hubs to minimise losses, to offering COD services and giving sales staff tablets to enhance the pick-up process. “COD and real-time tracking of shipments through SMS and email have helped customers and sharply aided our growth, both in the surface, express and e-commerce segments,” he adds.

Can Gati maintain its speed if the slowdown persists? Certainly. Given the inefficiencies in the unorganised logistics industry, there’s plenty of room for growth. The explosive growth in e-commerce, too, will help. Also, the introduction of the goods and services tax (GST) will prove to be a big driver. Fewer warehouses with more packages and fully-utilised trucks will mean more business efficiency for Gati in its surface distribution and supply chain divisions. But key risks remain, including weak global growth, aggressive pricing by competitors and infrastructural and bureaucratic hurdles. Also, as J Dhananjayan, founder, Artha Capital, points out, “The business has a very low margin of safety. The fact that the promoter has pledged much of his stakeholding also marks a red flag in my opinion.”

By Jain’s own admission, Gati’s cash position for the next two years will be “a bit stretched”. But after that, he expects the group to post free cash flows. Capex spending is also minimal, since Gati prefers to lease its vehicles. But even with excellent growth in the surface transport, e-commerce and cold chain divisions, the fact remains that Gati is overleveraged. That can only be taken care of if Gati can sustain strong cash generation. Damani possibly believes that can happen, which is why he might have bought in with such conviction. Gati as well as TCI have been on fire since the purchase became public. From a price of ₹27 on December 13, the stock now trades at ₹65. This run has more than doubled Gati’s market cap. At the current price of ₹65, it is trading at a steep price-earnings ratio of 22X. The stock has potential, but one can wait for it to cool off after the euphoric rise before buying.

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