The company is firing on all cylinders alright. The problem is that it makes and markets a mass commodity item and thus cannot capitalise on any brand equity.
Excelling in financial management
It is difficult to make money in the cement business, irrespective of the intentions of the management. In the case of ACC, the intention of the management is to excel or so the financial management reveals. That fact comes across very clearly after one peruses the annual report of ACC. The company now under the control of Holcim Group is a very tightly run ship - close to zero debt for one, and reporting negative net current assets of Rs 460 m at year end for another. It showed up a much larger negative net current assets total of Rs 9.9 bn in the preceding year. As a matter of fact ACC is one of the only cement manufacturers that I have surveyed which survives on a bare minimum of debt capital, Rs 5.1 bn, for its sustenance - a sum which it can easily extinguish if it so wishes. The point is also that it has socked away Rs 11.8 bn in liquid debt securities against Rs 13 bn previously. It is also only the second company that I have analysed which proudly shows off its current asset management skills-by reporting negative net current assets at year end. (The only other company that I have come across in the recent past is Bajaj Auto Ltd).
For those not quite familiar with accounting jargon, negative year end current assets means that its day to day management of finances infers living on the razor's edge. It means that it owes more dosh to its day to day creditors than is owed to it by its debtors. (Companies which are out of pocket are also in a similar situation - but then such a situation is characterised as a dilemma). But to be able to manoeuvre itself into such a commanding position it has to be top of the pops and be a dominant market leader to boot - which ACC is. The company is big and brawny - it has 17 cement plants spread over 11 states, produced 23.4 m tonnes of cement in 2011 (against a capacity of 28.7 m tonnes) possessed a gross block of Rs 96.4 bn, and boasts a national footprint to boot. It has also been around for some 76 years and hence has mapped the topography well enough. (The company is getting younger as it ages, and that is a very positive sign). But by fine-tuning its skills it gets to kill two birds with one stone. If the company in any event has indeed to borrow short term funds to finance its day to day operations, then the need to borrow such funds gets diluted. On the other hand, and as may be the case with ACC, if it does not have to borrow moneys at all, then the surplus cash can be made to sweat. (ACC earned Rs 1.21 bn as interest on bank deposits during the year).
Negative current assets
If the current assets position is actually negative on a day to day basis, then it can indeed be a very tricky situation. As the gross current assets includes slow moving items such as inventories, and in the case of manufacturing companies inventories are a big ticket item, and not forgetting trade debtors which is almost exclusively comprises of unsecured debtors. And if the debtors do not pay up in time, and if the inventories are also inflated (as is often the case) to cover up other shortcomings, then the company will be out of pocket when the creditors come calling. But in the case of ACC debtors at year end amounted to a mere Rs 2.6 bn against a gross turnover of Rs 104 .8 bn. In other words it sells cash down. And inventories at year end were valued at only 10.5% of gross sales. That is 38 days sales. The year-end debt was at Rs 5.2 bn and the interest paid out for the year and debited to P&L account was Rs 969 m. The interest paid out as a percentage of year end debt would suggest that the company borrowed short term bank funds during the year to keep its business humming.
The financial position is further accentuated by the workings of the cash flow statement. It generated net cash of Rs 15.7 bn from operations during 2011. This cash was more than enough to cope with all other capital commitments of the company including the gross block expenditure for the year. (Just to spice up matters it also corralled large sums of capital of Rs 1.3 bn by getting subsidiaries to repay loans, generating cash from the sale of fixed assets, and from the sale of investments). It is going slow on capacity addition for sure. The installed capacity of its cement unit increased by 1.6 m tonnes to 28.7 m tonnes. The production however averaged only at 82% of capacity against 78% previously. Obviously either the market cannot absorb more, or the company is unable to fine-tune its facilities to mark up production to meet market demand.
Inability to generate margins
But inspite of all this financial wizardry, ACC like cement companies is not able to generate margins relative to the turnover that they pile on. The reason is that cement is a commodity offering and not a brand and thus companies are not able to retail souped up versions of what is on offer. (A look see at ACC's average price realisation will help to buttress the point. At the gross level inclusive of excise duty ACC obtained a realisation of Rs 3,938 per tonne in 2011 against Rs 3,584 per tonne previously. That is an average percentage increase of 9.8%). There appears to be no change in the excise duty paid out over the two years judging from the figure debited to the P&L account. Thus then net realisation per tonne would have increased in a similar manner. And, cement cartels in India, (cartels are a fact of corporate life) are not very effective in maintaining prices at judicious levels. The bigger problem is that they have little control over material input costs, and transportation costs, which are soaring by the day.
The big ticket expenses items
Take a look at the expenditure schedule. The three biggest individual items of expense are all a part of the schedule listing manufacturing expenses. They are raw materials consumed, power and fuel, and freight charges on cement. Raw material costs rose 29% to Rs 14.3 bn, power and fuel went up by a mean 37%, while freight charges accelerated by 31%. Between the three, they accounted for 66% of all manufacturing expenses of Rs 75.6 bn. Of these three expenses, the company has some control over only one item- power -though this was the very item that rose the most on a percentage basis. It appears to be making efforts to control its unabashed growth to some extent. (The capital expenditure that it has to incur to tighten cost controls on power is however not known). The consumption cost of both electricity and coal for the production of cement has dipped in 2011 from that recorded in the preceding year. More importantly, this consumption cost per tonne is also well below the standard cost fixed for both electricity and coal according to the figures published by the Confederation of Indian Industries. But the most revealing picture is provided by the outgo on personnel costs. Employee handouts in the big picture are relatively minor at Rs 5.3 bn. Salaries and wages was a big ticket item in overall expenditure three decades ago. It shows the extent of change in production technology that has overtaken the cement industry over the years past.
The point that I sought to highlight earlier is revealed in the financial snapshot figures that the company has provided for the last ten operating years - 2002-03 to 2011. The net sales have risen inexorably each year over the preceding year in the last ten years. But the profit before tax, especially over the last six years has shown a topsy turvy trend, as has the profit after tax. As a matter of fact in the last five years it revealed the highest post tax profit in 2009, and the second highest post tax profit in 2007. It may not be out of place to mention here that other income is a fairly significant player in margin generation. Other income includes a mixture of 'Other operating income' and 'Other income'. Other operating income in either year also includes a judicious sum representing write-back of provisions. In any event, such other incomes in to accounted for a hefty 27% of pre-tax profit against 25% previously. Among other interesting statistics over this 10 year period, the borrowings at year end has fallen sharply to Rs 5.4 bn from Rs 14 bn, while the net fixed assets have rise to Rs 66.4 bn from Rs 24.5 bn.
The group outfits
Like all conglomerates ACC too has its own set of muddled investments in group companies. The book value of such investments is valued at Rs 3.6 bn. This includes assorted investments in six subsidiaries, and equity outlays in four other group companies. All the investments are in cement, concrete, limestone, or coal. The largest outlay by far is in ACC Concrete Ltd with an equity capital of Rs 1.5 bn at par, and a preference capital outlay of Rs 1 bn at par, or a total of Rs 2.5 bn. The other investments, individually and collectively, pale in comparison. The revenue returns on the investments collectively add up to not more than a farthing, but that was not the intention in the first place. There are enough and more inter-se transactions on revenue and capital account within this hallowed setting to more than make up for the loss in dividend incomes.
The one investment in this list that is a nugget of sorts is ACC Concrete Ltd. It is some sort of a bizarre operation. It is a five year old pup which has yet to get its bearings right. It is also a fairly large sized operation in its own right with a gross fixed asset base of Rs 1.7 bn, and gross current assets of Rs 1.3 bn. ACC Concrete also has an investment valued at Rs 60 m in a company called Aakaash Manufacturing Company Ltd which appears to be a high flyer or some such. ACC Concrete, like the parent, boasted negative current assets of Rs 144 m against negative current assets of Rs 129 m previously. But in this case it was not deft financial management that led to this peculiar state of affairs. Rather the precarious state of its finances.
Ready mix concrete
It is in the business of selling ready mix concrete (RMX) and appears to go about its business in a rather convoluted manner, leading to unwarranted results. It rustled up a turnover of Rs 6.9 bn in 2011, but its bottom-line was steeped in red ink to the tune of Rs 253 m. The figures for the preceding year were Rs 6.1 bn and a loss of Rs 291 m. The accumulated losses at year end were just a shade less than Rs 2 bn. It is a gentle way of saying that the company has gone belly up. But the tooth fairy parent, the company may have filed for liquidation by now. It also makes do with an inter-corporate loan of Rs 400 m from the parent - down from Rs 730 m previously. The P&L account does not show any interest payment to the parent on this ICD. Neither is there any payment on the cumulative redeemable preference shares of Rs 1 bn. So the dividend dues on this account will continue to accumulate. But the parent is not complaining, right? The parent provided some comic succour during the year - a fresh offering of Rs 500 m in capital to the sibling which helped facilitate a loan repayment to the parent of Rs 330 m. The left hand of the parent giveth to the sibling, and the right hand of the sibling payeth back to the parent. This is show time folks!
The bigger question is why the company continues to bleed and how it got into this mess. One reason could be the peculiar structuring of its fixed asset base. It has buildings valued at Rs 500 m, and plant and machinery valued at Rs 894 m. Not much difference here between the two figures, what? The value of cars, motor trucks etc, weighs in at Rs 139 m. How do you create value addition with a base like this? The usage of words in the financial statements makes it difficult to get a correct picture of some of the expense items. The company has purchased ready mixed concrete valued at Rs 715 m. It also consumed raw materials valued at Rs 4.3 bn. But in the statement of group company transactions, it has purchased Rs 2 bn worth of finished and unfinished goods from a string of entities including the holding company, its associate company, and fellow subsidiaries. Whether the unfinished goods refer to raw material purchases or to some other item is not known. In any event some 40% of material purchases appear to be group related. This could well be another reason for its inability to turn the corner. Then there are a string of other expenses like training, technical knowhow, market survey, management fees, training fees and so on and so forth payable to the ultimate parent Holcim. Is the ready mix business such a complex potpourri or what? On top of it there is the salary payable to its expat CEO amounting to a neat Rs 17.7 m - accounting for almost 5% of total employee outlay. What is the real deal here please?
Other bits and ends
Another sibling, ACC Mineral Resources, which was formed to take on the development and mining of coal blocks in Madhya Pradesh, is to get to the starting blocks dues to regulatory clearances or some such. In any event, it is a minor player as yet and is not a drain on the resources of the parent. Another sibling Bulk Cement Corporation has accumulated losses of Rs 34 m but appears to be on the mend, as is Encore Cements, another non-entity. Then there is Lucky Minmat and National Limestone Company which appear to be muddling along in their own tipsy manner.
Barring these colourful subsidiaries the company is indeed sailing on the high seas.
Disclosure: I hold 375 shares in ACC Ltd.
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.