The snapshot of Deepak Fertilizers that it has provided at the beginning of the annual report dwells on its credentials. It is the only manufacturer of IPA (iso propyl alcohol) in India. It has Asia's largest nitric acid complex. It has TAN capacities (technical ammonium nitrate) that place it among the market leaders. It is among the market leaders in the Indian water solubles, speciality fertilisers, and sulphur Bentonite segments. It has been ranked 3rd as per total income in the chemical sector by Dun & Bradstreet's India's top 500 companies 2010. It has a product basket comprising fertilisers, industrial chemicals, and realty which gives it a unique resilience.
Spreading its wares thin
The ground reality is that it produces 10 products and sells eight of them. It actually sells 13 items including derivatives of what it makes, and includes fruits and vegetables, and windmill power, or so the copy states. Its key raw material inputs are natural gas and its derivatives, ammonia, propylene, phosphoric acid and sulphur. It raw materials are either petro-based, or are largely of the imported variety. The CIF (cost/insurance/freight) value of the raw material imports amounted to Rs 1.2 bn out of the total raw material consumption of Rs 6.9 bn. If the company sticks to imports in the current year, then the value of imports is likely to increase significantly given the drop in the rupee parity rate. It also buys and sells finished products to complement what it makes and sells. It has licensed capacities to produce 12 items, though it does not make two of them-propane and crude IPE (Brent crude oil?). The ammonia and DNA (dilute nitric acid) that it makes is used largely for captive consumption. For segment reporting purposes its revenues are grouped under four distinct heads - Chemicals, Fertilizer, Realty, and 'Others'. Then there is another head called 'Common' which incorporates 'unallocated corporate other income'. Gosh, why realty business also?
The chemicals division showed a segmental profit margin of 30%, the fertilizer division a segmental margin of 6%, but the realty division was in distress showing a segmental loss of Rs 50 m on revenues of Rs 118 m. The miniscule 'Others' division however revealed a whopping segmental margin of 43%. This is very complex accounting for sure especially when it involves accounting for fertiliser subsidies (the fertiliser subsidies are humungous and can make or mar the financials of such units) , and having to invest in Fertiliser Company GOI bonds. And when these bonds are sold, the government reimburses a part of the loss on sale if the coupon rates on the bonds are below the going market rates for bonds. This is truly an absurd state of affairs.
The snapshot financials
The five year snapshot financials that the company has provided in brief from 2006-07 to 2010-11 shows a company which is on the upswing. The income from operations has risen steadily each year from Rs 8.4 bn to Rs 15.6 bn over this period (in different schedules the company has different computations for its revenues) barring a blip in the revenues for the year 2009-10. But the profit before tax has shown a steady rise each year from Rs 1.3 bn in 2006-07 to Rs 2.6 bn in 2010-11. The dividends too have risen each year over that of the preceding year. The equity capital has however remained steady at Rs 882 m over the 5 year period. But the medley of businesses that it is in, it makes for a very capital intensive operation for sure. And in times of difficulties this factor could well play spoilsport especially considering the level of debt on hand. The income generated from operations is consistently less than the gross block (inclusive of CWIP) in each of the five years. In 2010-11 for example, the revenues of Rs 15.6 bn was less than the gross block of Rs 19.5 bn or a factor of 0.8:1. In 2010-11, the company added Rs 3.3 bn to gross block with a capital work-in-progress outstanding of Rs 2.7 bn. This addition to gross block led to an increase in the capacity of two items of manufacture - the capacity of its diluted nitric acid increased from 3.9 lakh metric tonnes to 4.4 lakh metric tonnes, while the capacity of its TAN plant rose to 4.3 lakh tonnes from 1.3 lakh tonnes.
How it earns its bread
As stated earlier the company earns its bread from manufactured sales and from traded sales. In reality the sales realisations are a lot more complex than they appear. The gross revenues strictly speaking amounted to Rs 16.6 bn against Rs 13.5 bn previously as shown in the schedule listing the Income from Operations. The gross revenues in this specific instance include excise duties and subsidies on its manufactured and traded fertiliser sales and other operating income. Separately there is also other income of Rs 358 m (Rs 449 m previously). The manufactured sales, excluding the subsidies, are lumped under one head called Gross sales: Own Produced Commodities. Then there is the revenues accruing from traded goods sales including subsidies, revenues from Realty business, and 'Other' operating income. The manufactured sales including subsidies brought in 83% of the gross revenues at Rs 13.8 bn. This was followed by traded goods with 16% at Rs 2.6 bn, realty biz with 0.8% or Rs 131 m, and the last is operating income with 0.2%.The corresponding figures for the preceding year were 77%, 20%, 1% and 0.3%. The total amount of subsidies that it received on fertiliser sales accounted for Rs 2.4 bn against Rs 2 bn previously. The company also purchased Rs 2.4 bn worth of traded goods against Rs 2.7 bn previously. Assuming that all the traded goods were sold in the year of purchase, then the company would have made a ball park gross margin of Rs 311 m in 2010-11 against a margin of Rs 266 m previously, on such sales.
Elsewhere, in the quantitative details schedule, the company gives separately the revenues that accrue from its myriad manufactured product lines. But the sales that the company has derived in this working are different from the schedule which lists the Income from Operations. According to this schedule the manufactured sales revenues amount to Rs 12.8 bn against Rs 9.8 bn previously. (To get to the point, in this schedule listing the Income from Operations, the gross sales from manufactured products, excluding subsidies amounts to Rs 12.3 bn against Rs 9.6 bn previously. It is all very complicated if one may say so. Even the production figures relative to the installed capacities are a little difficult to stomach. The production and purchase figures have apparently been clubbed together or something to that effect.
According to this production cum sales schedule, the total sales value of manufactured products amounted to Rs 12.8 bn against Rs 9.8 bn previously. (This is yet another different total). The biggest contributor by far to the manufactured sales kitty is Iso propyl alcohol, which accounted for 32% of manufactured sales. According to the business dictionary this product is basically used as a solvent for coating in industrial applications and in the pharmaceutical industry. Next in line is TAN or technical ammonium nitrate, which brought in another 20%. This is followed by NP which possibly means nitro phosphate fertiliser which accounted for another 18%. Fourth in the list is CNA or concentrated nitric acid which brought in another 10%. The sales of methanol accounted for yet another 9%. That makes for a total of 89% of all manufactured sales. The sales of dilute nitric acid, propane, sulphur, carbon dioxide, ammonia and power brought in the balance moolah. As one can see this is a veritable medley of manufactured products to handle. There is, of course, no knowing which of these items bring home the bottom-line bacon, so to speak. In traded sales, the items involved include basically chemical and organic fertilisers, and micronutrients.
The cash flow statement
As the cash flow statement reveals the company generated net cash of Rs 2.3 bn from operating activities. It was barely enough to finance the demands of gross block addition. But what saved the day for the company was the reduction in the investment portfolio by Rs 545 m, on the one hand, and the dividend and interest receipts of Rs 140 m on the other. Given the uneasy situation, the company had to hike debt by Rs 444 m to Rs 7.7 bn. The significant factor in the accretion of debt is that the external commercial borrowings (ECB) rose to Rs 2 bn from Rs 763 m previously. Given the depreciation in the rupee value post the increase in borrowings, the repayment value will go up significantly. Besides, the 'other income' quotient is a not an insignificant contributor to the bottomline. Other income of Rs 358 m (Rs 449 m previously) added up to 14% of the pre-tax profit, against a more significant 21% in the preceding year. This includes a fortuitous gain of Rs 42 m (Rs 134 m previously) on foreign currency fluctuation gain. The company is apparently forced to contribute to the fertiliser bonds issue floated by the central government. At year end, the precious moolah locked up in such investments amounted to 307 m against a larger Rs 583 m previously.
Its investment portfolio
As a matter of fact its investment portfolio is very illuminating. It has investments in mutual funds to the tune of Rs 2.3 m against Rs 9 m previously. It also bought mutual funds of the value of Rs 23.4 bn and sold mutual funds of the value of Rs 23.4 bn during the year. The other income schedule says that the company made a profit of Rs 68 m from the sale of mutual funds. But there is no direct evidence of how such a profit could have been made. At year end, it also had investments in non-trade equity shares to the tune of Rs 13 m. Juxtapose this with the value of such investments to the tune of Rs 137 m at the previous year end. During the year it obviously unloaded some of these holdings. It is not immediately known what these shareholdings comprised of, though it is a statutory requirement to disclose the individual names of these holdings, I think. It also appears to have redeemed preference shares in its subsidiary to the tune of Rs 120 m during the year. It reduced the value of its holdings in the fertiliser company bonds by Rs 275 m during the year. The fertiliser bonds sale has led to a number of accounting entries where the loss on sales of Rs 40 m, which has been partly compensated for by the government, has been reversed through write back of provisions and what not and leading to a profit on this exercise to the tune of Rs 32 m! And what of the reduction in the value of its holdings in unquoted equity shares and the preference shares? There is no mention of any profit or loss on this exercise. The investment in its subsidiary companies amounting to an average value of Rs 760 m (average of the two years) yielded a dividend income of Rs 30 m. The entire dividend receipt was from one subsidiary company.
This brings us to the three wholly-owned subsidiaries that the company boasts of. There are also associate companies owned by the promoter directors through whom the parent has revenue dealings. Of the three subsidiaries, only one, Smartchem Technologies is of any significance. This subsidiary, on a capital base of Rs 70 m, rustled up revenues of Rs 636 m during the year and recorded a profit before tax of Rs 135 m. It even declared a dividend of Rs 30 m. What exactly it does to earn its living however is not known. The two other subsidiaries appear to be letter head companies or some such.
The parent sold goods worth Rs 277 m to its associates during the year, but the subsidiaries were richer by only Rs 5 m, thanks to the munificence of the parent. In the preceding year the two figures read as Rs 220 m and Rs 78 m respectively. Admittedly, the revenues accruing from such sales are small change in the overall scheme of things, and some leeway has to be given in such matters. It does not buy a penny worth from any of them though. It also received services worth Rs 90 m from key management personnel , while associate companies gave services worth Rs 8 m. What services might they be?
In the overall context however, given the medley of businesses that the company indulges in, and the manner in which it assembles all its pickings, it does not leave for much of a comfort factor. This company is definitely not for the discerning investor.
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.