company analysis note

							About
Ricoh India is a subsidiary of Ricoh Japan (73% ownership) and is in the business of
document management services and products (photocopier machines, commercial
printing machines etc). In addition, Ricoh also provides IT and other support services
to customers around the world.

The company started off in India as a JV with the RPG group in 1993. The company
amalgamated the business of Gestetner (India) Limited in 2005 and restructured the
share capital.

Financials
The company has turned around its performance since 2005 after the amalgamation
noted above. The company has maintained an ROE of 15% or higher during the last
7 years. In addition the company has paid off all the debt and is now debt free. The
company also has almost 35 Crs (30% of mcap) of cash on its books

The company has grown sales and profit by around 10% per annum for the last 6-7
years. The profit margin has fluctuated between 6-7% and the asset turns between
2.5-3. As the company is mainly into the assembly of the imported machines and
service support, it does not require as much investment in fixed assets.

Positives

The company has been a conservatively managed, low growth company. It has no
debt on its books and has excess cash which can be deployed for expansion of the
business.

The company is now planning to expand aggressively in the production printing
segment. The company has made an investment of 20 Crs to grow the production
printing business. The company is now targeting around 1000 Cr revenue in the next
3 years and is already increasing the manpower team from 660 to 1000 and expand
to around 400 channel partners, by the year end.

In addition to the above plans, the company is also looking at expanding into IT
services space to achieve the targeted revenue, via acquisitions and expansion. To
get an idea of the IT services provided by Ricoh in other markets such as UK, see
here

Risks
The key risk faced by the company is the expansion into IT services and new niche
businesses such as production printing which have other companies such as cannon.
The expansion plans have an execution risk and the company’s profits could suffer in
the short to the medium term.
In addition, the current management has not executed any aggressive plans in the
past and hence we do not have a history of success of any such initiatives. As a
result, there is always a risk that the topline may grow (which works for the parent),
but the profit growth will be low or non-existent.
As the company imports the products from the parent company, a topline growth
without commensurate profit increase works for the parent company (due to transfer
pricing), but would be a negative for the Indian shareholders

Competitive analysis
The main competitors in the industry are companies such as Xerox, cannon and HP.
These are large companies with deep pockets and have the will and capability of
defending their market share.
The details of the document management/ IT services part of these companies is not
available in the public domain, but most of these companies such as HP or cannon
are now focusing on providing complete solutions and services instead of just the
printers and other accessories.
The customer lock-in is quite high if a competitor is an outsourced service provider
and it would not be easy for Ricoh to gain entry into large accounts. At the same
time, a focus on commercial printing and the retail market should help the company
to expand its business.
There are no unorganized or Chinese companies in this sector which is more or less
dominated by 4-5 large companies. This is due to the nature of the product
(requiring large R&D and development budgets). As a result, there is quite a bit of
entry barriers in the business.

Management quality checklist

   -   Management compensation – seems reasonable at 1-2% of net profits
   -   Capital allocation record – the company has used the cash to pay off debt and
       has excess cash on its books. The management has stated an intention to
       acquire IT companies in India, to grow the business. We will get an idea of
       the capital allocation skills of the management in the next few years
   -   Shareholder communication – Bare minimum discussion and mandated
       disclosures are provided. Considering that the company is a subsidiary, it is
       unlikely the management will provide anything more than that
   -   Accounting practice – appears conservative
   -   Conflict of interest – no related party transaction appears out of the ordinary.
       However the company import the products from its sister subsidiary and a
       conflict of interest is likely to exist here, where the transfer pricing could be
       set to favor the parent and minimize the profit of the listed company
   -   Performance track record – till date has been adequate, though nothing great.

Valuation
The company sells at around 6-7 times free cash flow. I have uploaded the various
scenarios and the fair value for those scenarios. In summary these scenarios are

Pessimistic scenario – business continues as is
Topline growth – 8%, Margin – 6% Fair value = 50

Midpoint scenario – Company is partly able to achieve some of the plans, though the
profit lags
Topline growth – 10%, Margin – 6% Fair value = 70

Optimistic scenario – Company executes well and grows as planned
Topline growth – 10%+ , Margin – 7% Fair value = 85 or higher

Conclusion
As we can see from the previous section, the current price assumes worse than the
most pessimistic scenario. That provides us a downside protection from long term
loss of capital. If the management can do even half as well as they plan to, we
should have a decent gain in fair value.
At the same time, this is not a low risk stock. Companies such as Ricoh (MNC subs)
are not run for the benefit of the local shareholder, but to achieve the parent’s goals
and objectives. In a lot of cases (such as Novartis), there is complete neglect or
apathy towards the local shareholder. In other cases, the company may do well, but
the benefit does not accrue to the minority shareholder.

In view of the above risk, although the stock is at a substantial discount to fair value
(price as of writing this note is 32/ share), I am not getting too aggressive in
increasing the position in the model portfolio. The plan would be to watch the actions
and performance of the management and increase the position size, if management
keeps executing to the plan.