Federal Mogul Goetze (India) subsumed its new nomenclature in 2006 after Goetze Werke the German company was acquired by Federal Mogul, the American giant. (The promoters today control almost 75% of the paid up equity capital of Rs 556 m). The automotive ancillary maker christened initially as Goetze India, was originally set up in 1954 as a joint venture between Escorts, the Delhi based tractor manufacturer, and Goetze. It became a part of the corporate spoils that befell Anil Nanda, the estranged younger brother of Rajan Nanda after the family carve up of the group, which for long was dominated by the co-founder H.P. Nanda, the pater of the two siblings. Rajan in turn got to keep the flagship company Escorts. At some point in the first decade of the 21st century Anil ceded control of the company to the foreign collaborators. The company today makes and sells piston rings, pistons, pins, valve train components and structural components in the original equipment market and the after sales market, from the four manufacturing units that it has in Punjab, Karnataka, Rajasthan and, Uttarakhand.
The travails of the auto ancillary industry
The management in its latest report gives a take on the travails that dog this industry. "The company faces stiff competition in the market place as there are limited customers in the OE (original equipment) market. The company also faces stiff competition with the players in the un-organised sector. Further, instability in the prices of metals and other inputs is perceived as a threat." If this is not dire enough the auditors also have their own take on the company. The auditor's state that the company pays its foreign managing director a compensation far in excess of what is permitted by the provisions of the Companies Act. The compensation for 2010 was a most impressive Rs 45 m. (The CEO going by his name appears to be of European aristocracy or some such). The company has also given an interest free loan of Rs 172 m to its subsidiary, Satara Rubbers and Chemicals, which in the opinion of the auditor's was prejudicial to the interest of the company. The auditors have also commented on the slight delay in depositing tax and other dues. For the matter of record Goetze has in 2010, sold its entire stake in Satara Rubbers to Akme Projects Ltd, and booked a large loss of Rs 57 m on sale. If I am not mistaken Akme Projects is owned by Anil Nanda the erstwhile owner of Goetze. Now this is getting to be very interesting, what?
The past imperfect
The company's working in the last decade is roughly in keeping with the observations of the preceding paragraph. In the last ten years it has published its working results for one 15 month period, two 9 month periods, and seven 12 month periods - in all amounting to a total of 117 months. In normal circumstances it would have declared cumulative results for 120 months. Why it resorted to such shifty accounting is not readily known. Besides, in four of the 10 working results it has revealed a loss after tax (including in one of the odd accounting years). This also involves a bumper book loss of Rs 505 m for the 12 months ended 2005-06. It skipped making any dividend payment in the last 6 years. What is interesting here is that in all the 10 working results it has shown a consistent increase in turnover each year. The gross fixed assets too at each year end have shown a steady increase each year. As a matter of fact the gross fixed assets more than doubled from Rs 1.87 bn in end 2001-02 to Rs 3.9 bn in 2010. The paid up share capital too has grown from Rs 253 m to Rs 556 m over the same time span. So has the reserves and surplus - from Rs 1.2 bn to Rs 3.2 bn - but the vast bulk of these reserves is accounted for by the securities premium account. In other words the promoters were pumping in additional cash at a premium to the face value of the shares to keep the borrowings from ballooning out of control. In the process it managed to reduce 'indebtedness' from a high of Rs 3.9 bn in 2005-06 to a sharply lower Rs 865 m in end 2010.
Auto ancillaries operating in the domestic geography normally get the wrong end of the stick on several counts. They have no control over raw material inputs costs for one - and prices of metals especially, gyrate in epileptic fits given their glocal commodity status. On the other hand extracting price increases with the mother unit is difficult to come by. On the face of it these are some of the prime issues bedevilling any ancillary unit. They are even hard put to negotiate suppliers' credit. But by and large, and on the face of it, such concerns have to some extent been addressed by Goetze.
How its income totes up
Goetze registered a 19.5% increase in net sales, including traded sales, to Rs 9 bn in 2010, but the consumption cost of raw materials and components, including cost of traded goods, soared 39% to Rs 3.5 bn simultaneously. The higher rupee sales was primarily on the back of increased production/sales volumes of piston rings and pistons, rather than on the unit price increase on these products that it was able to realise. These two items together accounted for close to 90% of rupee sales. Pins and valve train components brought in the balance of the manufactured sales moolah. It also indulges in bought out traded sales but given the overall size of its operations, the contribution from this line of activity is minimal, though apparently profitable.
The company simultaneously has inter-se dealings on revenue and capital account with its ultimate parent, with its out of India fellow subsidiaries, with its within India fellow subsidiaries, as also with its own subsidiary. But again, given the scale of its operations, its dealings with its affiliates are kept on a low key. It has five fellow Indian subsidiaries and one subsidiary of its own. The latter is called Federal Mogul TPR Ltd. What these fellow subsidiaries do for a living is hazy and how their business activities dovetail into that of Goetze is also unknown.
As I stated earlier it was not able to generate any sizeable increase in its unit price realisations. On the contrary it also involved getting lower realisations on some products than in the previous year. On piston rings which accounted for 40% of all manufactured sales it was able to get an average price of Rs 74 per unit against Rs 61 per unit previously. On pistons which accounted for another 49% of all such sales, the unit price realisations dropped to an average of Rs 290 per unit against Rs 317 previously. In the case of pins too, which accounted for 6% of manufactured sales, the unit price dropped to Rs 37 from Rs 44 previously, and so on. It also generates some income from job works done. The margins earned if any from this line of activity is not known. Though the consumption cost of materials ballooned overall, it managed to stem the cost increases of a wide basket of raw material items where the quantity details are available. But one unique item appears to have spoiled the broth here. Consumption cost of a ubiquitous item called 'others' rocketed by 50% to Rs 911 m from Rs 609 m previously. (This is also the single biggest item of expenditure in the schedule of raw materials consumed). This expense item, and to a lesser extent the 19% hike in the consumption of stores and spares, and a 21% increase in power and fuel, appears to be the game changers.
The importance of other income
Given the dramatic increase in input costs relative to the rise in sales, the company was hard put to make ends meet. What came in its favour was the leap in 'other income' to Rs 444 m from Rs 287 m previously. Juxtapose this income stream with the pre-tax profit of Rs 481 m and one will know why the company omitted any dividend payment. In the preceding year such non-operating other income accounted for a sizeable 52% of pre-tax profits. The makeup of this other income is a very interesting potpourri. It includes a fair share of write back of provisions under three heads, a very mysterious and sizeable item called 'management support fees', a judicious miscellaneous income component and, commission received from subsidiary. It also received a dividend from this subsidiary. This subsidiary appears to function in the very opposite manner to which subsidiaries are usually made to function by the parent. That is to say the parent is squeezing it! Other income also includes two sales related income streams which together toted up to Rs 200 m. The management is not quite ingenuous one must add.
The expense schedule also features some nuggets. To make up for the lack of any dividend income the parent of Goetze rams it in through the modicum of royalty fees which amounted to a neat Rs 101 m in 2010 (Rs 92 m). The company does not appear to be writing off its depreciable assets fast enough. For it sold assets of the face value of Rs 192 m and with a depreciated value of Rs 51 m for a mere Rs 8 m and thus incurred a loss of Rs 42 m on sale. And given that it could not meet its export obligations to the govt., it was forced to provide for back duties to the tune of Rs 85 m.
The enterprising subsidiary
The company also boasts of a very enterprising 51% owned subsidiary - Federal Mogul TPR (India) Ltd. TPR is an acronym for Teikoku Piston Ring Company, the Japanese collaborator which holds a 24.5% stake in this venture. This company manufactures piston rings only. It has a capacity to make 46 m numbers of piston rings per annum, compared to the capacity of 58.5 m that the parent possesses. But the significant difference here is that the average unit price realisation per piston that the sibling obtained is a mere Rs 23.7 compared to the Rs 74 per unit that the parent realised on sale. Quite obviously these pistons rings are of a much smaller size and probably cater to a different vehicle segment to boot. In 2010 it recorded a gross turnover of Rs 1 bn, up from Rs 847 m previously, and is a piddling entity compared to the parent. Of the total revenues it 'apparently' affected sales of Rs 450 m to the Indian parent. But this sales figure is shown in parenthesis - as is the sales figure of Rs 370 m to the parent for the preceding year. (Cumulatively it had financial dealings of almost Rs 800 m with this parent in 2010. This included such deals as job work charges, sole selling commission paid, management support charges, and dividends paid). If indeed this company is affecting sales of its manufacture to the parent then it is not showing up specifically in the purchases schedule of the parent. But at year end the parent owed the subsidiary Rs 163 m as trade debtor dues. The subsidiary also paid the parent Rs 41 m as sole selling commission.
This 14 year young company is in a sense the very antithesis of the parent. Unlike the parent it is profitable enough by just making a single product, and the directors' report does not cavil at any competition from the trade. The company also became debt free during the year by repaying balance borrowings of Rs 153 m. It also generates sufficient cash from its operations to donate generously to the coffers of the parent. It paid a dividend of 67% for the year 2010. It is being sucked dry in a manner of speaking by the parent. Why it pays sole selling commission to its parent and at what rate is not clearly known. More to the point what is this Management support fees of Rs 64 m that it dishes out to the parent? The point is that the sibling incurred personnel expenses of Rs 26 m on its own in 2010. Wonder what the Japanese collaborators have to say about these goings on. It also logs in with an inter-corporate deposit of Rs 230 m to the parent.
Why is it that the parent cannot manage its business affairs in the same manner as that of the subsidiary?
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.