Corporates by and large resort to the issue of bonus shares to celebrate a jubilee year or better still as an additional bonus to shareholders for the good showing in the year past, and with continued prosperity in sight. KSB Pumps has missed the boat on all counts - but has proposed a liberal issue of bonus shares. (Not that the shareholders have any complaints on this score). The year 2010 is the 51st year of its corporate existence, and the year in which the standalone pre-tax profit fell sharply by 26% to Rs 742 m on sales which grew 9% to Rs 6.3 bn. Further, the directors' report gives no definite clue on in which direction the company's working results are headed for in 2011. The board of directors incidentally have proposed a 1:1 issue of bonus shares, which if approved will double the paid up capital to Rs 348 m. What is more, the financial summary of the results of the last five years does not make for very pleasant reading. Both sales and profits have alternated between the good and the not so good.
KSB in India manufactures and sells pumps/valves/spare parts and other related services and is a joint venture with the Swarups' of Paharpur Cooling Towers and the German parent. Between the two promoters they control a very healthy 66% of the paid up equity. The production is farmed out among five factories, with four factories located in Maharashtra and one located in Tamil Nadu. There is also a marginal purchase of finished goods from its group companies for resale. The company also affects sales through its affiliates. Exports of Rs 633 m in 2010 (Rs 782 m previously) accounted for 10% of net sales against 14% in the preceding year.
Falling realisations and other shenanigans
The directors' report states that the fall in profits is due to some very pressing reasons. The report states 'execution of the project orders which were obtained earlier with lower margin affected results considerably. Further cost push inflation increased the input costs significantly, mainly materials, which could not be passed on to the customers. Some of the large orders could not be executed as customers did not take delivery of pumps and valves on account of project delay at their end. Global crisis continued to affect exports.'
Not exactly true. The company for one has several deals going on simultaneously which would appear to split the income in a manner to its suiting. It also appears that one of the prime reasons for the haemorrhaging of profits is the intense competition that it has encountered from other foreign manufacturers in what it makes and sells, and the aggressive pricing strategy that the competition has adopted - as the company itself has admitted elsewhere in the annual report. The average gross price realisation of power driven pumps fell to Rs 30,290 per pump from Rs 34,682 per pump in the preceding year. I am assuming here that the excise duties levied have not materially changed over the two years. Power driven pumps accounted for close to 72% of all gross sales. Ditto with the per unit sales realisations of industrial valves which accounted for another 16.6% of all sales. The price realised fell to Rs 7,660 per piece from Rs 8,500 previously. These two items accounted for over 88% of all sales. And if this aint taxing enough the company also had to part with 'cash and quantity ' discounts of Rs 83 m (Rs 66 m previously) to register the sales. What is one to make of this?
Add to this a further Rs 11 m paid (Rs 26 m previously) in respect of late delivery under contracts. Not only is the company facing increasing competition it is experiencing difficulty in coping with delivery schedules. Besides, in a difficult year it also had to part with substantially higher royalty fees of Rs 10 m (Rs 4.6 m previously) to the parent. And to add to the grind it was forced to part with another Rs 66 m (Rs 29 m previously) to group companies, on account of technical/professional services. Coming to think of it, whichever way the dice is rolled, the parent is a clear winner.
The many expenses paid to the parent
It is difficult to get a similar fix on other items of sales that include spare parts and income from services, and which constitute items of note - given their accounting treatment. However the pile up of inventory by about Rs 415 m at year end may account for customers not taking delivery of their contracted purchases. The company also affects sales through selling agents and in 2010 it made payments on this count to the tune of Rs 87 m which in itself is down sharply from the Rs 114 m that it forked out in the preceding year. Of this sum 73% (Rs 63 m) was paid to sole selling agents, while the balance was paid to other selling agents.
A separate schedule to the accounts says that it exported goods of the value of Rs 633 m (Rs 781 m previously) and that it paid a commission of Rs 61.6 m for this. That works out to a neat payment of almost 10%. In the related parties transaction schedule we are informed that it has sold goods worth Rs 525 m to group companies. This schedule also shows that it paid a commission of Rs 63 m to companies under common control. Is one to understand therefore that KSB Pumps paid a commission to a group company for sales affected to them by it? It just does not seem to add up. This commission has in effect been paid to KSB Singapore (Asia Pacific Pte Ltd) which is the sole selling agent of the company for all territories outside India. This is just one of the many ways of bilking the Indian company. (The new agreement signed in 2011 will increase the commission rate to 12%). This schedule also informs us that it earned commission income of Rs 62 m from group companies. And what is this commission that it earned from group companies, and on what account? And where has it been accounted for in the receipts schedule?
Getting ready to face the challenge?
In the context of the company's lament that globalisation has thrown up fresh challenges in the wake of international players creating additional manufacturing capacities which would further intensify competition leading to further price pressures, it seems odd that the company is on the face of it not taking any corrective measures. The company does not appear to be sprucing up its manufacturing facilities, nor adding to its productive asset base. More than 50% of its plant and machinery is depreciated and the installed capacities appear to have been mothballed at the current levels. Besides, the production of power driven pumps is very close to its present capacity levels. But in an annexure to the report the company states that it is now resorting to import substitution on its high pressure valves to cut costs, and that its R&D (research and development) establishment is working towards developing higher rating submersible pumps along with newer generation of pumps and boosters. But this effort does not look like much from a reading of the main report.
The other incongruities
To add to the many incongruities, it also makes do with an affiliate company styling itself as MIL Controls, and one subsidiary, Pofran Sales and Agency. The shares in this company were acquired at Rs 85 per share against a face value of Rs 10 per share, for a total consideration of Rs 63 m. We are briefly informed that this company made a profit before tax of Rs 279 m against Rs 209 m previously. It apparently also paid a dividend of Rs 33 m to KSB Pumps during the year. If so this is a very well thought out investment. The subsidiary Pofran is a lot more colourful, but that is because we get to see the innards of its functioning. This lilliput with a paid up equity of Rs 0.5 m does not have to do anything of any worth to sustain itself. It is in the commission business--period.
This company earned a commission of Rs 17 m in 2010 merely for taking the trouble of despatching materials to clients as per the purchase order. The entire commission was earned in foreign currency, and hence presumably the entire shipments were made across the seven seas. There was some bank interest income too. The administrative costs and other 'kachra' expenses incurred were so miniscule that the company ran up a neat pre-tax profit of Rs 16.4 m. Erring on the side of caution though, the directors in their wisdom decided not to declare any dividend. It paid a 1000% dividend in the preceding year, on a lower post tax profit. One wonders at why this company was incorporated in the first place. It would appear that this company is only another conduit for parking funds which strictly speaking belong to the parent. Or is there some other benefit accruing which I am missing out on?
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.