Philips Electronics: Is it simply making a difference? - Outside View by Luke Verghese

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Philips Electronics: Is it simply making a difference?
Jun 23, 2011

A rudderless ship
From the manner in which Philips Electronics India is being run, none of erstwhile domestic shareholders are likely to regret having exited the company. It is also a world apart from the company it used to be decades ago - barring for the lighting division, that is. The company has of course delisted from the Indian bourses, but there still remain the diehard Philips fans, who refuse to let go of their holding in the company, if nothing else for old times' sake. This write-up then is for these poor souls who still continue to hang on to the coat tails of their 'benefactor'.

The directors' report to the shareholders is a very racily written performance sheet and even takes to flights of fantasy. The script writer has  a knack for inserting the right catch phrases and they include - 'the performance was encouraging with robust top line growth, the Healthcare business continues to perform strongly, the company bagged the highest ever order for supply of compact fluorescent lamps (CFLs), the company aims to gain significant market share in the fast growing medical equipment business through innovative products, it will introduce next generation technological products, Healthcare posted a phenomenal top line growth, market shares grew across all segments of healthcare, the acquisition of the Preeti business will make Philips the clear leader in the fast growing domestic appliances market', et all. The self proclaimed accolades reverberate right through the directors' report. This arty copy will win hands down in creativity.

Manufacturing prowess atrophying

The reality is a little different. Its manufacturing prowess for one is atrophying, and the management appears to be clearly out of depth in imparting a firm direction to the financial aspects of its business divisions. The fact of the matter is that there is a rotation in the operating loss of some of its divisions in each of the two years under review! For example, in 2009, the Healthcare division made a divisional gross loss, while in 2010 it made a profit. In 2009 the Consumer Lifestyle division made a profit while in 2010 it made a loss. Just to even matters I guess, the 'Other Segments' division reported a loss in both the years! The latter division does design work. Since they are all established businesses, why does the company resort to such a trapeze act?

For the matter of record the company markets some 18 different products /services, including 15 manufactured items - but for segment reporting purposes they are classified under 5 divisions. The divisions are the Lighting Division which rolled in almost 58% of the total turnover, followed by the nattily named Consumer Lifestyle division with 18%, Healthcare with 17%, Software development with 7.5%, and the piddling Other Segments division. (The software division appears to make do with low value added work). Cumulatively they accounted for a total turnover of Rs 36.8 bn -excluding unallocated income of Rs 208 m.

Not able to rein in expenditure growth

As a matter of fact the company has completely abandoned any effort at all in reining in expenditure growth. This is the only logical conclusion that one can arrive at. A look at the snapshot financial results for the 10 years that it has appended to the report is very instructive. In each of the 10 years starting 2001, and barring 2006, the company has consistently recorded higher sales each year. However, the comparison of various profit margins as a percentage of sales, starting at the operating profit level starts going completely haywire. The profit after tax as a percentage of sales is a lesson on how not to run a company. From a negative 1.4% in 2001 to a high of 8% in 2006, the only year in which sales saw a dip, to a low of 2.4% in 2010, is the bizarre story of its life.

Why this is so becomes even more difficult to surmise, as the company has over the years increasingly opted to generate sales through bought out items. In such an emerging scenario it presumably should be able to exercise some control over the cost of outsourced items, relative to the mark up that if fixes on the sale price. As a matter of fact the mark up that it fetches on sales is substantial. The nub of the problem is that the company per se is a high wage island and besides in-house manufacturing is a strict no-no. The average payout per employee which stood at Rs 430,000 in 2001 had escalated to Rs 910,000 in 2008, dipping to Rs 860,000 in 2010. The numbers of employees have also grown sharply from 2,410 in 2001 to 4,762 in 2010.

Bought our sales

As stated earlier the emphasis is on bought out sales. The company has a manufacturing capacity to make only Lamps, Glass shells and Filaments in the main, with Diagnostic imaging equipment thrown in for added measure. The first three are integrated items and form a part of one whole. In Lamps, the licensed capacity has shown a decrease to 719 m pieces against 762 m pieces previously, while the installed capacity has shown an increase to 527 m pieces from 449 m pieces previously! Mercifully production has grown to 409 m pieces from 385 m pieces previously. In similar vein, the production of glass shells and filaments too has shown an increase over the preceding year, along with capacity increases. The installed capacities of these three items have increased over that of the preceding year.

The big wonder is that it still sees value in increasing the manufacturing capacity of these items. All the other manufactured items that it hocks, barring Diagnostic sets partly, are bought out. The latter are also outsourced. However, in 2011, the manufacturing capacities of the Preeti business unit that it purchased will show up. Obviously this company boasted manufacturing facilities when the business was acquired. In will be interesting to see how it amalgamates this business, given the high cost manufacturing of Philips.

Lamps account for 37% of all sales, followed by Fittings, Diagnostic Equipments, Software development services, Domestic Appliances and Portable Systems in that order. These six items together rang in 83% of all sales. A comparison of the contribution of bought out items to overall sales in the above listing too is revealing. In the case of Lamps a little over 25% by volume constituted bought out sales, against 17% previously. Glass Shells and Filaments are a package that goes with the lamps, and individual sales of the two are therefore minuscule. The latter two have apparently not been outsourced in the last 2 years.

The effect of bought out goods

The effect of bought out goods in the company's materials consumption process is overwhelming to say the least. Of the total materials consumed of Rs 21.8 bn, the contribution of bought out goods is a phenomenal Rs 18.7 bn. (In this context, one wonders why the company maintains a manufacturing gross block of the face value of Rs 8.3 bn. Or what value addition the company does to the goods that it purchases prior to sale). Add to this the Rs 1 bn in imported raw materials and you have a double whammy. There are substantial inter-se transactions with group companies in this respect. It's all in the family you see. According to one of the schedules, it had transactions with 64 fellow subsidiaries during the year-and dotting the globe at that. Considering that Philips in India is not a competitive manufacturer, it is a puzzle how the group parent has made a success of the manufacturing efficiencies of other group companies.

Cut to the schedule which lists the company's cumulative inter-se dealings with its holding company, fellow subsidiary companies and such like. Philip's India affected purchases of goods worth Rs 7.5 bn from fellow subsidiaries, and services worth Rs 2.6 bn from them as also from its holding company. Similarly it affected sales of goods for Rs 468 m, and rendered services worth Rs 3.6 bn. Then there were sundry other transactions on capital account and such like. Cumulatively, the transactions amount to a humungous Rs 14.3 bn in 2010. But, in the schedule which gives a company wise transaction summary, the figures brandished on this score are completely at odds. The total purchases of goods from fellow subsidiaries are a mere Rs 3.2 bn, and entirely sourced from Philips Electronics, Hong Kong, and the services purchased from fellow subsidiaries was only Rs 94 m. The sale of goods to fellow subsidiaries was limited to Rs 301 m, while sales of services to fellow subsidiaries was Rs 3.1 bn. None of the figures add up with the figures given in the cumulative figures schedule. It is as bizarre as it can get. There is also no evidence whatsoever that it had transactions with 64 fellow subsidiaries. At best it had transactions with 22 group companies. What is the purpose of such wishy washy reporting please?

A rubber stamp?

Not only does the Indian sibling have to suffer the fate of having to earn its bread through substantial imports and exports, it also has little choice about its annual tithes that it has to pay to the parent. That is to say it paid a cumulative Rs 2.6 bn during 2010 both as 'Management support fees', and as 'Research and Development' expenses against Rs 1.9 bn previously. In 2009 it even paid 'Consultation fees and professional charges' amounting to Rs 502 m in forex!
As one can see this company is a mere rubber stamp of the parent.

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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