The management of SKF India appears to believe in the learned conclusion that the best way forward is to have a neat mix of both manufacturing and traded sales to generate maximum value. The current mixture is almost a perfect 50:50, at least in terms of rupee sales generation though not in value addition. This decision appears a little out of depth in the light of the management gloating over the contribution of the company in enhancing the knowledge skills of the local environment.
The company for one has 5 factories across the country to service its customers. But their combined output is small beer in terms of 'contribution' to the overall effort. Traded sales of bought out ball bearings and taper roller bearings - bearings are its primary source of sales income-accounted for 45% of gross rupee sales in 2009, the same level as in 2008. The balance 55% was footed by its in-house production centres. It would also appear on the basis of available evidence that the vast bulk of these traded sales are generated by imports from SKF Singapore, Germany and from 'others'. It also makes a laughable effort to make textile machinery components.
There is stark evidence elsewhere of its general lack of interest in its domestic manufacturing operations. The fixed asset base is considerably depreciated even after taking into account the additions to gross block for the new manufacturing capacities that is in the offing. The accumulated depreciation is a healthy 72% of the gross block if you please.
Why the company has chosen to go about its business in this manner has not been spelt out by the management. It is ofcourse the company's right to pursue business activities in any manner that it deems fit so long as it creates value in the process, but an explanation from the board would have helped to put matters in the right perspective. The point is also that for a entity which prides itself on being a knowledge engineering company, the bulk of the 'knowledge value added' appears to be of the outsourced kind.
As stated earlier it has 5 factories in India with the anointed purpose of adding value to what it makes and sells. But the elementary fact is that it makes and sells only the 'plain vanilla' bearings in India .The value added high priced bearings are bought out and sold.
Consider the evidence. It produced and sold 103 m bearings in 2009 and generated a sales turnover of Rs 8.1 bn at an average price (including indirect taxes )of Rs 78 per bearing. It however bought and sold another 12 m bearings in 2009 (a neat 47% more in volume terms that in the preceding year) at an average sale price of Rs 565 a bearing - against an average purchase price of Rs 513 a bearing. This boughtout purchase/ sale netted the company, on paper, a cool Rs 52 a bearing or a total gross margin of Rs 650 m in 2009, against an even more impressive Rs 1 bn in 2008. In 2008 it bought bearings at an average price of Rs 743 a bearing and netted a sale of Rs 865 per bearing.
Looked at it another way, sales of bought out bearings seem to contribute excessively to the pretax profit, on a rough back of the envelope calculation. What is equally interesting is that the company does export the low value bearings that it makes to its affiliates in USA, Germany and others and realized Rs 1 bn from this exercise in 2009.
This operational route has to be juxtaposed with the directors' waxing eloquent on the outstanding contributions of the domestic operations to the company's well being. It also crows that all its businesses are back on track and that its factories are fully loaded to cater to the demand in the offing. What should cheer domestic shareholders however is the new increased focus on local manufacture. The Hardiwar factory the report says is being set up at a cost of Rs 1.5 bn and will add another 60 m bearings to the present manufacturing capacity of 132 m bearings. Its factory at Ahmedabad to make large size bearings is also ready for commercial production the report says, though its productive capacity is not known.
It has also opened a new Global Testing Centre in Bangalore which will also include a global laboratory and an engineering centre. And the SKF solutions factory at Pune that will help customers reduce their operating costs and improve energy efficiency rounds out the picture.
Does this signal a marked shift in future operations of the company? It is too early to tell. For the present SKF India would be a prime candidate to take the help of the solutions factory to improve its own operational efficiency. Pre-tax margins on sales have slid to a low of 9% in 2009 from almost 16% in 2007. The company's main problem is that it is an 'ancillary unit' and has to follow the dictates of the parent unit. It supplies the vast bulk of what it makes to the automotive sector with the industrial sector mopping up the balance. The other knotty problem is that steel and alloy steel are its principal raw materials and the price of steel oscillates at its own nutty way.
In 2009 it produced and sold far more bearings but realised less per bearing sold. But inspite of the tense situation it managed to take on the larger problem head on, and in the process showed its standing in the market place. It actually generated significantly more cash of Rs 2.2 bn from operations in 2009 than the preceding year's take of Rs 474 m, by squeezing out every dime from every source, including a significant drop in inventory levels. It also brings to the fore the stark reality that profits and cash generation are not necessarily linked.
With only a pitiful addition to gross block and with no other worthwhile investment channels in mind, its cash resources soared to Rs 2.8 bn, not including the inter-corporate deposit of Rs 690 m. This deposit was made to SKF Technologies, an affiliate, in which the company has no equity stake. Needless to add the company remains fully debt free.
Ancillary units are not an investment proposition for the long term investor except where the parent has little control over the pricing by its supplier, as in the case of Bosch. Or where it has guaranteed foreign sales as in the case of Sundaram Fasteners. This inspite of SKF's brand equity in the marketplace.
Disclosure: Please note that I am not a shareholder of this company
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.
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