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SKF India: Robust Financials - Outside View by Luke Verghese

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SKF India: Robust Financials
Jun 25, 2013

A steady growth over the decade in both revenues and profits is the message that the company seeks to send out

Among the top 50 admired companies

SKF India Ltd. informs that its business is in The Power of Knowledge Engineering. Why the company uses such a high sounding nomenclature for an item of common use is not known. The annual report also informs that the company was ranked in the top 50 most admired companies in India by Fortune magazine in the engineering and capital goods sector. Dun and Bradstreet recognised SKF India as the best bearing company in India for the sixth consecutive year while Bajaj Auto conferred the company with a gold award for quality for supplying zero defect products consistently for the past two years. It is a fairly impressive list of achievements. The foreign principals, SKF of Sweden currently hold 53.6% of the outstanding equity base of Rs 527 m. The second largest category of shareholders who hold 16.1% of the capital is listed as foreign institutional investors (FIIs), OCBs & NRIs. The public shareholding excluding corporatized shareholders is as low as 10.9%--which in a sense infers a very low floating stock. The share price -Rs 10 paid up --coasted between a high of Rs 728 in April 2012 and a low of Rs 557 in Jan 2012. A limited fluctuation in the share price for sure and it was completely against the grain of the movement of the Sensex for the calendar year! The company is also quite conservative with dividend payments. The dividends including tax thereon amounted to only 24% of post tax profits.

The company as many readers know principally makes bearings, seals and lubricants. It makes a variety of bearings-ball bearings, roller bearings, precision bearings, spherical bearings, bearing accessories, and bearing units and housings. It possibly makes both automotive and industrial seals and lubricants too. Then there appears to be other knickknacks too--power transmission systems, actuation systems and magnetic systems. In the breakup of revenues from the sale of products of both manufactured and traded items, the classification is twofold--- revenues from Bearings, and Others. The company makes do with three factories at Pune, Bangalore and Haridwar (UP).

The financial highlights

The company has provided the financial highlights of the past ten years. The highlights show a rise in revenues in seven years out of nine over the base year 2003. The year 2012 is one of two years when the company reported a decline in sales over that of the preceding year along with a decline in profit margins. The profit before tax has shown an erratic trend in three of the nine years-with wild swings in profitability. With the profit after tax too being affected as a result, the percentage dividend payout was also pruned in some of the years.

The company has not given any specific reasons for the fall in profits during the year. It has vaguely touched on the matter. A decline in buoyancy in the Asian economies along with a fragile recovery in the advanced economies has affected export growth it states. A sharp drop in volumes led to a decline in sales it states. This coupled with inflationary pressures on cost and a weakening rupee put additional pressure on margins is the other takeaway. There appear to be other well founded reasons too why the company could have taken a hit during the year. It is the manner in which the company’s operations are structured that could be one of major cogs in the wheel. This is a situation that all siblings of MNCs have to bear with.

Welter of group companies

The Indian sibling has a welter of group companies to contend with. According to the related parties’ disclosure schedule there are 87 group companies across the globe including three group companies functioning out of India. (The three Indian group outfits are SKF Technologies India Pvt. Ltd, Lincoln Helios India Ltd, and Economos India Pvt. Ltd) They appear to be independent of their listed sibling. The company buys both raw materials and finished goods from group companies. In 2012 the purchases on this count amounted to Rs 5.1 bn against a higher Rs 5.8 bn previously. These goods etc were acquired from two group companies, the bulk of which was sourced from a sibling based out of Singapore. The Singapore office must be a centralised forwarding office for its Asian operations.

The sale of goods and services to group companies at Rs 1 bn against Rs 1.5 bn was a lot more restrained. The sales were affected to four group companies. There are other group company transactions on capital account, and some seemingly colourful transactions on revenue account, but the figures involved are on a far more muted level. The revenue transactions include such exotica as administrative and service fees of Rs 209 m paid to the holding company, royalty of Rs 287 m paid again to the holding company, and trade mark fees of Rs 173 m also paid to the same addressee. That makes for a total of Rs 669 m in damages to the sibling. It is definitely nice having subservient offspring. But let that be. But on a lighter note the sibling also managed to ingratiate itself with Rs 172 m being technical and other service income received from the holding company.

The total stock in trade that the company purchased amounted to an impressive Rs 8.3 bn. As stated earlier the total value of purchase of raw materials and finished goods from group affiliates amounted to Rs 5.1 bn. The total value of imports of raw materials and trading goods amounted to Rs 5.8 bn. This would imply that it sourced some of the raw materials/ traded goods locally and some materials etc from non group companies abroad. Why does the company import materials of such a large value in the first place? Are the raw materials not locally available? Cannot the finished goods be produced domestically by the local unit at a competitive price? For, by doing so it is keeping its factories in some other part of the globe humming at top speed.

The financials

To put matters in perspective the company realised gross revenues of Rs 23.5 bn during the year against Rs 25.5 bn previously. Of this the sales of manufactured goods brought in Rs 13. 4 bn while the sale of traded goods brought in the balance Rs 10.1 bn. The sale of ‘services’ and ‘scrap sales’ contributed only a few scraps of helpings to the top-line. The manufactured goods are almost completely classified under the head ‘bearings’ as does traded sales. Other income is big biz for the company’s exchequer at Rs 683 m against Rs 546 m previously. The other income added up to a hefty 24% of profit before tax-due to a fall in profit, against a much smaller contribution of 17.4% previously. The point is that traded sales brought in 43% of gross revenues from operations. There is absolutely no way of calculating the gross margin that manufactured sales brought in, or for that matter the margin that traded sales brought in-and besides, this calculation also involves the margin if any it made on the export effort. But the clue to the company’s profitability may well lie in the pricing format that the parent has adopted for goods outsourced by the company, and which in turn decides the price that it gets for sales effected by it. And, in this instance one is talking about big ticket stakes. For the uninitiated it is a cul de sac here.

Superb cash flow management

This is not to suggest anything to the contrary. The company spins like a top for sure. Take a look at the cash flow statement. The company generated net cash of Rs 1.99 bn in 2012. This excludes the cash inflows from other income which as stated earlier is fairly substantial. The spending on gross block was amounted to Rs 883 m. (The business is tech heavy going by the figures. A gross block of Rs 8.8 bn at year end could only generate manufactured sales of Rs 11.7 bn net of excise). The excess cash sloshing around after the capex spend was judiciously deposited in fixed deposits or in inter-corporate deposits. The company is totally debt free too and it boasts ample reserves of Rs 11 bn against a paid up capital of Rs 527 m. The cash and bank balances at year end stood at Rs 3.1 bn. This figure excludes interest bearing loans of Rs 2.2 bn advanced to group companies at year end, and separately another loan of Rs 248 m to group companies. The value of trade receivables and of inventories at year end shows that the company is able to squeeze buyers on the one hand, and on the other- keep a lid on inventories.

The company apparently does not evince much interest among the shareholding public judging from the fact that the shareholding base has fallen steadily from 28,382 in 2003 to a low of 22,070 in 2012. The share price movement would also suggest flagging interest in the scrip. The fact of the matter is that the growth in profitability of the company is faster than that of the growth in revenues.

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.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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