The Curious Case of Uniparts India Ltd EBITDA Margin Expansion
Digging deep into the explanation given by management doesn't yield satisfactory answers
Uniparts India Ltd is an auto ancillary company which makes parts for off-highway vehicles (mainly tractors) and construction equipment. The company is primarily export-oriented, counting global tractor OEMs such as John Deere and Caterpillar in the construction space.
The company came out with its IPO in Dec 2022 and since then the stock price has been around the same price. On TTM earnings, it is currently trading at around 13x which seems attractive in the current market environment where any export-oriented story is peddled as China + 1, India manufacturing and all that is fancied and trading at 30-40x forward earnings.
What is interesting in the case of Uniparts is its operating margins (EBITDA) which have gone from 10-12% (FY14 to FY21) to a respectable ~22% (see chart below). What is even more interesting is that this margin expansion happened just about the time when the company was prepping itself for its IPO.
Is this margin expansion a result of a strategic shift or is it some manipulation before IPO? Are these margins sustainable? What has changed in the business fundamentally that the margin profile has completely gone in a different territory? These are the questions that one should have answers to before investing in Uniparts since with revenue growth of mid-teens (as guided by the management) but margins going back to where they were, would result in a catastrophic shape of P&L (see below):
Considering how important it is to have a handle on EBITDA margins, we tried to understand the reason to this steep margin expansion. We went through the last 7 annual reports, sub-line items of P&L statements and the last two publicly available transcripts. We set the financial year FY17 as a base to understand the margin expansion. Why FY17 is because management in Q4 FY23 call indicated that in FY17 they made it a strategic priority to expand their EBITDA margins (while in AR of FY17 or FY18, these strategic priorities are not mentioned).
The reasoning that management gave behind the steep margin expansion is 1) discontinuing the loss-making products and 2) putting warehouses near their customer locations for providing just-in-time supplies to their customers which generates higher margins.
Let’s dissect the first reasoning to understand whether it adds up with financial numbers or not:
1) Discontinuation of loss-making products: If a company is producing loss-making products, it means that is not able to generate enough gross profit on it to recover other fixed operating costs and a delta to generate profit. Once a company discontinues these loss-making products, the gross margin should inch up since the other profitable products would essentially have higher gross margins.
In the case of Uniparts, as visible in the above graph, the gross profit margin for FY23 is below FY17 margins (barring two years). This doesn't add up to the management version of discontinuing the loss-making products. There is no reason why the gross margin won't expand if there is discontinuation of any loss-making product. We further don't know the quantum of sales and nature of these loss-making products.
So clearly the first reason doesn’t really add up. Let’s dig deep into the second reason-
2) Warehousing sale proportion increasing: As per the management, OEM customers are ok to pay a higher price for the product that comes to them at short notice which Uniparts supplies to them from a warehouse which is near the customer manufacturing location. Below is the proportion of warehousing sales as % of overall since FY17:
Now for the EBITDA margin to go from 12% to 22% only due to an increase in warehousing sales from 33% to 43%, which essentially means that EBITDA margin on warehousing sales is 100%! Even if we assume that 50% of margin expansion happened owing to warehousing sales, the EBITDA margin on warehousing comes to 50%. This would also mean that non-warehousing sales is loss-making (see calculations below). Clearly not adding up.
Now that we have demystified that both the management versions are not clearly adding up. It is worthwhile to actually see which line item in the P&L statement has led to margin expansion:
Table of key line items:
The delta in the above table is for the period of FY17 to FY22 since the annual report of FY23 is not yet out and we do not have a detailed P&L statement. During this period, It is noticeable that a large part of the expansion is led by the employee and other operating expenses. RM benefit-related delta went away in FY23 so what has remained in employee cost and other operating expenses related delta.
In the other opex, the only substantial change that has led to margin expansion is other operating expenses line items (which consist of my small and unexplained line items). Not only in percentage terms, but these other opex line items have also even gone down in absolute terms (INR 73cr in FY17 to INR 57Cr in FY22). We find this rather difficult to believe and hard to trust.
In all probabilities, there could be two reasons which could explain the above change 1) management was earlier over-reporting expenses and hence under-reporting profits for tax reasons or for 'some other' reasons and 2) management is trying to make margins look better fictitiously in a bid to IPO and post IPO.
In both cases, we would want to stay away from Uniparts Ltd at this price, unless we have a better explanation for these expanded margins.
However, if we find the valuations juicy in the 11-12% EBITDA margin scenario (which would only happen if the stock falls 40-50% from here) and we develop comfort with the underlying business model, we will revisit the company again.
Disclaimer: we may or may not own Uniparts India Ltd. We advise our readers to do their own diligence before choosing to invest or not invest in the company.
Great read, thank you for sharing!