Spinning yarns from fibres does not necessarily add up to much
What's in a name?
Nahar Spinning is a group company of the extended Oswal clan which has made its home in Punjab, and control a swath of entities in manufacturing, infrastructure, trading, finance etc. The immediate management, according to the notes in the accounts, is made up of Jawahar Oswal, Dinesh Oswal, the managing director, and Kamal Oswal. But curiously enough, Mr Jawahar Oswal does not even feature on the list of the board of directors. In what capacity then does he then function please? Nahar Spinning, we are also informed has 22 associate companies - some which sport the prefix name Oswal and yet others the prefix Nahar. It also has investments in two companies sporting the name Nahar - Nahar Capital & Financial Services and Nahar Polyfilms. Another note informs us that a company called Nahar Industrial Infrastructure Corporation had allocated land to Nahar Spinning for a consideration. Presumably therefore, this company is also a part of the group. But there is no evidence that Nahar Industrial is a group company in any sense of the term from the details furnished in the annual report. In what capacity then does Nahar Industrial Infrastructure function please?
Reduced volumes on expanded capacity
Nahar Spinning is cotton yarn spinning and weaving company. It has a licensed capacity to make 14 m pieces of textile and hosiery garments. In installed capacity terms it has a total spindleage capacity of 383,000 spindles, 1,080 rotors, and dyeing facilities to make yarn and fabric. In 2010-11 it made 7.7 m pieces of garments and 62.3 m kgs of yarn, against 7 m pieces of garments and 64 m kgs of yarn previously. Incidentally, the increase in spindleage capacity from 346,000 numbers previously was also accompanied by a reduction in the total tonnage of yarn produced. This means that it also averaged a lower output of 157 kgs per spindle (on a very rough basis) against 179 kgs per spindle in the preceding year -assuming that my calculation is right! Such production planning is a bit difficult to digest, but let that be. And from the statistics made available, the company appears to have produced more fabric and garments from this yarn - a case for productivity gains perhaps? Or have I got it all wrong here?
The company is now in the process of increasing the capacity of its spindles to 436,000 numbers. (In the meantime it has also raised the capacity of rotors to 1,080 numbers from 720 numbers previously). There is unlikely to be any gains on the yarn production front in the current year given the directors' own dire prognostications. In any event between 2009-10 and 2010-11 the company spent Rs 2.2 bn on capital expenditure including capital work in progress. It this financial year it also sold fixed assets with a historical purchase price of Rs 173 m for Rs 77 m and booked a profit of Rs 40 m. It is also making a feeble attempt of sorts at modernising its production facilities. The accumulated depreciation of its plant and machinery accounted for over 62% of its gross plant and machinery.
Cash flow generation under strain
What is expressly downplayed by the management is the fact that the addition to gross block and gross current assets during the year added to the difficulties on the cash flow front. On paper the company recorded a turnover excluding other income of Rs 13.9 bn against Rs 11.1 bn previously. Close to 72% of the manufacturing revenues was toted up by exports, while the balance 28% was contributed by sales made in the domestic tariff area. The revenue pickings are grouped under several heads of account-including an item called Wastes sales. (On a segmental income accounting basis, the vast bulk of the pickings is accounted for by yarn, with garments contributing the balance sales-implying that it sees value in yarn exports than in value added fabric of garment exports). But at the same time the margins that it garners on yarn sales are substantially more than it trots up on garments. Separately, other income added up to Rs 147 m against Rs 104 m previously. The pre-tax profits rose admirably by 121% to Rs 1.8 bn against Rs 806 m previously, albeit in a year in which by the management's own admission the company did not get its arithmetic right. It may be noted here that the cost of raw materials inputs rose in tandem with the percentage increase in sales. Thus the company did not gain any mileage here.
But what helped propel profitability was the marginal increase in other major items of expenditure - manufacturing expenses, personnel expenses and selling expenses. Add to this the company's god given ability to restrict the interest payout on its borrowings. The quantum of borrowings rose 56%. (See more on this later on in the copy). To commemorate the higher post tax profit of Rs 1.2 bn (after assorted adjustments), it increased the dividend payout to Rs 83 m from Rs 63 m. This in itself is not only a niggardly increase in the payment, but is simultaneously also a sharp decline in the percentage outflow of the post tax profits available for appropriation. But the muted dividend payout is in keeping with the reality of the prevailing financial situation.
A few monkey tricks too
The management has a trick or two up its sleeve on the finances. Going by the interest paid out on the borrowings it would appear that it was very thrifty on this count. (It is not known the extent of the interest component that it debited to capital account given the ongoing capital expenditure programme). But taking into account the interest debited to the P&L account, the average percentage interest paid out for the year on a rough basis would amount to 4.3%. The percentage interest payout appears to be abnormally low in the preceding year too. Such a low percentage payout appears to be simply beyond the realm of real life possibility. Is the textile industry able to garner debt at such low coupon rates or what? Or are there other sleight of hand considerations at work here please?
There are other equally weighty considerations to be taken into account too. Though the pre-tax profits rose by 121%, the fact of the matter is that the company was out of pocket, on the cash flow position from operations, in both the accounting years. In 2010-11 it recorded a negative cash flow from operations of Rs 2.5 bn against a negative cash flow of Rs 1.1 bn previously. But the company has chosen to camouflage this fact through a deft accounting entry in the cash flow statement. It has shown an increase in bank overdrafts to the tune of Rs 4 bn (Rs 2.3 bn previously) as a part of the working capital changes in the statement of cash flow from operating activities.
In reality, this increase in borrowing should be shown in the statement of cash flow from financing activities, even though it pertains to the increase in working capital limits. Sadly therefore, the dividend payout for the two years in question was paid out of borrowed capital and also partly accounts for the miserly payout of the post tax profits. The company did its best to garner some hard cash through the sale of its investment portfolio during the two years. It also sold liquid assets of the face value of Rs 65 m for Rs 74 m and booked a profit of Rs 9 m on the exercise, but such exercises are small beer in the overall potpourri.
The many complications that accompany strict management control
The problem with all family run units which wish to keep its operations within their immediate orbit is that they are relatively undercapitalised in terms of equity in the context of their overall operations. (The management controls 64% of the outstanding voting stock and the need for effective management control precedes prudent financial management). Nahar Spinning for example boasts of a niggardly paid up equity base of Rs 181 m in a net worth of Rs 20.5 bn. Given the company's inability to generate adequate cash from operations, and the need to finance gross block expansion on the one hand, and the need to maintain higher levels of gross working capital to meet market exigencies on the other, it has perforce to borrow. Consequently it is heavily geared relative to the paid up equity. At year end it had borrowings to the tune of Rs 13.3 bn. The main culprit for this present heavy dose of borrowing is the skewed picture on the working capital front.
It boasts a net working capital (excess of gross current assets to net current liabilities) to the extent of Rs 12 bn. This reflects very poor working capital management especially in the context of the fact that these net current assets are financed through borrowings. It appears that the management was not able to get its clairvoyant powers on the cotton price scenario right. It bought an excess of raw cotton at high prices and is now caught with raw material stock whose price has dipped. And being caught with excess stock of raw materials it was also caught down the line with excess stocks of work in progress and finished goods stock, all of which added to the extra burden of borrowings. There is unlikely to be any change for the better in the financial position.
A smattering of investments
Like all family oriented companies it also makes do with a smattering of investments in group outfits. Mercifully, in this instance, the total investment portfolio is limited to Rs 82 m in the overall outlay of Rs 141 m. The balance Rs 59 m is invested in liquid debt securities. It boasts of no subsidiaries, but appears to have an overseas based company called Crown Star Ltd as the equity capital is denominated in pounds sterling. Since the investments in group companies is listed under the associates nomenclature one does not get to see their financial innards. The total dividend income it received during the year for its troubles is a paltry Rs 0.9 m. That is not saying much but that is the reality of the situation.
Nevertheless it has several inter-se transactions with these associates in the form of purchase and sale of revenues goods. It sold goods worth Rs 458 m and purchased goods worth Rs 180 m. But more importantly the parent has several capital account transactions with these associates which involve receiving and giving of inter-corporate loans, presumably at the prevailing market rates. The other income schedule does not separately document such inter-corporate interest receipts.
In sum total this is definitely not a company which generates any cheer in the mindsets of 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.
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