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Kennametal India: Still on song - Outside View by Luke Verghese

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Kennametal India: Still on song
Feb 25, 2013

The company appears to be run more for the pecuniary benefit of the parent than in making an earnest effort in building up a secure base for the Indian offspring

Parenting two companies

Kennametal has parented at-least two companies in India. Kennametal India, the company being reviewed here, is 47annual reports young, which implies that it took life in 1965. This Company operates out of Bangalore, with its only factory based at Bangalore. In 1986 Kennametal formed another company in collaboration with the erstwhile Ashok Birla group now called the Yash Birla group. It was initially called Birla Kennametal, but now sports the name Birla Precision Tools, after the shares of the foreign collaborators was acquired by the India promoters in 2007. Its manufacturing unit is located at Aurangabad.

The foreign promoters of Kennametal India through Meturit AG and Kennametal Inc hold some 88.2% of the company’s outstanding equity capital base of Rs 220 m. The Indian public and other corporate bodies together hold the balance 11.2%. The holding of the parent is just below the previously mandated delisting holding upper limit of 90%. But since then Securities and Exchange Board of India (SEBI) has stipulated that companies which wish to remain listed for trading on the bourses must offer at-least 25% of their outstanding voting stock to non-management shareholders including the public. It is not known how the company plans to tide over this fiat.

In India the company manufactures hard metal and hard metal products (tungsten-titanium carbide alloy cutting tools) and machine tools. These products cater to wide range of manufacturing and other industries including transportation, general engineering, aerospace and defence, energy, power generation equipment, mining and construction, and so on. The list of industries that it caters to is impressive, but it appears there is also acute competition from rival manufacturers.

A sort of side- kick

In many respects this company operates as a complete sidekick of the parent - but then, the parent has an unassailable hold over the fortunes of its creation, and so does very much what it pleases. It has extensive deals going with the parent - especially for the purchase of what looks like of both raw materials and finished goods from group companies. It also extends to a much lesser extent to sales affected to group companies, payments made by the Indian offspring in respect of services rendered for IT services, royalty payments, and, other services received and paid The other quirk, as seen from the available data in the annual report, is that the sibling is forced to pay its trade dues to the parent at a quicker pace as compared to the total outstanding year end dues, and in relation to total dues payable to all suppliers. In similar vein, the sibling collects its dues for sales affected to the parent at a faster pace than the industry average. But, then, what it buys is a whole lot more      than what it sells to group companies. The corollary however is that a proper evaluation of the company’s working and its financials is well nigh impossible. Then there is the dividend payout to be considered too.

Revenues and profits

But in any event here goes. The revenues from operations net of excise rose 10.8% to Rs 5.62 bn during the year under review. Other income, though not very a sizeable entity number wise, anted up receipts of Rs 104.5 m against Rs 117 m previously. The pre-tax profit declined some to Rs 989 m from Rs 1.28 bn previously. (Thanks to this factor the contribution of other income amounted to 10.5% of pre-tax profit against a marginally lower 9.2% previously). The other income input is thus of some significance in either year.

Other major inputs costs such as employee benefit expenses and other expenses were well contained. The company correctly attributes the decline in profitability to higher input costs. It also attributes it to tight market conditions The Company is bang on the dot regarding higher input costs, but pointing a finger on tighter market conditions appears questionable. For sure, material input costs including purchase of stock in trade rose sharply by 35% to Rs 2.7 bn. But the fact of the matter is that some 65.3% of all such material consumption during the year was purchased from group companies, against 64.4% previously. I am assuming here that the finished goods purchased from group companies were consumed fully during the same year itself. Looked at it from another angle, the imported raw materials and components consumed accounted for 73% of all such consumption. Fortunately, only a minor quantum of the stores and spares consumed is of the firangi variety. The reason for the higher input costs may well have been a factor of its dependence on group companies to earn its succour.

Imports and exports to group companies

But the parent does not apparently see much value in importing finished goods produced by the Indian sibling. Actually it would have been quite a paradox of sorts if the parent had imported finished goods on a large scale from its Indian offshoot, as the Indian sibling is anyways importing large volumes of finished goods from the parent and its many offshoots for sale in India. The rupee sales affected by the sibling to the parent and its proxies amounted to Rs 415 m against Rs 383 m previously. This is a small sum given the total value of rupee sales that it affected during the year. The import of finished goods by the Indian sibling for sale has another beneficial spinoff though. In my reckoning there is good money to be made in the bargain. If my math is on the ball then the company would have made a gross margin of Rs 684 m on sales, against a gross margin of Rs 816 m previously. There is of course no way of computing other revenue expenses that it would have incurred to process the sales. But quite obviously it looks like a beneficial exercise considering that the pre-tax profit for the year amounted to Rs 989 m against Rs 1.28 bn previously.

In fine fettle

But, regardless, the company is chugging along fine thank you and besides it also appears to be totally debt free. This implies that there is no interest expenses to contend with on the expenditure side of the P&L account., and the moneys that it conjures up from the cash inflow that it generates from its operating activities is more than sufficient to pay for its fixed assets improvement. The latter in any case does not amount to much. In the year under review it plonked down Rs 479 m into gross block expansion, with the gross block at year end amounting to Rs 3.17 bn. In other words the company is fixed assets heavy with an asset to net turnover ratio of 1:1.8. This ratio has to be seen in conjunction to the fact that it outsources finished goods stocks of a large magnitude. Is it making the best use of its manufacturing fixed assets? This is also the first company that I have come across where almost the entire gross block consists of assets which are classified as plant and machinery! But it must also be added here that the equity dividend for the year amounting to Rs 639 m (including dividend tax) was mostly paid out of the cash surplus of Rs 875 m that it nursed at the beginning of the year. It is another matter that the dividend outflow in the preceding year was even more impressive at Rs 894 m and this amount too was mostly paid out of its cash surplus that it had at the beginning of the year. The cash surplus includes substantial investments in mutual fund schemes. (This is also the first company that I have reviewed which includes its investment holdings in mutual fund schemes in the cash and bank balance schedule). The dividend that it has paid out has to be seen in proximity to the paid up equity base of Rs 220 m. The parent is taking out every dime that it can tweak.

Where the company needs to get cracking is to reduce the excess of current assets over current liabilities. At year end the current assets (excluding cash and readily marketable securities) at Rs 2.24 bn overshot the current liabilities of Rs 1.21 bn by a mile. Whether these figures represent year end ‘book entries’ or not is not known. But it adds to locking up cash, which can be put to better use. The vast bulk of the current assets is accounted for by inventories and trade receivables. The trade receivables account for 17% of gross revenues for the year while the trade receivables account for a similar percentage. Fortunately there are no siblings of its own to contend with which would have meant a further drain on its resources.

The Rs 10 face value share oscillated from a high of Rs 1,140 to a low of Rs 637 during the financial year. One reason for that is that there is an abject shortage of floating stock given the saturation holding by the parent. This share is a pick for those interested in getting large dollops of dividends as return on investment. But as the share price trajectory shows, there is an upside in the stock price too. The liquidity and demand in this counter is however unknown.

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.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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