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NCC Ltd.: Needs financial re-engineering - Outside View by Luke Verghese
 
 
NCC Ltd.: Needs financial re-engineering

Like all construction companies it is too stretched, and this is telling on its financials

A change in name

NCC Limited was till the other day known by its original nomenclature - Nagarjuna Construction Company Ltd. The name change was affected to 'future-proof its brand identity'. Today 'it undertakes landmark infrastructure projects which are beyond the realm of construction'. According to the annual report, the company focuses on 11 verticals at present, including buildings, irrigation, power, mining, oil and gas and so on. The company claims that it has one of the most diversified business portfolios, which will help it in mitigating the risk of slowdown in one particular segment. For sure, the standalone company and the consolidated entity is a humungous operation. The standalone company registered a turnover of Rs 50.7 bn, and ratted up a pre-tax profit of Rs 2.6 bn. The consolidated entity posted a turnover of Rs 62.3 bn, and ponied up a pre-tax profit of Rs 3.2 bn. Compare its scale of operations to the present size of the construction sector, which the company says stands at Rs 5918 bn. By this yardstick, the company's share in the apple pie would amount to an insignificant 1%. The construction industry contributes 7.9% to the country's GDP.

Cash Flow Conundrum

It may be pertinent to add here that the construction industry undergoes severe convulsions on the cash flow front irrespective of the order book position, and the top-line performance of NCC is no less so. A look at the snapshot financials that the company has appended to the annual report reveals the stark reality. Though the order book position over the five years, the top-line growth, and the earnings before interest, depreciation and taxes, show a consistent increase each year over the preceding year, the post tax profit had to contend with tectonic shifts. NCC for example reported a negative cash flow from operations to the tune of Rs 2.3 bn in 2010-11, against a positive cash flow of Rs 239 m previously. Construction companies, given the very nature of their operations, also have to procreate humungous numbers of subsidiaries, fellow subsidiaries and step down subsidiaries, and yet other concoction just to be in business.

This in turn generates the need to spawn mega sized investment portfolios. NCC for example makes do with 42 subsidiaries, including two step down subsidiaries. Not to mention close to half a dozen JVs or so. The book value of its investment portfolio in its siblings and in other investments at year end toted up to Rs 12 bn. The siblings also owed the parent a sizeable Rs 5.5 bn at year end, being repayable borrowings. Not including the corporate guarantees etc of Rs 15.2 bn that the company has given to the banks for extending financial assistance to its subsidiaries, step downs, associates and joint ventures. The commissions payable to the banks for extending this facility toted up to Rs 219 m. The demands on the liquidity front were so shrill, that the company resorted to additional borrowings of Rs 9.5 bn during the year.

All in the family

NCC is also a Raju run concoction - period. Besides the Chairman Emeritus Dr A V S Raju, there are five other Rajus' on board as whole time directors. That is to say Mr Ranga Raju is the CEO, and there are four others with the designation of executive director or whole time director. If that is not enough yet another Raju is the chief financial officer. (Yet another Raju who officiated as a whole-time director resigned from the board on March 31). It appears that far too many family members have to be accommodated, and besides, the family believes in having a tight control over the finances of the company, by keeping the finance portfolio also in its grasp. Just to spruce up matters, there is additional colour imparted to the board by the presence of the ubiquitous Rakesh Jhunjhunwala, (Rakesh incidentally holds 5 lakh shares in the company) as also a nominee of the Blackstone Group, Mr Akhil Gupta, of the US based asset management Company.

The board in turn consists of 16 members including the chairman emeritus! Given the numbers, one wonders how the board members ever arrive at a consensus! The six Rajus on the board together earned a combined salary and perquisites of Rs 160 m in the latest accounting year end! They account for 6.5% of all employee payouts. The promoters incidentally control a mere 20% of the voting stock, bodies corporate 10.8%, while foreign Institutional Investors (FIIs) surprisingly control another 38.4%. Hence, the promoters appear well ensconced. This could be another reason why the paid up share capital is kept at the very minimum. A paid up equity of Rs 513 m appears to be small beer given the very scale of its operations.

The current mantra of India Inc is to make a vision statement. NCC's vision is to be a world class construction enterprise committed to quality, timely completion, customer satisfaction, continuous learning and enhancement of stakeholder value. It would appear that every possibility has been incorporated and one cannot get better than this. Besides the vision statement, there is the mission statement, value statement, quality policy and, quality objectives. This is working out to be more than a mouthful.

Scraping the bottom of the barrel

What is coming across very clearly is also that the company is scraping the bottom of the barrel on the profitability front. Juxtapose the following figures. In 2010-11 it generated other income of Rs 1.03 bn against Rs 1.07 bn previously. (The other income incorporated in the P&L account is erroneous, as it excludes bank interest of Rs 887 m that it received against Rs 638 m previously. This bank interest received by the company has been netted off against bank interest paid by it). The other income component on its part accounts for 40% of the profit before tax, against a lower 30.5% previously. These percentage contribution figures are substantial enough.

The principal causes for the drag in profitability are expenditure factors over which the company has control over, but over which it is unable to exercise much caution. For example turnover rose 6.2%, and the largest item of expenditure by far - construction and other expenses--rose only 5.2%. But where it got jiggered was in the increase in 'establishment' costs and in 'interest and financial' charges. In the former, which include employee handouts, the percentage increase was 30%. In the case of the latter, the increase was 31%. How does one expect the margins to show any improvement? The strain on the company's cash flow was exacerbated by the need to pump additional funds into inventories, fixed assets, investments in subsidiaries, and on still more loans to its siblings etc. The need of the hour then, is to pump in more money into its permanent capital structure - but that is unlikely to happen given the holding structure.

Siblings are a drain on its resources

Adding to its cash flow mismatch is its inability to extract direct tithes from its many offspring. The book value of its investment portfolio as stated earlier is Rs 12 bn. This investment is divided 81% in its subsidiaries and 19% in its associates. The parent is unable to extract even a farthing on this investment. The total dividend return was a rather mockable Rs 27 m. The other inter-se benefits that the company derives are not quantifiable. Going by the details furnished in the investment schedule it appears to have 14 subsidiaries (two of these companies - Himachal Sorang Power and NCC Power Projects Ltd - in reality are step down subsidiaries), and investments in some form or the other in another 21 companies. Four of the subsidiaries are either based out of the Gulf or Mauritius. Two of the gulf companies are in Oman and one is based out of Dubai, but the collective capital base does not quite endure. Among its other investments portfolio, one is based out of Dubai.

The largest individual investment by far is in NCC Infrastructure Holdings Ltd. The parent has an investment valued at Rs 5.6 bn in this company. The average acquisition price is Rs 39.5 per share. This investment outlay accounts for 47% of its entire outlay. Next in order of size is its outlay in NCC Urban Infrastructure at Rs 1.2 bn. This is followed by its sibling based in the balmy Mauritius where the outlay is Rs 969 m. The other two companies that follow in order are its debenture holdings in Tellapur Techno City and its equity capital outlay in OB Infrastructure Ltd. These five companies hog a cumulative 77% of the entire investment outlay.

But in reality NCC Ltd is infinitely more complex. According to the related party transaction schedule, NCC has 12 subsidiaries (this number differs from the numbers mentioned earlier on) 30 step down subsidiaries, 14 joint ventures, and 13 associate companies. Separately there are another 11 companies owned or significantly influenced by key management personnel. That is a lot of enterprises to keep track of.

The financials of the siblings

The parent has deigned to provide the financials of 42 subsidiary companies in the schedule of financial information of subsidiary companies. The most significant aspect of this listing is that not one of the siblings has declared any dividend. But, then, the point is that very few of these companies are in a position to do day out any dividend. The consolidated turnover that the group cranked out for 2010-11 is Rs 62.3 bn. In other words the top line value addition of the subsidiaries amounted to Rs 11.6 bn. The incremental per tax profit was a lot less impressive - a mere Rs 0.6 bn.

A look at the individual figures is more than illuminating. The parent's largest flunky in terms of capital allocation as stated earlier is NCC Infrastructure Holdings. It has a paid up capital of Rs 1.4 bn, reserves of Rs 4.2 bn, total assets of Rs 5.8 bn, and investments of the book value of Rs 1.5 bn. It registered a miniscule turnover of Rs 70 m, and posted a negative pre-tax profit of Rs 53 m. Some of these figures are more than puzzling. Obviously, this company being a holding company of the group generates no turnover and in any case it results in a loss at the end of it all. In which case it does not stand to reason that it should boast positive reserves which are far in excess of its paid up capital-unless they constitute share premium reserves. Besides, why did the parent pay top dollar to acquire shares in this sibling? Not that it makes any difference at the end of the day. This company's investment portfolio of Rs 1.5 bn also does not earn more than a farthing either. Does the pre-tax loss indicate that the company has borrowings on which it pays interest or some such? Or that it booked a loss on sale of investments or some such? How else was this loss arrived at please? And do these humungous total assets consist of the cash equivalent of the share premium reserves?

The second largest sibling of the parent, NCC Urban Infrastructure is an 80% offspring. With a capital base of Rs 1.5 bn, negative reserves of Rs 34 m, total assets of Rs 6.8 bn, and investments valued at Rs 715 m, the company generated a turnover of Rs 1.6 bn, but could only manage a pip squeak of a pre-tax profit. Like the parent the investments in all likelihood do not generate even a dime to the top-line. And like the parent it also makes do with the construction business or some such. But how did it accumulate such a large total asset base please?

Still more on the siblings

There are only two other companies boasting significant capital bases. One such is Nagarjuna Construction Company International LLC based in Oman with an equity base of Rs 592 m and NCC Vizag Urban Infrastructure Ltd with a capital base of Rs 526 m. The former is a 100% subsidiary; while the latter is owned to the tune of 95%. The Omani company is a giant in its own right. With a turnover of Rs 6.1 bn it notched up a pre-tax of Rs 432m.It has total assets of Rs 8.5 bn. The Vizag subsidiary is yet to go on stream and thus its financials cannot be assessed.

It has a sibling labelled Himachal Sorang Power which is a 95% subsidiary of its sibling NCC Infrastructure Holdings. On a teeny weenie capital base of Rs 44 m, it has total assets of Rs 5.6 bn and zilch revenues to boot. How is this possible - what type of debt/ equity ratio is this anyways? There are even bigger nuggets in this grouping. One such is Nagarjuna Contracting Company LLC, based out of Dubai. On a pint sized capital base of Rs 3.7 m, it boasts total assets of Rs 4.6 bn. It also notched up a turnover of Rs 3.9 bn and a pre-tax of Rs 267 m. Is it so damn easy to do business in the Gulf please? Western UP Tollway is another case in point. It is a subsidiary of NCC Infrastructure Holdings. The total size of its assets is also due to its investment portfolio amounting to Rs 877 m. The miracle here is that this offspring actually generated an income of Rs 89 m, and posted a pre-tax of Rs 23 m. It is possible that a part of its investment portfolio may be generating dividend or even interest on its debt portfolio for that matter. The India Inc norms however is that their Mauritius based subsidiaries generate zilch revenues.

Then there are its several JVs and enterprises owned by key management personnel. But expanding on these could make this copy a little too long winding. Suffice to add that investors should keep a safe distance from such enterprises.

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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