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Kansai Nerolac: Robust long term innings - Outside View by Luke Verghese
 
 
Kansai Nerolac: Robust long term innings

That the company is still going strong after almost a century in business is in itself a revelation

To begin with have a look at some interesting statistics- Kansai Nerolac Paints we are informed started corporate life some 93 years ago in 1920 as Gahagan Paints and Varnishes. It has metamorphosed over time to the present name plate. Prior to this it was known as Goodlass Nerolac Paints -and of English parentage. This brings forth the question of how it gets to keep a part of the earlier name plate of Nerolac under the new dispensation. It today has five manufacturing facilities --at Lote in Maharashtra, Bawal in Haryana, Janpur in UP, in Chennai, and at Hosur (state of the art plant) which has just undergone a massive expansion of gross block. The total addition to gross block in 2012-13 was Rs 2.8 bn. How much of this expenditure pertains to the capital expenditure of the Hosur unit in the overall equation is however not known. By how much the production capacity has increased as a result is also not readily known. Such crucial information should as a matter of propriety be disclosed by companies. Competitors know it in any case. The expanded capacity will go into production in the first quarter of 2013-14.

The market size

We are also informed that the industry size for paints as on March 2013 is estimated at Rs 285 bn. The organised sector accounts for 79% of this figure. That would imply an organised sector industry value of Rs 225.15 bn. It is not known whether this figure is gross of excise or net of excise. The gross turnover including excise duty that the company registered in 2012 -13 was Rs 32 bn and the net turnover - net of excise -was Rs 28.4 bn. Thus the company’s share of the organised apple pie amounted to either 14.2% at the gross level or 12.6% at the net level. The company claims that it is one of India’s leading paint companies. It is not known whether the market share that the company commands will enable it to call itself as a leading Indian paint company. But let that be. It is however making a lateral effort at becoming bigger. During the year it acquired a controlling interest of 68% in the equity capital of a Nepalese company called Nepal Shalimar Paints Pvt. Ltd-the company was then renamed as Kansai Paints Nepal. (The unit was acquired from a rival Indian paint company). The capital outlay to acquire the stock amounted to Rs 78.6 m. The shares of Rs 100 each were acquired at a per share cost of Rs 89. That amounts to a discount to the face value and probably implies that it is a nominal player or something. The parent also advanced a soft loan of Rs 63.8 m to the sibling. No other intimate details of this company are forthcoming. But from the brief financials it is as yet only a sissy. It drummed up net revenues of Rs 112 m, and a profit before tax of Rs 17 m. One fondly hopes that the parent sees some future value in this investment.

Change in accounting policy

The other interesting development that calls for attention is the change in the method of depreciation that the company has adopted during the year. It has changed the method of deprecation from written down method to straight line method. Due to this change the depreciation for the year is lower at Rs 471 m as compared to Rs 564 m which would have been calculated on the WDV method. The change in the method of depreciation retrospectively also involves a write back of excess depreciation of Rs 1.1 bn to gross block account. What the company has not explained is why it has sought to change the depreciation policy at this juncture and how it is going to benefit the company and its shareholders in any positive way. It is important for companies to explain to its shareholders the reasons for any such material changes in plain English when they implement accounting policies which have a bearing on their book profits. The company should logically be providing for a much higher depreciation in the current year running when the expanded plant capacity at Hosur goes on stream. Was the change in the policy timed with defraying the capital cost of the impending commissioning of the new plant capacity or what? Besides, higher book depreciation in reality means more funds on hand to ante up future capex costs etc.

The company was in a spot of trouble during the year. Put simply the company was not able to record a higher pre-tax on a 9.8% increase in net revenues. Besides, the other income including other operating revenues declined marginally to Rs 334 m from Rs 388 m previously as surplus funds were utilsed for capex expenses. (The makeup of the operating and the non-operating income would infer that a repeat of such receipts cannot be guaranteed for an encore in the next year). There is a curious aside to the sales figure. The gross sales rose 12% to Rs 32 bn but the net sales rose by a smaller percentage figure to Rs 28.4 bn. This was because the excise duty debited to the P&L account rose 32% to Rs 3.6 bn. Does this infer that the excise duty on the paints industry was hiked during the year or is it some accounting adjustment or something? In reality the gross and net sales have to be adjusted for another expense item. The company offered a cash discount of Rs 665 m against Rs 630 m previously to push sales apparently --which logically should be deducted from revenues and not added to the expenses schedule. But this is only a minor accounting entry. Further, the company had to suffer higher cost increases on materials inputs during the year. Material cost as a percentage of net sales rose to 68.4% against 65.6% previously. For the paint industry which suffers from high raw materials input costs and consequently a lower value addition this was a body blow of sorts. It hardly helped that employee costs, and other expenses-the latter expenditure is a sizeable sum at Rs 4.6 bn -also grew faster than the increase in net sales. The latter expenditure includes two heavyweights -one discretionary and the other not negotiable. Freight and forwarding rose 10.6% to Rs 1.2 bn while advertising spend was static at Rs 1 bn. As one can see the advertising outlay is a big ticket expense item for paints’ units, and the company has gone a bit slow in this aspect during the year.

A well run ship

Whatever be the temporary blip the company is indeed a very well run ship. It is debt free for all practical purposes-though it does boasts debt of Rs 604 m. This debt is however a googly of sorts that the company has bowled. It represents interest free debt in the form of sales tax deferrals. Imagine freeloading money off the sarkar of all people! Besides, the entire capex expense was drawn from internal resources including drawing down current investments from Rs 1.4 bn to Rs 125 m. The cash flow of Rs 2.2 bn that it generated from operations also came in very handy. The finance department also tried to wise up to getting a few nickels more by buying and selling large sums of debt securities. The total value of the purchase/sale transaction amounted to a humungous Rs 32.5 bn. If it made any money in this dual exercise, then it is not showing up in the other income schedule. It however made a small pile by selling its liquid investments.

The paints industry appears to suffer from two operating hindrances. This is in respect to the amount of inventories and trade receivables that they have to carry in their books. The total value of inventories and trade debts together at year end amounted to Rs 9.5 bn. That is a sizeable slice of funds locked up considering the net revenues that it generated during the year. Besides, the trade payables at year end were substantially lower than the trade receivables at year end. Given the heavy play on current assets, and the inability to drum up suitable sums of current liabilities, the net current assets at year end (or the current assets in excess of current liabilities) amounted to a respectable Rs 4.4 bn. (This figure however includes cash balances of Rs 600 m). The net current assets in effect represent the excess cash that gets locked up into the system because of the peculiarities of the functioning of the paint industry. But, still, the fact of the matter is that inspite of the holding of net current assets and the sharp capex funding requirements that it had to undergo, the company was still debt free at year end.

No major group company interactions

The other very good news is that it does not have to suffer any group company investments-at least not yet. The only material transactions to date with group companies involves the payment of royalty, and technical fees which are of marginal content as yet and some other minor infractions. Significantly, though the company bought finished goods in excess of Rs 1 bn, the purchase from group companies was close to zilch. In other words the operation of the Indian sibling is still based on a standalone arrangement.

The 10 year summarised statement of accounts shows a company which is growing at some speed. It clocked revenues including other income of Rs 7.7 bn in 2003-04. The income receipts grew each year subsequently to touch Rs 28.7 bn in the year under review-or a compounded rate of growth of 273 %. The profit after tax grew at a slightly more sedate pace of 244% to clock a pre-tax profit of Rs 3 bn against Rs 888 m in 2003-04. But for the blip in the bottom-line in the latest year the profit growth may also have been well on track. But the point to also note is that when a company grows in size it normally accumulates flab in the mid area. The dividend payout rose from Rs 191 m to Rs 593 m over this period. In effect it was a very good showing by the company. That it is fine fettle even after such a long innings is in itself a sign of its dexterity.

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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