Vesuvius India: Makes for a rock solid foundation - Outside View by Luke Verghese

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Vesuvius India: Makes for a rock solid foundation
Apr 16, 2012

On the face of it the company has a squeaky clean annual report, with a healthy financial backing to boot

A maker of heat resistant products

This is my second take on Vesuvius India; having first covered the company's working results for the 12 month period ended December 31, 2010. Vesuvius in India makes and sells refractory or heat resistant products which are used in kilns, and the steel industry makes for its biggest clientele. It also trades substantially in finished goods, whose composition is unclear. The foundry industry which makes castings and forgings is a major consumer. As a matter of fact, every aspect of the functioning of the steel industry has a one-off effect on the refractory industry. And with the growing clout of the steel industry in the domestic manufacturing segment, the fortunes of the refractory sector will only mount over time.

Vesuvius India is an MNC and 55.5% of its voting stock is held by Vesuvius Group Limited, UK, a subsidiary of Cookson Group plc, the ultimate holding company. The global operations of the Cookson group are vast, judging from the number of fellow subsidiaries that the Indian company boasts of - there are 41 of them spread across the globe. This listing excludes three companies which are characterised as 'Enterprises having control over the company' and a further three fellow subsidiaries- again separately mentioned- two of which are India based offshoots sporting the names Cookson India Pvt. Ltd and Cookson Overseas Ltd. There appears to be one other India based fellow subsidiary going by the name of Foseco India Ltd. A weird bunch of classifications for sure, but entirely in keeping with the way in which MNCs are run. From the evidence made available, it appears that the three companies are stand alone operations.

The importance of fellow subsidiaries

These fellow subsidiaries come in handy for sure given the manner in which Vesuvius India pans out both its purchases, and effects sales of its finished products. The total CIF value of imports was Rs 1.3 bn against Rs 1 bn previously. In this composition, the total value of imported raw materials at Rs 1.1 bn amounted to 50% of the total value of all raw materials consumed. Such large scale imports have also to be seen in conjunction with the sharp fall in the rupee dollar parity rate. It also imported finished goods of the value of Rs 119 m out of total purchases of finished goods valued at Rs 883 m. What exactly the finished goods pertain to is not known, but the amount involved is not exactly small beer in the context of net sales exclusive of excise duty of Rs 5.1 bn. Separately, there is also 'Sales of services income' of Rs 279 m. The company has inter-se transactions with 24 individual fellow subsidiaries, but this figure excludes an item called 'Others'. But the item 'others' is listed in the schedule of transactions with related parties-and hence a part of the group. In total, it sold goods and services worth Rs 310 m to its associates, and purchased goods and services worth Rs 436 m from such associates. Then there is a transaction head of account between the group companies called 'Other Income/ expenses' in all amounting to Rs 115 m, net. The need to have so many varied transactions between the Indian sibling and its various international siblings has not been suitably explained, but presumably the Indian company is one of the many beneficiaries of such group transactions.

What it makes and sells

The company has during the year upped the installed capacities of what it makes. Between 2009 and 2011 the company spent Rs 605 m on sprucing up its manufacturing base. This spending includes the creation of new buildings; plant and machinery, and tooling. The upshot is that the installed capacity of shaped refractories rose from 526,000 tonnes to 778,400 tonnes, while the capacity of unshaped refractories rose from 96,500 tonnes to 100,500 tonnes. The production of shaped refractories rose to 553,000 tonnes while that of unshaped refractories rose to 48,528 tonnes. In other words the production of unshaped refractories is lagging badly and the expansion of capacity of this product line appears to be not in order. The sales of shaped refractories accounted for 43% of all sales while that of the unshaped variety brought in another 34%.Traded sales brought in the balance 23%. On a rough basis, the purchase/ sales of this item would have brought in a gross margin of Rs 367 m in 2011, against a gross margin of Rs 240 m previously. Consider this margin in the context of the overall profit before tax figure of Rs 827 m in 2011 against Rs 737 m previously. And if one also juxtaposes the other income factor of Rs 325 m against Rs 251 m previously, (inclusive of sales of services, and other income) then one gets an idea of where the margins are really kicking in from. (I am, of course, presuming here that the sale of services head of account does not entail any revenue expenditure).

To put matters is a different perspective, overall net sales rose 22%, while the consumption cost of materials - the biggest expenditure item in the expenses schedule rose 26.7%. The reason for this is that the company has difficulty in eking out an increase in realisations of its biggest tem of sale - shaped refractories. It realised a sale price of Rs 4,324 per piece against Rs 4,206 per piece in the preceding year. It was, however, a winner on the second product item of manufacture - unshaped refractories. It was able to post a price realisation of Rs 46,190 per tonne against Rs 41,400 per tonne previously. These price realisations also factor in the excise element, so the net increase in prices is really a matter of conjecture. In the context of the price increases that it was able to realise, it would appear not to be in order for the company to hike the capacities of its shaped refractories at a faster pace than its unshaped refractories.

Financially astute

But the fact of the matter is also that the company is debt free, is cash rich to boot - cash reserves of Rs 545 m at year end - finances its gross block addition from funds generated from operations during the year, has no siblings of any hue (no questionable loans and advances either), boasts a reserves and surplus of Rs 2.8 bn against a paid up capital of Rs 202 m, has a miniscule provision for bad and doubtful debtors against sales effected, maintains an inventory level of less than 9% against sales made for the full year, and one has a winner all the way. Trade debtors however hover at around 27% of sales made for the full year. It is a squeaky clean annual report from what one can make of it-barring the inter-se dealings that it has with its affiliates, on which one cannot proffer any opinion.

A summary of its working results for the immediate past five years that it has provided makes for interesting reading. Gross sales have shown a consistent increase each year over that of the base year 2007. Gross sales have risen 69% over the four year period-not bad for a two product wonder catering to a very distinct segment of industry. Gross sales including other income also rose 69%. The profit before tax almost rose in tandem over the four year period - by 65%. This is indeed a very creditable achievement. In a manner of speaking this shows that the company has access to 'pricing power'. The net fixed assets increased by 59% over the same time span. But the ratio of net fixed assets to turnover hovered at 3.9 times in the year 2007 and in the year 2011.The borrowings in all the five years stood at NIL. This reveals excellent management of funds. The paid up share capital was stagnant but the reserves and surplus kept piling up leading to a piquant situation of reserves amounting to a humungous figure relative to the paid up equity. The company is also on the conservative side on the question of payment of dividend. It ranged from a high of 24% of post tax profit in 2007, to a low of 13% in 2008, and weighed in at 15.6% in 2011.

No specific policy on shareholder rewards

Quite obviously, the company does not have a steady shareholder reward policy as a part of its corporate governance code. All the more surprising since it is a member of a global conglomerate. The parent is, however, suitably compensated for in other ways. The sibling paid out Rs 91 m during the year as royalty to the parent. There is also a payment of management fees of Rs 30 m that it has affected. To whom this payment has been made is not known, but the beneficiary may well be the parent.

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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