Areva T&D, an oddly and sassily named France headquartered company has many parents both in India and abroad. The T&D in the name stands for transmission and distribution. In India as is abroad it is one of the key players in the private sector in the power sector - with its bandwidth extending across project execution, manufacture and sale of switchgears, transformers and reactors, and related accessories. The parent which calls itself a global specialist in energy management has its foot print in over 100 countries. And this company is apparently still majority owned by the French government (a French PSU so to speak).
The parent Areva is the product of a complex organization structure, and among its fathers include General Electric, Alstom, Schneider Electric, Framatone and yet others. In India it was created out of the acquisition of General Electric Company, Alstom, and the merger of several other Areva group companies. The group separately boasts of a fellow subsidiary in India called Schneider Electric India. The Indian sibling also has two 'naam ke vaaste' subsidiaries-which are up to no good. According to one schedule the parent and its associates control 72.2% of the outstanding equity of Rs 478 m in the India sibling. Yet another schedule states that the parent currently holds 73.4% of the total equity, following the completion of an offer made in 2010 to the Indian shareholders to acquire additional equity as per SEBI requirements. It will help if the management can get its basic bearings right in its only public document to the shareholders each year. This is not the only anomaly. Its website says that it has eight manufacturing units in India, while the latest annual report says that it has seven manufacturing locations in India! Talk about consistency.
How it earns its bread
The company ratcheted up a turnover of Rs 42.6 bn in 2010, against Rs 37.2 bn in the preceding year. This income is the product of the contribution of 9 businesses - the biggest of which is the Projects division. This division ramped up 43% of the turnover, followed by Transformers and Reactors with 29%, Switchgears with 17.7%, and Current Transformers with 1.3%.The first four items account for the vast bulk of the revenues with 90% of all revenues. There is of course no knowing which items bring home the bacon, as the company has not provided any segment reporting of the financial results, on the ground that its business is a composite whole.
The sales are largely generated out of India (88%) with Qatar (4%) and Others (4.5%) being the other principal generators. It also generates piddling revenues from Kenya, Germany, China, Brazil, France, UK, Vietnam etc - but this has probably more to do with the large heartedness of the parent, than the company's ability to market its produce in such diverse markets. Needless to add the good heartedness extends both ways. As can be expected, the company also had to also 'route' revenue purchases and sales through its foreign group companies. It registered sales and purchases together of Rs 1.3 bn with the holding company, sales and services of Rs 1.7 bn with fellow subsidiaries, and purchases of materials and services of Rs 1.9 bn with fellow subsidiaries - valued at close to Rs 5 bn. (The company however appears to maintain an arm's length distance from its fellow subsidiary, Schneider Electric India). Then there are the numerous tithes that it has to pay for the pleasure of being a group associate. It had to pay Royalty, Trade mark fees, and Data Management charges cumulatively adding up to Rs 916 m, against Rs 803 m previously. That is a rise of 14% over that of the preceding year.
Like many MNCs, it has two sets of rules for its employee base. Quite naturally it is much softer on its expat employees than on the domestic HR base. I do not know whether the fellow subsidiaries or the parent has a superannuation policy in place, but the Indian sibling definitely has one for its local staff. The list of its high powered employees that it has appended with the annual report is a pointer of the discriminatory policies in place - whether unintended or not. This list does not boast of any Indian staff who are 60 and above - presumably they have all retired. But the list gives the names of three expats who are 60 or above - the oldest being 66 years young. What exactly is the working arrangement here please?
The company has reported a 12.7% increase in nett rupee turnover to Rs 40.2 bn, but the operating profit before tax fell marginally by 6% to Rs 2.8 bn. The higher turnover was on the back of a light fall in project execution billing to Rs 18.3 bn from Rs 18.7 bn previously, but compensated for by a sharp hike in the production and sale of switchgears and transformers. Production and sale of switchgears rose 32% to 272,000 pieces, while production of transformers rose very sharply by 97% to 29,000 MVA (Mega Volt Ampere, mega=million), and volume sales grew by 54%. Both these units are producing at close to installed capacity levels.
Spending on capital assets
The company has during the past two years spent Rs 4.4 bn on fixed asset expansion. This has led to an increase in the capacity of some of its items of production. The fixed assets are relatively young - accumulated depreciation is only 27% of the gross block. But, the interesting aspect here is that the book value of the buildings is almost on par with that classified as plant and machinery. The gross book value of buildings is close to Rs 4 bn, while the plant and machinery is valued at Rs 5.5 bn. This looks like nuts! For how much 'wattage' can one generate from such high cost buildings? For the matter of record the value of furniture and fittings is Rs 1.1 bn.
Factors affecting fall in profitability
The management states that the fall in productivity is due to impact of severe price fall and ramp up cost of the three green-field sites which came into production in 2009 and 2010. It is not known how the company came to such a learned judgment on the reasons for the fall in profitability. Oh Really? The facts point to otherwise. As a matter of fact the cost of material inputs rose only 10.4% to Rs 27.5 bn, due to a strict cost control on raw material inputs, relative to a higher percentage increase in turnover. This cost increase becomes even more significant given its many inter-se dealings on revenue account with its overseas group companies. Clearly then the problem lay elsewhere. Employee costs at Rs 3.4 bn for one rose over 18% during the year. The company is also some sort of a high wage island. On a very rough basis and based on the employee strength at year end, the average payout per employee was close to Rs 700,000 per year in 2010.
The bigger culprit though the overall cost factor was not that significant, compared to material input costs, was the effect of 'Other Expenses' which rose 31% to Rs 5 bn. The significant items of expenses included in this grouping are forex variation costs (meaning loss) which rose 170% to Rs 493 m, and several other standard expenses such as power and fuel, rent, rates and taxes, provision for doubtful debts, and such like. Not to forget the tithes that it pays to the parent -this expenditure as stated earlier rose 14%.
One of the bigger factors impinging on profits and not quite expounded on by the management is the effect of interest costs. Okay, relative to the other expense items it is negligible but still. Companies in the power sector have to give large dollops of credit to create the sales effort-since the principal buyers of their products and services are the State. And Areva likewise is borrowed to the 'hilt'. The borrowings at year end accelerated to Rs 9 bn from Rs 7.6 bn previously, in tandem with the higher gross working capital requirements. The higher resort to borrowings was the fallout of the sharp increase in trade debtors which rose to a humungous Rs 21.4 bn against Rs 16 bn previously, which the company could not fully support from the generation of internal resources.
To give one an indication of the situation on hand, if one may call it that, trade debtors at year end accounted for a whopping 50% of gross sales, against 43% previously. The borrowings also have to be seen in the light of 'Payments received in advance from customers' of Rs 5 bn against Rs 4.8 bn previously. But for this largesse, the situation would have been a lot more critical. Add to this the inventory levels that the company is maintaining, and you end up with a double whammy. The good news here is that the provision for bad debts, and the write off of bad debts, is kept minimal relative to the scale of the risks that the company is taking. The two debits together amounted to a mere Rs 360 m. Whether such provisioning represents the reality is another matter.
A small paid up capital base
The reality however is that the company sits on a small capital base of Rs 478 m, with a Reserves and Surplus of Rs 9.5 bn. It also follows a very conservative dividend policy, with a payout of less than 27% of the net profits, though the percentage dividend for 2010 was 90%.
Though the directors report makes for much whining about the threats that the company has to face from established Indian manufacturers who are gearing up, and the external threat looming large from Chinese and Korean power equipment suppliers, the company signs off for the year, as could be expected, on an optimistic note. The company claims that with the expansion of its production facilities and the ramping up of the 3 new green-field sites, that it is well entrenched to capture the growth opportunities in the transmission and distribution sector.
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 Verghese. 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.