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GNFC: Not being run in best shareholder interests - Outside View by Luke Verghese
 
 
GNFC: Not being run in best shareholder interests

A management merry go round

A slowly fossilising company, suddenly trying to make a comeback is the impression one gets on a perusal of the latest annual report. The directors' report adds that 'they are seriously concerned about the failure/breakdown of the plants. An upkeep plan for countering failure susceptibility due to ageing of plants, and supporting facilities has been approved. It is planned to revamp/replace the ageing plants which have lived their life'. This is about as preposterous as it can get. Repairs are an ongoing process and not a piecemeal affair. Why then did Gujarat Narmada Valley Fertilizers' (GNFC) management allow matters to come to such a sorry pass in the first place? And, have they been taken to task for their non performance? Significantly, such questions remain unanswered. The point is also that the promoters are the Gujarat State government who control close to 42% of the voting stock in the company, and hence the CEO's office is a sort of a merry go round affair too. So nobody is accountable per se. (For the matter of record, the accumulated depreciation on the Plant and Machinery was 64% of the gross block of Rs 28 bn as on March 31, 2010. The accumulated depreciation on the Buildings was 31% of the gross block of Rs 1.4 bn. Is this considered a high level of obsolescence in the fertilizer industry?) The interesting fallout of the 'outages' that the company had to contend with is that it was richer to the tune of Rs 418 m (Rs 143 m previously) on account of insurance claims that it received.

Waking up from deep slumber

The directors' statement about ageing plants and breakdown of plants has to be seen in conjunction to the major plants operating at over 100% capacity utilisation. The company claims that it established 23 new records in terms of production, marketing and despatch during the year. It produces 10 items, and barring ammonia, it sells 9 items. (In this context, how the company established 23 production records etc is not readily known.) Ammonia is converted into urea and then sold. It also imports urea, DAP, muriate of potash, and a few sundry items for resale. Almost all the major plants produced at close to cent percent capacity or at even higher levels. If the plants are ageing and various units are breaking down at that, how does the company continue to achieve such high levels of capacity utilisation? What is the magic mantra here? Or was the directors' report written by a 'nobody' who had no clue of what is going on?

The directors have suddenly woken up from deep slumber and the company is now implementing various projects under its 'Growth Plan'. For this purpose it has tied up term loans of Rs 20 bn from banks. It is also implementing an ammonia plant feedstock conversion project at a cost of Rs 12 bn, (this will not lead to new capacity though), nitric acid unit, ethyl acetate plant and a new formic acid plant, etc. The directors also add that the Nutrient Based Subsidy policy for the phosphorus and potash segments was announced by the government of India during the year. This policy is effective April 2010. It will be extended to the urea segment in the second phase. This policy they state is expected to promote balanced fertilisation, increase in productivity and better returns for farmers, etc. The management also plans to trade in a higher level of fertilizers during the current year which it says will increase the turnover and profit of the company.

Unexplained losses

OK, the company registered a loss on the manufacture and sale of fertilizers in FY10. Its manufacturing operations, including purchases for re-sale, are classified under three heads, in the segment reporting schedule - Fertilizers, Chemicals and Others. The sales of fertilizers is the biggest revenue earner at Rs 14.5 bn, with chemicals coming in a close second with Rs 12.2 bn, and 'others' bringing in the tail end with Rs 353 m. The chemicals division is the biggest profit earner in either year at Rs 3.2 bn against Rs 3.1 bn previously. The items grouped under 'Others' contributed disproportionately to the bottom-line by raking in almost one third margins on sales. The fertilizer division reported a segmental loss of Rs 274 m against a profit of Rs 458 m previously. (Even after accounting for the insurance claims on loss of profit, the fertilizer division registered a large loss.) The 19% decline in rupee sales of fertilizers to Rs 14.5 bn was occasioned by two factors - the sharp decline in the sales of traded fertilizers to Rs 722 m from Rs 3.7 bn previously, and the precipitous fall in the rupee sales (on higher volume sales) of ammonium nitro phosphate (ANP) to Rs 812 m from Rs 3.7 bn.

Overall the company also lost another Rs 690 m during the year on account of extraneous one time provisions - on account of value of investments being written down, and business loss on project implementation being discontinued.

The sales of traded items is bringing in the margins - albeit at a minor level - but the reason for the fertilizer division to have recorded a loss appears to be the inexplicable fall in the unit sales realisation of ANP (Ammonium Nitrophosphate). The fall in the unit sales realisation of methanol and acetic acid may also have been another cause for recording the loss. This is a very perplexing situation indeed. On the one hand the unit sales realisation of ANP fell dramatically to Rs 4,781 per metric tonne from Rs 28,064 per metric tonne, and on the other the production of this commodity rose to 166,000 tonnes from 134,000 tonnes previously. (What freaking logic is this please?) The volume sales likewise rose to 169,000 lac metric tonnes from 131,000 metric tonnes. Why in heaven's name did the company have to produce more, to sell at a phenomenally lower price? By selling more, the quantum of loss only builds up. Or is there something else going on here?

A confused state of affairs

And to add to the confusion it simultaneously slashed volume sales of traded fertilizers from 510,000 tonnes to 110,000 tonnes. It however intends to increase sales of traded fertilizers to 200,000 tonnes in the current year as it will increase the profit of the company! Now, this is truly a topsy turvy way of running a company. The top management should seriously think of getting in touch with a shrink or something! The sales realisation of methanol and acetic acid also recorded a sharp drop to Rs 13,986 per tonne from Rs 19,755 per tonne and from Rs 30,574 per tonne to Rs 25,850 per tonne respectively. Whether these two products also added to its woes is not known. Just as perplexingly however, is the fact that the company sold higher volumes of both these products. The report gives no explanation for these anomalies. (Or is it that in a continuous process operation it is forced to produce these items?)

What is also interesting here is that the first product to come within the ambit of the new nutrient based subsidy scheme is ANP, but effective April 1, 2010. Under this scheme the subsidy amount will be fixed for the entire year based on the nutrient contents of the product, and the company will be free to decide on the selling price of the product in the market. This does not sufficiently explain how the selling price of the product can be freely decided when there is an inherent and pre-decided subsidy built in. Or will the profit margin be a factor of the manufacturing efficiency process?

The big game changer

The real big game changer in the results of fertilizer companies is the subsidy that they get for the sales of fertilizers at pre-determined prices. During the year FY10, the subsidy element was Rs 8.9 bn against Rs 6.8 bn previously. That is to say the subsidy element in FY10 was higher than the fertilizer sales at Rs 5.6 bn. In the preceding year the subsidy received was on sales of Rs 11.1 bn. The subsidies relate to a previous year but the extent of the subsidies is so humungous that all fertilizer companies will simply fold up and go belly up if the government goes slow in processing their demands.

There are several factors too which impede its ability to unlock value and grow at its own pace. Being a state government entity it is forced to contribute to the capital base of companies promoted by the state government. At end March 2010 the book value of its investments in Gujarat government promoted companies was to the tune of Rs 1.1 bn (Rs 725 m previously). The total book value of all investments was only a slightly larger Rs 1.3 bn (Rs 915 m). The depreciation on this book value was Rs 378 m (Rs 31 m previously). In all fairness one must add that the company is investment positive. The market value of its quoted investments is more than 2.5 times its book value. But then it also represents tied investments and the company cannot capitalise on these book profits.

A ray of hope?

There is still a ray of hope from the projects that the company has lined up and the capex that it involves. The capital work in progress at year end amounted to Rs 10.3 bn and the estimated amount of contracts on capital account and not provided for another Rs 10.3 bn. This expenditure is apparently a part of the total investments of Rs 36 bn that the company is implementing. The directors' report adds that on implementation of all the projects in FY12, the turnover of the company is expected to increase by around Rs 14.5 bn per annum. Hopefully this will also lead to a corresponding increase in profitability and reduce the company's over dependence on the 'other income' factor. In FY10 other income accounted for almost 40% of the pre-tax profit, against a significantly lower 19% in the preceding year. In a time of receding profitability, the company's tax provisions are increasing too. Inexplicably, the tax provision as a percentage of pre-tax profit rose to 46% in FY10 against 30% previously. In other words many of the book entry expenses do not count in the eyes of the tax man as legit expenses.

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