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Precot Meridian: Needs some new strategies - Outside View by Luke Verghese
 
 
Precot Meridian: Needs some new strategies

A very conservatively run company by a very laid back management and the fruits are there to see

A complacent plodder Precot Meridian was originally conceived as Precot Mills as far back as 1962. At some point of its existence it took on a fancy surname. (Meridian incidentally also means an imaginary north south line across the earth's surface - but obviously there is no connection with this definition). The workers co-operative society still operates under the old name though! The company is now in the golden jubilee year of its corporate life. Its first plant was a spinning mill in Kerala state. It presently manufactures a variety of yarn, polyester sewing threads, and fabrics at its seven plants in the four states of Tamil Nadu, Kerala, Andhra Pradesh, and Karnataka with a capacity of 2,18,000 spindles, 1632 rotors and 117 looms. Not only does it remain wedded to its knitting's, it comes across as a very slow and complacent plodder at the end of the day, dancing to the tunes of the management. The company is a part of the extended business clan which has its base in Coimbatore in Tamil Nadu. The promoters, including the chairman Mr D. Sarat Chandran and his two sons, control an unassailable 55% of the total voting stock of the company. The present paid up equity stands at Rs 70 m. This low capital base, relative to its operations, is one of the major causes for the awkward financial engineering that the company has to contend with. It is another way of saying the high gearing relative to the paid up equity.

The snapshot financial review

The company has provided a snapshot performance review of its working for the immediate past six years commencing the financial year 2005-06. It makes for both pleasant and unpleasant reading. The revenues have improved each year over that of the preceding year. But the pre-tax profits have been on a jolly good roller coaster ride over the six year period--including a pre-tax loss of Rs 67 m for the year 2008-09. However, the highest revenues and pre-tax profits were achieved in the latest accounting year - in a run-up to the 50th year celebrations. For the matter of record it achieved gross revenues including other income of Rs 5.8 bn and a pre-tax profit of Rs 440 m in the latest year. Rupee sales were higher by 32%, while pre-tax profits rose 59%. It would appear that the company's fortunes are made or marred basically by the price of cotton - its principal raw material input. And this is a commodity over which the textile industry has no control over - given the exigencies of maintaining a base price to please the farming lobby.

Its financial performance

It generates its revenues through domestic sales and export sales. Exports accounted for 21% of its gross revenues, excluding other income for the year. Domestic sales generation is a three way affair. Sales of yarn bring in the vast bulk of the domestic sales, followed by fabric sales. Bringing up the rear is a pidgin amount of garment sales. Export sales are entirely generated by yarn. The higher revenues materialised through higher production of yarn, fabrics and garments on the one hand, and higher unit realisation of each of the items on the other. But a sharper rise in the cost of material inputs, inspite of a favourable valuation of year end inventories, put a brake on profits. What helped retrieve the situation was the comparatively lesser rise of other major input costs such as the cost of power, salaries, selling expenses, etc. To the management's credit however, the company is almost able to sell cash down for what it puts out for sale both in the domestic and foreign markets. Trade debts at year end accounted for only a miniscule 6% of all sales during the year. This is a really a remarkable achievement for a pure play textile unit and a two bit one at that. And, almost the entire debtor dues are for less than six months! The company appears to command a premium in the market or something. What is more there does not appear to be any provision for bad and doubtful dues on sales. How can this be?

Given the excellent overall showing as the management puts it, the company hiked dividend to 100% or Rs 69.5 m against the dividend payout of 34.8 m previously. It is difficult to comprehend how the management came to the conclusion that the company had indeed put on a better show in the latest year vis-a-vis the performance of the preceding year. True the pre-tax and post tax profits were substantially higher than in the preceding year. But in effect it is only a smokescreen to the actual ground realities. As the company's cash flow statement reveals, it was actually completely out of pocket on the operational front. It suffered a negative cash flow to the tune of Rs 1 bn from operating activities against a positive cash flow of Rs 54 m previously. This was the result of a borrowing binge to fund the massive accretion to raw material inventories, and to a much lesser extent in the valuation of work in progress, and finished goods inventories. With no cash generation whatsoever to support its requirements for capital equipment purchases, it was out of pocket to the tune of Rs 401 m on its investing activities too. What saved the day was the accretion in debt to the tune of Rs 1.6 bn, which helped to balance the books. In effect therefore, the dividends were paid out of borrowed capital.

Accounting illusions

This then is the most delightful aspect of accounting. It can create illusions which even the noted magician Chris Angel will find difficult to emulate. It is one thing to report a profit and a totally different ball game on how the profits were arrived at. The entries which give rise to these year-end financials are bang on - except that they tend to distort the reality.

As stated earlier, the year end value of inventories rose to Rs 3.2 bn from Rs 1.4 bn previously. In this composite it is raw material stocks that rose the most - from Rs 1.1 bn to Rs 2.5 bn. Stock in process rose to Rs 202 m from Rs 125 m, and finished goods to Rs 455 m from Rs 77 m. Anticipating a rise in cotton prices, the company was stocking up on all the raw cotton it could afford to it would appear. It is not known at what point of time during the financial year that the company decided to set out on tapping the banks. And this is where the apparent anomaly arises.

Other anomalies

If one takes the average of the year end balances of debt that the company reported for the two years it would average out to Rs 3.1 bn. The total interest and financial charges that it paid out and debited to the PL account during the year amounted to Rs 146 m. (Of this total, the interest paid out on debt was Rs 137 m). It is not known the interest component that was debited to capital account, but in any case it is likely to be insignificant. In effect therefore and in percentage terms, the interest paid out would average only 4.4% of the average year end debt. Such a low interest rate in principal is an absurdity, especially in the context of the high gearing that the company has to contend with. There has to be something else going on here. The company has perforce to borrow monies to fund large expansion on capital account or on current assets account, as the directors do not see value in bringing the equity base (through additional issue of equity for cash) more in line with its operational requirements.

Little spend on capital assets

As a matter of fact the management does not appear to have addressed the need to soup up its manufacturing base either. The company did some sudden splurging of Rs 422 m on gross block expansion during the year (Rs 42 m previously) with the vast bulk of this expenditure going into plant and machinery. (It concurrently also sold capital assets with an original book value of Rs 102 m, and which was almost fully depreciated, for Rs 23 m, and turned a profit from that exercise). Some Rs 36 m of the expenditure went into buildings. Inspite of the enhanced spending on capital assets, the accumulated book depreciation at year end accounted for 65% of the plant and machinery gross block of Rs 4.5 bn-or is this the norm in cotton spindle and loom units? Besides, this capex has led to only a marginal accretion in the installed capacity of only its spindles unit. The bulk of the expansion may have gone into rejuvenation. In a manner of speaking, was this sudden spending on capex and on current assets, something to do with trying to make a point in its golden jubilee year or what? If so this is one hell of a way to put across a point. And, besides, what happens in the years' following the golden jubilee?

Its investment portfolio

It should definitely do something about the returns on its investments. It has plonked down Rs 249 m in the equity of its several trade and non trade investments. This includes Rs 17 m invested in four subsidiaries - of which three are non-performing, and separately Rs 10 m in SBI Mutual Fund. It earned a collective dividend return of Rs 5 m for its endeavours in 2010-11.Its single biggest investment is in A.P. Gas Power Corporation with an outlay of Rs 196 m. This per-se appears to be an unexplainable investment and the directors' report has no opinion to offer on the matter either. Way down the list in second place is its stake in Pricol Limited with an outlay of Rs 20 m. This in all probability is a group company.

Of the four subsidiaries, only one, Benwood Corporation, its Malaysia based entity, is exhaling oxygen. The parent has a 66.6% stake in this company. Who holds the balance stake please? The other three are 100% off-springs, but they are mere letter head companies and do not generate any revenues for whatever reason. Comically enough the three boast revenue losses and negative reserves. How the Malaysian sibling generates its revenues is not known ( is it from trading or from manufacturing of what ) but it racked up a turnover of Rs 222 m for the latest financial year ended March 2011. It also generated a pre-tax profit of Rs 29 m for the year. On a paid up equity base of Rs 14 m it has reserves and surplus of Rs 79 m. For some reason it even deigns to pay dividends to its parent. But the parent company does help it along - albeit in a very limited sense. It sold yarn worth Rs 8 m to this sibling during the year, and if my understanding is right the sibling owed the parent Rs 8.5 m at year end on this count. It would seem a rather nice way to conduct a two way biz between the parent, and its more humble creations.

Barring the fact that the management appears to be brewing a bizarre concoction which is out of the ordinary to celebrate its 50th year, there is precious little else in this scrip.

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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