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Alembic Ltd: Overtaken by old age - Outside View by Luke Verghese

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Alembic Ltd: Overtaken by old age
Jan 4, 2012

Not in the best of health

The brilliantly multihued front cover of Alembic Limited reminds shareholders that the company has been 'touching lives over 100 years'. Grammatically imperfect construction alright as it gives a different connotation, but the point that the company seeks to put across is that it has been touching lives for over a 100 years. Nevertheless, the management must be congratulated for its ability to keep this company on the trot for 104 years. Most corporate this old have sung their swan song. Not that it has much to show for it, and besides the results for the latest year end are of its truncated operations. In the sense that the 'pharmaceutical undertaking' of the company was demerged during the year and it was transferred to Alembic Pharmaceuticals. Presently it has one manufacturing facility at Vadodara in Gujarat, (which is about as old as the company itself) and where it makes bulk drugs and formulations. Why was there no effort at upgrading its manufacturing facilities all these years please?

Curiously enough the company has even upwardly revalued its self professed antiquated plant and machinery. And for what earthly purpose please? In a bid to gain additional traction in top-line generation, it also bought and sold a piddling amount of pharmaceutical preparations during the year. (In the preceding year such traded sales accounted for over 10% of net sales). Considering that the pharmaceutical undertaking has been demerged, it does not quite gel why the company is still making do with pharma operations. At some point of time two group companies - Neomer Ltd and Darshak Ltd - were also merged with the parent. What became of these operations is not known.

Truncated operations

The directors' report states that the company's operations currently include the manufacture of predominantly fermentation and chemistry based bulk drugs and power generation. There is however no sign of any income being generated from power as yet. (Separately, the company also intends to add value to its dated real estate holdings). The principal difference in its operational structure is that in the preceding year the company reported a profit before tax of Rs 235 m on a turnover of Rs 10.3 bn, while in the latter year it reported a loss before tax of Rs 68 m on a turnover of Rs 2 bn. The fall in the top-line is much greater than the fall in the bottom-line consequent to the split. Is one also to understand that the profitable division of the company has been hived off and the balance assets compensated for by the hidden value of its real estate holdings? According to the fixed assets schedule the gross value of the plant and machinery that was transferred was Rs 2.8 bn while the net value was Rs 1.7 bn. But the same is not so with the plant and machinery still in the company's books. The gross value of the plant & machinery is Rs 3 bn while the net value is only Rs 1.2 bn.

Clutching at straws

Seeing the writing on the wall, the company intends to now give emphasis on generating income from its real estate holdings. The company admits to as much. The pharma business is facing stiff price competition from Chinese manufacturers, and the company together with other manufacturers has petitioned the government to levy anti dumping duty, which has not been favourably considered by the government. That is reason enough for the company to flog its real estate, and invest the proceeds in modernising its plants and expanding capacity. But there is nary a mention of such a thought process in the making.

Whatever, as stated earlier the company registered a gross turnover of Rs 2 bn and a pre-tax loss of Rs 68 m during the year. Including expenses incurred of Rs 42 m under the voluntary retirement scheme, the loss totals up to Rs 111 m. (How many employees were given the pink slip, or what beneficial impact it will have on the company's future well-being has not been disclosed, but the company would appear to be making an effort to become more lean in the process). But for the incidental 'other income' of Rs 38 m, the reported loss would have been higher to that extent. The other income was almost entirely composed of rental income of Rs 25 m and miscellaneous income of Rs 10 m. (Alembic also has an additional problem to cope with. Some 25% of its raw material consumption is imported - which infers that the company has to cope with the vagaries of the rupee value against the dollar).

The interest burden of Rs 24 m and depreciation charges of Rs 101 m helped to do the company in. There appears to be an anomaly here. On a very rough back of the envelope calculation the percentage interest paid out and debited to P&L account would amount to a very low rate of 3.5%. This is an abnormally low rate of interest to shell out for a company which has a load of debt and is simultaneously operating at a loss. On the plant and machinery which accounts for the vast bulk of the gross block, it appears to have provided a depreciation of 7.6%.

Fixed assets unable to generate top-line

The point is also that on a year-end gross block of Rs 3.3 bn the company managed to eke out a net sales income of Rs 2 bn. That is not exactly an example of manufacturing efficiency at play and is one other reason that the company is not able to put its house in order. As the turnover details show the sale of bulk drugs accounted for the entire manufactured turnover. What is significant here is that the export sales chipped in only a slice over 10% of net sales against a significantly higher 31% previously. (It looks like the demerged operations also took away the vast bulk of the export sales too!) But in spite of the seemingly dismal picture it still managed to realise a net cash inflow from operations. But where the company ran out of cash was given the demands on the purchase of assets and investments.

This led the company to borrow additional debt. The company took an equity stake in the demerged pharma operations by plonking down Rs 110 m in the equity of Alembic Pharmaceuticals. It also sold goods worth Rs 632 m to its associates during the year (in all probability to the delinked sibling) as such sales did not occur in the preceding year. That would amount to 29% of gross sales for the year. It appears that the demerger is a one way house. (Alembic Pharma was a subsidiary of the parent till end March 2011. But the parent has not provided the summarised financials of this company as is required under law). What extra mileage the company obtained by putting down a measly Rs 102 m in fixed asset expansion during the year is not known. But this is the ground reality.

Tepid investments

There are other ground realities too which is adding to the confusion. The company has investments either as equity or as bonds in a plethora of corporate non entities valued at Rs 162 m. Small change by any reckoning but the point is that these siblings are not generating more than a dime as tithes to the parent. Besides, the parent can do with all the resources that it can muster. The largest investment by far is in Alembic Pharmaceuticals with a book value of Rs 110 m. Several of its investments are fully provided for too. There is its Rs 75 m stake in Xechem Biochemicals, its American adventure for example. It had global ambitions too at some point of time. An investment of Rs 3.4 m in a foreign company called Alembic Global Holdings SA, which too was demerged, when the bigger demerger took place. That is to say it had incorporated a subsidiary company in Switzerland at some point with a very ambitious sounding name attached to it, and sporting a pidgin capital base.

Monetising land

Having not made any headway by incorporating wayward siblings, among its other setbacks, the company has now belatedly wised up to monetising its surplus lands. For starters it has monetised land with a book value of Rs 0.12 m, and valued it under stock in trade at Rs 311 m. The company is launching its maiden residential project in the current financial year. This project is not being spun off as a separate subsidiary and thus the revenue streams emanating from this project will be fully reflected in its income and expenditure account. The extent of the land that it is developing is not known, or for that matter the anticipated future cash flows. The directors' report also mentions that the company is exploring various options for the development of other real estate projects. This probably infers that it possesses a lot more surplus lands whose values remain to be unlocked. But the real estate business is also fraught with hidden cul de sacs, and besides, requires large dollops of cash inputs. As things stand, this company does not appear to be generating substantial cash from operations. As a matter of fact most of the realty companies that I have surveyed suffer from topsy-turvy cash flows.

Why the company has chosen to focus on real estate instead of sprucing up its pharma facilities has not been adequately explained in the directors' report. The report does dwell briefly on the need to revamp the facilities of its undertaking at Vadodara facility to survive competitive pressures from within and without. Add to this the proposed diversification into power generation. How they plan to get it all together is a bit difficult to comprehend at this point in time.

From the looks of it there is very little in this share at this juncture.

104 years old and showing its age

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 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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