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Nagarjuna Fertilizers: Bogged down by subsidy woes - Outside View by Luke Verghese
 
 
Nagarjuna Fertilizers: Bogged down by subsidy woes

Fertilizer companies without exception are in a mess royale and Nagarjuna no less, and for no fault of their own. This is an anomaly that the government should endeavour to set right

This company is an enigma for more reasons than one. Read on..........

The annual report of Nagarjuna claims that it is India's largest private sector fertilizer company with sales of 4 m metric tonnes of fertilizers. It also claims that it is India's largest private sector urea company with sales of 3.3 m tonnes of urea. It has four factories-three in Andhra Pradesh and one in Gujarat which spew out nitrogenous fertilizers. The factory at Kakinada is now expanding the capacity of its urea unit by 3,860 metric tonne per day while the ammonia unit is being expanded by 2,200 metric tonnes per day.

The present undertaking is an amalgam of a scheme of arrangement wherein Kakinada Fertilizers Ltd (KFL) the wholly owned sibling of Nagarjuna Fertilizers and Chemicals (NFCL) acquired the residual businesses of NFCL (what residual business please?) and some other group entities including the oil business, and then changed its name to form the present undertaking. Subsequently, one of the merged entities, the oil business undertaking, was demerged into a separate undertaking called Nagarjuna Oil Refinery Ltd, while retaining the other merged units. The point is that such complex M&As' are resorted to merely for taxation purposes-no less.

The capital structure

The company presently has a paid up equity capital of Rs 598 m and maha impressive reserves and surplus of Rs 23.2 bn. The latter figure looks like it is shimmering, except that it is inclusive of capital reserves of Rs 9 bn, and securities premium reserves of Rs 10.9 bn. That takes away a lot of sheen from the loud figure. It is also loaded with a mountain of debt -Rs 30.3 bn as against Rs 22.2 bn previously. It is not quite clear what the holding of the promoters in the company is, as two different schedules on the shareholding pattern gives out different figures. (The company incidentally has many founding fathers including Krishak Bharati Cooperative Ltd, Fireseed Ltd, Government of Andhra Pradesh, and Saipem S.p.A.-the Italian engg. conglomerate. They still hold piddling amounts of stock in the company --- but, still, it gives a leg up to the promoters).

But on the face of it the core promoter holding appears to be around 43.7% of the issued capital. Another schedule says that two private corporate bodies including a trust sporting the name Nagarjuna, together control another 5.76% of the voting capital. Thus the promoter family-the Rajus-- are very comfortably ensconced in the driver's seat. Surprisingly enough, Zuari Global-formerly Zuari Industries Ltd -and a part of the K. K. Birla group holds 5.4% of the equity. What Zuari saw in this company is not very clear, but it further helps to further consolidate the hold of the core promoters.

Mercifully the company makes do with only a few siblings, associates and such like. From the data available it has two siblings, one step down sibling based out of Mauritius, two associate companies, and an associate of the sibling based out of Germany. The total direct investment in its siblings' etc amount to a mere Rs 531 m. That is the good news.

The revenue flows

The company earns its bread from the sale of manufactured goods and from the sale of traded goods. The country's largest fertilizer producer generates more revenues from traded goods than from manufactured goods! (This in itself is a good excuse to increase domestic manufacturing capacities exponentially, than to give the benefit of value addition creation to foreign producers. But look at the maha mess that the domestic producers have to make do with!). The text complains that the production of fertilizers in the country has remained stagnant for the last seven years due to lack of capacity addition, and the limited availability of raw materials to some extent. India it notes is also deficient in terms of the primary input of raw materials like natural gas, rock phosphate and potash, as also the sizeable dependence on the import of intermediate like phosphoric acid and ammonia.

So, the company sold manufactured goods worth Rs 20.5 bn and traded goods worth Rs 34.2 bn. The former category mainly consists of the sale of urea-Rs 18.7 bn, followed way down by the sale of extruded irrigation systems at Rs 1.65 bn. The manufactured sales include government subsidy of Rs 10.6 bn. (It gives one an estimate of the massive whack in toto that the central government takes on in doling out fertilizer subsidies). The delay in the distribution of this subsidy leads to severe working capital problems for the industry- and this happens inevitably at year end every year when the government has to balance its receipts and payments, and is completely out of pocket, and hence delays handing out the dole. The traded sales figure consists of the sale of bulk fertilizers of Rs 23.2 bn, followed by pool urea of Rs 9.2 bn. It also sold speciality fertilizers worth Rs 863 m. The balance is made up of a concoction called 'others'. It imported traded products valued at Rs 19.9 bn against Rs 21.8 bn previously.

The total revenues net of excise that it generated amounted to Rs 54.8 bn and there was other income of Rs 322 m. In the preceding year the figures were Rs 49.9 bn and Rs 294 m respectively. However, the profit before tax fell to Rs 1.6 bn from Rs 2.3 bn previously. The other income not surprisingly accounted for 19.8% of pre-tax profit against 12.7% previously. This resource basically came from interest on bank deposits etc and from other non operating profit whatever that may be. The two reasons for the decline in profitability and the decline in profits appear to be due to the marginally higher input costs of materials including the inventory valuation, and the steep rise in finance charges by 70% to Rs 2.6 bn. On the face of it the company has turned up trumps in the purchase/sale of traded commodities. The company realised a sale price of Rs 34.2 bn on input costs of Rs 30.8 bn, and realising a gross margin of Rs 3.3 bn in the bargain. The marketing, administrative, and interest costs associated with this transaction are however not quantifiable.

Expansion schemes

The ongoing expansion programme on the Kakinada unit is in all likelihood limping along given the cash crunch that the company is facing. The company could just about spend Rs 364 m on capital assets during the year, which is really small change given the cost of even brown field expansions. The big issue is that the company is straddled with trade receivables of Rs 24.4 bn at year end which is almost equal to 45% of its revenues from the sale of products during the year. (Fertilizer companies do not pay any excise duty on the manufacture and sale on the vital input for growing more food. Excise duties on fertilizers were completely abolished decades ago by the late Chaudhary Charan Singh when he was sitting on the hot seat at the Centre). This outstanding figure obviously includes the subsidy dues receivable from the central government, and it is truly a figure that the company cannot afford to bear.

This is also the reason that the company is saddled with such an unsustainable debt burden. This has also led to a ridiculous situation where the current liabilities is more than the current assets -which in theory is an exceptionable way for a branded company to present its year-end balance sheet. But this ulta scenario is not because the trade payables are larger than the trade receivables-rather it is a pittance compared to the latter. It is because the deficit on this account has been made up by short term interest bearing dues from lenders of money. And, with the Central government in hock every year end; this is a predicament which begets no earthly solution. This, then, looks is a ring side view of the theatre of the absurd.

Inspite of the roadblocks in its efficient functioning, the company could even generate a large cash flow from operations (read below). This is in itself a pleasant observation. It generated more cash from operations after the setting off of working capital changes than from before it! The net cash generated from operations amounted to Rs 6.2 bn from Rs 4.1 bn previously. The trick that the company resorted to here is that some of the increase in debts came from a sharp rise in foreign currency suppliers' credit to Rs 18 bn from Rs 13.5 bn previously. Whether this figure is interest bearing or not is not immediately known. But, given the massive increase in interest costs, this suppliers' credit in all likelihood is interest bearing. There is a sub head in the finance cost schedule called 'other borrowing costs' of Rs 631 m against Rs 380 m previously which may be tied to this.

The incongruous cash flow statement

The cash flow statement on its part avers that there is an increase in trade payables by Rs 4.1 bn during the year-which in turn will reduce the pressure on funds on a short term basis. But, paradoxically, the year-end trade payables balance sheet figure is actually lower at Rs 4 bn as compared to the preceding year end sums of Rs 6.1 bn. How then did the trade payables become a 'source' of funds? The cash flow statement goes on to add that the cash generated from operations helped the company to repay borrowings to the tune of Rs 2.6 bn. This again is an anomaly, for as stated earlier, the borrowings at year end amounted to Rs 30.3 bn against Rs 22.2 bn previously. IN MY HUMBLE OPINION THE CASH FLOW STATEMENT OF THE STANDALONE COMPANY AS PRESENTED BY IT DOES NOT DO ANY JUSTICE TO THE TRUE PICTURE. Why then bother to present this schedule? The net result of the overall topsy-turvy situation is that the company was not in a position-- given the ensuing cash crunch --to honour its decision to pay out a 100% dividend (Rs 666 m) that the board had recommended and was subsequently approved by the shareholders. This is another first for a company that I have surveyed.

As stated earlier the company has two siblings -Jaiprakash Engineering and Steel Company, and Nagarjuna Mauritius Pvt Ltd, and one step down sibling Nagarjuna East Africa Ltd. It also boasts of classifications like associates and associate of subsidiary. It does not appear to have given the brief year end financials of the siblings. It is not known whether these siblings are ongoing entities or not. It has plonked down Rs 529 m in the equity of the siblings and has also advanced Rs 292 m to its Mauritius sibling.

A note to the accounts however states that in respect of one sibling the project proposed by it was shelved for which the Karnataka body which had given possession of 987 acres of land  was approached for the surrender of land and repayment of the deposit. To this end some of the land has been surrendered and some of the deposit repaid. Why is the company silent on naming the sibling which was implementing this giant project? And what has become of the other sibling? What is it up to please? There appears to be no answers.

Poste script

It is a pity that fertilizer companies have to flounder in this manner. It is impossible for such units not to make money from its operations given the manner in which the industry is structured. The returns are decided on a cost plus basis and if the management gold plates the units the returns are that much more. Besides, selling the produce-as the quantum of imports show-- is a piece of syrupy cake. The point is that the fertilizer units operate at the mercy of the central government, and the late receipts of the subsidy doles due to them from the Centre affect their finances deleteriously. This is precisely the predicament that Nagarjuna finds itself in.

The net result is that fertilizer stocks are not of the investment grade variety.

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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