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Heidelberg Cement India: Reeling under debt - Outside View by Luke Verghese

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Heidelberg Cement India: Reeling under debt
Jun 11, 2013

The new management is making a concerted effort at getting its financial management on the ball

Finally getting on a roll

The Heidelberg part of the nameplate is of teutonic parentage, but it was not always like this. It was for many decades known as Mysore Cements, (the cement is still branded as mycem), and was initially incorporated as a joint venture between the Kaisers of the USA (better known as the erstwhile collaborators of Hindalco Industries) and a South based business family to manufacture cement in Tumkur, Karnataka. (Today the company has five manufacturing locations including two in Madhya Pradesh, and one each in Uttar Pradesh and Maharashtra). With the venture not going on expected lines the Kaisers sold their holding in the company to the Birlas who then forced the hand of the then management and took over the reins of the company. At some point in time it came under the fold of the SK Birla group. The company continued to flounder for years on end on the back of high debt, low cement manufacturing capacity, and indifferent management. Apparently seeing the writing on the fall and the attractive price offered for the promoter’s stake, the management was finally hived off to HeidelbergCement group some six years ago. The new promoters today control 68.5% of the outstanding equity of Rs 2.26 bn.

A vintage parent

Judging from the available data, Heidelberg has quite some standing in the cement business having commenced its corporate innings as far back as 1873. It is present in more than 40 countries and claims to have over 54,000 employees worldwide in its core activities at 2,500 locations. According to the annual report there are 50 group companies acting in concert including a company styled as Cochin Cements Ltd. (The company seems to be grabbing just about anything on offer it seems). Judging from the printed matter the company is still a small fry in the overall cement company pickings. The company states that it operated at 93% of capacity during the year producing 2.82 m tonnes which implies that the installed capacity is around 3 m tonnes-or 0.9% of the total industry capacity of 330 m tonnes. The volume sales at 2.82 m tonnes were marginally higher than sales of 2.81 m tonnes in the preceding year. These figures make for small beer. The directors’ report states that the company implemented some expansion schemes during the year at the two units at Madhya Pradesh-the total cement production capacity will thus increase by 2.9 m tonnes to 6 m tonnes per annum in 2013-or 1.8% of the total industry capacity. The pip squeak status does not change. The total capex spend-inclusive of capital work in progress and capital advances-- in the last two accounting years was a very impressive Rs 11 bn according to the cash flow statement, but this came with a rider. The total borrowings-long and short term--have grown by Rs 9.4 bn in the interim. But for the total dependence on loan capital to fund the capex, the company had zero debt. (It is very interesting to note here that the gross tangible gross block at end 2012 amounted to Rs 10.4 bn).

Funding capex through debt

The paid up equity capital base remains stagnant. The company will now have the unenviable task of generating cash flow to pay the interest on the mounting debt on the one hand, and pay back the principal on the other. Given the size of the task at hand it may be pertinent to point out that in 2012 the company generated a mere Rs 500 m cash from operations. With the fund raising spree that it had to resort to, the management wisely decided to forgo dividend payment for the year.

Why the management decided to fund the entire capex through additional debt is not known. But it is the manner in which the loan capital has been obtained which reveals the clout of the parent. The rupee loans from banks have been obtained on an unsecured basis-but it is fully guaranteed by the parent. The foreign loan component is via an ECB (external commercial borrowing) from the parent on an unsecured basis at a rate linked to LIBOR or what is known as the London inter-bank offered rate. It must have been able to pony up the loans in a jiffy. All companies should have parents like this lucky sibling.

A well run ship

For the present however the company is a well run ship. But the warts will show up in the current year as the expanded capacity goes on stream. The net revenues from operations grew 11.7% to Rs 11.0 bn while the other income fell marginally to Rs 105 m from Rs 118 m previously. (The other income constituent is a bit player as yet in the company’s overall scheme of things. Besides, a liberal dose of the other income in 2012 is accounted for by write-backs). Thus total revenues including other income rose 11.4% to Rs 11.1 bn. On a rough back of the envelope calculation the company obtained a net sale price of Rs 3,915 per tonne against Rs 3,516 per tonne previously-a rise of 11.3%.

But the profit before tax was almost unchanged at Rs 457 m against Rs 424 m previously. The chief culprit in stonewalling the profit margin was ‘power and fuel’ which rose 18.2% to Rs 3 bn. The other culprit albeit on a much lesser scale was employee costs which rose 18% to Rs 924 m. Needless to add the interest cost on the rising debt contributed its mite rising to Rs 105 m from Rs 39 m previously. The company was saved the blushes as the major chunk of the interest that it paid out was debited to capital account. But the entire pay out in the current year will end up in the revenue expenditure side of the P&L equation. Somehow the company was able to maintain the depreciation figure at Rs 315 m, the same as previously. This is indeed very fortuitous. This figure too will rise sharply in the current year.

Financials in fine fettle

But as stated earlier the year end financials show a company in fine fettle. Against the share capital, the reserves and surplus amounts to Rs 6.2 bn. In this quantum the largest component is the share premium reserves of Rs 3.7 bn. The company sells cash down and the trade payables at year end towers over that of the trade receivables. The inventory values at year end amounts to 13% of gross sales for the year. Here too the company maintains a tight leash. The company also made the bold move forward in its day to day operations by shifting to the negative working capital mode. The current liabilities at year end are significantly more than the current assets especially when one discounts the cash in hand. And, in the event of any unforeseen cash demands accruing suddenly there is always the sugar daddy-the immediate holding company Cementrum I B.V. --- lurking in the background to help out.

The Indian waif makes do with five fellow subsidiaries including as mentioned earlier -Cochin Cements Ltd. Currently the group company (enterprises where control exists/fellow subsidiaries) interactions are limited to capital account transactions like the ECB issue and guarantees issued on behalf of the sibling by the parent and the revenue considerations arising from it. But there are a few odd bits and ends on the revenue side of the equation too. Such as the technical know - how fees of Rs 174 m paid to a fellow subsidiary and product sales of Rs 160 m affected to Cochin Cements Ltd.

The current year could possibly see a more than doubling of the revenues as the expanded capacity goes on stream and the moot point that the company is able to maintain the rupee value of the cement and clinker sales. It will however not be easy for the cement industry to artificially balance the demand and supply scenario that easily in future considering that the Competition Commission of India is keeping a hawk’s eye on any price manipulations by the cement cartel and it has already come down hard on past malpractices by levying hefty fines on the industry

Will have a delicate act to follow through

It will be a delicate act to pull through in the current year as the cash flow from operations has to be more than sufficient to pay the interest and the pay back on capital account start ticking in. There is no clarity on the latter aspect though. But the parent is apparently already feeling the pinch of having depended entirely on debt to finance the gross block expansion. There are market indications that it wishes to unload a part of its shareholding in the Indian sibling to reduce the debt burden or some such. How such a move will help is beyond me as it is the Indian company which has sourced the debt while the parent has only guaranteed the repayment.

In any event it has a tough act to follow. But the market had a different viewpoint prior to this development. In 2012 the share price hurtled between a high of Rs 60 in December and a low of Rs 25.25 in January. That works out to be a massive price variation over the calendar year. Given the low floating stock the price may oscillate in similar fashion in the current year too.

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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