United Spirits: Cheers, but where are the profits? - Outside View by Luke Verghese

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United Spirits: Cheers, but where are the profits?
Jan 3, 2011

The Chairman is all smiles

The smiling visage of Dr. Vijay Mallya, very thoughtfully featured on 'Page 3' of the annual report, by the script writers, says it all. The chairman of the board in his annual pontification to the shareholders chortles that in FY10, the company achieved landmark sales of over 100 m cases, with prospects of double digit growth. It also marks he adds and I quote 'the company's position as the world's No. 2 player, but the differential growth rates that we expect in India vis a vis the current world leader, gives me good reason to believe that we shall shortly seize global leadership.' Making the present scenario possible was the merger during the year, of Shaw Wallace with United Spirits Shaw Wallace is the repository of such fine whisky brands as Royal Challenge, Haywards Fine Whisky, and Director's Special, which the Mallya group, try as they might, had never been able to replicate.

Some interesting details

In a manner of speaking, it was also a homecoming for Vijay Mallya, who it is believed, had first bought this company from its foreign principal's way back in the 1980s. In any case, all's well, that ends well. In its humungous scale of operations, USL sources nearly 100 brands, in an average four pack sizes each in 28 differentiated markets from 80 manufacturing facilities (the company per se has 27 facilities). Scotch whisky continues to be in short supply globally it says, with rising demand in markets such as China. This bodes well for the company, given its significant investment in Whyte and Mackay (the 4th largest scotch producer in the world). It has also set up a state of the art winery at Baramati with a capacity to bottle 4 m bottles per year, to complement its acquisition of Bouvet Ladubay, a French winery, which was founded in 1851. The other nuggets of information is that the global spirits industry is estimated at over 2 bn cases - with the Indian industry accounting for about 12% at 236 m cases. India is also predominantly a 'browns' market with whisky, rum and brandy being among the predominant players. 'White' spirits, gin and vodka have only a 5% share.

Price Controls

It is of course amazing to note that the Indian spirits industry is under an 'informal' price control, or so the annual report informs. To quote: 'A substantial portion of the company's sales are to monopoly distribution agencies owned by state governments. Consequently, price increases even to negate inflation are difficult to come by.' There are several other 'garam masala' disclosures, which reveal a less glamorous side of this company, and shows out glaringly the less than professional face of the management.

The other side of the income and expenditure

Well for starters take a look at the revenue accounts of both the standalone company, and the consolidated statements. The company generates big revenues for sure, but shorn of the 'sin tax' element it is only half as big. It recorded gross sales of Rs 87.8 bn for the accounting year FY10, against Rs 71.1 bn in the preceding year, but excise taxes took away Rs 42.5 bn of this (Rs 33.6 bn). It also recorded a pretax profit of Rs 4.7 bn (Rs 4.6 bn). But the top line also shows receipts under three heads, which total up to Rs 4.6 bn (Rs 4.1 bn).These receipts are inclusive of an item called 'income arising from sale by manufacturers under tie up'. It is not known whether there is any corresponding debit entry in the expense side to earn this income, or whether the company is merely accounting for the 'net income' after expenses. Assuming that it reflects the latter assumption, and if one nets off the pretax profit against this 'other income' then the company is scraping the nether regions of the barrel. This also implies that but for such abundant inputs of oxygen supply; it would be hard put for the company to make ends meet. (There was of course also a very well timed, and a very fortuitous one time 'other income' receipt of Rs 700 m, pertaining to the profit on sale of United Spirits shares held by Shaw Wallace. The latter merged into United Spirits in FY10.)

This lag in profits is inspite of the fact that production volumes of Beverage Alcohol during the year were higher by 35% at 252 m litres. Sales of Beverage Alcohol cases were also higher by 13% at 61 m cases. Input costs of major raw materials like spirits and molasses were also well under control. But higher manufacturing costs, and interest costs, put paid to its hopes.

The financials of the consolidated accounts

The financials of the consolidated statements is a total giveaway. This statement includes the working of 34 subsidiaries - and they largely comprise a whacko list of floozies and non performers. On a consolidated basis the group recorded gross sales of Rs 105 bn (Rs 89 bn). That is equivalent to an additional gross sales income of Rs 17.2 bn (Rs 17.9 bn) over that of the standalone results. The bottom-line is a lot less picturous, but simultaneously, a lot more colorful. It recorded a pretax profit of Rs 1 bn against a pretax loss of Rs 3.2 bn. The consolidated results in turn generated 'other income' of Rs 5.9 bn (Rs 5.2 bn). If one minuses this income from the pre-tax profit, then the company would be totally in hock recording a loss of Rs 4.9 bn against an even more impressive loss of Rs 8.3 bn in the preceding year. This is also called net value addition Indian 'isshtyle'.

Where the shoe pinches

The nub of the problem is that the company is borrowing loads of money and then splurging it on assets which can be gently be termed as of the not so productive variety. This situation is entirely of the management's own making. In FY10, the finance department was grossly overworked judging from the humungous inflow and outflow of debt capital. The net result was that at year end the company had taken on an additional leveraged burden of Rs 16 bn, against an additional net borrowing of Rs 5.5 bn that it took on in the preceding year. (That is to say the total debt in its books at year end was Rs 35.2 bn, against an outstanding debt of Rs 22.7 bn in the preceding year).

The other very curious note in the directors' report in this respect refers to the issue of additional equity for Rs 16 bn during the year (Rs 10 face value shares issued at Rs 913.7 per share) ostensibly for a mouthful of purposes, including reducing part of the debt incurred for the acquisition of Whyte and Mackay, to repay other debts, for capex, and other corporate purposes. As one can see very plainly, the company only accumulated bucketsful of additional debt during the year, rather than reduce debt. In effect the script writer was attempting to give a favorable spin to the factual position.

Where did the moolah go?

So where did all this moolah go? Fortunately the moneys remain within the group orbit. Close to Rs 36 bn (Rs 2.7 bn) was given as loans to select subsidiaries during the year, while some Rs 1.6 bn went into gross block addition. (The company also generated net cash flow of Rs 11 bn from operations during the year). As a matter of fact the total loans and advances to its subsidiaries at year end totaled a humungous Rs 44 bn, and some change. (The beneficiaries of the largesse from the Santa Claus parent include USL Holdings, Asian Opportunities and Investments, Royal Challenger Sports, Four Seasons Wines, and 'Others'.) This loaded 'gift' comes interest free, while at the parent has to suffer the ignominy of having to pay interest on what it borrows from lenders of money. This loan mela is in addition to the Rs 12.5 bn that it had invested in at year end, in the equity or preference capital of affiliates and subsidiaries - which earn not a dime in dividend returns to the parent. Not bad going at all for a management which has a holding of only 29% in the voting stock of the company.

The bulk of the lending, or Rs 39.5 bn, has been affected to USL Holdings BVI, a US dollar denominated subsidiary of the company, for the acquisition of long term strategic investments. (However what exactly is the investment proposition that the management has in mind remains hazy. But more on this later.) BVI is an acronym for the British Virgin Islands, a tax haven, located in the Caribbean. (Now you know what long term strategic investments the company is talking about, but let that be). Of late the parent is worrying itself silly about the ability of USL Holdings to repay in any form. So much so, that the parent has now very wisely decided to revert to the magic mantra of converting a large part of this debt, or Rs 33.4 bn, into equity. It is as simple as that you see. It is also a direct reflection of the games that the top management of United Spirits is up to, as they in effect control the purse strings of USL Holdings.

The list of investments/subsidiaries

The list of investments in the books of United Spirits is in itself a flummoxing potpourri, and different schedules give a different twist on the number of subsidiaries that it has. The company's primary investment schedule lists 19 direct subsidiaries, but just 2 of them account for anything, investment wise. Shaw Wallace Breweries, and Palmer Investment Group, (the latter a dollar denominated company), between them hog 90% of the total investment made in the subsidiaries, or Rs 10.2 bn, out of a total of Rs 11.3 bn. Another whackily named, and dollar denominated subsidiary, Asian Opportunities and Investments Ltd, accounts for another Rs 301 m. USL Holdings, the kingpin of the loan drama, is actually a minor subsidiary taking in an investment of only Rs 22 m at book value. There is also an investment in an entity called Montrose International S.A. with a face value of US$ 1,000 each, which was acquired at a cost price of Rs 268,000 per share. This looks like some fancy investment for sure. What this entity does for a living however is not known. Fortunately, the total investment in this set up is only Rs 133 m.

When one flips through the pages and come to the schedule disclosing the details of the subsidiaries under Sec 212, one is informed that the parent has only 15 direct subsidiaries and the balance 4 are merely step down subsidiaries. And the latter variety includes, Shaw Wallace Breweries, Montrose International, and Asian Opportunities and Investments, and McDowell and Co., Scotland Ltd. Yet another schedule informs us that the company in effect has 77 subsidiaries, plus another entity by the name of USL Benefit Trust (which holds shares in United Spirits) and which became a subsidiary during the year, and an associate company called Wine Society of India Ltd. It is about as nutty as it can get.

Then there is the schedule which gives the brief financials of the working of 34 subsidiaries, and this is where it gets really interesting. Fully 22 of the 34 generate zilch revenues to start with. The companies that bring home the bacon, turnover wise, are United Spirits Nepal, Bouvet Ladubay S.A.S., White and Mackay Group Ltd, White and Mackay Ltd, and Royal Sports Challengers. That's it. The biggest contributors to the kitty are White and Mackay Group with a turnover of Rs 11.9 bn with a profit before tax of Rs 1.6 bn, and White and Mackay Ltd, with a turnover of Rs 11.7 bn and a profit before tax of Rs 2.5 bn. The latter also has an investment portfolio of Rs 33 bn. (It is not known whether this investment portfolio generates any revenue streams.) Next in the pecking order is Bouvet Ladubay with a turnover of Rs 1.1 bn and a marginal profit before tax of Rs 67 m. United Spirits Nepal too does its bit to contribute to the value added table.

The enigma of USL Holdings etc

But what of the other hot shots, especially USL Holdings? In reality USL with a small capital base of Rs 22.5 m, has reserves of Rs 889 m, and an asset base of Rs 40.7 bn, zero revenues, and a pre-tax profit of Rs 457 m. The question is how do you register a profit without any revenues, please? (A similar question mark can be laid at the door of several other companies in the list too.) Remarkably enough, this company has yet to make any investments with the moolah that it ferreted out of the parent, though that we are told that this is its express purpose in the first place. Exactly ulta pulta is another subsidiary styled USL Holdings UK Ltd. It has a capital base of Rs 0.068 m, negative reserves of Rs 11 bn, total assets of Rs 39.5 bn, zero turnover, and recorded a pretax loss of Rs 4.5 bn. This company's performance is a live wire act, and should be classified as a fit case for study by management institutes. There are two other companies sporting the same initials, and going by the names of United Spirits (Great Britain) Ltd and United Spirits (UK) Ltd. The big difference here as compared to the other two UK subsidiaries is that, neither company has a capital base, but in all other respects they have recorded performances which will rank on par with that of the other two and then some more.

The United Spirits Great Britain Ltd subsidiary also has investments to the tune of Rs 34.5 bn, but again they yield not a dime in revenues. On the contrary this company recorded a pretax loss of Rs 954 m. (This company does not feature in the list of companies detailed earlier which are the recipients of the parent's largesse. So where did this funding come from?) There appears to be some serious competition here to outdo one another by resorting to magic. Then there is the cricketing outfit perhaps, styled as Royal Challenger Sports. With a miniscule capital base of Rs 0.100 m it has assets of Rs 5.3 bn, a turnover of Rs 913 m and a pretax loss of Rs 85 m. It is still early days for this company to show its true batting, bowling and fielding prowess. Palmer Investment Group which is the subsidiary in which the parent has laid out its biggest equity stake from amongst the direct subsidiaries is another washout by all accounts. With an equity base of Rs 674 m it had nothing to show in revenue terms. Zilch turnover followed by a pre-tax profit of Rs 0.056 m. it also boasts an investment portfolio of Rs 728 m. This can be safely be called portfolio management of the highest order. Seriously, the Finance Department should pay a little more attention to topping up these minor details. These companies then, feature among the big daddies of the subsidiary empire.

Another perplexing aside

There are other perplexing asides to this company. It does not appear to have any pucca Human Resources policy in shape, or if it does have one, then it gives a long rope to its employees. The oldest employee appears to be the Vice Chairman S R Gupte at 71 years young. Among the lesser mortals in the senior management staff, the oldest is 69 and there are a string of others who completed 60 years of age several years ago.

One would do well to steer clear of companies in the public domain which are run in a manner which is not in the best interests of the shareholders at large.


This column Cool Hand Luke is written by . 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.


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