Honeywell Automation: A confused conglomerate - Outside View by Luke Verghese

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Honeywell Automation: A confused conglomerate
Jun 10, 2011

A confused conglomerate

Honeywell Automation is an 81.2% subsidiary of the American giant Honeywell International. It has been operating in the Indian geography for over 27 years now. (The non management shareholding is a mere 1.7 m shares). It is only one of the several Honeywell group companies doing business in India, and the only publicly listed company with the Honeywell name in India. The company seems unsure on how many fellow subsidiaries it has operating in India. In the schedule of 'Fellow Subsidiaries' It has detailed the names of 63 fellow subsidiaries worldwide. This list includes apparently the names of four Indian offspring. They are Honeywell Technology Solutions Lab Pvt. Ltd, Honeywell Electrical Devices and Systems India Ltd, Honeywell Investment India Pvt Ltd and probably one other such. However in the schedule of 'Transactions with Related Parties' it has given the names of three Indian companies - Honeywell Turbo Technologies (India) Pvt. Ltd, Callidus Technologies India Pvt Ltd, and Honeywell Turbo India Ltd - which are listed as fellow subsidiaries in this schedule - but whose names do not find any mention in the earlier stated list. How can this be? Or do they belong to some other separate category? And Honeywell Asia Pacific Inc, the immediate holding company of the Indian sibling, is shown as Honeywell International Asia Pacific Inc. in the fellow subsidiary list!

A potpourri of activities

The total turnover of all the Honeywell companies in India in a given year is not known, but this entity has registered a gross sales of Rs 13.7 bn in 2010 (Rs 11.9 bn previously) and rustled up a pre-tax profit of Rs 1.4 bn (Rs 1.8 bn) to boot. The profits of the Indian subsidiary are not decided by its manufacturing or operating efficiencies for sure. As a matter of fact it does very little manufacturing in India and is merely a pre-paid post office for its worldwide operations. So the extent of the profits that it is allowed to show in its books is decided by the paterfamilias or some such.

It has extensive sideway deals going you see, with its fellow subsidiaries in India and with the affiliates that dot the globe. It does not have a direct investment in any of the other Honeywell group companies. As a matter of fact it does not even boast of a schedule called investments. The company has two geographical segments in its sales generation. The domestic tariff area accounted for 63% of its sales generation in 2010 (53% previously), while exports brought in the balance. The exports were affected to group companies. As can be expected, it also purchases goods, services, and fixed assets from its parent and from other fellow subsidiaries based out of India and elsewhere. This amounted to Rs 2.5 bn in 2010 (Rs 2.5 bn previously). The exact trifurcation of these purchases is not known. Then there is the sharing of expenses which appears to be 'two-way traffic', with the company contributing its share of expenses reimbursement to the global kitty, and receiving its share of expenses from the global kitty. It paid out Rs 610 m (Rs 226 m) in 2010 and received Rs 378 m (Rs 433 m) in return. There does not appear to be any set pattern in the working of this schedule. It is however all laid out down to the last T in some apparent predetermined programming. Given its bundle of excess cash that it possesses it also lends moneys to its group companies in India.

What its operations are all about

For the matter of record, as its name plate suggests, it is the business of automation solutions for a variety of industries and also sells the complex software that goes with the hardware, along with related services. It has five business units to cater to its income -Process Solutions/ Building Solutions/ Environment and Combustion Control/ Sensing and Control and, Global Services. In the financial year 2010 the manufacturing income (made up of Systems and Transmitters) constituted a mere 9.4% of all sales revenues, while bought outs and traded products brought in the vast bulk of the top-line at 63.7%. (Whether it adds any value to these items of purchase before they are sold is not known.) Services rendered tossed in the balance 26.8% to the kitty. This in a nutshell is what this company is all about. The company makes do with a manufacturing block of Rs 1.2 bn just to rustle up a manufacturing related revenue of Rs 1.3 bn. But the makeup of this fixed asset base is also a trifle interesting. The depreciable gross block is 50% depreciated and the company depreciates assets to the bone before selling them. During the year it sold plant and machinery and such like with a face value of Rs 274 m and having a depreciated value of Rs 19 m for a pitiable Rs 2.3 m, and realised a loss of Rs 17 m.

How the bottom-line adds up

The company states that the profits in 2010 took a hit due to several reasons - a competitive environment leading to lower selling prices, investments made by the company, increase in employee costs, and higher charge on the company by the parent as a part of the international expenses. Yes and No. The only reason for the fall in profitability seems to be the higher charge under 'Material and manufacturing expenses' which grew by a shade over 29% to Rs 8 bn compared to the 15% growth in gross sales. Since the company outsources the bulk of its material costs and its sales are also substantially affected to group companies it appears that this was not a particularly good year for the company - as the parent decided to squeeze it a little more out of its sibling both on the cost front and on the sales front as compared to the preceding year. Okay, it also got doubly squeezed in 2010 due to a sharp hike in the allocation of fees payable to the parent, as stated earlier. Actually it got squeezed three times over if one factors in the 100% dividend that it declared and paid - a shade over 81% of the dividends went into the parent's coffers. In any event nobody is complaining about the state of affairs.

Given the niche business that it operates in and the clientele that it boasts of, it somehow also takes a huge hit on the bad and doubtful debts front. It has made a provision of Rs 417 m towards doubtful debts during the accounting year. Furthermore it has separately provided for another Rs 69 m on this account in the P&L (profit and loss) account, besides writing off Rs 16 m as bad debts, all in all amounting to Rs 502 m. The company had written off Rs 553 m on this count in the preceding year.

Irrespective of the manner in which the company is made to conduct its business it is sailing on high seas, no less. It has a surfeit of cash amounting to over Rs 2 bn and with nowhere to invest for one. Add to this a very conservative dividend policy. The dividend payment of 100% on the face value was a mere 8% of the after tax profit. The Reserves & Surplus at Rs 5.2 bn is some 59 times the paid up equity!

A very difficult call

It is indeed very difficult to take a call on a company which has an operating portfolio like the one that Honeywell Automation has. Its primary dependency is in outsourcing goods and services also from group companies and then selling them also to group companies. Furthermore It is a contract manufacturer for other companies in the group and therefore entirely dependent on the dictates from the powers that be. Suffice to say that the company will be assured that is operations will result in a decent enough profit margin at the end of the day. The only real attractive aspect of this company is the brand.

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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