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SKF India: Nothing short of its parent's pawn - Outside View by Luke Verghese
 
 
SKF India: Nothing short of its parent's pawn

A high flown image of itself

SKF India likes to case its image in slightly exalted terms in a manner of speaking. In India it basically produces and sells, or imports and sells, as the case may be, ball bearings, roller bearings, and kits and vogel (whatever that is ), and it produces and sells textile machinery cand other bits and ends. But that is not how the top bosses at head quarters view the business. The way the management tells it, 'SKF is a leading technology and solutions provider of products, solutions and services in the areas of roller bearings, seals, mechatronics, services and lubrication systems. Services include maintenance services, condition monitoring and training'. Mechatronics to the uninitiated is a combination of several branches of engineering.

A muted celebration

SKF India was incorporated in 1961, and thus the year 2010 was a very eventful year in its existence. But it chose to celebrate its golden jubilee in a muted manner so to speak. On a record turnover of Rs 20.6 bn and record net profits of Rs 1.8 bn to boot, the company has merely upped its dividend to 70% from 40% previously as a part of the jamboree on offer. No bonus shares however, though the meagre paid up equity of Rs 527 m is backed up by reserves and surplus of close to Rs 8 bn. Coming to think of it, bonus shares are increasingly losing their appeal, especially to the multinational fraternity, who in any case have little to benefit from bonus offerings, and the trend is to increase dividend payouts from which the benefits are immediate and real. The flip side of this deal is that with a static floating stock, and with increased investor interest as the company continues to forge ahead, the demand supply imbalance leads to a ramp up in the price of the stock in the secondary markets, as it keeps pace with the higher EPS (earnings per share). The parent incidentally controls an unassailable 53.5% of the outstanding equity.

With the ringing in of the golden jubilee, the pressure was on the new CEO, Mr Shishir Joshipura, to deliver in his very first year in the corner office. (His predecessor Mr Rakesh Makhija was appointed President Asia of SKF Group based in Shanghai, China.) And, Shishir was sort of up to the task, but with a load of backroom help from the parent, or so it would appear. But, more on his subtle trick later on in this show. Somehow the wheel turned in 2010. The net sales of the bearing major including other income grew 32% to Rs 21 bn, while the profit before tax ballooned 86% to Rs 2.6 bn. The company had been going through a rather indifferent patch both in 2008 and 2009 in the top- line and the bottom-line segment. In 2010 it helped that the company was able to take advantage of the increased capacity on offer in its bread and butter line of ball bearings and roller bearings division. The installed capacity grew 24% to 163 m units while production grew more sedately by 15% to 118 m units. But the real winner here was the sharp increase in sales generated by traded goods purchased for resale.

The nuts and bolts of its business

The manner in which SKF India generates its total purchases and sales is an intricate affair as is with the operations of all multinationals. During 2010 SKF India imported raw materials and finished goods worth Rs 7.3 bn (Rs 5.1 bn previously), largely from SKF affiliates in Singapore, Germany and from 'others'. In the overall sales, it also sold goods and services worth Rs 1.7 bn (Rs 1.1.bn previously) to SKF affiliates around the world including to 'Others'. Such dedicated sales accounted for 8% of overall net sales. But such dedicated sales appear to exclude sales made to SKF Technologies India Pvt Ltd. This company may also be the largest player among the group companies that interact with SKF India. Paradoxically enough, SKF Technologies has been included in the group company trade debtors' schedule. Why then have the sales made to this company been excluded from the group sales?

Moreover, the breakup of the trade debtors schedule shows that fellow subsidiaries of SKF India owed SKF India Rs 2 bn at year end. This in itself is anomalous, as this outstanding is greater than the total sales made to them by SKF India in 2010. SKF Technologies alone has an outstanding balance of Rs 1.6 bn in trade debtor dues. (SKF Technologies also appears to sponge off SKF India, as the latter has also advanced mega loans to this company). What exactly this company does to earn its living and how it fits into the SKF structure is not known.

SKF India also had to part with royalty fees of Rs 113 m (Rs 89 m previously). Strange indeed are the ways of multinationals but that is the way in which such conglomerates are run, and there is no use complaining. The managements of the respective companies may indeed have very little say in such matters and one wonders at the quid pro quo that the parent company institutes in such two way transactions between group companies. But quite apparently the way it is all laid out, all affiliates get to share a bit of the cake each. One also seeks to ponder at how much self respect and power the managements of local companies exercise on their own.

Kowtowing to the bosses at H O

SKF India produces and sells the run of the mill low value added ball bearings while it imports and sells the high end stuff. That is to say, in the context of overall manufactured sales, the domestic produce accounted for 54% of all sales, while traded sales accounted for the balance 46%. The company recorded almost similar percentage figures in the preceding year in overall sales. The number of bearings that it produced rose 22% to 125 m while sales rose 15% to 118 m. The average gross price realised per bearing sold increased marginally to Rs 83 from Rs 77.6 previously. There was a severe mismatch between the numbers that it produced and the numbers that it was able to sell in 2010. There was no such mismatch in the preceding year.

The number of bearings that it purchased for resale rose 86% to 22.5 m while sales rose 61% to 20 m. The average purchase price per bearing slid to Rs 372.8 against Rs 513 previously. The average price realised per bearing sold also slid in unison to Rs 473 from Rs 565 previously. However, on a rough basis the company realised a gross margin of Rs 100 per bearing sold in 2010 against Rs 51.7 previously. The margin per bearing sold appreciated very mysteriously in the latter year. In other words the company would have earned a gross margin of Rs 2 bn in 2010 on traded sales alone against Rs 643 m previously. Despite a lower purchase cost per bearing, the price that the company realised per traded bearing sold was substantially higher than what the company was able to realise from the sale of domestically produced bearings.

Even in the specific instance of traded bearings, the company appears to have outsourced far more numbers of bearings, than the quantum that it was able to sell - such an aberration was conspicuous by its absence in the preceding year. Inspite of such mishaps, the delicate balance in percentage contribution of both manufactured and traded sales in the overall rupee sales was maintained. The company has elevated this game to the fine art of how to manage the environment. What is left unexplained here is why the parent prefers to follow this intricate pattern of recording sales in its Indian sibling.

How the profits are derived

From the deductions that one has arrived at in the preceding paragraph, it would appear that the parent either imported less expensive bearings for sale by the Indian sibling during 2010 as compared to the preceding year, or that the parent deliberately cut the sale price of the bearings to the sibling so that the latter would be able to ratchet up substantially higher sales and profits to boot, in 2010. This scenario is very plausible as SKF India had perforce to make a statement - what with the year 2010 being the golden jubilee year. As a matter of fact the Rs 2 bn gross margin that it racked up on traded sales could even imply that manufacturing is not a very profitable exercise in the first place. One could even stick ones neck out and say that the profits were 'managed' in a most admirable manner.

The CEO's take on the company

Whatever may be the subtle message that the company seeks to convey from the manner in which its affairs are being massaged the CEO has signed off on a very optimistic note.Says Mr Joshipura, 'We have already invested in a completely new plant at Haridwar in March 2010.This facility will serve the fast growing two wheeler market and the expanding after vehicle service market. Additionally we have expanded capacity at the Bengaluru unit to serve the automotive and industrial segments demands. As we embark on the next phase of our journey, our business portfolio of 5 technology platforms namely bearings, seals, lubrication systems and mechatronics will significantly strengthen our endeavour to offer integrated solutions'. What is left unsaid here is the booster support that the parent will be providing.

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.

Disclaimer:
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