Carborundum Universal: Expansion fails to yield high returns
A company which is expanding all around but does not at the end of the day add much to the wealth accretion of the minority shareholders.
A leader in the abrasives industry
This is my second take on a marquee company belonging to the Murugappa Chettiar group and headquartered out of Chennai. According to the group profile Carborundum Universal boasts of 28 businesses including 11 listed companies traded on the BSE and NSE. Prominent companies in the group include Coromandel International, EID Parry Ltd, Tube Investments, Cholamandalam Investment, Parry Agro, Wendt India, Coromandel Engineering Sabero Organics, Parry and Company, privately held companies in the plantation sector, and a host of siblings operating out of India or out of foreign shores and controlled by their parent outfits.
Set up some 59 years ago with the dual collaboration of Carborundum Company of the USA and Universal Grinding Wheel Company of the UK -- and hence the name plate -the company today manufactures and sells bonded abrasives, coated abrasives, industrial ceramics, refractories, grains and an item labelled as Others. The company also purchases stock in trade, though of minor value, from its numerous underlings for resale. Having siblings does come in handy-right? It gets to keep the name of the two original collaborators, but it is not known whether the collaborators continue to have any equity stake in the company, or continue to get any royalties from the Indian offspring for that matter. It may have even outlived the original alma maters. It is even more unique that a company which boasts two foreign name plates gets to be controlled by an Indian entrepreneur! The promoters control a slice over 42% of the paid up equity. For the matter of record the company gets by on a piddling share capital base of Rs 188 m on a total asset base of Rs 13.5 bn (based on gross fixed assets).
How the revenues add up
The net revenues from operations (excluding other income) of the standalone entity fell 2% to Rs 11 bn. The revenues have been churned out by 17 plants within the country. (The revenues include export sales of Rs 2.2 bn, other operating revenues' of Rs 208 m and 'income from contracts' of Rs 107 m). The revenues of the consolidated entity have fallen by a similar percentage to Rs 19.7 bn. According to the directors' report this marginal fall in revenues was apparently due to a 'very subdued' environment and hence a 'very challenging' year not only for the parent but also for its siblings, and associate companies. The company is hydra headed with operations across geographies -- the purpose of which is a trifle difficult to comprende. The parent holds shares of the book value in Rs 1.25 bn in group companies. The vast bulk of the holdings vest in just one entity - CUMI International based out of Cyprus. (This appears to be a new find from the tax haven point of view). The investment in this one company alone amounts to Rs 986 m in the form of equity shares and preference shares. The parent has a direct stake in six siblings, and another six companies are held through the step down subsidiary route. There are also three joint ventures to round out the picture.
The largest product item on sale for the standalone company is bonded abrasives. It accounted for 37% of all gross manufacturing revenues, followed by coated abrasives with 18%, industrial ceramics with 14.8%, refractories and grains with 14% each, and the rear end shooed in by 'others' with a pittance. The revenues in turn were compounded by 'other income' of Rs 183 m against Rs 155 m previously. In the preceding year there was also exceptional income of Rs 150 m.
However, the profit before interest, depreciation and tax fell sharply by 31% to Rs 1.5 bn. (According to the segment results disclosure statement which has grouped its operations under three heads -- abrasives, ceramics and electrominerals -- the division which showed the sharpest decrease in segment profit was the last named. The profit declined to Rs 73 m from Rs 440 m previously). It is of-course very difficult to put a finger on where the margins actually emanate from as the revenues also include as stated earlier export sales of Rs 2.2 bn-or 21% of net product sales.. After providing for interest and depreciation, the pre-tax profit fell even more sharply by 38% to Rs 1.1 bn. However, the decline in the bottom-line did not lead to a lower payout. The dividend - including tax upped to Rs 326 m from Rs 310 m previously. The decline in margins appears primarily due to the company's inability to set off the increased consumption costs of materials through higher end product pricing. Add to this the higher employee costs, and higher other expenses too. Other expenses includes an item called 'services outsourced' and amounted to a sizeable Rs 690 m.
One area where the company appears to be unable to collect its tithes is in the direct returns from its investments in it siblings etc. The total return on this count for the latest year was a paltry Rs 161 m. The parent has some inter-se revenue deals with its siblings. But how the parent benefits from such deals is not very clearly visible. For example it sold goods and services worth Rs 811 m to its siblings and JVs, and purchased goods worth Rs 576 m from them. Among other revenue deals it purchased power worth Rs 116 m from them. What is most interesting here -- on capital account -- is that the trade receivables at year end amounted to 34% of sales, while the trade payables amounted to only 4% of purchases (excluding power). If power is included in the purchases calculation then the ratio gets even more skewed! So who appears to be the real beneficiary here anyways? Besides, the letters of comfort and guarantees given on behalf of siblings at year end amounted to Rs 2.6 bn. There is a price to be paid -guarantee fees -- on revenue account for such generosity too.
Financially well managed entity
However one must add here that the year - end financials reveal a company in fine mettle. I may add here that the net worth of the company would have been several notches higher if only the company had adopted the prudent policy of upping the paid up capital by issuing additional shares at a substantial premium. The company generated more than sufficient cash to pay for its fixed asset acquisition of Rs 678 m and also meeting other exigencies too on investment account. The healthy cash flow generation in all probability helped the company reduce debt by Rs 275 m at year end and also emboldened the management to step on the gas pedal and pay out a higher dividend -including the dividend tax.
That the year- end debt is down a notch or two is one of the positive aspects. It is also one of the handful of companies that I have surveyed that boasts a much higher trade receivables figure (Rs 2 bn) at year end as compared to the trade payables amount (Rs 914 m). Inventory levels are low relative to sales, but, again, the total current assets at Rs 4.4 bn are far higher than the total current liabilities at Rs 2.8 bn. But the basis reason for this is the relatively high level of holding of inventories and trade receivables. This is also a reason why the company is so dependent on debt to fund its daily operations.
As stated earlier, how the operations of the many cross border siblings' help to add to the wealth quotient of the minority shareholders is not clear. The company has provided the brief financials of 13 siblings. Some five of the manufacturing entities in this list have the suffix Abrasives or the suffix Ceramics, or the suffix Refractories attached to them. The list includes four companies which are India based, and nine which are based offshore. Among the offshore units -barring the Australian and one South African company where the shareholding of the parent is limited to a 51% stake each, the others are 100% owned or very close to it. To round out the picture, somes even of the foreign siblings are subsidiaries of the investment arm CUMI International based out of Cyprus. All in all a bit confusing I must admit.
Some of the financials on display are baffling to say the least-and besides, only four of the 13 siblings declared a dividend -a collective total of Rs 130 m. Some six of the thirteen reported a pre-tax loss. But first - the company with the highest revenues by far is the Russian sibling Volzhsky Abrasive Works. It toted up revenues of Rs 5.7 bn and generated a pre-tax profit of Rs 749 m. What is incredible here is that it achieved these results on a piddling share capital base of Rs 6 m! The company was however pleased not to pay any dividend. Not surprisingly, the company with the highest share capital is CUMI International with a capital base of Rs 1.3 bn. It is not known whether this company generates any income of its own. But the fact of the matter is that it generated a turnover of Rs 290 m - and the plain truth is that not one of its siblings declared any dividend during the year.
Even more bizarre is the working of another sibling Thukela Refractories Isithebe Pty Ltd the second South African entity. It generated revenues of Rs 584 m and reported a pre-tax loss of Rs 215 m. Not bad going at all-what? It achieved these revenues on a ludicrous sounding paid up capital of Rs 0.01 m! But that is not the bizarre part. The reserves have accelerated sharply to Rs 545 m during the year from Rs 153 m previously and that too on a static paid up capital. How is this possible in a year when it was steeped in losses? Then there is CUMI America Inc which has difficulty standing on crutches.
There are several other eccentricities too-but it will tend to get very boring.
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.
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