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United Phos.: Not causing the right reactions - Outside View by Luke Verghese
 
 
United Phos.: Not causing the right reactions

A little bit on the promoters

The most interesting aspect of this company is that the promoters do not personally hold any shares in this company. That's right, not even one share each. That is to say Mr R.D. Shroff, the Chairman, his wife Sandra who is the Vice Chairman, and their two children, Vikram, the executive Director, and J.R. who is the Global CEO of the group, get no dividends in their personal names. But the Chairman of the Board and his Executive Director are not exactly out of pocket as a result. Far from it - they are both well reimbursed nevertheless for their troubles. The chairman was richer by Rs 52 m through salary, perks and commission, while Vikram will not be unhappy with his Rs 40 m share, both for his designation, and value addition. The global CEO is apparently paid through some other route, but in all probability should be just as well heeled in this respect.

But, the family's group holding in the voting stock at 122.8 m shares in the company aggregates to just under 28% of the outstanding stock - and the company declared a dividend of Rs 2 per share on Re 1 face value. The notes to the accounts have a curious aside to this shareholding. It says that in 2007 the company issued preferential convertible warrants to a promoter group company for which it received Rs 1.1 bn being 10% of the total face value of the debt instrument. The company subsequently issued 608,700 shares against an amount of Rs 207 m, being 10% of the total face value, implying a conversion price of Rs 34 per share. The balance advance received of Rs 853 m was subsequently forfeited by the company and credited to reserves. That would imply a final conversion price of Rs 174 per share. It is the wording that the company has used to describe this whole exercise that makes it look so illuminating in an amusing manner of speaking. The effect of the share issue raised the holding of the promoter group very marginally from 26.9% by a percentage point. What is left unsaid is whether the final conversion price had any bearing with the quoted price of the share on whichever date the additional issue of capital was made effective. And pray, how much of 'planning' went into this whole freaking exercise please?

A global operation?

The other interesting aspect of this company is that it has subsidiaries, affiliates and joint ventures literally dotted all over the globe. To put in perspective it has 65 subsidiaries, 19 associate companies grouped under a brand called Advanta, and 3 joint ventures. (The book value of its equity/preference/debt investments in such companies was Rs 4.1 bn at end FY10). It must also be noted that the parent has only 4 direct subsidiaries with an investment book value of Rs 1.2 bn, with Bio-win Corporation accounting for Rs 942 m out of this (face value of US$ 100 each or an issue price of Rs 3,991 per share). The others are step subsidiaries or some such. Then there are 24 other companies over which key management personnel and their relatives have significant influence. So much so that one would be moved to think that in its pure scale of operations it can match wits with a Unilever, or a Proctor and Gamble, for that matter. (The obvious longer term plan, however flawed, is to cast itself as one of the global biggies in the agrochemical and industrial chemical business.)

Its biggest single holding is in Advanta India Ltd. (For some reason the entities falling within the ambit of this company are referred to as the Advanta Group.) The shareholding of United Phosphorus in Advanta India is grouped under the 'Other than trade' category - and Advanta is an associate company for legal purposes. The total book value of the parent's holding in Advanta is Rs 2.4 bn with a face value of Rs 10 each, at an issue price of Rs 281.5 per share. (The footnote states that 56% of the outstanding capital of this company is pledged to LIC against NCDs issued to LIC). Why the shares of this company were issued at a substantial premium to the face value is not quite clear. But needless to add, it is a very intricate arrangement.

The grouping of companies under the Advanta brand is in itself an interesting mathematical puzzle. The consolidated statement furnishes the names of 16 associates. The standalone company states that it has 8 associate companies. But in the consolidated statement, 5 of the companies in the standalone list find a mention. Then there are a further 11 companies specifically appearing in the consolidated list and, take another 3 which appear only in the standalone list - making a total of 19. The subsidiaries and associates are controlled through a complex web of interlocking companies which would make even the zaniest spider look like an amateur. For example, just three of the 65 subsidiaries are 100% owned by the parent. The rest of the subsidiaries make do with intricate holding patterns, the details of which are furnished in such fine print in the annual report that one requires the use of an advanced magnifying glass just to read the lettering. It has all been done on purpose, it appears.

The many twists and turns

The shareholding pattern in the 16 company Advanta group (including Advanta India) as stated in the consolidated statements is just as illuminating. The percentage group holding in Advanta India is 49.9%. Just see the extent of the fine tuning in this shareholding pattern. This has been resorted to only to avoid some 'unnecessary complications' of the Companies Act. Advanta India in turn has 14 wholly owned subsidiaries; almost all of whom are of the 'videsi' variety. Then there is the Australian company which is a 70% subsidiary. (That adds up to 16 companies). There are no specific details of another three companies (as stated earlier on under the subhead 'A Global Operation?' - the Advanta group consists of 19 companies). There are many other interactions too among the group as we shall discover further on.

United Phosphorus is of course a midget viz-a-viz a Unilever or a P&G, but it is also one of the few companies surveyed to date whose siblings (subsidiaries, associates and JVs) collectively tote up a turnover almost equal to that of the standalone entity. In FY10, the consolidated entity recorded a turnover of Rs 55 bn, against a turnover of Rs 26.3 bn that the standalone entity could rustle up. That is to say the contribution to the top-line of the others was Rs 21.3 bn. Where the consolidated entity has really performed is in the profit generation front. It recorded a significantly higher pre tax profit of Rs 5.9 bn as compared to the parent's contribution of Rs 2.5 bn per se. The contribution to the bottom-line of the others therefore was Rs 3.4 bn. On what basis the company has arrived at the 'sales value added' of the consolidated entity is not known. The point is that the subsidiaries per se - as per the separate figures furnished - toted up a turnover of Rs 48 bn, and a pre-tax profit of Rs 3.5 bn. If one adds the turnover of the subsidiaries to that of the parent, then total revenues will ring up to Rs 74.3 bn. The auditor's report states that the consolidated balance sheet of United Phosphorus includes that of its subsidiaries, associates and joint venture companies. In what manner exactly is the catch.

What it is all about?

For the uninitiated this company makes and sells Agrochemicals, industrial chemicals and an item called 'Others' as per the segment information of the company's working. This turnover also includes a hefty export income of Rs 14 bn, which is slightly lower than the exports it recorded in the preceding year. Which brings us to the question, if the company is exporting such large sums worth on its own, what is the need for so many 'firang' subsidiaries etc? The company also buys and sells pesticides and chemicals. How the company earns its revenues appear to be fairly complicated. The footnotes state that it produced 'W' litres, 'X & Y' kilograms, and 'Z' numbers of formulations out of technical grade products that it either produced, or sourced in. The bulk of the revenues emanate from the agrochemicals division as do the bulk of the segment profits. There is also quite some emphasis on R&D as it boasts of 5 such laboratories located between Gujarat and Maharashtra. The company spent a cool Rs 329 m together in capex and revenue expenditure in FY10 on the R&D effort.

Not generating sufficient t margins

So what has the company got to show for its efforts? The standalone company is merely coasting along on the profitability front. (As a way to generate income it even resorted to buying and selling debt securities worth Rs 32 bn, but it was a wasted effort of sorts.) And the way the segment information of the working results is presented, there is also no way of knowing whether the substantial value of exports is profitable to start with. All that we know is that the company earned export incentives of Rs 405 m during the year. The company also had to give discounts and rebates of Rs 1.9 bn just to push sales. Further, the commission on export sales rocketed to Rs 1.3 bn from Rs 706 m in the preceding year. In other words the commission payable rose to 10.2% from 5.1% in the preceding year. What was the need to double the commission on export sales? And there is a group company link too in this commission. Bio-win Corporation a subsidiary received Rs 130 m as commission on exports. Separately there also appears to be an expense item called 'Commission on exports' amounting to Rs 429 m. But at the end of the day it is the 'other income' which is the effective game changer. Such other income, including 'other income from operations' amounted to Rs 1.7 bn against Rs 2.5 bn in the preceding year. Juxtapose this with the pre-tax profit of Rs 2.5 bn (Rs 1.7 bn previously). Other income, accounts for 70% of pre-tax profit against a humungous 154% in the preceding year.

There are two caveats here. In the preceding year the company lost Rs 1 bn on exchange difference on borrowings, while in the latter year the company gained Rs 265 m. These are exceptional losses/gains. If you reverse these entries, then the contribution of other income in FY09 becomes less marked. Further, one can argue that other income from operations isn't a part of the definition of other income; as such income is sales related. But in this express instance the breakup of this operational income also includes a mish-mash of write backs and excess provisions, discounts received and miscellaneous receipts. What is happening in effect is that the manufacturing business is simply not generating sufficient traction in operational cash flow terms. The management has no explanation for this state of affairs. For a company with the global ambitions that it has, it is first necessary to clean up its own backyard before casting its net far and wide.

Some possible reasons for the drag in profits

The reasons for the desultory performance may a direct factor of its emphasis on promoting its many affiliates. As stated earlier it has invested Rs 4 bn in the equity/debt of its affiliates. It does not earn more than a farthing as dividend for its troubles. Just 3 of the 65 subsidiaries for example declared a dividend, totalling to Rs 130 m! The vast majority of the subsidiaries amount to nothing, though the combined asset base of these companies amounted to Rs 82 bn. A mere 13 companies accounted for a turnover in excess of Rs 1 bn each - with the largest United Phosphorus USA, and its subsidiaries, toting up a turnover of Rs 8.9 bn, and the second largest, United Phosphorus, registered out of Gibraltar of all things, rolling in a top-line of Rs 6.2 bn . And a mere 8 companies odd account for 90% of the pre-tax profits. The company with the largest asset base of Rs 18 bn is Bio-win Corporation based out of Mauritius, but it registered a paltry turnover of Rs 1.3 bn. This company is obviously some sort of a holding company and features prominently in the group company transactions. Surely such expansion is not anyone's idea of a profitable diversification. This is only half the story.

The parent had outstanding interest free loans to the tune of Rs 14 bn at year end due from its subsidiaries (the maximum outstanding at year end was Rs 17.8 bn). The point is that the parent is paying interest on the borrowings that it has to resort to, to fund the appetite of its siblings. Further it sold goods worth Rs 8.5 bn to its siblings and bought goods worth Rs 2 bn from them. There are of course innumerable inter-se transactions with its affiliates. But from the evidence available it is the subsidiaries which are profiting at the cost of the parent. There is of course little information on how the other affiliates are functioning. This is also a very rare instance of a consolidated group showing a markedly improved bottom-line performance than the standalone entity. The subsidiaries may in all probability be pampered by the parent in an effort to make a point. The other solid evidence that we have of the hold that the siblings have on the parent is in the amount of corporate guarantees that the parent has furnished on their behalf. It has furnished guarantees of Rs 7.3 bn on behalf of 11 siblings. Quite obviously it entails paying guarantee commission fees but this expense item is not separately visible in the P&L account.

Vox Populi

Unless the management shows some change of heart it will do well for minority shareholders to steer clear of such companies.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio

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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2 Responses to "United Phos.: Not causing the right reactions"

srinivasan

Aug 21, 2011

Dear Luke,

Thanks for your candid review.

Seems to be a rather dangerous stock to play agriculture sector. 15th Aug 2011 Economic times intelligence says "Long term investors should take exposure to the stock." I don't know what sort of intelligence it is. Think of small investors fate if ET intelligence is like this.

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S

Mar 16, 2011

Do you even know how a company is run or how global operations are run? Do you know anything about accounting and finance? If I was in United Phosphorus's place I would sue you and equitymaster for libel!

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