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Shree Cement: Profitability remains low - Outside View by Luke Verghese
 
 
Shree Cement: Profitability remains low

The company marches on at a sedate pace as per the dictates of the incumbent management

Facing difficulties on the bottom-line front

The financial results of the year under review are for 15 months and hence not comparable with that of the preceding year which is for a period of 12 months. It is just as well, as in the preceding year Shree Cement was scraping the bottom of the barrel on the profitability front. This is inspite of the fact the company generated sufficient funds from its operating activities and it was almost enough to fund the capex of Rs 11.54 bn. The sale of securities held as current investments, together with the cash balance at the start of the year, were able to bring in the balance moolah to meet other exigencies to close out the operations for the year. This proves yet again that cash flow generation and profits can go in different tangents.

The company has chosen to present its accounts for 15 months. Why the company has chosen to extend the year end by three months has not been explained--even briefly, barring saying that it has been extended. Obviously there is more to it than meets the eye. It also works at cross purposes to the year ending for both direct tax and indirect tax purposes-which is March end. This company comes under the orbit of the BG Bangur group and it is headquartered out of Kolkata, though its manufacturing units are largely based at Rajasthan, with a unit in Uttrakhand. It has eight manufacturing units and several power generating units to boot. Separately it also has cement grinding units. It generates power and sells a part of it.

A large cement unit

In the preceding 12 months the company sold 9.3 m tonnes of cement and 0.9 m tonnes of clinker or a total of 10.3 m tonnes. In the current year on a pro-rata basis it sold 11.4 m tonnes of cement and 0.53 m tonnes of clinker or a total of 11.93 m tonnes. It qualifies as a large cement manufacturing company. But on a pro-rata basis it generated substantially more power and sold more power too- and also lost substantially more money in the bargain, and as revealed by the segment results! This makes for a very strange state of affairs from what I can make of it.

As would be expected the vast bulk of the gross revenues from operations of Rs 65.7 bn in the latest accounting year was rigged up by cement sales. There was some contribution from sales of clinker and power to the kitty. Net revenues from operations grew 71% to Rs 58.98 bn. The company generated 'other income' of Rs 1.6 bn in the latter year, against Rs 1.3 bn previously, and this manna comes in very handy too. (The other income in the latter year includes a generous 'write back of provisions no longer required' amounting to Rs 402 m).  What is significant here is that the pre-tax profit in the preceding year amounted to Rs 1.1 bn after providing for exceptional items. This figure matches with the other income figure. In other words, the face saver was this income receipt. It helped turn the red ink into black ink. In the latter year too other incomes toted up a very respectable 24% of pre-tax profit. Apparently the company is unable to generate an increase in revenues which is commensurate with the increase in the cost of major inputs.

Generates adequate cash flow

In other words the company faces difficulty in generating margins but faces no difficulty in generating cash flow. This makes for a very anomalous situation. For cement manufacturers it is not the 'material' input cost which is the debilitating factor. This is only a minor irritant. The biggest bugbears are power and, fuel and freight. Add to it interest costs arising from the quantum of the debt load, the gross block required to generate the revenues, and the inventory baggage. For Shree Cement the cost of power and fuel accounted for over 25% of net rupee sales, while freight and forwarding charges cost another 17%. Very creditably enough, the percentage cost structure relative to net revenues of both these items of expenditure in the preceding year was almost similar, though the users of such services have little control over their cost structure.

However the interest costs did increase disproportionately to Rs 2.4 bn from Rs 1.8 bn previously even though the interest bearing debt increased only marginally to Rs 19.5 bn from Rs 18.8 bn previously. The percentage interest outflow was substantially higher. Not to mention the 30% higher depreciation charges due to gross block rising to Rs 52.4 bn from Rs 40.4 bn previously. As I stated earlier cement units are very capital intensive. On a year- end gross block of Rs 52.45 bn the company was able to rustle up net revenues from operations of Rs 58.98 bn, or a gross block to sales ratio of 1:1.12-only marginally better than a 1:1. Then there is 'other expenses' which bounced up by 57% to Rs 8.34 bn. The two big constituents of this expense item are stores, spares and packing materials and, discounts, rebates etc-the former is unavoidable while the latter is avoidable. The former cost item rose 59% over the preceding year to Rs 3.43 bn, while the latter grew 54% to Rs 1.78 bn. Such percentage increases in cost, even though it is lower than the percentage increase in sales, tells on profits. There is another item of expenditure over which it can exercise some control if it so wishes. Employee benefits for example. Between the three Bangurs-the chairman of the board, son and grandson they collected a combined remuneration of Rs 270 m which accounted for 8.4% of all employee remuneration during the year. There should be some connect between what the top rank gets as compensation and what the bottom rank can squeeze out. The elder Bangur is however hanging up his toppi from the current year running. So there should be some cost saving here.

Needs to rework its capital structure

There is also a very real issue the company needs to address to control expenses and over which the company has complete control over. It boasts a meagre share capital of Rs 348 m. Juxtaposed with the gross revenues it works out to a ratio of 1:188. This is a plainly lopsided capital structure. The company also has reserves to the tune of Rs 27 bn. There should be a more realistic share capital to turnover ratio - though it is difficult to put to a finger on a 'realistic' ratio. A ratio of 1:20 would just about suit fine I would imagine. According to the financial statements, the promoters hold close to 65% of the paid up equity capital. And thanks to the lack of floating stock the share price in the secondary market is ruling high. The Rs 10 face value share clocked a high of Rs 3,280 and a low of Rs 1,625 during the financial year--which is totally at variance with its financial performance. Issuing shares at a hefty premium is mere money for jam for the company given the high quotation being recorded in the secondary market-but the promoters may not be willing to play ball given their reluctance perhaps to make their prospective contribution to maintain their stake-holding. (They are quite at home with matters as they are). If an issue of capital does happen, then in one stroke the company can completely eradicate the entire debt, and the margins will gain traction in the bargain. For the present the number of shareholders amounts to just 10,644 members. The shareholders include two NRIs' who own a small slice over 10% of the voting stock.

In reality the situation on the ground is a lot more bizarre. The debt component can be reduced to nothing even without the issue of additional capital. The company is loaded with an investment portfolio of Rs 25.3 bn consisting of both 'current investments' and 'non-current investments'. The fact of the matter is that the investments in toto constitute current investments-period, as they are made up of readily encashable debt securities. The company realised a total income of Rs 401 m from these investments during the year on capital account and on revenue account. Some of this income however escapes the IT net due to its very constitution. Whether this route is the better option than having any debt at all or not is not known. Along the way for a brief period of one year it acquired a controlling interest in the Raipur Cement Company Pvt. Ltd. It is not known what led to the acquisition and then the transfer out of its fold. The timing is excellent though.

The power division

As stated earlier the most impractical aspect of its financials deals with the functioning of its power division. The power division generated total revenues of Rs 11.27 bn including inter-segmental revenues. As I understand it some of the power was apparently consumed internally and the balance was sold. But what I cannot understand it is how it led to a segmental loss of Rs 2.78 bn. This is not a small sum of money by any measure. Or is it that the power generated and then consumed in-house led to the booking of the loss in its books. Either way there does not appear to be any clarification. In the preceding year the segmental loss amounted to Rs 156 m.
This is not a company which excites any interest in its stock. But that apart, there is money to made in this scrip. The share price oscillated by a wide margin in the previous financial year and if one gets one's timing right then there is a bundle to be made.

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 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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