Outside View by Luke Verghese
A multiproduct group
Rico Auto Industries' core values are Excellence, Commitment, Integrity, Teamwork and Entrepreneurship. This 28 year old Delhi headquartered company manufactures and supplies a broad range of high precision fully machined aluminium and ferrous components and assemblies to original equipment manufacturers across the globe. Its integrated services include design, development, tooling, casting, machining, assembly and R&D across its product lines. Its strategic relationships include tie ups with foreign companies for clutch systems, hydraulic brake systems, Oil and water pump systems, and Alloy wheels. Besides Rico Auto, the group includes subsidiaries and joint ventures totalling some 10 entities. According to the brief financial highlights, collectively the group achieved a net turnover of Rs 13.3 bn in 2010-11. However the parent alone contributed a turnover of Rs 10.2 bn to this total. A 50% joint venture FCC Rico Ltd accounted for another Rs 3.1 bn. The other siblings are basically non entities-with four of them yet to open their account on the operations side. The parent makes do with four manufacturing units to crank out its fare, including the newly inaugurated unit at Gujarat. A manufacturing unit each in Bangalore and Chennai are on the anvil.
The performance sheet
The performance sheet of the company for the last five years reveals in all probability in stark detail the pounding that component units have to endure just to keep their heads above water. They have little or no bargaining power with the mother units that they cater to, and further, they are locked into strict quality and price control norms, and delivery schedules. Fortunately, after long years of somnolescence, the government has now taken steps to ensure that they are at-least paid on time for the services that they render. This was the biggest bugbear hurting component units prior to government intervention.But even given the many concerns that such companies have to address, there appears to be no dearth of entrepreneurs to play the role of pied piper to the parent units.
The company's operational income shows an erratic pattern. Net revenues have oscillated over the last five years in a very uncertain manner. If the top-line performance was erratic, then the bottom-line underwent a tectonic shift of sorts. That is to say the profit before tax hit a high of Rs 370 m in 2006-07, and then careened to a low of Rs 28 m in 2008-09, before bouncing back to a record a figure of Rs 291 m in 2010-11. Given the resultant topsy turvy state of affairs on the cash flow front, the management must be having its hands more than full when budgeting for capital expenditure outlays. And for whatever reason it keeps germinating new subsidiaries and pumping dosh into the equity of existing siblings, simultaneously. In 2010-11 for example it pumped in Rs 343 m in additional capital into the equity of three group companies. The book value of its investments in its subsidiaries which are all privately held amounts to Rs 986 m. This excludes any loans that it has may have advanced to them. The loans and advances schedule does not mention separately any advances that the parent has given to the siblings, but the auditor's notes state that one of the subsidiaries has used the parent's non funded letters of credit to the extent of Rs 35 m. Further, the schedule showing the transactions between the parent and the group companies reveals that the interest bearing loans outstanding at year end by the group companies amounted to Rs 627 m. This amount should logically have been shown separately in the loans and advances schedule.
MInadequate long term capital funding
Why the management does not do a similar to the equity capital of the parent to reduce its debt burden and interest payout is a Rubik's cube puzzle. (Probably they have a very well reasoned argument for not doing so). One says this in conjunction to the fact that the management which holds a slice over 50% of the voting stock has gone to the extent of hawking 47% of their holding as part of security wall to avail of loans or some such. In their collective wisdom they obviously believe that holding on the controlling stake at any cost is more desirable than diluting their hold, or even increasing the floating stock which may follow after a further issue of capital or something. The company presently supports on paper a reserves and surplus of Rs 3.1 bn on a piggly wiggly paid up capital base of Rs 135 m. The paid up capital in the preceding year was Rs 129 m. That is to say there was a capital infusion of sorts by the promoters during the year. The paid up capital rose by Rs 84 m through the issue of equity shares of Rs 1 each at Rs 17.5 per share to a holding company called Kapsons Associates Investments Pvt. Ltd. (The name Kapsons is an acronym for the Kapurs who appear to be the promoter owners). But such niggardly largesse will not suffice given the considerable requirements of long term capital by the parent. And, debt at year end stands at a very healthy Rs 4.5 bn. This is an increase of 90% over the base year 2006-07, against a 49% rise in the gross block to Rs 8.9 bn over the comparable period.
The company is virtually scraping the bottom of the barrel on the profitability side of the operations front. The revenues that it generates are on account of sales affected to the domestic tariff area and on account of export sales. The exports sales of Rs 1.8 bn, which also include sales of Rs 1.5 bn to its US and UK subsidiaries, account for a little over 17% of gross sales. How profitable these export sales are will however not be known as the disclosure requirements are silent on this aspect. The unit price increase that it generates on sales appears to be inadequate. To its good fortune though, debtor's out-standings at year end is a mere 13% of sales. More importantly, there are no bad debts to be provided for on these out-standings.
The P&L account
The way the profit and loss account is presented, the company managed a profit of Rs 290 m after depreciation. This profit figure includes Other Income of Rs 402 m. In the preceding year the corresponding figures were Rs 50 m, and Rs 247 m respectively. That is to say, barring the other income factor, the company would have reported a loss after depreciation in either year. The other income schedule is in itself under represented in the P&L statement. Bank interest receipts of Rs 81 m (Rs 59 m previously) has been netted off against bank interest paid out during the year. Logically, this receipt should have been added to other income. This would have inflated other income for the year to Rs 484 m against Rs 306 m previously. But let that be, as it does not in any way alter the outcome. What should also be taken note of here is that one of the receipts that constitute 'other income' was manufactured for the benefit of the company, which is struggling to show a bottom-line inked in black. The company logged a profit of Rs 191 m on the sale of assets. During the year it sold assets with a historical book value of Rs 207 m for Rs 370 m realising this profit on sale. The catch here is that the assets sold included leased land held by the company worth Rs 90 m. This land was forced down the throat of its subsidiary KRP Auto Industries for Rs 203 m. This is merely a book entry transfer of resources in every manner of speaking, and does not constitute an act to be proud of.
The company was able to register an increase in rupee sales by 30% to Rs 10.6 bn, gross of excise duty. The revenues include sales of Rs 2.2 bn affected to four siblings, and also to one company in which the directors are interested, but which does not form a part of the group. The unit price realisation on such sales is not separately known. (The company in itself was able to eke out an 11% increase in the unit price realisation in rupee terms on what it bought and sold during the year). However, manufacturing expenses rose in tandem with the percentage increase in sales to Rs 5.7 bn. Thus it negated any benefits that could have accrued to the company from the biggest expense item on the revenue expenditure side of the equation. The parent also bought goods worth Rs 126 m from one sibling, and goods worth Rs 599 m from one company in which the directors are interested, but which does not form a part of the group. It is not known at what price these goods were then flogged in the market place, assuming that these goods were finished goods in the first place. Neither has the company shown where this purchase value has been debited in the P&L account. The sharpest increase in costs among the other biggies was recorded by employee handouts which rose 39% to Rs 1.2 bn. Matters were hardly helped when interest costs rose 26% to Rs 517 m. The interest debited to P&L account averaged around 11.5% on a rough basis, on the average of the borrowings for the two years. The rate of interest that the parent charges its siblings are not known, barring the fact that they are interest bearing.
The many add ons
The parent has an equity stake in 10 subsidiaries and or joint ventures. The book value of the investments adds up to Rs 986 m. Just one company, Continental Rico Hydraulic Brakes accounts for 50% of the total investment. The parent earned a dividend income of Rs 48 m on this account - though none of the siblings have declared any dividend for the current year. These dividends could have emanated from the JVs' though. But that is not a matter of any real pertinence, given the fact that the primary purpose of these siblings is to add to the group image. But the related party disclosures shows linkages with 17 companies including seven in which the directors are interested but do not form an immediate part of the group. The parent has furnished the financial summary vitals of seven siblings. Only three of the companies have anything to show for it, and they are big ticket items if you please.
At the top of the heap is Rico Auto Industries, USA, which posted a turnover of Rs 1 bn, but managed a pre-tax of only Rs 19 m. What is very interesting here is that this sibling is a mere post office of that of the parent. As stated earlier the parent sold goods worth Rs 989 m to this sibling which in turn sold the goods by adding a small mark-up. This also begets the question as to why a post office needs total assets of Rs 419 m. Next in line is the UK based offspring which rang up sales of Rs 501 m, but managed a pre-tax of only Rs 17 m. Ditto with this company too. It is also a post office of the parent. The parent sold goods worth Rs 488 m to it, and the sibling in turn flogged these goods. This company has total assets of Rs 157 m. The other company of significance is Rico Jinfei Wheels Ltd, which appears to be the China based sibling. This company registered a turnover of Rs 382 m, but was awash in red ink on the bottom-line front. The other four companies have yet to open their account.
Clearly then the siblings have a long way to go before they impact positively on the accounts of the parent is any substantial way. The parent's biggest investment by far as stated earlier is in Continental Rico Hydraulic Brakes, but since this is a 50% JV, no financials have been appended.
It is not enough for the management to make statements of intent which look catchy to the eye. It needs to be backed up by margins which justify its ability to make its intentions come true.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.
Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.
(Source:
http://www.equitymaster.com/outsideview/detail.asp?date=12/28/2011&story=2&title=Rico-Auto-Preferred-global-OEM-supplier)
